Bar News - May 18, 2012
Real Property Law: MERS: A Chicken and Egg Problem
By: Richard Hubbard
Which came first, the note or the mortgage? To many real estate practitioners, this may seem like a nonsensical question. But today, as the foreclosure process across the country receives increasing microscopic review, this is exactly the sort of legal dissection necessary in some courts that weigh in on challenges associated with Mortgage Electronic Registration Systems (MERS) secondary mortgage market loans.
When I first started in practice here in New Hampshire more than 30 years ago, I periodically did a foreclosure or two for a local bank (You might remember that now-extinct species of bank.). I remember sitting at the bank with the vice president to gather the exact outstanding arrearage, so a 30-day default notice could be sent to the mortgage borrowers. With the loan file in hand, he provided the necessary information and then made copies of the original note and mortgage, both of which were tucked neatly in his file. Those were the simple and "good old days."
Then, MERS came along.
MERS was created in 1993 to track ownership interests in residential mortgages. Mortgage lenders and other entities, known as MERS members, subscribe to MERS and pay annual fees for the electronic tracking of sales and transfers of mortgages. Members contractually agree to appoint MERS to act as their agent in all mortgages registered into the MERS system. As designed, MERS is the mortgagee, but not the note holder, or owner of the indebtedness.
By operating through MERS, financial entities could buy and sell mortgage loans, without having to record a mortgage assignment for each transaction, because the named mortgagee would never change. It would always be MERS, even though the loans change hands. MERS would perpetually track the mortgage sales internally, so as to know which entity was holding the mortgage at a given time.
During the recent foreclosure crisis, legal challenges to MERS and its process became plentiful. Much of the litigation has centered on the MERS business model and the question of whether it has "standing" to foreclose a mortgage registered into the MERS system. While this sea of litigation is evolving, some plaintiffs have succeeded in their challenges in those cases where MERS is neither in possession of the note, nor the mortgagee party foreclosing.
According to Blackís Law Dictionary, to "own" means, "to have good legal title, to hold as property, to have a legal or rightful title to." Arguably, the note and mortgage are two different legal transactions providing two different sets of rights, even though they are typically employed together. Under basic hornbook law, the mortgagee has two interests: (1) the debt or obligation which is owed to him, and (2) the security interest in land represented by the mortgage. The legal nexus of these two interests of the note and mortgage are at the heart of the MERS conundrum. By some theories, where the mortgagee has "transferred" only the mortgage, the transaction is a nullity and the "assignee" receives no interest in the underlying debt and has a worthless piece of paper. And, as one New York court stated, in Merritt v. Batholick:
"As a mortgage is but an incident to the debt, which it is intended to secure, the logical conclusion is that a transfer of the mortgage without the debt is a nullity, and no interest is acquired by it. The security cannot be separated from a debt and exist independently of it."
If MERS, as mortgagee, holds only an interest in the property as security for the note, and not an interest in the note itself, does MERS have the authority to enforce the note? And, is it necessary that the foreclosing party own the note interest? The foreclosure crisis has sparked litigation over the finer legal points of a residential mortgage transaction and the role of MERS. One court recently explained it this way, in Mer-Scorp Inc. v. Romaine:
"The problem arises from the difficulty of attempting to shoehorn a modern innovative instrument of commerce into nomenclature and legal categories which stem essentially from medieval English law."
In a precedential California bankruptcy case, the court held that MERS could not foreclose, because it was a mere nominee:
"Since no evidence of MERSís ownership of the underlyingnote has been offered, and other courts have concluded that MERS does not own the underlying notes, this court isconvinced that MERS has no interest to transfer to Citibank. Since MERS did not own the underlying note, it could not transfer the beneficial interest of the Deed of Trust to another."
In contrast, the Michigan Supreme Court has ruled that, even though MERSís status as an "owner of an interest in the indebtedness" does not equate to an ownership interest in the note, MERS was record holder of a mortgage, whose existence was contingent upon the satisfaction of the indebtedness. MERS had standing and authority to foreclose.
The battle line in this series of cases is over whether MERS is the real party in interest and can, as the mortgagee of record but not the note owner, enforce the note provisions, especially if it has possession of the instrument. Under New Hampshire law, possession of a negotiable instrument, such as the note, is a prerequisite to its enforcement. In elementary terms, case law developing around the country begs a simple question: Can the note and mortgage ownership and interest be split?
These are not simple times in the real estate mortgage world. As one court has aptly observed, "it is the incongruity between the needs of the modern electronic secondary mortgage market and our venerable real property laws regulating the market that frames the issue before us." In the arena of foreclosures, the days when real estate law was static and sometimes as dusty as the registry volumes themselves are ancient history. Likewise, long gone are the days when the bankerís file contained the original note and mortgage for anyone to see.
Richard H. Hubbard is from Bedford, New Hampshire where he concentrates his practice in real estate matters and federal criminal defense. In 2008 and 2009, he served as Chair of the New Hampshire Barís Real Property Section. He is a member of the Criminal Justice Act ( "CJA" ) panel in the US District Court for the District of New Hampshire. He is an adjunct professor at both Great Bay Community College and Manchester Community College.
|Richard H. Hubbard