A mortgage lender has standing to foreclose even when it obtains assignment of the underlying promissory note after the note has been discharged in bankruptcy, a New York appellate court has ruled.
The case arose after the borrower filed for Chapter 7 bankruptcy and named the servicer of the original lender as a creditor in the bankruptcy case. The servicer subsequently assigned the note and mortgage to another lender, which subsequently brought the foreclosure action. While there was a factual dispute as to whether the transfer of the note occurred before or after the discharge, the Appellate Division for the Second Department held on July 1, 2015 that the mortgage lender could still assign a note even if it had been discharged in bankruptcy.
The borrower argued that if the assignment occurred after discharge that it was invalid because the assignment of an unenforceable note could not convey standing. The Court, however, held that the note need not be “collectable and payable at the time of the transfer.” The Court noted that the discharge “extinguishes one mode of enforcing a note—namely an action against the debtor in personam, it leaves intact another—namely, an action against the debtor in rem.”
Because the bankruptcy discharge does not the affect the lender’s right to proceed in rem against the property, the note survives the proceeding and can still be assigned to confer standing upon an assignee that only pursues foreclosure. The Court did affirm that the discharge prohibits the assignee from seeking a deficiency judgment against the borrower.
This decision is an important victory for lenders and assignees, since pools of loans sold on the secondary market may include discharged notes. While assignees may foreclose on delinquent loans, it is critical when the loans are initially boarded to ensure they are properly coded to prevent the seeking of deficiency judgments, which would violate a bankruptcy discharge order and possibly subject the assignee to sanctions.