"Produce-The-Note" Foreclosure Rescue Litigation Runs Aground In California

As the numbers of residential foreclosures reach record highs, a wave of novel foreclosure rescue litigation has flooded California's courts. Known as "produce the note" lawsuits, thousands of these suits have been filed within the short span of just a few months. Almost as quickly as the suits have been filed, however, they are being dismissed by the courts.

The suits do not dispute that the borrower is in default or allege that the trustee conducting the foreclosure failed to comply with the exhaustive statutory scheme that governs non-judicial foreclosures in California. Instead, these suits seek to delay and ultimately enjoin the non-judicial foreclosure process by alleging that the lender or financial institution responsible for commencing the foreclosure does not have possession of the borrower's original promissory note and cannot foreclose until it proves to the court otherwise. The complaints are forms in which the only difference is the name of the plaintiff and the address of the property.

California's Non-Judicial Foreclosure Process

California's non-judicial foreclosures process is governed by a comprehensive and exhaustive statutory framework contained in Civil Code sections 2924 through 2924k. One of the Legislature's purposes in establishing the non-judicial foreclosure process was to ensure that a properly conducted foreclosure sale constitutes a final adjudication of the rights of the borrower and lender. The laws evince the legislative intent to establish an equitable tradeoff of protections and limitations. Thus, the statutory scheme has long contained a myriad of rules relating to standing, notice, and a borrower's right to cure. Because the borrower is protected by applicable notice requirements the lender gains the certainty of a quick, inexpensive, and efficient remedy. Accordingly, a non-judicial foreclosure sale in California is entitled to a common law presumption that the sale was conducted regularly and fairly. Courts hold that it is inconsistent with the comprehensive and exhaustive statutory scheme regulating the nonjudicial foreclosure to incorporate other unrelated provisions. Thus, a successful challenge to a non-judicial foreclosure sale requires evidence of a failure to comply with the procedural requirements for the foreclosure sale that caused prejudice to the person attacking the sale.

The Origin of the 'Produce-the-Note' Theory

Advocates of the produce-the-note lawsuits point to a single unpublished opinion from a bankruptcy court in Ohio as their legal precedent. In October 2007, U.S. Bankruptcy Court Judge Christopher Boyko dismissed without prejudice fourteen judicial foreclosure actions filed by the trustees of securitized trusts against borrowers who had defaulted on their residential mortgages that had been sold into securitized trusts. In re Foreclosure Cases, 2007 WL 3232430 (Bankr. N.D. Ohio 2007). In each of the cases, the plaintiff-trustee alleged that it was the holder and owner of the note and mortgage to be judicially foreclosed. Yet the note and mortgage attached to the complaints identified the lender that originated the loan as holding the beneficial interest, not the plaintiff.

In dismissing the cases, Judge Boyko held, among other things, that the plaintiffs' failure to provide documentary evidence that they owned and held the beneficial interest in the notes in question meant they failed to carry their burden of demonstrating actual injury and thereby the prudential standing requirements necessary for plaintiff's. Judge Boyko's unpublished opinion captured immediate attention and two weeks later the New York Times rightly predicted: "Lawyers for troubled homeowners are expected to seize upon the district judge's opinion as a way to impede foreclosures across the country or force investors to settle with homeowners."

A Unique Litigation Business Model

A Nevada corporation called United First, Inc. appears to be the driving the force behind the wave of produce-the-note litigation that has flooded California's courts and is spreading to Nevada and Arizona. Although United First is not a plaintiff in the produce-the-note cases and its name does not appear anywhere in the complaints, its many Websites boast that it is the only company doing what it does because "nobody else has figured out how they can profit by doing what we do[.]"

What United First does is recruit borrowers facing foreclosure into signing a unique "joint venture" agreement with it through which a borrower pays the company a flat monthly fee in exchange for United First paying the attorneys fees associated with prosecuting the resulting case. Initially, United First teamed up with one California law firm to prosecute the produce-the-note cases. In less than one year, that firm filed approximately 2,300 of these cases.

Borrowers are recruited to sign United First's joint venture agreement through websites and commissioned representatives that United First says will receive $500 to $1,000 per borrower per month depending upon the number of borrowers they and their sub-agents recruit. The first "frequently asked question" published on United First's Web sites asks "Is this a scam or a fraud?" The Websites answer the question in the negative, explaining that the borrower does not sign their property over to the company. Until recently, United First also explained that the Joint Venture agreement was not a scam because the attorney that filed the 2,300 cases would not risk his good name by working with a fraudulent company.

Once a borrower signs the joint venture agreement, it is to add the company as an additional insured on the property and pay an initial fee of $2,250. Thereafter, the borrower pays a monthly fee equal to one-third of the borrower's annual property taxes, with a minimum fee of $1,350 per month. Borrowers continue to make monthly payments to the company until the termination of legal proceedings and are told that in exchange for the payment of monthly fees, United First is "committed to spend an average of $100,000 plus to fight your case in court." In an audio interview with a co-founder of United First, the attorney that has represented United First and each of the individual borrowers explains that this arrangement allows his firm to "rigorously defend the case."