LNAs Can Be Used in Power of Sale Foreclosures when the Present Holder Lost the Note

In an October 2, 2018 published opinion from the North Carolina Court of Appeals, the Court confirmed that a lender who lost the original promissory note while it was in physical possession of the original note may proceed with a power of sale foreclosure proceeding before the Clerk of Court. In In re Frucella, No. COA 18-212 (October 2, 2018), the homeowners appealed the Clerk’s order authorizing a foreclosure sale for a hearing de novo before a Superior Court judge. At the Superior Court hearing, lender’s counsel presented a pair of “lost note” affidavits executed by the same affiant. The first affidavit described the circumstances by which the lender seeking to foreclose came into possession of the original Note and, that after it obtained possession, the Note was lost. The second affidavit tracks the elements required to establish the right to enforce a lost promissory note under North Carolina’s U.C.C. § 3-309 – e.g., that the party seeking to enforce the Note had that right when it was lost; the loss was not the result of a transfer/assignment; and that a due and diligent search had been made to locate the Note and it could not be found. The Superior Court entered its own order authorizing a foreclosure sale, from which the homeowners appealed.

In affirming the trial court’s order, the Court of Appeals expanded the scope of “who” could avail themselves of North Carolina’s quasi-judicial foreclosure process. Although the Court had signaled its intent to head in this direction in an earlier unpublished decision in In re Iannucci, No. COA 16-738 (February 7, 2017), the holding of the Frucella Court is contained in a published decision and, with that, carries the gravitas of precedent. Before Frucella, courts strictly held that only the “holder” – e.g., party in possession of the original appropriately endorsed promissory note – could use the streamlined power of sale foreclosure process. Under North Carolina’s Uniform Commercial Code, however, a party who was not the holder could still enforce the Note if it was either a non-holder in possession with the rights of a holder (think: missing or defective endorsement in the chain) or a party who had lost the Note while it was in possession of the Note. Those two classes of lender were previously required to file a judicial foreclosure proceeding, which entails formal litigation and all its trappings like discovery, mediation, and trial, rather than being able to proceed with the more efficient power of sale foreclosure process.

In attempting to defeat the lender’s efforts to foreclose via the streamlined power of sale process, the homeowners presented evidence that parties prior to the petitioning lender had held the Note. But, as the trial court noted, the homeowners “presented no credible evidence tending to show that any other entity is the holder of the debt or there is an actual controversy” regarding the foreclosing lender’s current status. In essence, the Court rejected the long-held urban legend that there is a risk of “multiple judgments” or “double jeopardy” of duplicative foreclosure actions when homeowners simply cast doubt that the party asking for payments isn’t the one who is entitled to collect them.

The expansion of the class of persons permitted to go before the Clerk in power of sale foreclosure proceedings may open the door to the third and final class of person – the non-holder in possession with the rights of the holder – to give the quasi-judicial foreclosure route a whirl. This ruling does not change the fact, however, that North Carolina’s Uniform Commercial Code does not allow a servicer to use a lost note affidavit (LNA) in a power of sale foreclosure proceeding if the prior servicer lost the note. In those situations, the loan must still be foreclosed judicially, unlike the vast majority of jurisdictions which allow a direct successor to rely on LNAs. Whether the Frucella expansion remains in place remains to be seen, however, because as of press time for this article the homeowners have sought discretionary review to the North Carolina Supreme Court.

For further assistance with lost note issues or questions regarding North Carolina foreclosure law, please contact Jeff Bunda.