REQUIRED READING: The first full month of winter is now upon us, and snow blankets the landscape in much of the country, providing a new resource for child's play. One such favorite, the rolling of a small snowball down a snow-covered hill, could be likened to the challenges against Mortgage Electronic Registration Systems Inc. (MERS).
At first, the challenges against MERS were few and far between. As the issues morphed and gained national exposure, the momentum increased exponentially, and the problems became much more widespread. As with the snowball effect, the larger problem often results from a small event. In the case of MERS, it seems that a lack of an understanding of it as an entity, and of its systems, was the driving force behind the challenges against it and the now far-reaching attacks in courts around the country. In order to slow the momentum of the MERS snowball, the opposition needs to understand MERS, including the fundamentals of the system and the application of MERS Membership Rule 8, which governs foreclosure.
An explanation of the underlying legal principles provides a helpful background of the MERS system. In a mortgage transaction, the two most important documents are the promissory note (the underlying debt) and the mortgage/deed of trust (the security instrument). When mortgage loans are bought and sold, the promissory note is endorsed and physical possession of the original is delivered to the purchaser of the loan or its custodian. Transfer of possession and endorsement are accomplished in order to comply with the Uniform Commercial Code (UCC), which governs commercial transactions. The purchaser of the mortgage loan, by possessing the original note endorsed either specifically to it or endorsed to the bearer (i.e., in blank), is identified as the note holder and is entitled by law to enforce the promissory note. The mortgage is said to follow the note; therefore, the note holder is also entitled to enforce the mortgage.
Generally, at the time of execution of the mortgage, MERS is named as the mortgagee, granting it legal title to the instrument. In the MERS system, except under limited circumstances, MERS is not the holder of the note. Instead, the terms of the mortgage name MERS as the mortgagee "solely as nominee" for the lender or the lender's successors or assigns. The lender under the mortgage, or its custodian, is the note holder with the power to enforce the note and mortgage. MERS retains a legal interest in the mortgage as the mortgagee of record solely as nominee for the lender, its successors and assigns. MERS identifies note holders as "beneficial owners" of the mortgage. As beneficial-ownership interests are transferred, MERS continues as mortgagee of record for each successive beneficial owner, as long as the beneficial owner is a MERS member.
Critics often complain that MERS acts as a veil over the mortgage industry to keep the sale and transfer of loans from public knowledge. However, a detailed explanation of MERS' function, its membership rules and a vast amount of other information are publicly available on MERS' website, www.mersinc.org. One of the most valuable features of the website allows borrowers to query the MERS system using their unique MERS Identification Number, found on the first page of the mortgage, to determine who services their loan. As of last year, that feature also tells borrowers who owns their loan, with limited exceptions.
All MERS members are bound by the rules of membership, which are available on the MERS website. Membership Rule 8 is particularly significant because it governs the steps to which MERS members must adhere during foreclosure.
In general, for mortgages naming MERS as nominee, a member may either foreclose in the name of MERS or foreclose in a different name (Rule 8(c) specificallyÂ in the name of MERS in the state of Florida). Foreclosures in the name of MERS require that the promissory note be endorsed in blank and in possession of the member's MERS certifying officer.
The more likely case is that an entity other than MERS will bring the foreclosure. This different entity is often the beneficial owner or a servicer (if a servicing agreement allows). In that case, Rule 8, Section 1(d) states that "the servicer designated on the MERS system shall cause to be made an assignment of the mortgage from [MERS] to the person designated by the beneficial owner." While not explicitly stated, the foreclosing entity must also hold the note or otherwise have the ability to enforce it, per UCC Â§3-301.
Compliance with the rule serves at least two functions. First, it ensures that the foreclosing entity has written proof of its interest in the mortgage and the note. In the current climate, judges, debtors and bankruptcy trustees are less likely to object to a foreclosure where the foreclosing entity can attach to the petition a correct chain of title. Second, compliance with Rule 8 eliminates MERS' interest in the property, which is generally required by title companies when insuring post-foreclosure transactions.
Although compliance with Rule 8 is beneficial, one could argue it is not legally necessary. As cited above, the mortgage follows the note, and whoever holds the note is entitled to enforce both the note and the mortgage. Despite the fact that MERS may hold legal title to the mortgage, the holder of the underlying note has the beneficial interest and the equitable right to enforce the note. That said, assigning the mortgage from MERS to the note holder merges the legal title in the mortgage with the beneficial title and often completes the chain of title evidence desired by the courts. This dual-title concept was the subject of Jackson v. MERS, a Minnesota Supreme Court case decided in 2009, and is more fully explained in that opinion.
MERS in practice
An October 2010 SM article titled "MERS Prevails In The Show-Me State" focused on MERS' recent success in litigation challenges. However, at the time of its publication, the ultimate challenge to the MERS system – whether a note and mortgage are split and unenforceable due to the naming of MERS as mortgagee – had yet to be decided. Since then, the Western District of Missouri Bankruptcy Court has issued an opinion specifically addressing the "splitting" challenge. The case, In re Tucker, involved a Chapter 7 trustee's objection to a loan servicer's motion for relief, with the trustee alleging that the servicer did not hold both the note and deed of trust on the date of bankruptcy filing, rendering the documents split and unenforceable.
The facts of Tucker show the practical application and effect of the MERS rules and business model. The case involved an original lender that was a MERS member. The note was transferred multiple times after origination to other MERS members, each transfer being tracked by MERS. The borrower thereafter filed bankruptcy, and the loan servicer moved for relief from the automatic stay. At the time of the bankruptcy filing, the loan servicer seeking relief possessed the original note with an endorsement in blank. The deed of trust was assigned only one time, after the bankruptcy filing, from MERS to the loan servicer seeking relief.
The source of the trustee's "splitting" theory came from a legal treatise, cited in Bellistri v. Ocwen, as follows:
"Generally, a mortgage loan consists of a promissory note and security instrument, usually a mortgage or a deed of trust, which secures payment on the note by giving the lender the ability to foreclose on the property. Typically, the same person holds both the note and the deed of trust. In the event that the note and the deed of trust are split, the note, as a practical matter, becomes unsecured. The practical effect of splitting the deed of trust from the promissory note is to make it impossible for the holder of the note to foreclose, unless the holder of the deed of trust is the agent of the holder of the note. Without the agency relationship, the person holding only the note lacks the power to foreclose in the event of default. The person holding only the deed of trust will never experience default, because only the holder of the note is entitled to payment of the underlying obligation." (Emphasis added by author.)
The servicer seeking relief countered the trustee's position by arguing that MERS was at all times the nominee for each note holder, and that the designation of "nominee" is simply a form of agency. The servicer argued that because MERS is an agent, the emphasized language in Bellistri allows MERS to hold a legal interest in the mortgage without splitting it from the note. As a result, the case turned on whether an agency relationship existed between MERS and its members.
In deciding Tucker, the bankruptcy court looked to state law for the creation of agency relationships. In Missouri, "[a]n agency relationship arises, where, as here, one party is specifically authorized to act on behalf of another in dealings with third persons." Notwithstanding the use of the term "nominee" in the body of the security instrument rather than "agent," the court found that the plain language of the security instrument created an agency relationship between MERS and the lender, or any successor or assign as long as that lender was also a MERS member. Because an agency relationship existed,Â the court held that the note and deed of trust had not been split, and granted the servicer's motion for relief.
Although the MERS snowball has grown into a blanket defense relied on by debtors in every courtroom throughout the country, one must remember how it began. MERS was in existence long before the snowball effect took over, and its purpose and function remain the same. The effect is largely exacerbated by a simple confusion about the relationship between MERS and the beneficial owner. Once the opposition and the judiciary understand that relationship, the snowball will melt for good.
Adrienne E. Strecker is a litigation attorney for South & Associates PC, a creditors' rights law firm. Her practice is primarily focused on contested bankruptcy matters. She can be reached at email@example.com.
This article was originally published in the January 2011 edition of Servicing Management.