North Carolina Lost Note Practice Point

• By: ALFN
• On: 11/22/2016 18:24:55
• In: Legal Update

The facts of Emerald Portfolio, LLC v. Outer Banks/Kinnakeet Associates, LLC, 790 S.E. 2d 721 (N.C. Ct. App., September 6, 2016) are straightforward and standard.  On August 30, 2006, Outer Banks/Kinnakeet Associates, LLC (OBKA) gave a $3,025,000.00, secured note to First South Bank (FSB). Part of the security was real estate.  After liquidating various items of collateral, FSB, in February, 2013, sold the loan to Emerald Portfolio, LLC (Emerald). At the time of the transfer, FSB could not locate the original note, and instead provided to Emerald a true copy of the note, an allonge bearing an endorsement of the note to Emerald, and an affidavit of lost note.
 
On June 19, 2014, Emerald filed a collection lawsuit on the remaining balance of the note ($1,509,163.89, plus interest accruing at the rate of $126.39 per diem) and preserved its right to pursue its remedies against the remaining collateral, including foreclosure, at a later date. OBKA contested the collection lawsuit on several grounds, asserting that Emerald was not entitled to enforce the note because FSB could not locate the note at the time it was assigned to Emerald.  Eventually, both Emerald and OBKA filed a Motion for Summary Judgment.  On September 3, 2015, the trial court entered an Order granting Emerald's Motion for Summary Judgment and denied OBKA's Motion for Summary Judgment. OBKA appealed this Order to the North Carolina Court of Appeals. 
 
The Court of Appeals began its analysis of whether Emerald could enforce the note by reference to N.C. Gen. Stat. § 25-3-309(a) which specifically states:
 
A person not in possession of an instrument is entitled to enforce the instrument if (i) the person was in possession of the instrument and entitled to enforce it when loss of possession occurred, (ii) the loss of possession was not the result of a transfer by the person or a lawful seizure, and (iii) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person or a person that cannot be found or is not amenable to service of process.
 
In interpreting statute, the Court of Appeals held that FSB could enforce the note under North Carolina law; however, the Court also held that Emerald could not.  Important in this analysis was that Emerald did not have the right to enforce the note at the time it was lost, while FSB did.  The Court of Appeals emphasized that this holding has been North Carolina law since 1995 (when N.C. Gen. Stat. § 25-3-309(a) was enacted in its current form) and cited a 2012 Bankruptcy Court decision from the Western District of North Carolina as support for its holding.  See In re Patterson, 2012 WL 5906865 (Bankr. W.D.N.C. Nov. 26, 2012).
 
Critical to the Court's analysis was a comparison of N.C. Gen. Stat. § 25-3-309(a) to the 2002 revisions to Uniform Commercial Code, in particular UCC § 3-309(a)(1)(B) which provides that, “A person not in possession of an instruments is entitled to enforce the instrument if … the person seeking to enforce the instrument … has directly or indirectly acquired ownership of the instrument from a person who was entitled to enforce the instrument when loss of possession occurred.”  The Court noted that, “(the North Carolina) legislature could have revised (N.C. Gen. Stat. § 25-3-309(a)) to coincide with the UCC revision in 2002, but it did not do so.  We must conclude from this distinction that our legislature intended to exclude the additional language of the UCC, and as such intended not to provide this avenue of recovery to parties not in possession of the relevant instrument.”  In conclusion, the Court held, “that where a party who would otherwise have a right to enforce a lost note under N.C. Gen. Stat. § 25-3-309, subsequently assigns that note, the assignee does not acquire the right to enforce the note unless the assignee is in actual possession of the note.” 
 
What does this decision mean going forward for lenders attempting to enforce a negotiable instrument that has been lost, misplaced, or destroyed?  First, that only the entity that lost, misplaced, or destroyed the commercial paper at issue can enforce its terms.  This applies to promissory notes secured by deeds of trust, security agreements for installment loan contracts secured by cars and manufactured homes, and any other instrument controlled by the North Carolina's Uniform Commercial Code. 
 
Second, under existing North Carolina law, the right to enforce a lost negotiable instrument cannot be transferred.  Lenders who regularly become holders of transferred commercial paper should always ensure they have possession of the original Note before enforcing its terms.  With regard to mortgages, assignments of deeds of trust secured by a promissory note should not be recorded until the lender obtains possession of the original note. 
 
Finally, lenders should obtain the appropriate powers of attorney to enforce lost notes from prior holders.  If a prior holder of a note loses it, that lender still maintains the right to enforce the note.  The prior lender can give a power of attorney to a subsequent servicer to enforce the terms on its behalf. 

By Franklin Greene, Esq.
Brock & Scott, PLLC (North Carolina)