On June 18, the New Jersey Appellate Division issued an opinion in the matter of Capital One v. Peck, No. A-0582-16T4, which involved the appeal of a final judgment entered in a residential foreclosure matter. The issue on appeal was separation of the note and mortgage, and whether that affected the plaintiff’s right to foreclose.

On appeal, the borrower argued that the note, but not the mortgage, was sold to Federal Home Loan Mortgage Corporation (“Freddie Mac”), and that Capital One (Freddie Mac’s servicer and the plaintiff in the foreclosure action) lacked standing to foreclose on the mortgage because it did not have both possession of the note and a valid assignment of the mortgage at the time the complaint was filed.

The court stated the facts of the case as follows.: The originator of the loan sold the note to Freddie Mac in 2005, but retained the mortgage. MERS subsequently executed a written assignment of the mortgage, in its nominee capacity for the originator, to Capital One on Feb. 9, 2011, “more than one year after [the originator] merged into [Capital One].” A prior action to foreclose the mortgage was dismissed in June 2012, and the current foreclosure action was commenced on Feb. 15, 2013. The borrower’s contesting answer was dismissed on June 9, 2015, and the matter was returned to the Office of Foreclosure for entry of final judgment, which was the subject of the appeal.

It was undisputed that Capital One had possession of the original note during the prior foreclosure action that was dismissed in 2012. However, at some point, the original note was provided to Freddie Mac. According to the court’s opinion, in the current foreclosure action, Freddie Mac owns the note, while the originator—which since merged into Capital One—retained the mortgage. Finding that these facts presented “unusual circumstances,” the Appellate Division held that:

To preclude the possibility of one entity foreclosing on the home while the other enforces the note, we now hold that, when the note is separated from the mortgage, the plaintiff in a foreclosure action must demonstrate both possession of the note and a valid mortgage assignment prior to filing the complaint.

The Appellate Division noted that, while Capital One had both possession of the original note and a written assignment of the mortgage prior to the filing of the current foreclosure action, it subsequently returned the original note to Freddie Mac, and did not obtain the written assignment from MERS on behalf of the originator until after the originator merged with Capital One.

The court also rejected the argument that the mortgage follows the note by operation of law, noting:

Here, MERS as nominee for [the originator] and its “successors” did assign the mortgage to [Capital One], a formality because [Capital One] is a successor to [the originator]. Thus, [Capital One] had both the original note and an assignment before filing this foreclosure complaint. The twist here is that [Capital One] returned the original note to Freddie Mac, and obtained the assignment from MERS as nominee of [the originator] after [the originator] merged with [Capital One].

Notwithstanding these findings, the court declined to reverse the foreclosure judgment, finding that: (1) the borrower was given ample notice that Capital One serviced the loan on behalf of Freddie Mac; (2) “Freddie Mac is a GSE [government-sponsored enterprise] that publicly declares its policy to foreclose through its servicers”; and (3) Capital One as servicer possessed the note and received a written assignment of the mortgage in the prior foreclosure action. Therefore, the court found that the aforesaid “irregularities” did not warrant vacating the foreclosure judgment.

While the court’s holding was narrow and limited to uncommon situations where the note and mortgage are separated, it is possible that borrower-defendants may seek to rely on the decision to raise standing issues. Avoidance of that argument is simple if the foreclosing entity has physical possession of the original note and a valid written and recorded assignment of the mortgage to the same entity prior to commencement of any foreclosure action (but particularly with respect to GSE loans foreclosed in the name of a servicer).

Importantly, the court ultimately affirmed the foreclosure judgment despite its disapproval regarding the so-called “irregularities” with the perceived separation of the note and mortgage. It further recognized the procedure by which GSE entities foreclose, namely, “[f]oreclosures will normally be processed or litigated in the [s]ervicer’s name.”