Monthly Analysis of Important Issues and Recent Developments in Bankruptcy Law
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As the mortgage meltdown has spread and deepened nationwide, courts must grapple with challenges to efforts to recover on defaulted mortgages. The challenges involve a complex mix of legal concepts and principles. Everything from contract law, state statutory foreclosure law, negotiable instrument law under the Uniform Commercial Code agency, standing and real party in interest issues, to evidentiary and civil procedure issues have been implicated in recent cases. What follows is a survey of the cases analyzing the legal authority of Mortgage Electronic Registration Systems, Inc. (MERS) to act for its constituents in enforcing rights under defaulted mortgages.
MERS is a construct of the mortgage finance industry created and implemented to facilitate the sale of promissory notes and servicing rights in residential mortgage transactions. But, the architects of MERS did not simply create a modernized system of keeping track of loan transfers. They also adopted untested, novel terminology for the most important documents that protect lenders and investors claiming liens on real estate—the mortgage/deed of trust and assignments. Then they decided that the execution and/or recording of assignments was unnecessary unless foreclosure needed to be filed.
Historically, the effectiveness of mortgage language and assignments of mortgages were rarely questioned. Time outran the MERS system, and now state and federal courts across the country are struggling to give meaning to the terminology used in the standard MERS mortgage—including the ubiquitous “acting solely as nominee.” And bydesign, MERS assignments are not created until default has occurred. As a result, assignments are often not executed and/or recorded until bankruptcies, motions for stay relief or foreclosures have commenced. And MERS assignments sometimes state that they are effective years before the actual date of execution.
The MERS language and assignment policies present courts with a complex bundle of procedural and substantive issues: standing to seek relief from stay and/or to sue; contingently necessary party status; agency; equitable and beneficiary ownership vs. legal title or bare legal title; note holder and non-holder status under the UCC; delay in execution and recording of assignments; perfection; noticing issues; as well as the interpretation of language not ordinarily used for the purposes and results intended or not intended. MERS and its assignees have repeatedly taken contradictory positions—sometimes arguing that MERS is only a tracking system with no lending or servicing powers; other times contending that MERS has the right to hold notes, assign or foreclose mortgages; and still other times, MERS and its assignees say that it acts on behalf of its own property interests or simply as the “nominee” and/or the agent of another. These interpretive problems and inconsistencies have provoked some courts to determine the worst possible fate for secured loan buyers—that their mortgages were not effectively transferred or even that the mortgages have been separated from the note and are no longer enforceable.
How did so many different banks and investment companies sign on to using this standardized but unusual mortgage language and nonrecording system? Perhaps for the same reason that the marketing and securitization of subprime loans happened. The original lenders—the actual scriveners of the mortgages—no longer retained, serviced and depended upon the viability of the loans they created. They made their fees and sold the loans to others—often immediately after creating the loans—and the new buyers in turn sold to other buyers for yet more fees. The lenders and the next-in-line loan owners weren’t concerned if the borrowers would be able to make the payments nor apparently if the language of the mortgage was valid. Conservative banking and long tested legal principles were disregarded.
As Professor Peterson notes in his soon-to-be published article147 describing the formation and evolution of MERS, the MERS system was not tested in court nor approved with legislation before being propounded so effectively by MERS. Credit rating companies simply agreed that the conveyances of mortgage loans without recordation and notice would not be subject to contest by subsequent purchasers. Rating companies, of course, also gave AAA rating to the same securitized loans that were originated with MERS documents and tracked in the MERS system. One must question if the reasons for the MERS system approval were the same for the AAA approval given the securitization of subprime loans supposedly secured by this “system.” In his article’s conclusion, Professor Peterson points out that the MERS system should be acknowledged as one “important cog in the machine that churned out the millions of unsuitable, poorly underwritten, and incompletely documented mortgages that were destined for foreclosure.”148 As another author noted, the machine that turned the U.S. housing market into a system of “‘Ponzi finance.’”149
Whether the MERS construct holds water is being robustly tested in a variety of contexts. Given the pervasiveness of MERS, if the construct is not viable, if MERS cannot file foreclosures, and, perhaps most importantly, cannot even record or execute an assignment of a mortgage, what then?
Already, legislation has been proposed in attempts to rectify the problems caused by MERS. In Kansas, House Bill 2613 would amend Rule 60-219 in the Code of Civil Procedure and make a person a contingently necessary party in a civil law suit if the person is “a party or nominee with whom… a contract has been made for the benefit of another.” FannieMae has recently announced (Servicing Guide Announcement SVC-2010-05 issued March 30, 2010) that MERS will no longer be named as the plaintiff in any foreclosures of FannieMae mortgage loans.
Over half the nation’s mortgage loans are now recorded under MERS’ name. The CEO of MERS has declared that MERS’ mission is “to capture every mortgage loan in the country.’”15150 How ironic that the banks too big to fail who created this system and the investors who relied upon them now argue as one defense to attacks on MERS’ mortgages that the system is too big to be allowed to fail.