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Equitable Mortgage

Installment Land Contracts

• Uphoff borrows $200K from Litton, and grants Litton a mortgage on Uphoff’s home (worth $300K)

• Litton also requires Uphoff to deliver a deed conveying the home to Litton

• Litton: “I won’t record the deed, unless you default. If you repay, I’ll tear it up.”

• Is the deed valid?

The “Clogging” Rule• Deed by MR, delivered simultaneously w/ mortgage, is an invalid “clog” on MR’s equity of redemption

• 1) Deed was intended only to circumvent the foreclosure process and MR’s right of pre-foreclosure redemption

• 2) Deed was not intended to effect a transfer of outright title at time it was executed and delivered

• Litton must foreclose mortgage if Uphoff defaults

• Uphoff borrows $200K from Litton, grants Litton a mortgage on Uphoff’shome (worth $300K)• Mortgage: “In case of default, Litton has the option to buy the Mortgaged Property for an amount equal to the then-remaining balance due, plus $5.”

• If Uphoff defaults, can Litton get specific performance of the option?

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Contemporaneous Option as “Clog”• ME option to buy mortgaged land, taken contemporaneously w/ mortgage, is an invalid “clog” on equity of redemption [p. 286]

• Concern: option would circumvent MR’s right to redeem and the foreclosure process

• Instead, if Uphoff defaults, Litton can only extinguish Uphoff’s right of redemption through a foreclosure

Contemporaneous Option as “Clog”• Restatement § 3.1: contemporaneous option is not a per se invalid clog unless its effectiveness is expressly dependent on mortgagor default

• Option could be bona-fide, bargained-for aspect of the transaction and not just an “end run” around redemption

• Suppose Litton had option to buy Uphoff’s home at any time during the mortgage term for a price of $350,000? Valid option, or invalid “clog”?

§ 3.1. MR’s Equity of Redemption and Agreements Limiting It(a) From the time the full obligation secured by a mortgage becomes due

and payable until the mortgage is foreclosed, a mortgagor has the right to redeem the real estate from the mortgage ….

(b) Any agreement in or created contemporaneously with a mortgage that impairs the mortgagor’s right described in Subsection (a) of this section is ineffective.

(c) An agreement in or created contemporaneously with a mortgage that confers on the mortgagee an interest in mortgagor’s real estate does not violate this section unless its effectiveness is expressly dependent on mortgagor default.

• April 1: Lambert pays a $160K debt owed by Mitchell• April 1: Mitchell executes/delivers a deed to Lambert, who

records it, but Mitchell stays in possession• They agree that if Mitchell pays $168K to Lambert by

August 1, Lambert will deed home back to Mitchell• When Mitchell doesn’t repay by August 1, Lambert brings an eviction action

• Can Mitchell tender $168,000 and redeem his title, or can Lambert evict him?

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• Did Lambert really buy the home (was this a “sale”), or was he just using title to it to secure Mitchell’s obligation to repay the money?

• If latter is shown by clear and convincing evidence, then Lambert’s “deed” is deemed to be a mortgage

• Lambert would thus have to foreclose (by judicial foreclosure, b/c “deed” would not have a power of sale)

• So was this a bona fide deed, or is it really an equitable mortgage that Lambert must foreclose?

• Relevant Restatement factors [p. 301]• Statements of parties (“This is a loan.”)• Substantial disparity between consideration received by

Grantor and the fair market value of the land• Grantor remained in possession of the land• Grantor paid taxes or made improvements• Nature of parties and their relationship prior to/after the deed

• Additional factors sometimes mentioned by courts:• Was Grantor in financial distress at the time of deed?• Did Grantor have legal counsel?

Variation 1 (Easy “Mortgage” Case)• Facts:

• Prior to April 1 (date of deed to Lambert), Lambert held a mortgage loan on the home, Mitchell was in default; unpaid balance of loan was $160,000

• Fair market value of land => $300,000• Court should re-characterize deed as an “equitable mortgage” and require Lambert to foreclose

• Variation 1 analysis• Prior to April 1, Mitchell was legally required to pay back

the money to Lambert• After April 1, while Mitchell may not be legally required to

pay $168K to Lambert (at least in form), he is practically obligated to repay if he wants to protect his equity (why would he rationally “sell” a $300K home for only $160K?)

• Compare Perry, p. 292, where the “grantor” delivered absolute deed in the context of a “foreclosure rescue”

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Variation 2 (Easy “Sale” Case)• Facts:

• Pre-April 1, Wells/Lambert had no contractual relationship• Wells/Lambert enter into “Lease” for April 1-August 1• Appraised FMV of land = $160,000

• Court could/should treat this as a bona fide sale • Mitchell’s possession is consistent with bona fide tenancy; he

has no obligation to pay Lambert (“no debt, no mortgage”), no “economic compulsion” based on FMV

• Lambert signs installment contract to buy a flat-screen TV (12 payments @ $350 each) from “Tiger John” Cleek

• Contract says: Tiger John retains title to the TV until all payments are made

• Lambert makes the first 11 payments, but he misses the 12th payment

• Can Tiger John repossess TV, terminate the contract, and keep all of Lambert’s past payments as damages for breach?

UCC: “Security Interest”• § 1-201(b)(35) defines a “security interest” as “an interest in personal property ... which secures payment or performance of an obligation.”

• § 1-201(b)(35) also provides that “... [t]he retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer ... is limited in effect to reservation of a security interest.”

UCC Installment Sale Contracts• Under Article 9, Tiger John has only a security interest in the TV, which he must enforce by UCC foreclosure procedures

• Foreclosure sale required in this situation [§ 9-610]• Before sale, Lambert can redeem TV by paying debt balance

(last $350 payment + any costs of collection) [§ 9-623]• If sale price >> balance of debt, any surplus must be returned

to Lambert [§ 9-615]

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• Sometimes, an owner of land sells it to buyer by installment land contract or “contract for deed”

• Buyer agrees to pay price in monthly installments over time (term may vary; some as long as 40-50 years!)

• Buyer takes immediate possession of the land, but usually (per ILK) doesn’t get title until Buyer pays all installments

• ILK usually provides that if Buyer defaults, Seller can terminate ILK, evict Buyer, and retain all of Buyer’s prior payments as liquidated damages for Buyer’s breach!

• Assume Barrett buys a home from Smith on an installment land contract

• Price = $200,000; Term = 30 years; Interest rate = 10%; monthly payments = $1,755

• Barrett pays for 10 years, then defaults• Total payments in 10 years = $210,600• Contract balance at default = $181,500• FMV of home at default = $220,000

• What happens under each judicial approach (e.g., Russell, Petersen, Watkins)?

• Under Russell (p. 311), forfeiture clause is enforced as a contract remedy, unless forfeiture would “shock the conscience”

• In that case, Russell forfeited $56K in equity on land on which ILK balance was only $26,500

• In our example:• Smith would be able to recover land (worth $200K) and

would not have to sell it at foreclosure sale• Smith could keep Barrett’s past payments ($210,600); no

obligation to make restitution to any extent

Vendor(Seller)

Vendee(Buyer)

Contract

! Vendee agrees to pay contract pricein installments

! Vendor does not deliver deed (title)until Vendee pays final installment

PurchaseMoney

Mortgagee(Seller)

PurchaseMoney

Mortgagor(Buyer)

Deed (Title)

Note and Mortgage

The Purchase Money Mortgage Compared

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• Under Watkins (p. 329), Smith’s ILK is deemed to be a mortgage, and Smith would have had to foreclose the mortgage under mortgage law

• Smith can retain prior payments, but if sale brings price = $220,000, then

• Smith gets first $181,500 (to satisfy K balance), but• Remaining $38,500 surplus would be returned to Barrett

(reflecting equity accrued due to 1) principal amortization during 10-year contract period and 2) market appreciation during that period

Watkins v. Eads [p. 329]• Any attempt to use title to land as security for a debt

should have the same legal effect; thus, ILK must be enforced as a mortgage, by foreclosure

• Cf. Restatement of Mortgages: “A contract for deed creates a mortgage.” [§ 3.4(b)]. Cf. Article 9

• Note: many ILKs don’t contain a power of sale, so in states following the Watkins approach, Seller would have to bring judicial foreclosure action

• Pro-Restatement view: ILK buyer and purchase money mortgagor are in essentially the same position and should be treated the same

• Both purchase money mortgagee and ILK Seller are using title to land to secure payment of a debt

• Pro-ILK view: ILK buyers are different• ILK buyers have poor credit, can’t qualify for conventional

mortgage financing; ILK sellers should be able to bargain for remedies commensurate with risk

• Under Petersen (p. 315) approach, ILK is not deemed a “mortgage” per se; if Buyer has not made “substantial payments” on the ILK, or if the default is nonmonetary, seller can terminate

• But, if Buyer has made a “substantial” number of payments or improvements, and the default is purely financial, then the defaulting Buyer has a right to specific performance [p. 319]

• Petersen court calls this a right to “redeem” Buyer’s interest in land [p. 321]

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• Under Petersen, then:• If Smith tries to terminate K and recover possession,

Barrett is entitled to seek specific performance• This would permit Barrett to pay off the full K balance

($181,500), within time period established by court• If Barrett can make this payment, then court will order

Smith to deliver legal title to land• Why didn’t Petersen treat ILK as a mortgage?• What if Barrett can’t tender full performance?

• Note that California law not only gives mortgagors a right to redeem, but also a statutory right to reinstate the mortgage (by curing the default) [Cal. Civ. Code § 2924c]

• To equate an installment K and a mortgage, court would have to give defaulting K Buyer a right to reinstate too

• Majority viewed this as being an unnecessary conclusion in the Petersen case (since Buyer in Petersen was able to tender full performance) [fn, pp. 323-324]

Petersen: Restitution to Buyer• If Barrett can’t pay off the full balance of the contract ($181,500), then what happens?

• Seller can cancel ILK, terminate Buyer’s equity of redemption (analogous to strict foreclosure)

• But, Buyer can compel restitution of past payments, to the extent they exceed Seller’s actual damages due to Buyer’s breach [Freedman v. The Rector, p. 319; this should prevent Seller’s “unjust enrichment”]

• Suppose Smith makes this argument: “My damages due to Barrett’s breach are equal to the rental value of the land that I could have collected by renting the property.”

• Suppose Smith further argues: “Under the terms of the contract, Barrett stipulated that the rental value of the land was $1,755/month.”

• Can Smith thus argue that no restitution to Barrett is required?

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• How should the court determine the value of Smith’s “lost opportunity” when calculating Smith’s damages as Seller?• Is it the lost use of the land (customarily measured by the fair rental value of the land)?, or

• Is it the lost value of the money that Smith decided to forgo by selling the land to Barrett on credit, rather than for cash (customarily measured by interest)?

Is Buyer Really an Owner, or a Tenant?

• Giving Smith/Seller a credit for rental value really treats Buyer/Barrett as a “Tenant” until Buyer makes full performance

• Problem: If “Seller” is really a “landlord,” why shouldn’t Seller be responsible for the habitability of the premises (like a landlord would be)?

• Most ILKs place on the Buyer the full responsibility for maintenance and repair of the premises

Statutory Regulation of ILKs• Legislatures in several states that do not treat ILKs as mortgages have enacted statutes that regulate seller enforcement [pages 338-342]

• Most require minimum notice/cure period before Seller can terminate ILK [e.g., MN § 559.21, p. 339-40]

• A few allow the defaulting Buyer to reinstate by catching up back payments (rather than Petersen, which required payoff of full contract balance)

Tex. Prop. Code § 5.066(a). If a purchaser defaults after the purchaser has paid 40 percent or more of the amount due or the equivalent of 48 monthly payments under the executory contract, the seller is granted the power to sell, through a trustee designated by the seller, the purchaser's interest in the property as provided by this section. The seller may not enforce the remedy of rescission or of forfeiture and acceleration.This converts an ILK into a mortgage after Buyer has paid 40% of price

or 48 monthly payments, whichever occurs first

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Specific Performance as Alternative Seller Remedy to Termination

• In “down” market, or after uninsured casualty, value of property at breach may be << balance due on ILK

• In such cases, Seller might seek specific performance of the ILK, rather than declaring forfeiture and terminating the contract

• This remedy would enables the Seller to obtain the equivalent of a deficiency judgment

Specific Performance: Gershman [p. 348]• Remaining ILK balance = $108K at time of breach, but FMV of condo = $73,000. Buyer wanted to “walk away,” but Seller sued for specific performance

• Seller got judgment = $108,000, and then had condo sold to satisfy judgment; condo sold for $73,000; Buyer (Summit) was held liable for $35,000 deficiency!

• In CA and some anti-deficiency states, Buyer would be protected from deficiency after sale

Transfer by the Mortgagee:Assignment of Mortgage Loans

• Transfer/assignment of a mortgage loan can occur:• 1) By outright sale of ownership (buyer of note takes all

risks and benefits associated with collecting the note), or• 2) By “collateral” assignment or “assignment for security”

purposes (lender receives a lien on the right to collect payments due on note, as security for another debt)

Securitization Process (Simple Model)

Originator

Borrower (x10,000±)

Loan$$

Note/Mtge

SecondaryMarketBuyer

$$Note/Mtge

SecuritizationTrust(SPV)

Investors

Note/Mtge

$$

Trustee

$$

Note/M

tge

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Securitization Process (Simple Model)

Originator

Borrower (x10,000±)

Loan$$

Note/Mtge

SecondaryMarketBuyer

$$Note/Mtge

SecuritizationTrust(SPV)

Investors

Note/Mtge

$$

Trustee

$$

Note/M

tge

WarehouseLender

(Notes)

Mortgage Assignments• Primary asset assigned is the promissory note (which

embodies borrower’s obligation to pay mortgage debt)• If the note is properly assigned, the mortgage “follows

the note” automatically — even if there is no written “assignment” of the mortgage document! [Restatement of Mortgages §5.4(a)]

• Rationale: a mortgage has no purpose or value, other than to secure the obligation to pay the debt

Transfer of a Mortgage Note• There are TWO key aspects to the transfer of a

mortgage note, and it is important to distinguish them• The first is ownership of the note (i.e., who owns the right to

the money if the note if is paid/collected?)• The second is the right to enforce the note (i.e., who has

the right to bring an action against the maker of the note and to foreclose the mortgage, if the maker defaults?)

• These can (and often do) reside in same person, but they do not have to

Relevant Commercial Law• UCC Article 3 governs right to enforce the borrower’s

obligation to pay a negotiable promissory note• Common law of contracts governs right to enforce the

borrower’s obligation to pay a non-negotiable promissory note

• UCC Article 9 governs question of who owns a note (whether note is negotiable or not) [Article 9 applies to “sales” of promissory notes, §9-109(a)(3)]

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Problem 1• June 1: Litton borrows $100K from Bowman, signing a note to repay on Dec. 1, with 5% interest

• Sept. 1: Bowman sells note to Uphoff for $90K cash• He gives Uphoff a photocopy of the note and signs a

letter stating “I assign Uphoff all my rights” under the note• Dec. 1: Uphoff presents the photocopy of the note to Litton and demands repayment. Can Uphofflegally do so?

• Answer depends on whether the note is “negotiable”• A promissory note is “negotiable” if [§3-104(a)]

• It is an unconditional promise or order to pay a fixed amount of money (principal), with or without interest

• It is payable “to bearer” or “to order” of specific person• It is payable on demand or at a definite time, and• It does not state any other undertaking to do any act in

addition to the payment of money (other than an undertaking to provide or maintain collateral)

• Most courts have concluded that the Fannie/Freddie Uniform Note is a “negotiable” instrument

Transfer of a Negotiable Note: Say Hello to PETE

• If a note is negotiable, the right to enforce it can be transferred (whether by sale or by assignment for security purposes) ONLY as required by UCC Art. 3

• Usually occurs by “negotiation”: indorsement (i.e., payee signs back of note) and delivery of note to transferee

• Transferee thus becomes “holder” of note and the PETE (“Person Entitled to Enforce” the note) [UCC §3-301]

• UCC Article 3 provides that the obligation of the maker of a note is owed to the Person Entitled to Enforce the note (or the PETE)

• UCC § 3-301 — the PETE is:• The holder (the original payee, or another person to

whom the note was properly negotiated)• A nonholder in possession of the note with the rights of a

holder (someone with possession of an unendorsed note)• In some cases, the owner of a “lost” note

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Problem 1• If the note Litton signed was negotiable, Uphoff cannot enforce it

• Uphoff is not the PETE (note was not endorsed to him, nor does he have physical possession of it)

• If Bowman still has the original note, Bowman is the “holder” and thus the PETE — even though he has actually sold ownership of the note to Uphoff!

• Having possession of a photocopy of the note ≠ possession of the note

Nonnegotiable Notes• By contrast, if Litton’s note was NOT negotiable, transfer of the right to enforce it is governed by the common law of Contracts, not UCC Article 3

• More flexible; transfer can occur by written agreement, w/out indorsement (such as by Bowman’s signed letter)

• Thus, if note was nonnegotiable, Uphoff (as assignee) could enforce the note vs. Litton

Problem 2: Payment/Discharge• Litton borrows $100K from Bowman and signs a negotiable note, secured by mortgage on his home

• Bowman later properly “negotiates” the note to Uphoff, but does not tell Litton; Litton later tenders $100K prepayment to Bowman (who disappears with the money)

• Can Uphoff now collect the note from Litton, or can Litton argue it has been paid/discharged?

• Problem: Litton did not pay the PETE (Uphoff, the note’s “holder”)

• Thus, Litton’s obligation to pay the note was not discharged by his payment to Bowman [UCC §3-602(a)]

• Uphoff (the PETE) can enforce the note and collect from Litton (and foreclose the mortgage if unpaid)!

• Is this the appropriate result?

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• Revised Art. 3 reversed the “payment rule” [p. 569]• Under Revised UCC § 3-602(b), Litton’s payment to

Bowman discharged the note, b/c it occurred before Uphoff notified him of the transfer (consistent w/Article 9 rule for collection of accounts receivable)

• Only 11 states have adopted Rev. Art. 3; MO still has old Art. 3 (payment to someone other than PETE does not discharge note)

• What should Litton have done differently?

• In a state that follows the payment rule, before Litton makes payment of the note, he must make sure that he is paying the PETE

• He should ask Bowman to show proof that Bowman holds the note (and is thus the PETE), or

• He should ask Bowman for satisfactory proof that Bowman is the agent of the PETE (i.e., authorized to collect the note on behalf of the PETE)

• People don’t often ask for this proof, however

Payment Rule: Nonnegotiable Notes• The payment rule also applied to nonnegotiable notes

under Contract law; but, the payment rule has been rejected by the Restatement of Mortgages [§5.5, p. 570], which takes the same position as Revised Article 3

• Under that approach, if the note is nonnegotiable, Litton’s payment to Bowman before receiving notice of the transfer to Uphoff would discharge Litton’s debt

Problem 3: Defenses• May 1: Litton borrows $150K from Bank and grants Bank a mortgage on his home

• Bank sells note to Fannie Mae, but continues to “service” it pursuant to a servicing agreement with Fannie Mae

• When Litton receives his payment coupon book, the amount of payments is suspiciously high

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Problem 3 (Continued)• Litton goes back and looks at the loan documents he signed, and learns that the note he signed bears a 10% interest rate

• But, Litton had a written commitment from Bank for a 5% interest rate!

• Can Litton assert this defense against Bank? Can he assert it against Fannie Mae?

If Note Is Nonnegotiable … • If the note is not a negotiable instrument, its enforcement is governed by the common law of contracts (not UCC Article 3)

• Under contract law, assignee takes subject to all defenses of the counterparty to the contract (i.e., derivative rights)

• Thus, Fannie Mae’s ability to collect the note from Litton would be subject to Litton’s valid defenses

If Note Is Negotiable …• If the note is “negotiable,” Article 3 applies, including its “holder in due course” (HIDC) rule

• HIDC takes note free of maker’s personal defenses (e.g., failure of consideration) [UCC § 3-305(b)]

• Thus, if note is a negotiable instrument and Fannie Mae is a HIDC, it can collect the note from Litton, even though Litton would have had a valid partial defense against Bank!

Holder in Due Course [§ 3-302]• To be a HIDC of the note (if it is a negotiable instrument), Fannie Mae must:

• Be a “holder” (i.e., indorsement + delivery)• Pay value to acquire the note• Take the note in “good faith,” and• Take it “without notice” that it is/has been (a) overdue or

dishonored, (b) forged or altered, (c) subject to claim of another party, or (d) subject to defenses

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“Real” and “Personal” Defenses• Real defenses (even HIDC takes subject to them)

• Infancy/incapacity• Duress• Forgery• Fraud in the factum• Bankruptcy discharge

• Personal defenses (HIDC takes free of them)

• Any general contract defense (breach of warranty, failure of consideration)

• Fraud in the inducement

• Should the holder in due course (HIDC) rule apply in the modern mortgage market?

• Does applying the HIDC rule in this context create the appropriate incentives for those involved in the process of making and securitizing mortgage loans?

Rationale for Keeping HIDC Rule?• Promotes commerce by facilitating the availability of business credit on more favorable terms

• Policy argument: “Investors would be less likely to buy notes (or lenders would be less likely to lend using notes as collateral) if the notes were subject to the maker’s defenses or third party claims. Without HIDC protection, investors or lenders would demand higher returns. Mortgage rates would go up.”

• Note: HIDC doctrine has been pretty much abolished in the consumer credit context (either through introductions of the Uniform Consumer Credit Code, the FTC rule, or state “lemon laws”)

• This was based on substantial abuses/frauds in the making/transfer of consumer auto/appliance loans [pages 559-562]

• The home mortgage market is the only major form of consumer financing in which HIDC rule still survives

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• UCCC § 3.404(1): “With respect to a consumer credit sale or consumer lease, an assignee … is subject to all claims and defenses of the consumer against the seller or lessor arising from the sale or lease of property or services, notwithstanding that the assignee is a holder in due course of a negotiable instrument ....”

• E.g., assignee of retail installment sale contract for sale of a car would take subject to buyer’s warranty defenses

• FTC Rule requires that any consumer credit contract for $25,000 or less must say: “NOTICE. ANY HOLDER OF THIS CONSUMER CREDIT CONTRACT IS SUBJECT TO ALL CLAIMS AND DEFENSES WHICH THE DEBTOR COULD ASSERT AGAINST THE SELLER OF GOODS OR SERVICES OBTAINED WITH THE PROCEEDS HEREOF.”

• Legend (if included in contract) prevents transferee from qualifying as HIDC

• Not including the legend is an “unfair trade practice” (fines)

Critique of HIDC Rule• Encourage/incentivizes bad underwriting practices

• A lender holding loans in its own portfolio has a strong incentive to maintain rigorous underwriting standards

• “Loan-to-sell” lenders may not be as scrupulous, because risk of loan default is being shifted to note buyers!

• But HIDC rule diminishes incentive for note buyers to seriously vet/monitor the loan originators from whom they purchase mortgage loans

Mortgage Assignments• When a mortgage loan is transferred, the mortgage “follows the note” automatically [note 1, p. 533]

• Thus, in Problem 3, if Bank properly transferred the note to Fannie Mae (and Fannie Mae became PETE), Fannie Mae can enforce the mortgage, even if Bank:

• Doesn’t make a written assignment of the mortgage, or• Doesn’t record any written assignment of the mortgage

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Still, Note Buyer Wants a Written Assignment of Mortgage Because ....

• 1) If foreclosure is required, note buyer will want to record evidence of mortgage assignment (to establish a proper “chain of title” to the land), and

• 2) Without recording an assignment of the mortgage, the note buyer becomes subject to the risk of wrongful or negligent release by record mortgagee

• Example: In Problem 3, Bank sells Litton’s loan to Investor (no assignment of mortgage is recorded)

• Two months later, Bank mistakenly records a release of the mortgage after getting loan numbers mixed up

• Litton then sells the home to Bailey, who thinks (based on the release) that Litton has clear title

• Bailey would take title to land free of the mortgage• As record mortgagee, Bank has apparent power (but not the

legal right) to record a release; Bank’s release is voidable, not void [note 5, p. 574]

• Bailey, as BFP, would take the land free of the apparently released mortgage under the recording act

• Given this risk, why wouldn’t a note buyer like Fannie Mae record an assignment of every mortgage?

• Cost of recording a mortgage assignment ≈ $25-50• If Fannie Mae is pooling 20,000 mortgages into an RMBS

pool, the cost of recording assignments for mortgages in that pool = $500K-$1MM per assignment!

• Thus, note buyers like Fannie Mae often have the originating mortgagee execute a written assignment of the mortgage, but only record it if borrower later defaults and it becomes necessary to foreclose

MERS• Mortgage Electronic Registration System (MERS) was created by the mortgage industry to deal with “record” title to the mortgage

• Buyers/sellers of mortgage loans on secondary market become members of MERS

• Members register their loans with MERS, which keeps track of who owns the loan as the loan is transferred through the securitization process

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• Problem 3: when Bank (a MERS member) makes a mortgage loan to Litton, the mortgage doesn’t name Bank as the mortgagee; instead, it names MERS as the mortgagee of record

• But, MERS is just a “nominee” (agent) for note owner (Bank)

• When Bank sells the loan to Fannie Mae (also a MERS member), MERS tracks the transfer of the note, but no assignment of the mortgage is needed

• MERS remains the mortgagee of record, but now as the nominee/agent for Fannie Mae, not Bank

Attacks on MERS [p. 528]• There have been numerous judicial attacks on MERS

• 1) Borrowers have argued: “Having MERS as mortgagee results in separation of note and mortgage, rendering the mortgage invalid”

• 2) Recorders have argued: “MERS is an illegal scheme to avoid paying recording fees”

• 3) Borrowers have argued: “MERS cannot legally foreclose the mortgage b/c it doesn’t own the note”

• As the text suggests (p. 529), nearly all of the litigation attacks on MERS have failed

• Use of MERS does not “separate” the note and the mortgage

• The MERS member that holds the note has the right to enforce the note and the mortgage, and MERS functions as their agent for holding title to the mortgage

• Use of MERS does not illegally avoid recording fees, b/c no one has any legal obligation to record a deed or mortgage

MERS and Foreclosures• Foreclosures in the name of MERS have been the most controversial practice

• MERS itself has very few employees• To facilitate MERS’s operations, certain employees of

MERS members are also “officers” of MERS• Thus, if Bank needs to assign a mortgage following sale

of a note, it is really a Bank employee that executes the assignment, but he/she does so as an officer of MERS

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• Foreclosures in the name of MERS have been the most controversial practice

• In many states, MERS members holding notes would start foreclosures in MERS’s name (not in their own names)

• Technically, that’s not problematic, if the note holder is a member of MERS

• But from a PR perspective, it is — it enabled note holders to conduct foreclosures without the PR hit (e.g., “MERS is taking my house” not “Wells Fargo is taking my house”)

• Plus, when borrowers would contact MERS for information about the foreclosure or a loan modification, MERS would say, “don’t ask us, ask your lender”

MERS and Foreclosures• Because of criticisms and successful judicial challenges in a few states, MERS’s rules no longer allow MERS members to conduct foreclosures in the name of MERS

• Now, when foreclosure is necessary, MERS will execute and record an assignment of the mortgage to the then-current holder of the note

• That holder then must start a foreclosure in its own name

Foreclosure of Securitized Mortgages• In a judicial foreclosure proceeding, foreclosing lender or its servicer must show that it had possession of the note, properly indorsed, at the time that it commenced the foreclosure action

• This has been a big problem (belated indorsements and backdating, due to poor tracking of notes)

• If lender/servicer fails to make this showing, courts will dismiss the foreclosure action (without prejudice)

Foreclosure of Securitized Mortgages• In nonjudicial foreclosure states, foreclosure by someone other than the PETE may create question about the validity of the sale

• Courts in a few states have held that nonjudicialforeclosure by someone other than the PETE is valid b/c their statute doesn’t require proof that foreclosing creditor is the PETE [note 9, p. 564]

• That’s wrong; courts in other states have correctly set aside sales conducted by a creditor who was not the PETE [Eaton v. Fannie Mae, 969 N.E.2d 1118 (Mass. 2012)]