March 19, 2019 Articles

It’s a Wonderful Payment History

George Bailey would have never heard of securitization of debt.

By Donald R. Pocock

December is a month of celebrations and traditions. The end of the year brings with it gift giving and party throwing—and, of course, family movie traditions such as It’s a Wonderful Life, starring Jimmy Stewart as George Bailey in a classic slice of Americana. In this film, Bailey lived in the world of building and loan banking when bank lending was a very different business than it is today. Bailey had never heard of “securitization” of debt; and while checks may have been a common way of paying bills, most long-term debt obligations were financed and serviced by small, local banks.

In today’s world, more and more homeowners manage their single biggest asset and liability using a smartphone in the palm of their hand. There are even TV commercials depicting first-time homebuyers falling in love with a house and using their phone to find a mortgage that suits their needs. Speed and efficiency have replaced small and locally owned. Bailey probably would not recognize the modern-day banking system—in particular, the transferability of long-term debt obligations and the problems this creates in terms of using records of prior servicers when a default occurs.

Transference of Long-Term Debt Obligations

Key to the efficiency demanded by consumers is the flexibility of lenders to transfer long-term debt obligations easily. Indeed, the whole concept of negotiable instruments rests on facilitation of this transferability. As a result, the typical 30-year mortgage may change hands a dozen times or more over its lifetime.

This system of change and transferability may facilitate the making and servicing of loans, but challenges can arise when the train comes to a screeching halt and a debtor defaults, leading to proceedings to enforce the note or foreclose a security instrument. Specifically, what happens when a lender takes over servicing of an account that is either already in default or near to it but the debtor proclaims his innocence, maintaining that he made all scheduled payments on time? The solution, of course, is to look at the payment history. But if the payment history is a patchwork quilt of records from prior servicers, how can the current servicer offer into evidence records that were created by completely different, unrelated companies? Similar problems of proof can arise in any long-term debt obligation.

Rule 803(5) in the World of Modern-Day Banking

Rule 803(5) of the Federal Rules of Civil Procedure permits the admission of business records even though the records themselves are hearsay, but the rule as drafted presumes that the business offering the record is the same as the business that created the record. Rule 803(5) requires the testimony of a records custodian or “other qualified witness” who can attest that (1) the record was made at or near the time by—or from information transmitted by—someone with knowledge; (2) the record was kept in the course of a regularly conducted activity of the business; and (3) making the record was a regular practice of that activity. Fed. R. Civ. P. 803(5).

The structure of the rule presumes that the witness works for the company offering the evidence, but in the world of long-term negotiable debt, very often the witness may be from a completely different organization than where payment records were created, which raises the potential that testimony by a subsequent servicer could be excluded for lack of proper foundation under Rule 803(5) or lack of personal knowledge under Rule 602.

Courts and the Modern Reality of Lending

Fortunately, courts have recognized that strict compliance with Rule 803(5) would undermine the modern reality of lending.

In Beal Bank, SSB v. Eurich, the Supreme Court of Massachusetts addressed a factual scenario where the loan servicer changed between the time of default and the time of enforcement. 444 Mass. 813, 831 N.E.2d 909, 914 (Mass. 2005). When the borrowers objected to the new servicer relying on records from earlier servicers, the court held as follows:

Given the common practice of banks buying and selling loans, we conclude that it is normal business practice to maintain accurate business records regarding such loans and to provide them to those acquiring the loan. Therefore, the bank need not provide testimony from a witness with personal knowledge regarding the maintenance of the predecessors’ business records. The bank’s reliance on this type of record keeping by others renders the records the equivalent of the bank’s own records. To hold otherwise would severely impair the ability of assignees of debt to collect the debt due because the assignee’s business records of the debt are necessarily premised on the payment records of its predecessors.

Id. at 819, 831 N.E.2d at 914 (internal citations omitted).

In Bank of New York Mellon v. Adams, the defendant mortgagors moved to strike an affidavit, arguing that the current lender was not able to lay a proper foundation for business records, including payment histories that were created by a prior servicer. 5:13-CV-245-BO, 2014 WL 3810631 (E.D.N.C. Aug. 1, 2014). The court held that “receiving a document from another business can lay a sufficient foundation where it, acting in the regular course of its business, integrates the received record into its own business records, relies on it in its day to day operations and surrounding circumstances indicate trustworthiness.” Id. at *1.

This reasoning is consistent with other jurisdictions presented with similar situations. See, e.g., United States v. Adefehinti, 510 F.3d 319, 326 (D.C. Cir. 2007), as amended (Feb. 13, 2008), judgment entered, 264 F. App’x 16 (D.C. Cir. 2008) (holding that a record of which a firm takes custody is thereby “made” by the firm within the meaning of the hearsay rule on business records); WAMCO XXVIII, Ltd. v. Integrated Elec. Env’ts, Inc., 903 So. 2d 230 (Fla. Dist. Ct. App. 2005) (prior loan servicer documents were admitted).

Conclusion

When confronted with a case that seeks to enforce a long-term debt, practitioners must investigate what information was provided to the current lender or servicer from prior servicers and determine how that information has been incorporated and used by the current servicer. Where the evidence demonstrates that a subsequent servicer incorporates those records into its own, they should be admissible as business records even though the current servicer did not create them. If a subsequent loan servicer could not rely on these records, it would paralyze the transferability of negotiable instruments. Sorry, George Bailey, but time, technology, and loan servicing march on!

Donald R. Pocock is a partner with Nelson Mullins Riley & Scarborough LLP in Winston-Salem, North Carolina. 


Copyright © 2019, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).