Adam Brown | Bloomberg Law In 2008, a decade-long housing bubble fueled by the growth of mortgage securitization finally burst, and the United States fell into a deep recession. Tightening credit markets, plummeting home values, and increased unemployment led to a massive increase in residential foreclosures, particularly among subprime borrowers. Although current foreclosure activity is down at least 14 percent from a year ago, with one in every 579 units subject to a filing, the foreclosure pipeline remains full.1 An estimated 14 million distressed properties (1.5 million already in the foreclosure process and another 3.5 million with delinquent mortgages) must be absorbed by the housing market before foreclosure rates can return to historical norms.2 The abundance of foreclosure actions have given courts from virtually every state an opportunity to weigh in on various aspects of the business model developed by Mortgage Electronic Registration Systems, Inc., and its parent company MERSCORP, Inc. (collectively, MERS). Originally established to track mortgage loan assignments electronically, MERS has become one of the most recognizable faces of the foreclosure crisis despite the fact that courts, academics, and regulators continue to struggle to define its role in the foreclosure process. MERS has had some favorable court rulings in the past year. Nevertheless, its litigation record is far from perfect, and significant questions remain in many states regarding the proper scope of MERS's authority. This article will (1) provide a brief background regarding the MERS model, (2) examine some of the significant 2011 rulings that exemplify the types of problems courts continue to encounter in trying to understand MERS and defining the boundaries of its rights and authority, and (3) discuss a new wave of lawsuits being filed against MERS by various counties and states.
MERS and Its Role in the Mortgage Lending ProcessMortgage loans consist of two components—the promise to repay (i.e., the note) and the security instrument (i.e., the mortgage or deed of trust, herein collectively referred to as the mortgage).3 The note recites the specific terms of the loan and serves as proof of the borrower's indebtedness to the noteholder. By contrast, the mortgage secures the property pledged as collateral for the loan.4 Whereas the notes may be transferred or assigned with relative ease, mortgages are subject to the requirements of state recording statutes, meaning the original mortgage and any subsequent sale or assignment thereof must be recorded in the county records before the mortgagee's lien against the property is perfected. MERS, which counts various banks and lending institutions among its major shareholders, is an electronic mortgage registration system and clearinghouse which electronically tracks the beneficial ownership interests in and servicing rights of mortgage loans.5 It was created in the mid-1990s to facilitate the growing business of mortgage securitization—the pooling of mortgages into a trust and selling of the beneficial rights to the income in the secondary market as mortgage-backed securities (MBS). As securitization increased, MBS participants began to view the traditional recording process as too antiquated and cumbersome to handle such a high volume of trades.6 MERS was designed to minimize recording obligations for its members. When a residential loan is originated, the borrower and the lender agree to designate MERS as both the nominee for the lender (and any successors or assigns) and the beneficiary under mortgage.7 As the beneficiary, MERS holds legal title to the mortgage, which allows any subsequent sale of that loan to be tracked internally by MERS (as long as the buyer is a MERS member), rather than through the public records.8 Only when the beneficial interest in the loan is sold to a non-MERS member is the mortgage transferred out of the MERS system and recorded in county records. In effect, MERS was set up as a shell company—until recently it had only 65 true employees—to serve as the nominal owner of all mortgages held by its members.9 Once MERS holds the mortgages, its members may buy and sell the accompanying notes as many times as they want without triggering an obligation to record—a favorable system for participants in the securitization market since it purports to avoid payment of county recording fees. According to the standard language in MERS mortgage loan documents, upon a default, the then-current noteholder has a choice: it can direct MERS to assign the mortgage back to it and initiate foreclosure in its own name, or it can designate MERS a trustee with the power to carry out the foreclosure on the lender's behalf. With respect to the latter option, however, in order for MERS to have the power to foreclose, [it] must have authority to act as the holder, or agent of the holder, of both the deed and the note together. The deed and note must be held together because the holder of the note is only entitled to repayment, and does not have the right under the deed to use the property as a means of satisfying repayment. Conversely, the holder of the deed alone does not have a right to repayment and, thus, does not have an interest in foreclosing on the property to satisfy repayment.10 For this reason, some of the earliest cases against MERS argued that by splitting the note and the mortgage—with the lender or the lender's assignee holding the note and MERS holding the mortgage—the MERS model violates the long-standing rule still applicable in most jurisdictions that mortgages and deeds of trust cannot be separated from their underlying notes.11 The typical security agreements used by mortgagee banks state that MERS is both a "separate corporation that is acting solely as the nominee for the Lender and Lenders successors and assigns" and the "mortgagee" under the security agreement.12Thus, MERS seemingly claims to be acting as both nominee and actual mortgagee with authority to record mortgages in its own name. Questions regarding MERS's true status have spawned an enormous number of cases against the company across all jurisdictions. If MERS is the true mortgagee of all of its members' loans, then its system potentially violates the rule against separating mortgages from their notes. If MERS is merely an agent or nominee for the lender, then it is unclear whether MERS has the authority to name itself as the mortgagee or beneficiary of a mortgage for recording purposes or to foreclose on behalf of its members when a borrower defaults.
Significant Decisions from 2011— Cervantes v. Countrywide Home Loans Two recent decisions, one from the Ninth Circuit and one from the District of Arizona, add to the growing weight of authority rejecting the MERS-as-mortgagee theory. Cervantes was a putative class action filed in Arizona federal court by three borrowers who had signed promissory notes with their lenders and executed deeds of trust in favor of their lenders naming MERS as the "beneficiary" and the lenders' "nominee." After each plaintiff defaulted on their loan, their lenders or the lenders' appointed trustees initiated non-judicial foreclosure proceedings against them. Plaintiffs subsequently commenced an action against their lenders and MERS asserting a conspiracy to commit fraud against unsuspecting borrowers, violations of the Truth in Lending Act (TILA), 15 U.S.C. § 1601, and the Arizona Consumer Fraud Act, Ariz. Rev. Stat. § 44-1522, and intentional infliction of emotional distress. The district court dismissed those claims, and the ruling was affirmed on appeal on grounds that were not particularly noteworthy.13 What was significant was the Ninth Circuit's treatment of plaintiffs' subsequent request for leave to add a new claim for wrongful foreclosure based on the theory that "the naming of MERS as the beneficiary on the deed of trust . . . results in the note and deed of trust being split and unenforceable."14 The Court rejected the proposed claim as both "procedurally improper and substantively unsupported."15 Aside from the fact that Arizona does not recognize wrongful foreclosure as a valid cause of action, the fact that plaintiffs were in default at the time they initiated suit would have barred their wrongful foreclosure claim in states that do recognize such a cause of action. Moreover, with respect to plaintiffs' note-splitting theory, the Court observed that MERS's role as a "sham" beneficiary is not an issue where, as here, MERS was not the party to initiate the foreclosures. "Even if MERS were a sham beneficiary, the lenders would still be entitled to repayment of the loans and would be the proper parties to initiate foreclosure after the plaintiffs defaulted on their loans."16 The Court also rejected the notion that the deed and the note were irreparably split, explaining that such a split would "only render the mortgage unenforceable if MERS or the trustee, as nominal holders of the deeds, are not agents of the lenders."17 (Emphasis added.) — In re MERS Rejection of the "split-the-note" theory as it relates to non-judicial foreclosures gained more support in the subsequent decision of the District of Arizona in In re MERS.18 In that case, the Judicial panel on Multidistrict Litigation (MDL Panel) transferred to the Arizona district court a subset of cases asserting that the MERS model was invalid because (1) MERS was not a valid beneficiary of the deeds of trust, (2) the failure to name a valid beneficiary along with the splitting of the deeds of trust from the notes rendered them unenforceable as security instruments, and (3) as a non-beneficiary, MERS had no right to assign the deeds of trust to the lenders. As such, plaintiffs argued that they were the victims of wrongful foreclosures in violation of Arizona, California, Nevada, and Oregon wrongful-foreclosure and predatory-lending statutes. The district court rejected plaintiffs' split-the-note theory based on the Ninth Circuit's reasoning in Cervantes. It held that MERS was a valid nominee beneficiary with the power to initiate non-judicial foreclosures. While acknowledging that splitting notes from their respective deeds of trust can affect the parties' legal rights, the court found no legal support for the argument that making MERS a beneficiary under the deeds of trust "completely destroys the security and bars all attempts at non-judicial foreclosure in [the four states at issue in the case]."19 The decisions in Cervantes and In re MERS reflect the growing recognition by courts that the legality of MERS's roles as a nominee is not an issue in cases where MERS does not initiate the foreclosure proceedings or the complaint does not allege a violation of state recording or foreclosure statutes. Perhaps more importantly, the decisions stand as a strong rejection in the Ninth Circuit of the notion that any splitting of the note and mortgage caused by MERS' status as nominal beneficiary is irreparable and renders the mortgages and any assignments unenforceable. In light of the fundamental rule of agency law that a company cannot act as both agent and principal with respect to the same right, both the Ninth Circuit and the District of Arizona implicitly rejected the MERS-as-mortgagee theory and relied instead on the theory that MERS has an agency-like relationship with its members.20 — Residential Funding Co., L.L.C. v. Saurman Notwithstanding Cervantes, In re MERS, and their progeny, courts have continued to grapple with the concept of MERS as agent, in particular, the question of whether MERS has a sufficient interest in the mortgage loans to confer standing to bring foreclosure actions on behalf of its members, or, alternatively, whether it has the power to assign mortgages back to its members when the need for foreclosure arises. One case dealing with this issue is Residential Funding Co, L.L.C. v. Saurman.21 In Saurman, two individual borrowers purchased homes using loans from the same bank. The mortgages included the standard two-sided language designating MERS as both the mortgagee and a separate entity "acting solely as a nominee for Lender and Lender's successors and assigns."22 After both borrowers defaulted, MERS used Michigan’s foreclosure by advertisement statute,Michigan Compiled Laws (MCL) § 600.3204, to foreclose on the mortgages and sell the properties. Under MCL § 600.3204(1)(d), foreclosure by advertisement is available only to a party that (1) owns the underlying debt, (2) owns an interest in the debt secured by the mortgage, or (3) is the servicing agent of the mortgagee. All other parties must use the more time-consuming and expensive judicial foreclosure process. When the purchasers of the foreclosed properties sought to evict the borrowers, the borrowers objected, alleging that the foreclosures were defective because MERS did not qualify as an eligible party under any of the three definitions provided by MCL § 600.3204(1)(d).23 MERS argued that it owned an interest in the underlying notes by virtue of its status as mortgagee, contractual language in the mortgage, and its status as the lender’s nominee for purposes of foreclosure.24 The Michigan Court of Appeals sided with the borrowers and held that the language in the mortgage granted MERS an interest in the property securing the debt but gave it no interest in or control over the debt.25 It also ruled that MERS's designation as the noteholder’s nominee was insufficient to qualify under the statute as a servicing agent. Thus, the Court of Appeals vacated the foreclosures and held that MERS may only use judicial foreclosure in Michigan. The Michigan Supreme Court reversed the appeals court, ruling that "MERS owned security lien[s] on the properties, the continued existence of which [were] contingent upon the satisfaction of the indebtedness."26 As owner of these liens, MERS indeed owned an interest in the indebtedness such that it could foreclose by advertisement. The court also noted that, historically, the record holder of a mortgage had been recognized as an eligible party under the statute. Although MERS appears to have dodged a bullet, Saurman serves as one of the most recent examples of the difficulties courts have in defining MERS's rights and the shaky ground on which MERS's role in the foreclosure process stands.27 — Culhane v. Aurora of Loan Services Nebraska The District of Massachusetts's decision in Culhane v. Aurora of Loan Services Nebraska serves the latest example out of Masschusetts of that state's willingness to examine every aspect of the modern foreclosure process and suggests that challenges to the MERS business model are likely to continue.28The controversy in Culhane did not directly implicate the issues regarding the true nature of MERS's role in the lending process or its standing to initiate foreclosures. In fact, the case, which challenged MERS's policy of using dual employees as "certifying officers" of the company for purposes of withdrawing or transferring mortgages out of the MERS system, was resolved in favor of MERS, albeit by the "thinnest possible veneer."29 The issue in Culhane was whether a bank serving as trustee holding securitized mortgages could foreclose on the subject property. Prior to foreclosure, MERS assigned the mortgage to the servicer for the bank, as trustee. Judge William G. Young interpreted Massachusetts law as requiring the party foreclosing to be both the holder of the mortgage and either the owner or servicer of the note. Because the servicer was wearing both hats, it was entitled to foreclose. Nevertheless, in reaching his decision, Judge Young addressed a number of the myriad legal issues implicated by MERS. After expressing bewilderment as to MERS's claim to be both mortgagee and nominee, Judge Young explained that based on the express terms of the mortgage instruments MERS holds only bare legal title to each mortgage registered on its system. Thus, MERS is at best an agent but, more likely, is nothing more than a "party who holds bare legal title for the benefit of others."30 And while MERS's status as "mortgagee" in a nominal capacity for the noteholder complies with Massachusetts law, which permits spitting of notes from their mortgages prior to foreclosure, by its own admission, MERS has no interest in the accompanying notes.31 Without a right to the underlying debt, MERS "cannot exercise the power of sale, regardless of the language in the mortgage contract giving it this power."32 Thus, in Judge Young's opinion, MERS lacks the authority to foreclose in Massachusetts. Judge Young also voiced his skepticism regarding the MERS's business model and its use of dual employees. With only 65 actual employees, MERS is able to house 60 percent of the nation's residential mortgages only because it deputizes employees of the noteholders as officers of MERS with authority to assign troubled mortgages. Judge Young called MERS "the Wikipedia of land registration systems" and compared a MERS's dual employee to an "Admiral in the Georgia navy or a Kentucky Colonel with benefits" rather than "any genuine financial officer."33 He wrote that he was "deeply troubled that, with little to no oversight, individuals without any tie to or knowledge of the company on whose behalf they are acting may . . . transfer legal title to someone else's home." The lasting effect of the Culhane decision remains to be seen. Judge Young's ruling that MERS cannot foreclose in its own name in Massachusetts is not likely to have a huge effect on MERS because the company recently instituted a policy prohibiting its members from foreclosing in its name.34 Nevertheless, Judge Young's criticism of MERS, even though much of it should probably be considered dicta, stands as one of the strongest critiques to date of the overall MERS model.
Recent Complaints against MERSThe newest wave of suits filed against MERS this year has come from states and local municipalities. Counties in Kentucky, Michigan, Ohio, Oklahoma, and Texas have filed suits for unpaid recording fees which, they argue, MERS members impermissibly avoid via the MERS system. In one of the largest cases, Dallas County, Texas, sued MERS in October, asserting that the company owes it as much as $100 million.35 The Dallas suit was later converted to a class action seeking to represent all other Texas counties where deeds of trust naming MERS as a beneficiary had been filed.36 MERS argues that its transactions do not trigger recording obligations under state law.37 Some states have gone even further by challenging the accuracy of the tracking system used by MERS. In October, Delaware Attorney General Beau Biden filed a complaint against MERS and its owner banks asserting that the MERS tracking system, which is inaccessible to the public, is inaccurate and deceptive and "harms consumers by permitting and encouraging foreclosures for which the authority has not been fully determined and may not be legitimate."38 The complaint seeks to enjoin MERS from initiating foreclosures in its own name, acting as a nominal mortgage lender, and assigning or taking any other actions on Delaware mortgages until an audit of its system can be performed and MERS corrects any chain of title defects in the Delaware land records.39 In perhaps the broadest suit filed to date, Massachusetts Attorney General Martha Coakley filed a complaint in Massachusetts state court on December 1, 2011, accusing MERS and the five largest U.S. banks of engaging in unfair and deceptive trade practices in violation of state law. The complaint seeks broad relief for a variety of alleged wrongs, some of which may ultimately be resolved as part of the larger multistate settlement negotiations. The complaint, however, also points the finger at MERS, arguing that it cheats counties out of recording fees and undermines the purpose of recordation by inhibiting public disclosure of the holder of the mortgage. Even as state attorneys general and federal officials continue to work towards a settlement with the largest mortgage lenders and servicers that would fund loan modifications for troubled homeowners and impose stricter requirements on banks seeking to initiate foreclosures, all indications are that any such settlement would not bar state or municipal suits over lost filing fees from going forward.40 Consequently, 2012 promises to be another difficult and potentially expensive year for MERS and its major shareholders. DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to email@example.com.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).