Who Is The Real Party For A PSA Foreclosure?

To foreclose you need possession of the original note and deed to trust representing the residential home loan.   If the note and deed of trust have been transferred to a trust as part of securitization, the trustee must comply with Pooling and Servicing Agreement (“PSA”) which gives the Trustee power over all the notes and deed of trust in that particular security.[1]

A PSA foreclosure defense is the failure of the note and deed of trust to be transferred into its particular trust or security according to the Pooling and Service Agreement.  An argument that a PSA foreclosure defense does not apply to a foreclosure by a Trustee because the homeowner is not a party to the PSA as a third party beneficiary is a misunderstanding of the PSA foreclosure defense.[2]

A PSA foreclosure defense is not based on the homeowner being a third party beneficiary to the PSA but is based on whether the Trustee has possession of the note and deed of trust, which is a standing issue.

A basic rule of contract law is that “a person not a party to an express contract may bring an action on such contract if the parties to the agreement intended to benefit the non-party, provided that the benefit claim is a direct and not merely an incidental benefit of the contract.” E.B. Roberts Construction Co. v. Concrete Contractors, Inc., 704 P.2d 859, 865 (Colo.1985).  Jefferson County School Dist. No. R-1 v. Shorey, 826 P.2d 830
(Colo., 1992).

A homeowner is not a third party beneficiary to a PSA because the PSA is not intended to directly benefit the homeowners.[3]  The investors in the security which contains a pool of home loans are third party beneficiaries to the PSA because they benefit from the PSA’s requirement that the Trustee oversee the collection of the monthly loan payments and transfer of these funds to the investors. 

If the home loan (the note and deed of trust) is not transferred to the trust according to the explicit requirements of the PSA on the transfer of the home loan into the security, the Trustee does not possess the home loan and is precluded from bringing a foreclosure action.  

In Colorado, a homeowner can challenge the foreclosing party’s right to bring a foreclosure action in a Rule 120 hearing.   Goodwin v. District Court In and For Sixteenth Judicial Dist. 779 P.2d 837, (Colo.1989).   Goodwin allows a court in C.R.C.P. 120 motion to decide whether the moving party is a real party in interest.  

Courts have the authority to whether a party has a right to bring a foreclosure action because of due process.  Due process is a constitutional principle that no person can be deprived of life or liberty or property without adequate legal procedures and safeguards.  C.R.S.A. Const. Art. 2, § 25. Plymouth Capital Co., Inc. v. District Court of Elbert County 955 P.2d 1014 (Colo., 1998)

In Colorado, C.R.C.P. Rule 17(a) provides the necessary mechanism to comply with due process by ensuring the “real party in interest” is bringing the foreclosure action.  C.R.C.P. 17(a) provides that "every action shall be prosecuted in the name of the real party in interest." "The real party in interest is the party who, by virtue of substantive law, has the right to invoke the aid of the court to vindicate the legal interest in question." In re Goodwin, supra.   

Simply, Rule 17(a) ensures the person or entity bringing a foreclosure action has the right to foreclose by asking do they have an "interest," which is material (not incidental) and properly before the court.

With respect to a Trustee bringing a foreclosure action on a home loan within a securitized trust, the question is does the Trustee have an “interest” in the note and deed of trust.    

There is Colorado case law that states a trustee who holds legal title to property is a real party in interest.  Koch v. Story 47 Colo. 335, 107 P. 1093 (Colo. 1910). Elk-Rifle Water Co. v. Templeton, 173 Colo. 438, 484 P.2d 1211 (Colo. 1971).  However, this rule does not apply to a Trustee of a securitized home loan.   Colorado is lien theory state, which provides that the holder of a note and deed of trust does not hold legal title to the property. “Colorado has adopted the lien theory of mortgages under which the mortgage or deed of trust creates a lien against real property but does not convey title. Section 38-35-117, C.R.S.[4]   Hohn v. Morrison, 870 P.2d 513 (Colo. App. 1993).

A Trustee can foreclose on a home loan if it has an “interest” in the home loan according to “substantive law” governing the transfer of notes and deeds of trusts into a security.  

“We mean by substantive law the positive law of duties and rights which gives rise to a cause of action, as distinguished from adjective law, which pertains to practice and procedure, or the legal machinery by which the substantive law is made effective.”  Allen v. Bailey, 91 Colo. 260, 14 P.2d 1087 (Colo. 1932). 

In the context of a Rule 120 hearing, the “substantive law” governing the “rights which give” a trustee an “interest” in the home loan and thus the right to foreclose is Article 3 of the Uniform Commercial Code (“UCC”) (C.R.S. §4-3-101 et seq.).

The Colorado foreclosure statute (C.R.S. § 38-38-101 et seq.) sets forth the procedure for foreclosing on a defaulted home loan and is, as such, “adjective law” and not dispositive on who can bring a foreclosure action.

The “substantive law” of Article 3 applies because when the note and deed of trust travel from the original lender in Colorado into a security managed by a Trustee in New York the note becomes a “negotiable instrument”.[5]  In fact the foreclosure statute references Article 3 when it identifies the person entitled to bring a foreclosure action as the “holder” [6] and defines “holder” in similar terms to Article 3.       

The “substantive law” of Article 3 of the Uniform Commercial Code determines whether or not a foreclosing entity is a “entitled to enforce an evidence of debt”.  C.R.S. § 4-3-301 provides a “Person entitled to enforce” an instrument[7] means (i) the holder of the instrument, (ii) a nonholder in possession of the instrument who has the rights of a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the instrument pursuant to section 4-3-309 or 4-3-418(d).  A person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument .”

The right to enforce a note in foreclosure depends on the transfer of the note to a person entitled to enforce the “negotiable instrument”.   “To be a holder one must meet the two conditions in section 4-1-201(b)(20): (1) he or she must have possession (2) of an instrument drawn, issued, or indorsed to him or her. With rare exceptions, those claiming to be holders have physical ownership of the instrument in question.”[8]  

Possession is designed to prevent two or more claimants from qualifying as holders who could take free of the other party's claim of ownership.  

The right to possession of the note depends on the transfer.  Article 3 provides two ways to transfer a note: “negotiation”[9] and “transfer”[10].    A “negotiation” of a note gives the person in possession the rights of “holder”.  A “transfer” gives the person in possession the “right to enforce” the note.

UCC Comment 1 to C.R.S. § 4-3-203(a) explains:

“The right to enforce an instrument and ownership of the instrument are two different concepts….A thief who steals a check payable to bearer becomes the holder of the check and a person entitled to enforce it, but does not become the owner of the check….Moreover, a person who has an ownership right in an instrument might not be a person entitled to enforce the instrument…The right to payment is transferred by delivery of possession of the instrument “by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.” 

Under both the Colorado foreclosure statute and Article 3, a “holder”  is  person in rightful possession of the note:  C.R.S. § 4-1-201(20) “Holder” means: (A) the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession;  C.R.S. §38-38-100.3(10)(c) “Holder of an evidence of debt” means the person in actual possession of or person entitled to enforce an evidence of debt. §38-38-100.3(10)(c).

The safest way to transfer a note to ensure a right to payments is to deliver possession with an endorsement [11] on the note specifying the name of the party taking ownership of the note.  The second safest way to transfer a note is to deliver possession of the note to a party endorsed in blank or endorsed to bearer[12].  In both instances the person who has possession of the note is deemed a “holder” with a right to payment on the note. 

Endorsement is important because it is the way to know if the person in possession is rightfully in possession.  When notes are transferred into a trust for the purpose of securitization, the requirements for endorsements are all the more important.  For an outline for all the reason why transfer of a home loan into a securitized trust is stricter than that allowed under Article 3 and state foreclosure laws please refer to my prior blog post “A Chink in the Armor- A Foreclosure Defense”.

The UCC allows stricter requirements for transfers of notes by agreement.[13] The PSA requires proof of the transfers of the note or a chain of title from original lender to the deposit of the note into a securitized trust for the trust to own the note.  The reason for a clear chain of title from lender to the trust serves several purposes.  One main reason is to establish the integrity of the trust in order that certificates in the trust can be sold to investors.  Another reason is to obtain favorable tax treatment. 

A sample of the PSA language which requires a clear chain of title of the note into the trust states:

“In  connection  with the above  transfer and  assignment,  the Sponsor  hereby  deposits with the Trustee or the related Custodian, on behalf of the Trustee, with respect to each Mortgage Loan: (i)  the original  Mortgage Note,  endorsed  without recourse (A) in blank or to the order of the  Trustee  or (B) in the case of a Mortgage  Loan  registered  on the MERS  system,  in blank,  and in each case showing an unbroken chain of endorsements.” 

If there is no documented chain of title tracking the delivery of the note into the security, the note is not properly lodged within the   security and the Trustee has no right to foreclosure as the “real party in interest”.

Therefore, an argument that a homeowner has no right to contest a Trustee’s status as a “real party interest” because the homeowner is not a third party beneficiary of the PSA is an opportunity to explain why a Trustee is bound by the PSA.  

[1] Asset Securitization: Comptroller's Handbook, Office of the Comptroller of the Currency, November1997http://www.occ.treas.gov/handbook/assetsec.pdf.

[2] “Standing to Invoke PSAs as a Foreclosure Defense”posted by Adam Levitan, Credit SlipsAugust 4, 2011.

[3] See my previous Blog, “Chink in the Armor, A Foreclosure defense”  citing an Alabama case, Horace vs. LaSalle Bank National Association, et al., CV-2008-000362.00, (3/30/11) Circuit Court of Russell County Alabama, where Judge found homeowner was third party beneficiary because without the homeowner the security would not be funded.  

[4] § 38-35-117. Mortgages, not a conveyance--lien theory:  Mortgages, trust deeds, or other instruments intended to secure the payment of an obligation affecting title to or an interest in real property shall not be deemed a conveyance, regardless of its terms, so as to enable the owner of the obligation secured to recover possession of real property without foreclosure and sale, but the same shall be deemed a lien.

[5] C.R.S. 4-3-104(a) Except as provided in subsections (c) and (d) of this section, “negotiable instrument” means 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, if it:(1) Is payable to bearer or to order at the time it is issued or first comes into possession of a holder;(2) Is payable on demand or at a definite time; and(3) Does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorization or power to the holder to confess judgment or realize on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor.

[6] C.R.S. § 38-38-101. Holder of evidence of debt may elect to foreclose.  §38-38-100.3(10) “Holder of an evidence of debt” means the person in actual possession of or person entitled to enforce an evidence of debt. §38-38-100.3(10)(c) The person in possession of a negotiable instrument evidencing a debt, which has been duly negotiated to such person or to bearer or indorsed in blank.  Possession of a Note without a proper indorsement to a specific person or “to bearer” is enforceable if the person in possession can “account for possession of the unindorsed instrument by proving the transaction through which the transferee acquired it.” Comment 2,

C.R.S. § 4-3-203, 

[7] “Instrument” means a negotiable instrument.  C.R.S. §4-3-104.

[8] Georg v. Metro Fixtures Contractors, Inc. 178 P.3d 1209 (Colo. 2008). 

[9] “Negotiation” means a transfer of possession, whether voluntary or involuntary, of an instrument by a person other than the issuer to a person who thereby becomes its holder. C.R.S. § 4-3-201(a).

[10] An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument. C.R.S. § 4-3-203(a).

[11] “Indorsement” means a signature, other than that of a signer as maker, drawer, or acceptor, that alone or accompanied by other words is made on an instrument for the purpose of (i) negotiating the instrument. C.R.S. §4-3-204.

[12] “Bearer” means a person in control of a negotiable electronic document of title or a person in possession of a negotiable instrument, negotiable tangible document of title, or certificated security that is payable to bearer or indorsed in blank. C.R.S. § 4-1-201(5).

[13] Except as otherwise provided in subsection (b) of this section or elsewhere in this title, the effect of provisions of this title may be varied by agreement. C.R.S. § 4-1-302(1).

Seana Peele