I’ll admit it.  One of my favorite words is “allonge”.  It breaks up my otherwise decumbent register with something exotic.  Legally, it’s a way to assign a promissory note to another party who then has the rights to assert the promissory note against the obligors.  The last post discussed the importance of compliance with simple legal requirements.  But, what happens if the simple act of signing the allonge is done by an entity which doesn’t exist?  Does the new note holder have the right to assert the promissory note against the obligors. The Fifth Circuit says, “Yes”.

Credit: M.C. Escher

In this case the commercial real estate special purpose entity (“SPE”) and its guarantors fought to avoid a foreclosure (and deficiency) with the lender, and eventually get poured out by the 5th Circuit.  However, I am writing about the opinion because of an interesting holding concerning the various assignments that occurred of the promissory note following execution.

In the case, the SPE borrower (“Borrower”) was obligated on a commercial mortgage note.  After the promissory note was originally executed by the Borrower and original lender the note was transferred several times by assignment and accompanying allonge.  Eventually, the note was assigned to US Bank, as trustee for a CMBS trust.

One of the intermediate assignments was from Greenpoint Mortgage Funding to Aurora Bank.

Borrower was able to prove to the trial court that Aurora Bank did not actually exist at the time of the assignment into Aurora Bank. On this basis, the Borrower sought to attack US Bank’s ability to assert the note against the Borrower.  In considering the argument, the 5th Circuit held:

“This logic and conclusion treats as legally insignificant whether Aurora existed at the time of the transfers and therefore had a legal capacity to either endorse the Note or assign the Deed to US Bank.  Assuming without holding that any of the Deed assignments from Greenpoint to Aurora to US Bank were forgeries under Texas law…,and acknowledging that a forgery makes a Deed assignment void…, when the foreclosing party is the holder of the promissory note, any defects in the Deed assignment are irrelevant.”

This holding is predicated almost entirely on the rule that the mortgage follows the note, which is discussed in some detail in the opinion.

For the litigators, the opinion also contains good language concerning diversity with regard to trusts.  For the UCC folks, the opinion has a full paragraph discussing instrument negotiation.  Finally, the case has a brief discussion on fraudulent misrepresentation.

Interestingly, despite raising a host of legal challenges, the Borrower and the guarantors appear never to have raised a challenge to the note being an instrument – which would remove the holder in due course rights which underpin the opinion.

So, the lesson here: good news for all you banks out there who do not exist yet hold debt.

5th Circuit opinion in SGK Properties, LLC v. US Bank, case no. 17-20130