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A proposal for a National Mortgage Registry: MERS done right.

Abstract: In this Article, Professor Whitman analyzes the existing legal regime for transfers of notes and mortgages on the secondary market, and concludes that it is highly inconvenient and dysfunctional, with the result that large numbers of market participants simply did not observe its rules during the huge market run-up of the early and mid-2000s. He also considers Mortgage Electronic Registration System (MERS), which was designed to alleviate the inconveniences of repeatedly recording mortgage assignments, but concludes that it was conceptually flawed and has proven to be an inadequate response to the problem. For these reasons the legal system was ill-prepared for the avalanche of foreclosures that followed the collapse of the mortgage market in 2007, and continues to be beset by litigation and uncertainty. This Article then provides a conceptual outline for an alternative National Mortgage Registry, which would supplant the present legal system and would provide convenience, transparency, and efficiency for all market participants. He concludes with a draft of a statute that could be enacted by Congress to create such a registry.

Contents

I. THE TRADITIONAL MORTGAGE TRANSFER PROCESS

   A. Apparent Separation of Note and Mortgage

   B. The Uses of Recorded Mortgage Assignments

      1. Prevention of Fraud by the Transferor

      2. Assurance of Receiving Notice of Legal Proceedings

      3. Recordation of Assignments as a Practical Necessity for
      Future Title Examiners

      4. Recordation of Assignments as a Statutory Prerequisite to
      Foreclosure

      5. Conclusion: What are Assignments Worth?

   C. Transfer of the Note

   D. The Cost of Following the Rules

II. THE ADVENT AND FALLACIES OF MERS

   A. A Weak Legal Foundation

   B. Separation of Mortgage from Note

   C. Use of Multiple "Corporate Officers "

   D. Foreclosure in the Name of MERS

   E. Transparency

   F. Loan Tracking Accuracy

III. FEATURES OF A NATIONAL MORTGAGE LOAN REGISTRY

   A. Federal Preemption

   B. What is Being Registered?

   C. Initial Recording of Mortgages

   D. Registration or Recording?

   E. Electronic Registration and Transfer and the Problem Of
   Document Authenticity

   F. Registration of Servicing

   G. Capturing the Entire Loan File

   H. Transparency

   I. Fees

   J. Notice of Registered Information

   K. A Bureaucratic Home

   L. The Holder in Due Course Doctrine

   M. Constitutionality

IV. CONCLUSION.

Appendix: Draft Statute


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The law of the United States governing transfers of mortgages on the secondary market and foreclosures by secondary market investors is in a dismal state. In this Article I propose to explore those deficiencies and to present a proposal for an alternate legal regime that I believe would be far more functional and efficient.

The need for such a system--a nationwide registry of mortgage ownership --has already been recognized. In its recent white paper, "The U.S. Housing Market: Current Conditions and Policy Considerations," the Federal Reserve Board commented:

   A final potential area for improvement in mortgage servicing would
   involve creating an online registry of liens. Among other problems,
   the current system for lien registration in many jurisdictions is
   antiquated, largely manual, and not reliably available in
   cross-jurisdictional form. Jurisdictions do not record liens in a
   consistent manner, and moreover, not all lien holders are required
   to register their liens. This lack of organization has made it
   difficult for regulators and policymakers to assess and address the
   issues raised by junior lien holders when a senior mortgage is
   being considered for modification. Requiring all holders of loans
   backed by residential real estate to register with a national lien
   registry would mitigate this information gap and would allow
   regulators, policymakers, and market participants to construct a
   more comprehensive picture of housing debt. (1)


Section I of this Article will discuss the traditional methods by which mortgages were traded on the secondary market in the United States prior to the mid-1990s and will attempt to illuminate why participants in the market found these methods lacking and generally discontinued using them. Section II will explain why and how MERS was set up in the mid-1990s and why it has largely failed to achieve the purposes which many envisioned for it. Section III will present an alternative to MERS--one that would not suffer from its deficiencies, and would achieve the results MERS could not accomplish. It will analyze the policy and legal questions that must be answered in creating such a new system. Finally, an appendix to this article will provide a draft of a statute that would create such a new system.

I. THE TRADITIONAL MORTGAGE TRANSFER PROCESS

Mortgage borrowers in the United States are nearly always asked to sign two documents, one of them an evidence of the obligation to repay the debt, and the other a security agreement encumbering the real estate. In former times, a bond was sometimes used as the debt instrument, but today a promissory note is virtually always employed. (2) The security instrument may be a mortgage, a deed of trust, or (in Georgia) a security deed. While these different names for security instruments may portend differences in foreclosure procedure, for most purposes of mortgage law they are treated as identical.

A. Separation of Note and Mortgage

Borrowers probably wonder why two documents are used instead of one. Why are the note and the mortgage not combined into a single document, as is usually done with consumer credit contracts? The reason is partly tradition, and perhaps partly that the drafter wished to make the note negotiable in order to take advantage of the Holder in Due Course doctrine (which permits the holder of the note to take free of many defenses that the maker might raise), and could not accomplish this negotiability if the terms of the mortgage were incorporated into the note. (3) Therefore, modern practice is to have two separate documents, (4) though on rare occasions in the past the two were incorporated together. (5)

However, the use of two documents raises a troublesome prospect: that they could be transferred to two different parties. As we will see, the courts labor diligently to prevent this result from occurring unless it is very clearly the intention of the transferor, and for good reason. If a legal separation of the note and mortgage occurs, the Comment in the Mortgages Restatement explains the results as follows:

   [Separating the obligation from the mortgage results in a practical
   loss of efficacy of the mortgage.... When the right of enforcement
   of the note and the mortgage are split, the note becomes, as a
   practical matter, unsecured. This result is economically wasteful
   and confers an unwarranted windfall on the mortgagor.

   It is conceivable that on rare occasions a mortgagee will wish to
   disassociate the obligation and the mortgage, but that result
   should follow only upon evidence that the parties to the transfer
   so agreed.
   The far more common intent is to keep the two rights combined.
   Ideally a transferring mortgagee will make that intent plain by
   executing to the transferee both an assignment of the mortgage and
   an assignment, indorsement, or other appropriate transfer of the
   obligation. But experience suggests that, with fair frequency,
   mortgagees fail to document their transfers so carefully. This
   section's purpose is generally to achieve the same result even if
   one of the two aspects of the transfer is omitted. (6)


Not only does the note become unsecured if the note and mortgage are separated, but "[t]he mortgage becomes useless in the hands of one who does not also hold the obligation because only the holder of the obligation can foreclose." (7) This outcome follows from the universally-agreed principle that "a mortgage may be enforced only by, or in behalf of, a person who is entitled to enforce the obligation the mortgage secures." (8) It is apparent that any situation that results in the holding of the note and mortgage by two independent parties is likely to prove bitterly frustrating to both of them - one because his or her obligation has become unsecured, and the other because she or he holds a mortgage that can never be foreclosed.

To accomplish what is nearly always the intended purpose of the parties, the Restatement thus provides that "[a] transfer of an obligation secured by a mortgage also transfers the mortgage unless the parties to the transfer agree otherwise." (9) The common way of expressing this principle is to say, "the mortgage follows the note." (10) Hence, a transfer of the note will transfer the mortgage with it automatically in the absence of a contrary agreement. On this point the Restatement is supported by a host of authority, (11) much of it taking an even stronger position: that it is legally impossible to separate the mortgage from the note, even by means of a contrary agreement. (12)

Suppose a mortgagee creates a situation in which holding of the note and mortgage seem to be bifurcated, by transferring the note to another but carelessly or malevolently retaining the mortgage or transferring it to a separate and independent party. What could the holder of the note do about it? If the holder of the mortgage refused to assign the mortgage to the noteholder voluntarily, the noteholder could bring an action in equity to compel such an assignment, (13) or simply apply to the equity court for a decree that the mortgage was deemed to be held for the benefit of the noteholder. (14) The noteholder could then foreclose the mortgage as readily as if he or she held a paper assignment of it. (15)

B. The Uses of Recorded Mortgage Assignments

If a person to whom a note, secured by a mortgage, is transferred without an accompanying assignment of the mortgage itself, can then foreclose the mortgage, what is the purpose of mortgage assignments? A quite plausible argument can be made that they are simply unnecessary, except perhaps as a quick and simple way to prove to a court that the note is indeed secured. But as it turns out, mortgage assignments, particularly if they are recorded in the public land records, have their purposes. There are, I suggest below, four grounds on which a secondary mortgage market investor might decide that it is worthwhile to obtain and record a mortgage assignments. Before considering them, however, we need to take a closer look at the recording process itself.

1. The Recording System and Mortgage Assignments

Recording in America is a unique institution, and is quite different than the system of title registration employed in most other developed countries. Recording a document that conveys or creates an interest in land places it in the public domain, where anyone who wishes (and who knows how to locate it) can find and read it. Hence, in general, recorded documents are deemed to give constructive notice of their contents to anyone who acquires a subsequent interest in the same land. Thus, a conveyee who records his or her conveyance can be sure that the conveyor cannot later "pull the rug out from under" the conveyee by making a competing conveyance to someone else. On the other hand, if a conveyance is not recorded, the conveyor can do exactly That--provided that the subsequent and competing conveyee qualifies under the particular recording by being a bona fide purchaser, recording his or her own document first, or both.

Because conveyees have a strong incentive to record, most conveyances are in fact recorded. This makes it possible, in most cases, for a person who is about to acquire an interest in land to perform a "title search" in the public records, finding the chain of title (which in theory will extend back to some sovereign owner) and ensuring that no holder in that chain of title made an "adverse" conveyance to someone outside the chain before creating the next link in the chain.

But one must not place too much confidence in recording or in searching titles. There is no assurance whatever that, merely because a document is recorded, it is valid. It might be a forgery, or for any number of other reasons be ineffective. In addition, there are numerous types of rights or interests in land--title by adverse possession is one example--that can arise without being documented, and hence without being recorded. Finally, there is no requirement that anyone record a conveyance of land that she or he receives, and conveyances are perfectly valid as between their parties without recording --although they are at risk of being made void by a later competing conveyance from the same conveyor, as explained above. For all of these reasons, the popular notion that one can always find out who owns interests in land by performing a title search in the public records is fraught with serious fallacies. (16)

So how do these general principles affect mortgage assignments? It is perhaps best to begin by identifying what a recorded mortgage assignment does not do--in addition to its being unnecessary to the noteholder's right to foreclose. As we have already seen, the assignment, recorded or not, is not essential to a completed transfer of the note and mortgage between the mortgagee and a transferee, or between successive transferees. (17) Likewise, a recorded assignment provides no notice to the mortgagor that his or her obligation has been transferred, and that it is now necessary to begin paying a new party. (18) This situation follows for the simple reason that to suppose otherwise would require us to assume that mortgagors will examine the public records before making each payment on their loans--an absurd burden that no sensible court would inflict on borrowers.

Similarly, the recording of mortgage assignments is likely to have little significance in a case in which the same mortgagee executes and delivers two or more competing assignments of the same mortgage. The recording acts may determine which of assignees is regarded as holding the legal interest in the real estate security, but under the principles already discussed, whoever wins that battle can expect to have the holder of the note successfully demand the mortgage as well. Under U.C.C. Article 9, a purchaser (19) of an instrument (that is, a promissory note, whether negotiable or not (20)) can acquire ownership by complying with the following rules, as recently summarized by the Permanent Editorial Board of the U.C.C.: (21)

   Section 9-203(b) of the Uniform Commercial Code provides that three
   criteria must be fulfilled .... The first two criteria are
   straightforward--"value" must be given (22) and the debtor/seller
   must have rights in the note or the power to transfer rights in the
   note to a third party.... (23) The third criterion may be fulfilled
   in either one of two ways. Either the debtor/seller must
   "authenticate" (24) a "security agreement" (25) that describes the
   note (26) or the secured party must take possession (27) of the
   note pursuant to the debtor's security agreement. (28)


Thus, either a delivery of possession of the note or the execution of a written document of assignment of the note will serve to transfer its ownership. And under U.C.C section9-203(g), the transfer of "a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest (29) in the security interest, mortgage, or other lien." This provision is, of course, reminiscent of the common law principle that the mortgage follows the note. (30) Hence, which of the competing holders of mortgage assignments will prevail under the recording act is likely to be irrelevant in practical terms; the transferee of ownership of the note, as determined by Article 9, will have the benefit of the mortgage as well. (31)

If the foregoing are not persuasive reasons to record mortgage assignments, what incentives exist for market participants to record their ownership on a current, timely basis? The next four subsections will discuss plausible reasons to record.

2. Prevention of Fraud by the Transferor

This reason for recording a mortgage assignment is based on the notice-giving effect of recording mentioned above. If an original mortgagee transfers the note, but there is no recorded mortgage assignment, it appears on the public records as if the mortgagee still holds the mortgage. This appearance opens an opportunity for the mortgagee to engage in a variety of fraudulent but potentially successful tricks, in cahoots with the mortgagor.

For example, the mortgagee may issue and record a satisfaction of the mortgage, allowing the mortgagor to sell the property free and clear of the encumbrance to a bona fide purchaser or to remortgage it for a new loan. (32) He or she may subordinate the mortgage to a subsequent lien obtained in good faith, thereby greatly reducing the value of the mortgage as security, or may even foreclose the mortgage, obtain title, and sell the land to a bona fide purchaser. (33) In each of these cases (and several other variations on them), the courts have held that a bona fide purchaser or secured creditor of the real estate, relying on the apparent state of the title, will prevail over the holder of the mortgage debt. The facts that the note may be negotiable and that the noteholder may be a Holder in Due Course are irrelevant. In all of these cases, the recording of a mortgage assignment would have prevented the mortgagee from perpetrating the fraud, because it would have made it obvious on the face of the public records that the original mortgagee no longer had any authority to deal with the land.

Is this risk (assuming secondary market mortgage investors and their counsel are aware of it) enough to convince them to record mortgage assignments? Practically speaking, probably not. Essentially, the jeopardy here is that the mortgage originator will become a criminal and turn to fraud. While such cases have occurred and will doubtless occur in the future, (34) they are probably quite rare. Most lawyers would, of course, warn their clients to record assignments in order to mitigate this risk, but many clients would likely conclude that doing so was not worth the trouble and expense. (35)

3. Assurance of Receiving Notice of Legal Proceedings

The notice-giving effect of recording, discussed above, applies not only to provide notice to persons who acquire subsequent interests in the land but those who file suits or other legal proceedings against it as well. Suppose a secondary market investor buys a mortgage loan, but records no assignment. Then a suit is filed that could jeopardize the validity or priority of the mortgage. One obvious example is a foreclosure of a mortgage senior to the one in question. The plaintiff in that foreclosure action performs a title examination, discovers the identity of the original mortgagee or previous holder of the mortgage, and makes service of process on that party. The actual (but unrecorded) holder of the mortgage gets no direct service (because there is no obvious way for the plaintiff to identify the holder), and may or may not learn of the suit from the party who was actually served.

This is precisely what occurred in Fifth Third Bank v. NCS Mortgage Lending Co. (36) In Fifth Third Bank an Ohio court found the judgment binding on the secondary market investor, which had never learned of or entered an appearance in the litigation, despite its claim that it had instructed its predecessor to record an assignment of the mortgage--an act that was "inexplicably" never done. (37) Because most secondary market investors use independent servicers to manage their mortgage portfolios, an investor may prefer to have a recorded assignment run to its servicer rather than itself. In this way, any notice issued will find its way directly to the entity that is responsible for the loan, rather than having to take the circuitous route of going first to the investor, who will then need to notify the servicer. But in Fifth Third Bank, no assignment at all was recorded, and hence no notice was directed either to the investor or its servicer. (38)

Alternatively, the investor may prefer to have an assignment recorded to MERS, the Mortgage Electronic Registration Systems, about which we will have much more to say later. MERS is merely a nominee for the investor, but it operates a "mail room" function, keeping a record of all investors and servicers, and redirecting to the relevant servicer any notice that it receives with respect to a particular mortgage. Unfortunately, this notion is not foolproof, for it depends on the courts taking the same view of MERS that MERS itself takes. In Landmark National Bank v. Kesler, (39) the original mortgagee named in the junior mortgage was MERS, as nominee for the actual lender. The senior mortgagee filed a foreclosure action, but never served either MERS or the junior lender, and a default judgment was entered against both of them, wiping out the second mortgage. (40) The Kansas Supreme Court found no error in the trial judge's refusal to set aside the default judgment against the junior mortgagee because there was no assignment to it in the public records, (41) and against MERS because it was merely a nominee, had advanced no funds under the mortgage loan, and was therefore not a real party in interest. (42) This result may seem like the ultimate "Catch-22," but it illustrates starkly how failing to record an assignment to the right party can leave a mortgage investor exposed to the drastic losses that may flow from failure to get notice of pending litigation.

Foreclosures of prior mortgages are not the only examples of this risk. Other possibilities include an eminent domain action, a government forfeiture proceeding, (43) a quiet title action, or an action to enforce a zoning, housing code, or building code infraction. It is obviously in the interest of a mortgage holder and its servicer to get immediate notice of such suits because they can have a powerful effect on the value of the real estate collateral. However, suits of all these kinds are relatively rare. Protection against them, like protection against foreclosures of prior liens, may well be an insufficient incentive to convince secondary market investors to record mortgage assignments.

4. Recordation of Assignments as a Practical Necessity for Future Title Examiners

Another reason to record mortgage assignments might be to serve the title industry and the system of records on which it depends. When a mortgage is foreclosed future title examiners may want to be able to locate a complete and recorded chain of title establishing that the party foreclosing the mortgage is the person with the right to do so. Otherwise, title examiners may say, they will be faced with cases in which A mortgages land to B, and some time later C forecloses and a foreclosure deed is delivered to D. The problem is that it is not apparent on the face of the land records why C had the right to foreclose.

While this argument seems plausible, in reality it is highly dubious, and assignments based on it are almost certainly unnecessary. To show why this is so, we need to consider each of the three types of foreclosure processes that are common in the United States.

First, consider a judicial foreclosure. Here, the court's foreclosure order implies that the judge has verified under oath that the party seeking foreclosure has demonstrated the right to enforce the note. As we have already seen, (44) under traditional mortgage law, having the right to foreclose depends on holding the obligation represented by the note, not on having an assignment of the mortgage, recorded or not. Leaving aside for a moment the question of exactly what evidence the judge will demand before ordering a foreclosure, (45) if the judge concludes that the right person--namely, the person with the right to enforce the note--is foreclosing, that conclusion can be the end of the inquiry. Assuming that the time for any possible appeal of the court's order has run, it is res judicata and can be relied upon by any future title examiner. (46) Hence, the existence of a chain of assignments is irrelevant.

Second, suppose the security instrument is a deed of trust, foreclosed by trustee's sale. In this setting the trustee (or a substitute trustee, if there is a recorded substitution) is literally the titleholder, and if the trustee forecloses, it can be presumed (and there is often a statutory presumption) (47) that the trustee is acting on the instruction of the proper beneficiary. This presumption is valid whether the beneficiary is the original noteholder or a subsequent transferee from the original noteholder. (48) If the trustee can be relied upon to make this determination--much like the judge in a judicial foreclosure--then as with judicial foreclosure, the existence of a recorded assignment or chain of assignments should be unnecessary to future title examiners. (49) Such reliance is a fundamental premise of foreclosure by trustee's sale.

A third possible foreclosure mode is non-judicial foreclosure of a mortgage. In nine states, mortgagees and their successors may exercise a direct power of sale. (50) No deed of trust is involved, and there is no trustee to exercise independent judgment. In this setting, if the mortgage is sold on the secondary market and then foreclosed, and if there is no recorded assignment, it is literally a case of A (the mortgagor) to B (the mortgagee) and C (the secondary market holder to D (the foreclosure purchaser), with nothing in the public records to connect B to C. (51) Some members of the title industry seem to argue that a recorded assignment is essential in this setting, (52) but this argument is unconvincing. Proof of the existence of a recorded assignment or chain of assignments proves nothing about whether the foreclosing party held the promissory note at the time of the foreclosure, and it is the holding of the note that gives one the right to foreclose. If any recorded evidence is needed, it is evidence as to who holds the note, but no American jurisdiction seems to require recording of evidence of transfer of the note as a condition of the right to foreclose. (53)

In sum, the comfort provided to title examiners by chains of assignments in mortgage foreclosures is illusory. If the note is negotiable, the important question is whether the foreclosure was done by the person entitled to enforce the note--a status which, as I will discuss in detail below, usually depends on physical possession of the note. (54) Finding a mortgage assignment is no proof at all that the note was not previously assigned to someone else. Thus, a recorded chain of assignments may make a subsequent title examiner feel good, but it is weak evidence on which to rely. Its supposed benefits to title examiners are likely insufficient to induce mortgage investors to record.

5. Recordation of Assignments as a Statutory Prerequisite to Foreclosure

By statute, eleven states require the existence or recordation of a chain of assignments from the originating mortgagee to the foreclosing party as a prerequisite to foreclosure. (55) They include California, (56) Georgia, (57) Idaho, (58) Maine, (59) Massachusetts, (60) Michigan, (61) Minnesota, (62) Nevada, (63) Oregon, (64) South Dakota, (65) and Wyoming. (66) In all cases except Maine, these statutes apply only to non-judicial (power of sale) foreclosure. (67) However, why a chain of assignments should be required is not made clear by the statutes. In fact, the requirement seems a bit more logical in states which do not consider the mortgage to follow the note automatically, but instead authorize the foreclosure court to declare that the mortgage is held in trust for the benefit of the noteholder, because in a non-judicial foreclosure there is no court to make that declaration. (68) Oddly, several other states using non-judicial foreclosure have held, by case law or statute, that a chain of assignments is not essential to a proper foreclosure. (69)

Overall, it is doubtful that there is any sensible rationale for a statutory requirement of a chain of mortgage assignments. Indeed, such a requirement can be mischievous and produce dramatically unfair results if no assignment was given when the loan was sold, and by the time foreclosure occurs it is practically impossible to obtain one. Consider Euihyung Kim v. JP Morgan Chase Bank, (70) decided in Michigan, which has such a statute applicable to non-judicial "foreclosure by advertisement." In that case the originating mortgage lender had been taken over by the Federal Deposit Insurance Corporation ("FDIC") as receiver, and the FDIC in turn had sold all of the lender's loans, including the mortgage in question, to JP Morgan Chase pursuant to a blanket "Purchase and Assumption Agreement." (71) Hence, there was no individual assignment of the mortgage for JP Morgan to record. The court found the foreclosure void, (72) which is an absurd result but one the court thought mandated by the statute. Of course, the bank could now foreclose judicially, but the runaround seems pointless. What would a recorded assignment prove about the bank's right to foreclose? Nothing at all, but it would satisfy the statute.

6. Conclusion: What are Assignments Worth?

As we have seen above, a recorded assignment or chain of assignments of a mortgage can provide two valuable benefits to the mortgage's holder: (1) protection against a fraudulent discharge or further encumbrance by a prior holder of the mortgage; (73) (2) assurance of receiving notice of the filing of a suit that might affect the holder's rights. (74) A third supposed benefit is confidence that a foreclosure of the mortgage will appear in the public records to be credible in the eyes of future title examiners. (75) But as we have seen, belief in this "benefit" is entirely misplaced, for a recorded assignment actually provides no significant value to title examiners at all. Finally, to carry out a valid non-judicial foreclosure in some states, a chain of assignments may be absolutely mandatory by statute, whether this makes any sense in terms of good policy or not. (76) Outside the eleven states with such statutes, the incentive for investors to record mortgage assignments is really quite weak.

Note that only the first two benefits of recording mortgage assignments mentioned above require current, timely recordation when transfers occur. The "chain of title" rationale (even if one accepts it) and the statutory mandates to record apply only when there is a foreclosure or payoff of the loan. For this reason, many secondary market investors have long followed the practice of obtaining assignments, but not bothering to record them at the time of acquisition of the loan. More than 25 years ago, two knowledgeable commentators wrote:

   Although assignments] must be executed and delivered, recordation
   for some buyers [of mortgage loans] is not necessary unless it is
   required by law to perfect the buyer's ownership interest or is
   commonly required in the region by other mortgage buyers. (77)


Fannie Mae and Freddie Mac continue, to this day, not to require current recording of assignments of the non-MERS mortgages that they purchase, (78) and most other investors probably do the same. (79) Of course, a secondary market investor that delays or omits recording of assignments is taking some risk by foregoing the first two benefits mentioned above, but the proportions of that risk may seem quite trivial in comparison to the trouble and expense of immediate recording. (80)

In light of this long-standing practice, a great deal that has been written about mortgage assignments is nonsense. Here is an illustration:

   If borrowers receive a notice in the mail indicating that their
   mortgage has been transferred, they should call their lenders to
   confirm the sale and ask who the mortgage was sold to. It is also
   advisable to check the records office to confirm that an assignment
   of the mortgage has been followed. (81)


This author has expressed a fond wish, but the probability that a borrower could confirm the transfer of the mortgage by checking the public records is naive and completely unrealistic. Another author, condemning the impact of MERS on the public records system, wrote:

   When half of the nation's mortgages are recorded under the name of
   one company [MERS] that does not publish its own records, the
   public's ability (including both consumers and lenders) to use
   public records to evaluate who owns real property interests will
   inevitably decline. (82)


The problem with this statement is that long before MERS was created in 1993, the ability to use the public records system to determine who holds mortgages was lost, a victim of the widespread decisions of secondary market investors not to record mortgage assignments on a current basis. (83)

Here is one more illustration, taken from a complaint filed by an Ohio county prosecutor against MERS and a large group of mortgage lenders and servicers:

   Defendants systematically broke chains of land title throughout
   Ohio counties' public land records by creating gaps due to missing
   mortgage assignments they failed to record, or by recording
   patently false and/or misleading mortgage assignments ....

   ...Defendants' purposeful failure to record each and every
   mortgage assignment has resulted in far-reaching, devastating
   consequences for Ohio counties and their public land records--
   damage to public records that may never be entirely remedied. (84)


All of the statements quoted above reflect a major misconception concerning the information that the public records system can be expected to adduce. Those records have never been a reliable basis for discovering who holds a mortgage loan. The incentives necessary to induce market participants to record their ownership of mortgages on a current basis simply do not exist, and in any event, evidence of ownership of a mortgage proves nothing about holding of the note. The only way for a borrower to be certain who holds his or her note, if it is negotiable, is to demand that the purported holder exhibit the original document--a demand that is completely impractical from the viewpoint of all parties because the note, if it continues to exist, is probably in the vault of some remote custodian.

This is not to say that creation of a system that actually tracks mortgage loan ownership and the holding of notes, and provides transparent access to that information to the public, would not be desirable. It is merely to say that the real estate recording system does not do, was not designed to do, and can not be expected to do that job. (85) Criticisms based on the failure of MERS or mortgage investors to make it do so are simply silly.

C. Transfer of the Note

As the foregoing discussion shows, the critical thing a secondary market mortgage purchaser needs and wants is the note. Although mortgage assignments have their uses, the mortgage will follow the note and can be foreclosed by its holder, with or without an assignment. I have dealt with mortgage assignments above in considerable detail, simply because so little that is useful has been written about them in the context of the modern secondary market. This is not the case with transfers of notes, so the treatment of notes here can be much briefer. To a great extent, it is covered accurately and thoroughly in a report issued by the Permanent Editorial Board of the Uniform Commercial Code in November, 2011, (86) (hereafter "the PEB report"), which I will rely on heavily here.

Hence, this section will provide a brief outline of the way U.C.C. Article 3 impacts mortgage notes. It will then consider the strange cases in several states that seem to disregard Article 3's requirements in non-judicial foreclosures.

1. Summary of Article 3's Effect on Mortgage Notes

The legal principles applicable to transfer of a note hinge on one critical fact: is the note negotiable or not? Both Article 3 and Article 9 of the UCC apply to notes, but they do not apply to all mortgage notes with equal force. Article 9 deals with the way sales and security transfers of notes occur. It governs ownership of notes, as well as security interests in ownership rights. It plainly applies to all mortgage notes, whether they are negotiable or not. (87)

Article 3, on the other hand, governs not ownership but "entitlement to enforce" a note--a quality that certainly sounds as though it is the thing that mortgage investors and their servicers want and borrowers need to know about (88)--and by its terms Article 3 applies only to negotiable notes. (89) The distinction drawn in the Code between owning a note and being entitled to enforce it seems strange at first blush, but it is actually quite useful. The two concepts are distinct, and unfortunately, confusing them has produced a good deal of imprecision and nonsense in briefs and judicial opinions.

Entitlement to enforce a note means that a party can sue on it or (if other applicable foreclosure requirements are met) foreclose the mortgage that secures it. The maker of the note (the mortgagor, in the case of a mortgage note) is the party most concerned with who is entitled to enforce the note, for the concept is designed to protect the maker against having to pay twice or defend against multiple claims on the note. If the maker pays in full the person entitled to enforce the note, the note is discharged and the mortgage that secures it is extinguished. (90) Ownership of the note, on the other hand, is a concept that deals with who is entitled to the economic fruits of the note--for example, who is entitled to the proceeds if it is enforced or collected. (91) In the mortgage context, one obvious application of the distinction is that servicer of a mortgage in a securitized pool might well be entitled to enforce the note (if it met the applicable requirements of Article 3), but the trustee of the securitized trust, as owner, would be entitled to have the proceeds of the enforcement action remitted to it. One court, which got it exactly right, explained as follows:

   Under established rules, the maker should be indifferent as to who
   owns or has an interest in the note so long as it does not affect
   the maker's ability to make payments on the note. Or, to put this
   statement in the context of this case, the [borrowers] should not
   care who actually owns the Note--and it is thus irrelevant whether
   the Note has been fractionalized or securitized--so long as they do
   know who they should pay. (92)


Article 3 says nothing at all about nonnegotiable notes, which are left to the common law of contracts. (93) This seems simple enough, but it is problematic, because it can be extremely difficult to determine with certainty whether a note is negotiable or not. The definition of negotiability is complex and technical, and for many mortgage notes, arguments can plausibly be made either way. (94) The courts often seem to assume that mortgage notes are negotiable and are covered by Article 3, but only rarely do they actually analyze the note language to determine whether negotiability exists. In particular, there are few judicial opinions that thoroughly and competently examine the negotiability of the standard Fannie Mae/Freddie Mac one-to-four-family residential mortgage note, although recent cases that do so seem to be running in favor of its negotiability. (95)

Hence, it is often unclear which body of law governs mortgage notes--Article 3 or the common law. This is a fundamental structural problem with the present law that must be dealt with if we are ever to have clarity. (96) The proposal presented later in this Article will address the point.

For the moment, let us assume (as the courts usually do) that we are dealing with a negotiable note. If this is the case, the PEB Report clearly explains how a party can become entitled to enforce the note. The methods are described here only superficially, and the reader is directed to the PEB Report (and Article 3 itself, of course) for the details and relevant citations. In brief, there are three ways:

1. Becoming a holder (97) This will occur if the note has been delivered to and is in the possession of the person enforcing it, with an appropriate endorsement (either in blank - which makes the note a "bearer note," or specially --an endorsement that specifically identifies the person to whom the note is delivered). These actions will constitute the person who takes the note a "holder," entitling him or her to enforce the note. (98)

2. Becoming a nonholder who has the rights of a holder." (99) This will occur if the note has been delivered to and is in the possession of the person enforcing it, but without an endorsement. In the absence of an endorsement, the person taking delivery cannot be a holder, but can still get the right of enforcement if the delivery was made for the purpose of transferring that right. (100)

3. Providing a "lost note affidavit. " Under section 3-309, a person who does not qualify to enforce the note under (1) or (2) above because of a lack of possession may still enforce it by providing a "lost note affidavit." (101) However, the requirements for the affidavit are quite strict: the note must have been destroyed, its whereabouts not discoverable, or it must be in the wrongful possession of an unknown person or one who cannot be served. Before accepting such an affidavit, a court might well demand evidence as to the efforts that have been made to locate the note. In addition, the court can require the enforcing party to provide assurance (typically in the form of a bond) against the possibility that the borrower will have to pay twice. (102)

Fannie Mae and Freddie Mac have developed careful procedures for maintaining custody of mortgage notes, (103) and lost notes are rare for loans they hold. But other secondary market investors have not been so scrupulous, and it is all too common in foreclosure cases that neither the investor nor a custodian designated by it has possession of the note. Hence the lost note affidavit procedure is extremely important. (104) There is little doubt that in some sections of the country it has been the subject of serious abuse, with foreclosing parties using it not because the original note was impossible to find, but merely because it was inconvenient. Prior to the 2002 amendments to section 3-309, some courts took the view that the party attempting to enforce the note had to aver that it lost the note itself, a loss of the note by its predecessor (for example, the originator of the note) would not count. (105) This narrow interpretation of section 3-309 was expanded by the 2002 amendments to Article 3, the current version of which allows a person to enforce the note if he or she "has directly or indirectly acquired ownership of the instrument from a person who was entitled to enforce the instrument when loss of possession occurred." (106) But the 2002 amendments have been adopted in only ten states, so in much of the nation a secondary market investor may still be in serious trouble if the note was lost or destroyed by its predecessor. (107)

To return to the first two methods of becoming "entitled to enforce" described above, while they require that the enforcing party possess the note, (108) they do not literally insist that the note be produced in court. Conceivably, the foreclosing party could prove that it had possession of the note by other means, such as oral testimony or affidavits. (109) But one can easily see why courts in judicial foreclosure states often demand that the note itself be produced; if you have the note, why not show it to the judge? (110)

2. Non-judicial Foreclosure Decisions that Disregard Article 3

In states where non-judicial foreclosure is used, the situation becomes more complex. There is no judge to show the note to, unless a suit is filed to enjoin or set aside the foreclosure. If the security instrument is a deed of trust and a trustee conducts the foreclosure, one might assume that the trustee should, at a minimum, determine whether the note is negotiable (perhaps by reviewing a photocopy), and if it is, demand to see the original document or a lost note affidavit. In reality, it is doubtful that this inspection occurs on any regular basis, although I am aware of no evidence on the point. (111)

In light of the discussion of UCC Article 3 requirements discussed above, it may seem perfectly obvious that only a party who is "entitled to enforce" a negotiable note can foreclose the deed of trust that secures it. After all, what could be a plainer example of enforcing a note than a proceeding to foreclose the security attached to it? This view is routine in judicial foreclosures, and in non-judicial proceedings as well in some states. (112) Yet rather remarkably, a large number of federal courts dealing with non-judicial deed of trust foreclosures from 2007 to 2012 in Arizona, California, Hawaii, Idaho, Nevada, Virginia, and Texas have held the contrary: no one--neither the trustee conducting the foreclosure sale nor a court reviewing the foreclosure need be satisfied that that the party instituting the foreclosure holds the note! (113) One federal judge in Idaho disagreed and required compliance with Article 3, distinguishing the other federal cases on the sketchy ground that they deal with the foreclosure procedure, but not with the foreclosing party's right to initiate that procedure. (114)

Four state appellate court decisions on this point have come down during late 2011 and 2012, and they largely agree with the federal cases mentioned above that disregard Article 3. In the first, Residential Funding Co. v. Saurman, the Michigan Supreme Court held that MERS, as holder of a mortgage in the capacity of nominee for the noteholder, could foreclose in its own name despite not holding the note. (115) The reasoning of the opinion is astonishingly garbled:

   [A]s record-holder of the mortgage, MERS owned a security lien on
   the properties, the continued existence of which was contingent
   upon the satisfaction of the indebtedness. This interest in the in
   debtedness--i.e., the ownership of legal title to a security lien
   whose existence is wholly contingent on the satisfaction of the
   indebtedness--authorized MERS to foreclose by advertisement under
   MCL 600.3204(1)(d). (116)


It is clear that the court intended to uphold MERS-name foreclosures, and was willing to engage in certain amount of verbal nonsense in order to do so. In any event, the net result is that an assignee of the mortgage need not show that it holds the note to foreclose non-judicially in Michigan. (117) The decision betrays no awareness whatever of the demands of UCC Article 3.

In Hogan v. Washington Mutual Bank, (118) the Arizona Supreme Court held that "the deed of trust statutes impose no obligation on the beneficiary to 'show the note' before the trustee conducts a non-judicial foreclosure." (119) While this may seem to ignore the requirements of UCC Article 3, "[t]he trust deed statutes do not require compliance with the UCC before a trustee commences a non-judicial foreclosure." (120) These statements may seem extreme, but perhaps they are only about the burden of going forward with evidence. The court pointed out that the borrower "has not alleged that [the lenders] are not entitled to enforce the underlying note; rather, he alleges that they have the burden of demonstrating their rights before a non-judicial foreclosure may proceed. Nothing in the non-judicial foreclosure statutes, however, imposes such an obligation." (121) Suppose the borrower had alleged in the complaint that the assignee of the deed of trust lacked possession of the note; (122) would the court have compelled the assignee to produce it? Of course, if this is the court's position it seems nonsensical; it effectively requires the borrower to bring a lawsuit in order to make such an allegation, and then places the burden of producing evidence as to possession of the note on the borrower--the party least likely to have any information or knowledge on the subject. The court's handling of this issue is, to put it mildly, unsatisfactory.

The Idaho Supreme Court took a far more radical view of a trustee's power to foreclose a deed of trust in Trotter v. Bank of New York Mellon. (123) The borrower asserted that the foreclosing party (the trustee of a securitized trust) was obliged to establish its standing to foreclose by proving that it held the loan. (124) The court was unimpressed;

   nothing in the text of the statute can reasonably be read to
   require the trustee [of a deed of trust] to prove it has 'standing'
   before foreclosing. Instead, the plain language of the statute
   makes it clear that the trustee may foreclose on a deed of trust if
   it complies with the requirements contained within the Act." (125)


The Act, in turn, has only five requirements: (1) any assignments of the deed of trust or substitutions of trustee has been recorded, (2) there is a default by the borrower, (3) an appropriate notice of default has been recorded, (4) no suit on the debt is pending, and (5) a notice of sale has been given to the proper parties. (126) Taking literally the bare-bones nature of these requirements, the court reached a truly bizarre conclusion: "a trustee may initiate non-judicial foreclosure proceedings on a deed of trust without first proving ownership of the underlying note or demonstrating that the deed of trust beneficiary has requested or authorized the trustee to initiate those proceedings." (127)

Finally, in Debrunner v. Deutsche Bank National Trust Co., (128) the California Court of Appeal fully endorsed the federal cases mentioned above that construe California law. Quoting earlier California authority holding that the foreclosure statute sets forth "a comprehensive framework for the regulation of a non-judicial foreclosure sale pursuant to a power of sale contained in a deed of trust," (129) the court explicitly rejected the notion that the "person entitled to enforce" provisions of UCC Article 3 played any role in establishing the right to foreclose. (130) "[W]e are not convinced," the court said, "that the cited sections of the Commercial Code (particularly section 3301) displace the detailed, specific, and comprehensive set of legislative procedures the Legislature has established for non-judicial foreclosures." (131)

Most of the remaining state courts in non-judicial foreclosure jurisdictions have thus far generally remained silent on the point, and a few have taken the opposite approach, reading their statutes to require possession of the note. (132) But the decisions discussed above, both federal and state, are extremely troublesome. They either completely ignore UCC Article 3 or give it very short shrift; in effect, they seem to hold that the state's foreclosure statutes supersede the Uniform Commercial Code, although most of them do not analyze that issue in any rigorous manner. In essence they rely on the literal language of the foreclosure statutes, and assume that no requirement found anywhere else in the state's codes is relevant.

In addition to the issue of standing to foreclose discussed above, the "lost note" problem mentioned earlier assumes a very different cast in non-judicial foreclosure states. There is no court to which the lender or beneficiary of the deed of trust can present the affidavit, nor any mechanism in most non-judicial foreclosure jurisdictions for requiring the posting of a bond by the lender to protect the borrower against having to pay twice. (133) The effect is to render the "adequate protection" provisions of UCC 3-309 meaningless unless the borrower is willing to file a lawsuit.
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Title Annotation:Abstract through I. The Traditional Mortgage Transfer Process C. Transfer of the Note 2. Non-judicial Foreclosure Decisions That Disregard Article 3, p. 1-36; Mortgage Electronic Registration System
Author:Whitman, Dale A.
Publication:Missouri Law Review
Date:Jan 1, 2013
Words:8574
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