“If a note is pursued by a party that is not entitled to possess and to enforce it, the mortgage is meaningless. The question, therefore, is not whether the Mortgage is unperfected, but is it enforceable.” … The result is essentially the same as assertion of the Trustee’s strong arm powers against an unperfected mortgage. If Vanderbilt cannot enforce the Note, it is as if the Mortgage does not exist. The Mortgage would not secure repayment of anything if there is no enforceable promise to pay.
Pepper Hamilton LLP-
A chapter 7 trustee sought to use his “strong arm” powers as a hypothetical judgment lien creditor, arguing that a mortgage could be avoided because the mortgagee (which was an assignee of the original mortgagee) was not entitled to enforce the note secured by the mortgage. Although the bankruptcy court did not avoid the mortgage lien, it did conclude that the trustee could sell the mortgaged property free of any claim by the mortgagee assignee.
The debtors (the Dorseys) executed a note in favor of Popular Financial Services, LLC (PFS) that was secured by a mortgage given to Mortgage Electronic Registration Systems, Inc. (MERS) as nominee for PFS. The debtors executed an Affidavit of Conversion of Real Estate so that the mobile home encumbered by the mortgage was treated as real estate, and the mortgage properly perfected the lien on the mobile home.
A couple of years later Vanderbilt Mortgage & Finance, Inc. (Vanderbilt) acquired certain installment loan agreements pursuant to a purchase agreement with the parent and an affiliate of PFS to purchase. The schedule of contracts attached to the purchase agreement included a contract with one of the Dorseys, and the Dorsey note was identified as one of the notes that was transferred.
Vanderbilt obtained possession of the Dorsey note, and MERS’ assignment of the Dorsey mortgage to Vanderbilt was recorded. However, unfortunately for Vanderbilt, there was no indorsement of the note from PFS to Vanderbilt, and PFS was not a party to the purchase agreement.
The court began with an analysis of the trustee’s ability to assert the rights of a hypothetical judicial lien creditor under Section 544(a)(1) of the Bankruptcy Code. Typically a trustee’s strong arm power is asserted to establish rights in collateral that are superior to liens that are unperfected as of the commencement of the bankruptcy, so that the unperfected liens can be avoided. (See, for example, Bankruptcy “Strong Arm” Powers: Bye Bye Mortgage.)
