Question:  I have several investment properties in Arizona that may go into foreclosure.  I am looking for an attorney who understands and believes in the “Produce the Note” defense.  Can you represent me?

Answer:  No.  The “produce the note” defense is where the borrower attempts to stop a foreclosure on real estate secured by a lien on the basis that the party foreclosing (the lender) cannot produce the original promissory note signed by the borrower(s).  Some states have apparently allowed this as a defense to a foreclosure on real estate.

I would not take the case for two reasons:

  1. The cost to litigate the defense could be very, very expensive.  I would not want you to waste your money on legal fees.
  2. No Arizona appellate court has ruled on the issue, but there is at least one Arizona case that could decide the outcome against the borrower in favor of the lender.

Issue 1:  Legal Fees to Defend

To defend against the foreclosure under a deed of trust on Arizona real property, the borrower must file a lawsuit in Superior Court asking the Court to stop the foreclosure and find that the lender does not have the right to foreclose because the lender cannot produce the original note.  Do you have the money to pay to litigate?  To take a case to trial could cost $10,000 – $50,000.  Are you willing to pay that kind of money to pursue a lawsuit?  If you win at the trial court level and the defendant appeals, the cost to pursue the appeal will further increase your legal fees and costs.  I can’t imagine you could find a lawyer to take the case on a contingency so you would have to pay as you go.  Most lawyers would require a substantial retainer ($10,000 or more) before accepting your case with assurance from you that you can pay more as the lawsuit proceeds and fees increase.

I don’t know any lawyers who have experience defending a borrower who owes the money, but wants to defend on a technicality.  One potential problem is the lender could drop the foreclosure and sue on the note in court, which would eliminate the protection from a deficiency judgment provided by ARS Section 33-814(G). The lawsuit to defend on the lack of a note could be the equivalent of jumping out of the frying pan into the fire if the result is the lender waives its right to foreclose on the lien and sues for a judgment on the note and gets a judgment for the full amount against the borrower.

If the borrower’s goal is to pay money to buy time to stay in the home, then one option that may succeed is for the borrower to file a lawsuit demanding that the lender produce the original promissory note.  However, if the borrower hires a lawyer to file the lawsuit, the legal fees could be very high.

Issue 2:  Adverse Case Law

The Arizona Court of Appeals case Florence Melni vs. Joseph Custer, Trustee, et al., 162 Ariz. 153 (1989), sheds light on how Arizona courts may handle a claim by a borrower that the lender cannot foreclose on a lien because the lender cannot produce the original promissory note.  Florence Melni went to an open house on s Sunday in the 1984 in Scottsdale, Arizona, and said she wanted the buy the home.   The guy showing the home said “ok, its $500,000 meet me at Metro Home Loans tomorrow and bring a check for $75,000.”   That’s what Mrs. Melni did.   Florence did not have a purchase contract, open an escrow or get title insurance.  The next day she gave the man the check for $75,000 and he gave her the keys to the home.  Mrs. Melni moved into the home and about a year later called a realtor to list the home for sale.   The realtor checked the records of the Maricopa County Recorder and found out the woman never got a deed to the home.  That’s when I got involved.

About that time the President of Metro Homes Loans was murdered and the State Department of Banking put MHL into receivership.  There were two deeds of trust (a first for $300,000 and a second for $115,000) on Florence’s home, both signed by  a “Doctor DM Conrad,” the same person who signed the held legal title to the home that was never conveyed to Florence Melni.  It turns out that DM Conrad was a fictitious person created by MHL to scam people into investing in the two loans that were the first and second liens on the home.

Mrs. Melni could not or did not want to pay the debt secured by the second deed of trust on the home.   The lender threatened to foreclose.  The parties then litigated the issue of whether the lender had a valid lien on the home.   Florence Melni’s position was that neither the promissory note that evidenced the debt nor the second deed of trust that secured the debt were valid because neither document was signed by an actual person.  DM Conrad did not exist.   The documents were signed by somebody at Metro Home Loans, which had created this fictitious person including bogus financial statements of “Dr. Conrad.”  A notary falsified the acknowledgment of DM Conrad’s signature on the deed of trust.  Dr. Conrad looked great on paper, but he did not exist.

You’d think that a promissory note and a deed of trust that lacked a signature would not be valid and prevent the second lender from foreclosing on the property.  The Arizona Court  of Appeals concluded otherwise.  It said the lender had an “equitable lien” on the property that gave the lender an enforceable lien to secure payment of a debt evidenced only by a promissory note and secured by a deed of trust, neither of which were  ever signed by a real person or  the purported owner of the property.

This Arizona appellate case could affect the out come of a lawsuit filed in Arizona by a borrower against a lender that is trying to foreclose a lien on Arizona real property if the borrower’s defense to the foreclosure is that the lender cannot produce the original note.

State law will control.  For example, according to Foreclosure University, the foreclosure law of Virginia says:

If the original note has been lost a copy with a lost note affidavit will suffice, but the lender, prior to the institution of the foreclosure, must give the obligor(s), including the property owner, written notice that the original note is unavailable and that a request for sale by the Trustee will be made upon expiration of 14 days from the date of the notice.

For some actual situations involving this issue, see “Foreclosure sales in limbo over title issue” and “Who owns your home? Lost paper trail allows borrower to keep her house.”  For a ton of articles on this topic, just Google foreclosure original note.

For information about short sales, see “Arizona Department of Real Estate Publishes Short Sale Seller Advisory.”  For information about the federal income tax consequences of a short sale or discharge from indebtedness income see “Mortgage Forgiveness Debt Relief Act of 2007” and “Federal Income Tax Consequences of Home Foreclosures & Cancellation of Indebtedness.”