REQUIRED READING: There is little doubt that America is infatuated with convenience and efficiency. The assembly line, the microwave, the Internet, speed dating and drive-thrus are just a few examples.
Another example, although not as publicly well known or understood as the foregoing, is the MERS system of registering and tracking transfer of interests in deeds of trust. Incorporated in 1997, Mortgage Electronic Registration Systems Inc. (MERS) revolutionized mortgage banking. By acting as the designated ‘holder’ of a loan's security instrument – albeit, as a nominee for the holder of the loan – MERS circumvents the administrative hurdle of publicly recording documents that reflect each sale or transfer of a secured home loan. As a result, the common burdens, inefficiencies and expenses associated with selling or transferring secured home loans were greatly minimized.
Unfortunately, with convenience and efficiency, come negative side-effects. The assembly line, the microwave, the Internet, speed dating and drive-thrus arguably brought on poor quality, obesity and antisocial behavior. Similarly, with the ease of transfer of loans under MERS, some argue, came a substantial factor in the exploitation of the subprime lending market by unscrupulous lenders. In fact, many defaulted borrowers continue to allege that the MERS system permitted numerous lenders and investors to play "hot potato" with their subprime loans, which they naively believe caused the nation's current housing crisis.
Finding MERS' nominee relationship incomprehensible, many defaulted borrowers filing lawsuits today, in an attempt to thwart, or at least delay, foreclosure, allege that MERS' role as nominee illegally splits the loan from its security instrument, rendering the loan unsecured. Although it is true, with exception, that the law requires a loan and its security instrument to be owned by one entity, these defaulted borrowers attempt to stretch the law beyond its intent.
Nevertheless, courts across the country are having trouble reconciling MERS' relationship loans and its security instruments. Using a title from one of Clint Eastwood's best movies, here is the Good, the Bad and the Ugly of the recent MERS debate in the courts.
The good
The first recent noteworthy judicial decision favoring MERS is the case of Ramos v. MERS. There, the Federal District Court of Nevada rejected the plaintiffs' argument that MERS, as nominee beneficiary, "has no rights or powers to confer upon the [foreclosure] trustee the power to sell" in a deed of trust. The Ramos court held that since Nevada law permits a deed of trust's beneficiary to foreclose, and because the deed of trust expressly named MERS as its beneficiary, MERS was legally empowered and contractually authorized by the borrower to foreclose and appoint a substitute foreclosure trustee.
Several months after the Ramos case, came the Supreme Court of Minnesota's decision in Jackson v. MERS. In Jackson, the plaintiffs argued that MERS could not commence foreclosure proceedings because the numerous assignments of the underlying promissory note had not been publicly recorded, in violation of Minnesota law.
Although Minnesota does require the recording of all mortgage assignments before initiating foreclosure, the court in this case distinguished an assignment of the mortgage from an assignment of only the promissory note.
The court articulated that "â�¦an assignment of only the promissory note, which carries with it an equitable assignment of the security instrument, is not an assignment of legal title that must be recordedâ�¦." In rendering its decision, the Minnesota Supreme Court held that nominee mortgagees, like MERS, can "hold legal title of the security instrument without holding an interest in the promissory note" since the equitable beneficiary interest – or "real ownership" – in the security is held by the noteholder, which keeps the note and mortgage intertwined.
Bucci v. Lehman Bros. Bank FSB, from the Superior Court of Rhode Island, is another recent judicial decision in favor of MERS. Similar to the court in Ramos v. MERS, the Bucci court held that MERS had both a contractual and statutory right to commence foreclosure proceedings. First, the Bucci court recognized that the language in the mortgage expressly granted "MERS as nominee for Lender and Lender's successors and assigns" the "Statutory Power of Sale" and right to foreclose.
Second, the Bucci court reasoned that even though MERS is acting as nominee and does not have a beneficial interest in the note, the express designation in the mortgage that MERS is the "mortgagee" permitted MERS to initiate foreclosure proceedings as a mortgagee pursuant to the Rhode Island law.
A final notable decision in favor of MERS is Cervantes v. Countrywide Home Loans Inc. In this case, the Federal District Court of Arizona dismissed MERS from the action, holding that: (1) MERS, by acting as a nominee beneficiary and never owning or acquiring a beneficial interest in the promissory note, is not a "sham" beneficiary, and (2) the MERS system of tracking assignments of promissory notes, as opposed to public recordings, is not fraudulent.
While MERS was given a legal boost in 2009, MERS also received a few interesting defeats.
The bad
The bad starts in the Midwest, with the Missouri Court of Appeals' decision in Bellistri v. Ocwen Loan Servicing LLC. There, the court held that because "MERS never held the promissory note�its assignment of the deed of trust to [the assignee] separate from the note had no force," and, thus, the assignee was without any legal interest in the deed of trust. The Bellistri court relied on the general legal premise that if the note and its deed of trust are separated and not held by the same person, then the note becomes unsecured.
However, the Bellistri decision may have relied more on counsel's failure to explain MERS' agency relationship with its principal noteholders, rather than a finding that the note and deed of trust were actually separated. In fact, the court acknowledged that when the holder of the deed of trust is the agent for the holder of the note, a separation or "splitting" does not occur, leaving the deed of trust unaffected and valid.
Relying, in part, on the holding of Bellistri, the Supreme Court of Kansas recently stunned the industry with its decision of Landmark National Bank v. Kesler. In Landmark, MERS was acting as the nominee mortgagee for a second mortgage. When the first lienholder filed a petition to foreclose, neither MERS nor its principal noteholder were named parties or given notice of the litigation.
As a result, the trial court entered a default judgment in favor of the first lienholder. MERS unsuccessfully challenged the ruling. The Supreme Court found that since MERS did not have any tangible interest in the mortgage (i.e., it was not a beneficiary, did not issue the loan and was not entitled to collect on the debt), it was not entitled to notice.
Fortunately, the Landmark Court seemed to imply that it was merely deciding whether the lower trial court acted appropriately, not whether MERS was technically entitled to notice. However, the case could be interpreted both ways, and you can be sure which way the borrowers will read it: If MERS does not have an interest in the mortgage to entitle it to notice, it does not have the right to foreclose.
Another recent negative MERS decision is In Re Hawkins. In Hawkins, the U.S. Bankruptcy Court for the District of Nevada held that MERS did not produce sufficient evidence to demonstrate that it was entitled to lift a bankruptcy stay on foreclosure. The Hawkins court did acknowledge that Nevada only permits enforcement of a note by its holder (i.e., the person to whom the instrument is made payable) or a nonholder in possession with the rights of the holder, but the court found MERS did not prove it was either.
As was the case with the Bellistri court, the Hawkins court recognized that a note cannot be split from its deed of trust, but it also noted the exception of when the holder of the deed of trust is the agent for the holder of the note. As such, the Hawkins court indicated that had MERS proven it was the actual agent for the holder of the note, then MERS would have likely been able to lift the bankruptcy stay, albeit, only in the name of its principal.
The ugly
While extremely limited in scope, the holdings of Bellistri, Landmark and Hawkins have opened the door for numerous class action lawsuits in Arizona, Nevada and California. These class action plaintiffs claim that MERS' designation as beneficiary under their deeds of trust impermissibly splits the promissory note from its deed of trust, rendering the note unsecured.
On this basis, the class action plaintiffs are seeking to enjoin all foreclosures in Arizona, Nevada and California. Fortunately, there have not been any broad injunctions issued as of yet. The cases are currently awaiting a decision from the Multi-District Litigation (MDL) panel on whether to centralize the cases before one judge. Co-author Robert Finlay had the privilege of sitting in on the MDL hearing in early November at Harvard Law School. Interestingly, half of the lender defendants argued for centralization, while Freddie Mac, Fannie Mae, other lenders and the plaintiffs argued to keep the cases in their respective courts.
A ruling could have been reached by the time this article lands in print. Centralization could be a great result, if the case gets the judge who decided the Cervantes case discussed above. But, centralization with the wrong judge could turn these class actions even uglier.
In addition to the troublesome class actions, numerous homeowners across the country are filing individual lawsuits also challenging MERS' role as nominee beneficiary/mortgagee. Not only do these lawsuits greatly delay pending foreclosures and require a substantial amount of money in litigation expenses, but they also create more opportunities for the courts to make decisions like Bellistri, Landmark and Hawkins. This will only cause further trouble for MERS and its principal noteholders.
Although Bellistri, Landmark and Hawkins provide fodder for the seemingly nationwide attack on MERS, these cases appear to supply the answer for MERS' plight: demonstrating, elaborating and explaining to the court MERS' agency relationship with its note-holders.
Both Bellistri and Hawkins recognized the exception to the rule: When the holder of the security instrument is an agent for the holder of the promissory note, the instruments are not split. Unfortunately, the courts in Bellistri and Hawkins were provided insufficient explanations and evidence to demonstrate that MERS' agency relationship falls within the exception. Consequently, while such litigation will continue – for the short run, anyway – the net result may be favorable for MERS, with changes in the law that finally recognize and incorporate the utility of the MERS system.
Robert Finlay is a partner with Wright, Finlay & Zak LLP specializing in mortgage- and title-related litigation throughout California. He can be contacted at (949) 477-5050 or rfinlay@wrightlegal.net. Nicholas Hood, an attorney with the firm, can be reached via e-mail at nhood@wrightlegal.net.
