Third Party Defenses to Mortgages

Ann M. Burkhart* I. INTRODUCTION When the holder of a note and mortgage 1 asserts its rights, well-established law delineates what defenses are available to those who are liable for the debt. However, in some cases a person who is not liable for the debt-a "third party" to the loan transaction-may have a defense against the holder's action. Although the third party is not liable for the debt, it may have an interest in the mortgaged land or in the mortgage itself. Unfortunately, the law is not nearly as clear in this situation. The confusion arises in large part because the laws concerning notes and mortgages have evolved with little regard for each other, despite their close association in commercial transactions. To resolve the conflict between the two bodies of law, courts state that, because the mortgage is a mere ancillary of the note, it should be governed by the same law as the note-Article 3 of the Uniform Commercial Code (UCC) or the common law of contracts. This reliance on commercial law is completely misplaced when deciding issues concerning title to land or to a mortgage and leads to untoward results. Although commercial law defines which defenses are available to a person liable on the note, titles to land and to mortgages are governed by the land laws and by the recording acts in particular. Pursuant to those laws, a third party's claim to land or to a mortgage is governed by one criterion-notice. That one factor is the correct basis for decision in all the third-party defense cases. II. CATEGORIES OF THIRD-PARTY DEFENSE CASES Another source of confusion in these cases is the morass of facts involved in each case. Because the cases almost always involve fraud or other wrongful conduct, the facts are often quite complicated. Wrongdoers often act through a series of nominees, designees, straw people, and shell corporations; engage in conduct that wrongfully enables them to collect payments on loans they no longer own or to sell the same loan more than once; and otherwise act to obfuscate and cover their tracks. However, order does exist within this chaos of facts. Distilled to their essentials, the third-party defense cases virtually all involve one of the following six fact patterns:2 In a typical fraud case, a landowner is fraudulently induced to convey title to a grantee who then gives a mortgage on the land to secure a debt. If a court voids the deed because of the fraudulent conduct and the former owner thereby reacquires title, is the title still encumbered by the mortgage or can the former owner successfully assert the fraud to eliminate the mortgage? A resulting trust is created when a landowner conveys title to a trustee but does not designate the trustee's status on the deed so that the deed appears to be an outright conveyance of fee title. Despite the failure to express the trustee's status on the deed, the trustee holds the property in trust for the beneficiary. If the trustee violates the trust by mortgaging the land to secure a personal loan, can the beneficiary successfully assert the existence of the resulting trust to eliminate the mortgage? When an assignee fails to record a mortgage assignment, the original mortgagee still appears from the property records to own the mortgage. If the landowner sells the land after the assignment and uses the sale proceeds to pay the debt to the original mortgagee in exchange for its execution of a mortgage release, is the buyer's title subject to the mortgage? Similarly, if the landowner borrows money to pay the mortgage debt and gives a mortgage to secure the new loan, is the new mortgage subject to the prior mortgage or is the prior mortgage eliminated? This category of cases is similar to the third category but differs in legally significant ways. As in the last category, the original mortgagee purports to release a mortgage after having assigned it to someone else. Unlike the last category, however, the original mortgagee has acquired title to the encumbered land after assigning the mortgage. …