Posts tagged ‘note’

MERS Mortgages May Be Invalid

A mortgage loan has at least two parts: a note and a mortgage instrument. The note evidences the debt and the mortgage instrument provides an interest in real property as collateral for repayment of the debt. In a non-MERS mortgage loan transaction, the borrower signs a note payable to the lender and a mortgage instrument giving the lender an interest in the property. In a MERS mortgage loan transaction, the borrower signs a note payable to the lender but the mortgage instrument gives the mortgage interest to MERS instead of the lender. This splitting of the note and mortgage may make the mortgage interest invalid, which would make the mortgage loan an unsecured debt.

To see why, it’s helpful to consider a non-MERS loan where the original lender attempts to assign, or sell, only the mortgage interest and not the underlying debt. The original lender in a non-MERS loan owns the debt and has the mortgage interest in the property. It is a fairly universal principle that where a party tries to assign only the mortgage interest, without the underlying debt, the transaction is a nullity. It can’t be done. The putative assignee gets no mortgage interest in the property and acquires no right to foreclose. Logic suggests that if the original lender can’t transfer a mortgage interest to a party that does not have the debt, neither can the borrower. MERS does not make, buy or sell loans. Its sole function is to receive the mortgage interest. Thus, in a MERS mortgage transaction, the mortgage interest is purportedly created in a party that does not also have the underlying debt. This, as we’ve seen, cannot be done.

Of course, MERS and the bank will claim that MERS takes the mortgage interest only as the lender’s “nominee,” whatever that means; MERS mortgages do not define “nominee.” They do, however, usually say things like “MERS is the mortgagee under this security instrument” and “MERS holds only legal title to the interests granted herein.” They also usually purport to give MERS the right to foreclose. This gives the borrower a good argument that the mortgage instrument certainly purports to vest the mortgage interest in MERS. At worst, MERS mortgages are ambiguous on the point, which under the well-known contra proferentem rule, requires the mortgage to be interpreted against the party claiming the mortgage interest.

The Connecticut Supreme Court will be considering this argument regarding the invalidity of MERS mortgages in a case most likely to be heard in the Fall 2011.

What is MERS?

MERS, or Mortgage Electronic Registration System, Inc., is a company formed by the residential mortgage lending industry to avoid paying government mortgage recording fees and to make it simpler to buy and sell residential mortgage loans. It is easier to understand what MERS is if you first understand why it was created. A mortgage loan has two parts: a promissory note and a mortgage instrument (mortgage deed or deed of trust). The mortgage instrument must be recorded with a governmental office. In most states, the governmental recording office is the County Clerk or County Recorder. In other states, like Connecticut, the governmental office is the Town Clerk. The governmental office charges a fee to record the mortgage instrument. Recording helps potential new creditors evaluate whether to accept the mortgaged property as collateral for a loan because it determines the order in which the creditors are paid if the property is sold. Recording also identifies the parties claiming interests in the property. This information can be necessary to foreclosure proceedings. It is also important to know where to direct questions about the claimed interest.

The mortgage securitization industry is in the business of buying, selling and pooling mortgage loans and then selling rights to receive a fraction of the payments on the mortgages in the pool. Every time a mortgage loan is sold, an “assignment of mortgage” or “mortgage assignment” is supposed to be filed with the government recording office. The assignment must specifically describe the individual mortgage being assigned and must be signed by the assignor. The recording office charges a fee for recording the assignment. Since securitizations involve hundreds or thousands of mortgage loans, it is burdensome to prepare and sign an assignment for each individual loan. It is also difficult and expensive to identify the proper recording office and to pay the recording fee for each assignment.

The mortgage industry formed MERS to avoid the burdens and costs associated with recording mortgage assignments. Think of MERS as a club, with membership open to mortgage loan originators, buyers and sellers. The mortgage loan originator who is a MERS member has the borrower sign a note payable to the originator and a mortgage instrument in favor of MERS. The borrower is charged the recording fee as a closing cost. The closing agent for the loan sees to it that the mortgage instrument is recorded in MERS’ name in the proper recording office. The member-originator can sell the loan to another MERS member without having to record a mortgage assignment. The buyer-member can also turn around and sell the loan without having to record an assignment. The members are supposed to report mortgage loan sales to MERS so that MERS can keep track of who owns which debt. If MERS receives an inquiry about a mortgage interest, or is named in a foreclosure proceeding, MERS notifies the member who owns the associated debt.

The industry’s theory is that MERS is merely a placeholder in the recording office for the owner of the debt. As we will see in future posts, however, there is an argument that giving the note to one party and the mortgage interest to another voids the mortgage interest such that the loan is unsecured.

Produce the Note, An Alternate View, Part 2

Picking up where I left off in Produce the Note, An Alternate View, Part 1, UCC 3-301 is entitled “Person Entitled to Enforce Instrument.” It provides in relevant part that the “Person entitled to enforce” an “instrument” is the holder of the “instrument.” UCC 3-104 defines “instrument” as “an unconditional promise or order to pay a fixed amount of money.” In other words, as far as the UCC is concerned, an instrument is a promissory note. Instruments under the UCC do not include mortgage deeds or deeds of trust. This is the main problem with the produce the note defense. By the express terms of UCC 3-301, the party that can produce the note has nothing more than the right to enforce the note. But, the foreclosing party is not trying to enforce the note. The foreclosing party is trying to enforce the mortgage deed or deed of trust because it’s the mortgage deed or deed of trust, not the note, that describes the lender’s rights to the property and how to exercise those rights.

Not only is UCC 3-301 expressly limited to the enforcement of notes, no court can expand its reach to mortgage deeds or deeds of trust. The statute provides that “[a] person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument.” We saw in Part 1 that at common law the owner of the debt is directly injured by its non-payment (“common law” is judge made law as opposed to legislature made law). UCC 3-301 does not require any injury. It gives the right to enforce the note to a nonowner or even a thief, i.e., a person “in wrongful possession of the instrument.” Because the statute provides a right to sue without requiring an injury, it is “in derogation of the common law” or, more simply, changes common law. It is a fairly universal principal that statutes in derogation of the common law must be “strictly construed.” That’s just a complicated way of saying that a judge can’t expand a statute that changes the common law; the statute means only what it says and nothing more. Under this principle, a judge can’t expand UCC 3-301 to apply to the enforcement of mortgage deeds or deeds of trust.

In Part 3, I will discuss how producing the note actually makes it easier for a “lender” to overcome challenges to its standing.