Notes, Indorsements, Allonges, and the Pitfalls You Need to Know About (Part III)
Part III – When is a Note NOT a Note, and Why Does it Matter?
Lots of note investors, attorneys, and judges frequently refer to all debt obligations as “notes.” In such cases, I often find myself quoting Inigo Montoya from The Princess Bride – “You keep using that word. I do not think it means what you think it means.”
As we talked about in Part 1 of this blog series, a “note” refers to a negotiable instrument as defined by the Uniform Commercial Code which can be negotiated or transferred by an indorsement. In Part 2, we clarified how and when an allonge can be used to effectuate that negotiation or transfer. Now in Part 3, let’s take a look at a growing issue of mischaracterization, particularly concerning secured debt obligations that many commonly refer to as “notes” but which are not really notes at all.
For example, the most common occurrence of a non-note being called a “note” is when that non-note is a HELOC. Say it with me…a HELOC is NOT a NOTE.
Notes really are easy to transfer. Stamp or write “pay to the order of __________” on the note, or affix a signed allonge to the original note, and you’re done. So, it is no wonder that note investors (and not just beginners) nonchalantly slap an indorsement or an allonge onto a HELOC or a Land Contract that they sold to another investor, and think the deed is done. But…I’m getting ahead of myself. Let’s first explain why a HELOC or a Land Contract or a Contract for Deed is NOT a note.
HELOCs are Not Notes (Except Maybe in Nevada)
HELOC is the abbreviation for Home Equity Line of Credit. Sometimes you’ll see other abbreviations such as HECLA (Home Equity Credit Line Agreement) Most often, in my experience, HELOCs (and HECLAs) are held by courts to be non-negotiable instruments. To be a negotiable instrument an obligation must be an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order. See generally UCC § 3-104. The problem with most HELOCs that want to be a note is that they are a line of credit that, by the agreement’s terms, can be drawn down over a “draw period.” So, the HELOC agreement does not, and cannot, state a fixed amount of money that must be repaid.
This tends to be the approach in many jurisdictions…
In New York, a court held that a Cash Account Agreement that did contain an unconditional promise to repay but also contained an open-end line of credit (among other things) was not a negotiable instrument. OneWest Bank, N.A. v. FMCDH Realty, Inc., 165 A.D.3d 128, 135, 83 N.Y.S.3d 612, 617 (2018).
A Florida court held that a HELOC was not a negotiable instrument because the HELOC note did not contain a promise by the borrowers to repay a specified sum of money, the record did not reflect how much was distributed at closing, the HELOC provided a credit limit of $40,000, and “nothing on the face of the HELOC note indicates how much the borrowers actually borrowed.” Third Fed. Sav. & Loan Ass'n of Cleveland v. Koulouvaris, 247 So. 3d 652, 653 (Fla. Dist. Ct. App. 2018).[1]
Other jurisdictions like Colorado, Indiana, Nebraska, Pennsylvania, Vermont agree with this position. See CadleRock Joint Venture LP v. Esperanza Architecture & Consulting, Inc., 2021 COA 119, ¶¶ 16-17, 500 P.3d 402, 405.
But, HELOCs can be different from each other, and we know that different states’ courts see things differently. For example, a Court in Nevada held that a HELOC was both a negotiable instrument and a promissory note. The court acknowledged that “the ultimate sum that the [borrowers] would borrow during the draw period was unknown, but at the close of the draw period in February 2017, that sum would become a fixed debt with principal due upon the maturity date in 15 years.” The court held that a HELOC with a closed draw period and specified maturity date, …is an unconditional promise to pay a fixed amount of money [and, thus, a negotiable instrument], rather than a revolving line of credit. Wishengrad v. Carrington Mortg. Servs., No. 83176, 2023 WL 3571007, at *4 (Nev. May 18, 2023).
That Nevada case is great for that plaintiff. Essentially, the court agreed with an argument that I’ve made from time to time in other state courts that the HELOC eventually became a negotiable instrument because once the draw period closed, all you needed was math to figure out the sum of the unconditional promise to pay.
Why Does it Matter if my HELOC is Not a Note…and What Can I Do About It?
Many of you might be thinking, “Who cares if my HELOC is not a negotiable instrument? Does that issue ever actually come into play?” The answer, although it comes further down the line, is YES, if you ever have to establish “standing” to foreclose on the mortgage loan.
Often times, a borrower in a foreclosure case (or the borrower’s attorney) will advance the argument that the plaintiff lacks standing to foreclose. “Standing” simply means establishing the plaintiff as the proper party to enforce the note and the mortgage. Many jurisdictions require a plaintiff to establish standing as to the note or debt obligation even if the plaintiff simply wants to foreclose and isn’t seeking a money judgment.
A foreclosure plaintiff with a true note (a negotiable instrument) can simply show the proper indorsements and/or the properly affixed allonges to show that the instrument has been negotiated and transferred as per the UCC requirements. However, it is not so easy with a HELOC, because a simple “pay to the order of ____________” indorsement or allonge probably will not, by itself, be sufficient evidence of the plaintiff’s standing to enforce the HELOC.
The consequences can be disastrous. A litigious borrower can use this to drag your matter all the way to trial, and at trial they can make your HELOC much more difficult to enter into evidence. (HELOCs, unlike notes, are not “self-authenticating.”) That same borrower will probably throw up some counterclaims against you – especially if you cannot prove standing, or they can prove to the court’s satisfaction that you don’t have standing. (I have a war story for another time on this where we successfully fought off such a claim.) So, if you don’t have proof of standing to enforce your HELOC, you need to be prepared for the financial risks and legal exposure of potentially having to fully litigate your foreclosure at trial.
There is some good news, however. This is not the end of the line, and there are things you can do to litigate the issue and prove proper standing, so you don’t have to stop buying HELOCs. You can put on various forms of proof to establish standing, such as proof of the purchase agreement you used to buy the HELOC, or an affidavit or witness testimony from the prior owners of the HELOC. Most fortunately, some courts have even held that the language in an Assignment of Mortgage can save you. In a New Hampshire case, for example, the court read the language of the assignment which “assigned both the mortgage and the ‘promissory note(s) described therein ... together with all rights therein and thereto’” to be sufficient to convey standing to foreclose. Kreik v. Partners for Payment Relief, DEII, LLC, No. 2019-0729, 2020 WL 7663830, at *3 (N.H. Nov. 13, 2020).[2]
In sum, HELOCs are usually not notes, (unless you are in Nevada, and then maybe). Simple indorsements and allonges won’t typically be enough to prove to the satisfaction of the courts that you own the HELOC and have standing to enforce it. To make sure your enforcement rights are protected, take the following precautions:
Pay close attention to your assignments of mortgage when you are buying the HELOC-based mortgage loan and check for the “assignment of rights” language mentioned above;
Be prepared to prove ownership – don’t dispose of the purchase agreement, gather affidavits from the prior owner ahead of time, and make sure you keep diligent records (preferably originals if possible);
Most importantly, be aware of the law in the property’s state.
To conclude this three-part blog series, “Notes, Indorsements, Allonges, and the Pitfalls You Need to Know About” I leave you with this reminder – If you are diligent in the collateral review stage, take proper care of all original documents, and gather as many necessary curative documents as possible at the time of purchase, you will save yourself a lot of time, money, and headaches down the road.
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[1] The Koulouvaris court minced no words stating that the “distinction is not esoteric legalese. Florida law is clear that a “negotiable instrument” is “an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order.” § 673.1041(1), Fla. Stat. (2012) (emphasis added). The HELOC note reflects no such undertaking. It only obligates the Koulouvarises to repay whatever they borrow, up to $40,000.”
[2] Take note that Kreik was a Supreme Court of New Hampshire case that arose after a non-judicial foreclosure had completed and took well over a year to complete.