‘There is hardly a political question in the United States which does not sooner or later turn into a judicial one,’ observed Alexis de Tocqueville in the mid-19th century.
Tocqueville's words ring loud and clear in today's mortgage industry when one considers the political – and now judicial – hurdles being foisted upon mortgage servicers.
It was only a matter of time before the us-versus-them attitude sweeping the country translated over to the judiciary. In recent months, we have seen judges across the U.S. stiffening their reception to mortgage servicers who petition the court for relief.
The shift in judicial demeanor coincides with the recent upswing in political involvement in the country's mortgage industry. Examples of this trend include the Bush administration's announcement of its measure to freeze interest rates for specific subprime borrowers, as well as multiple mortgage-related bills that have been proposed by the House of Representatives – such as the Emergency Home Ownership and Mortgage Equity Protection Act, which was approved on Dec. 12, 2007.
Now that the 2008 election year is in full swing, the political inquiry into the mortgage industry is bound to intensify as new solutions to the "mortgage crisis" are proposed and debated. As we will continue to see, as the political pressure heats up, so too will the judicial demands placed on mortgagees who attempt to assert their rights.
Many judges have reacted to the stirring political climate by denying mortgagees' requests to foreclose on properties and denying relief from the bankruptcy stay so that lien holders may resume a halted foreclosure.
Judges have similarly denied requests from stripped-off junior lien holders seeking surplus funds left over from a foreclosure sale. The reasons for denying judicial relief vary from court to court depending on the particular facts surrounding the case and the judge who is hearing the matter.
Reasons given by judges for denying the requested relief frequently stem from the mortgage servicer's ability to prove ownership of the loan in question. Without solid proof of ownership, judges are becoming more inclined to deny relief sought by the servicer, granting more apparent protections to borrowers while simultaneously making lien holder rights more difficult to enforce.
While proof of ownership is a basic element one must establish in order to seek relief from the court, the ambiguity surrounding what constitutes enough proof is being felt out across the country by the mortgage industry.
A second reason often cited for denying judicial relief relates to the court's dissatisfaction with the completeness and accuracy of documentation presented by the lien holder. This issue may take the form of perceived inaccurate descriptions of assessments charged against the borrower's account.
The assessments in question are often the fees and costs associated with default – including late charges, attorney's fees, property taxes, insurance premiums, title reports, recording fees and appraisal costs, just to name a few.
Three judges in the Houston area have sanctioned – or considered sanctions against – creditors and their attorneys for filing motions in bankruptcy court that made allegedly inaccurate claims about what debtors owe. While mistakes are never acceptable, particularly when citing what a debtor owes, such oversights are not new.
The difference now is that judges are analyzing each mortgagee's pleading more carefully than ever before – resulting in a reduced tolerance for inadvertent errors.
To a judge sitting on the bench, who is constantly hearing horror stories of borrowers in mortgage crisis, it has become easier and more commonplace to subject the mortgagee to increasing scrutiny before ruling one way or the other. As a result, borrowers are quickly realizing they have inadvertently been given a way to impede foreclosure and bankruptcy processes, giving them additional time to strike a deal with the servicer or a third party that allows them keep their homes.
New demands
In order to bring a lawsuit or have rights in a matter pending before the court, the party must establish an interest – or what is known in the legal community as standing. Standing is important, because without it, a lender or servicer cannot judicially foreclose a property, assert title superiority over another lien holder, obtain relief from the bankruptcy stay or seek distribution of surplus funds resulting from a foreclosure sale.
In cases involving a property interest, like a mortgage note, standing is usually established by demonstrating ownership of the property interest to the court.
This demonstration can take the form of a title report, promissory note, affidavit, recorded documentation like a deed of trust or other document evidencing a mortgage, or any combination of the above. For mortgage servicers and their attorneys, standing has always been relatively easy to establish when all the documents are present and properly notarized and signed.
When proceeding judicially against a borrower, the servicer should be ready and able to produce all of the requisite documents before ever filing anything with the court, as standing is typically established at the time a suit is brought.
With the ever-increasing rate of foreclosures, investors and servicers are moving quickly these days to keep up with the pace and demand being placed upon the industry. Consequently, mortgagees and their attorneys are being carefully watched and subsequently faulted by judges for what has become a common practice in the industry: filing a foreclosure suit or similar action (in states that require them) without showing proof that the plaintiff actually holds the mortgage and has the right to foreclose.
This practice is especially common in an economic environment where subprime lenders are going out of business in record numbers.
As these loans are purchased and absorbed, the new owners find themselves the beneficiaries of mortgages already in default. In some cases, the new mortgagee moves too quickly by filing a foreclosure suit before it even acquires the mortgage.
A state judge in Cincinnati dismissed such a lawsuit in November 2007. In dismissing the case, Judge Steven E. Martin wrote a warning letter to the bank's law firm, advising that it never again proceed without legal standing.
The origination documents typically contain the best proof of ownership, but these are often lost or buried in a vault due to the number of times a loan can change hands. The origination documents are those that include the promissory note executed by the borrower in favor of the entity to receive payment, as well as any instrument signed by the borrower that creates a security interest (mortgage) that will be recorded in the property records.
Promissory note
The security instrument has always been important to both the mortgagee and the courts because its recordation and any subsequent assignments notifies the world of a lien holder's interest in property.
Thus, an assignment must be obtained and recorded if the loan has changed hands so that the recorded interest reflects the name of the new owner. An undocumented assignment is problematic because the petitioner in front of the court cannot prove his or her ownership of lien interest, as the name listed in the real property records is that of the old mortgagee.
The failure to effect an assignment is one of the primary ways judges are able to dismiss foreclosure actions or deny judicial relief altogether due to lack of standing. For example, in November 2007, a bankruptcy court in Massachusetts stated that "a party seeking relief from the automatic stay to exercise rights as to property was required to demonstrate at least a colorable claim to the property."
In that case, the exhibits attached to the motion for relief indicated that another creditor was the holder of the note and mortgage. At the hearing, the creditor presented the court with an assignment of the mortgage.
The assignment, however, was dated four days after the filing of the motion for relief. Therefore, the court concluded that the creditor was an unrelated third party that had no interest in the mortgage or note until after the motion for relief was filed and did not have standing to seek relief from stay.
In the past, demonstrating a recorded and properly assigned security interest was enough proof – a measure that, in the above case, likely would have been sufficient. But now, we are seeing that the promissory note is being demanded more and more by judges in addition to the recorded documents.
This promissory note is especially important because whoever has the ability to produce the original promissory note to the court is considered the person or entity entitled to receive payments under the note – and thus entitled to default the borrower and foreclose.
Unfortunately, promissory notes are documents that regularly fall by the wayside in the ongoing day-to-day management and servicing of a loan, causing it to be nearly impossible at times to produce the promissory note.
An inability to produce the note is perhaps the most problematic obstacle for a mortgagee that seeks to assert its rights. In those instances where it is demanded by a judge, the lien holder may elect to sign a lost-note affidavit, attesting to the date the loan was purchased and for what consideration.
In many cases, the judge will consider the lost-note affidavit when it is accompanied by the recorded mortgage or deed of trust with any subsequent assignments and a title report in order to establish ownership with reasonable certainty. Otherwise, the lien holder may be forced into reconciling with the borrower if it is unable to establish its standing to the court's satisfaction.
Securitization
Recent rulings by the country's federal and state judges, particularly in the Ohio federal court system, have raised questions about the practice of trading home loans via securitization processes that can make it difficult – or perhaps even impossible – to provide legal clarity on who owns the debt.
One recent en masse ruling was from the Federal District Court in Dayton, Ohio, where the attorney filing for foreclosure on 26 properties was given 30 days to obtain proof that his institutional-lender clients actually owned the mortgages in question. In making this decision, Judge Thomas Rose cited a University of Iowa research study showing that 40% of mortgagees foreclosing on borrowers failed to show proof of ownership.
Meanwhile, according to the Center for Responsible Lending, by the end of 2007, more than 90 subprime lenders had gone out of business – meaning that each loan previously controlled by these firms was assigned to a new servicer.
For those assignees, it is critical that the documentation on each loan includes the original promissory note and reflects an accurate recorded assignment. Waiting until the borrower is in default to collect and record the appropriate documents simply delays the ability of the servicer to take judicial action to assert its rights.
The unfortunate reality is that what used to be a relatively smooth judicial process has become increasingly burdensome and – in some cases – nearly impossible to complete satisfactorily. Snags like the promissory note predicament discussed above can pose significant challenges for servicers.
Therefore, it will be up to servicers and their legal counsel to take the required, painstaking measures to ensure every last "t" is crossed and every "i" dotted before pursuing judicial remedies.
Kimberly M. Raphaeli is an attorney in the Bellevue, Wash., office of Routh Crabtree Olsen PS. She can be contacted at (425) 586-1970 or kraphaeli@rcolegal.com.
