by Adam Leitman Bailey, Dov Treiman
Adam Leitman Bailey is the principal of Adam Leitman Bailey, P.C., in New York, New York. Dov Treiman is a partner in the New York, New York, office of Adam Leitman Bailey, P.C.
In Homer’s Odyssey, Odysseus is called on to sail his crew through the Straits of Messina, passing between two legendary monsters, Scylla and Charybdis. To avoid one, the only option was to approach the other, risking a horrible death in either instance. Odysseus was at times a wise captain and managed to minimize the number of deaths, if not to avoid them altogether.
Thanks to the still-writhing tendrils of the economic collapse of 2008, most of the nation is caught between, on the one hand, the Scylla of further economic collapse by making the foreclosure procedure so difficult that banks refuse to make residential mortgage loans, and, on the other, the Charybdis of wholesale ejectment of homeowners from houses they should not have purchased. Tightening the foreclosure rules threatens economic destruction from the top down; loosening them threatens that destruction from the bottom up. There can be no doubt that any action taken, including complete inaction, threatens to thrust enormous hardship onto thousands, if not millions of people. Exacerbating the problem, there is no Odysseus in this story. In other words, there is no one to captain the ship to safety.
Although not the cause of the foreclosure problem by any means, yet still at the heart of its mechanics, is the national “Mortgage Electronic Registration Systems,” known as MERS. Operating near Washington, D.C., MERS is involved in nearly 60% of residential mortgage and mortgage-like transactions nationally, with a registry that numbers some 60 million residential mortgages. The authors and sponsors of this national system intended it to simplify and centralize the tracking of rights regarding each mortgage-like instrument.
MERS attempts to attain this centrality and uniformity, despite the fact that states differ on whether “mortgages” or “deeds of trust” are used under their laws and customs. Mortgages are mere liens on land. Deeds of trust are actual conveyances of the land, in trust, to a trustee who acts, ostensibly, on behalf of both the borrower and the lender, but in actual practice acts on behalf of the lender in a power of sale foreclosure procedure. Many states following the lien theory of mortgages require that foreclosure be done exclusively under judicial supervision. Title theory states, where deeds of trust are used, inherently follow entirely nonjudicial foreclosure procedures or judicially supervised private foreclosure procedures; in light of the epidemic of foreclosures sweeping the nation, more jurisdictions are requiring court supervision of the exercise of the nonjudicial power of sale or are increasing the level of supervision. Although not a sure indicator of local practice, states that started as British colonies by and large tend to be mortgage states, and those that achieved statehood by congressional declaration tend to be deed of trust states. This is part of the French and Spanish heritage of the younger states.
How such mortgage and deed of trust instruments are recorded, and what remedies are available to the lender in the event of a default by the borrower, all differ by jurisdiction. MERS’s attempted uniformity is compromised by the fact that each of the states’ highest courts (and the applicable federal courts sitting in such states) must decide for themselves exactly what a MERS registration means. Even federal district courts sitting in different districts may or may not find their rulings influenced by the laws of the host states, depending on whether they find foreclosure rules to be essentially substantive or procedural in nature. Because foreclosure proceedings always involve real property, the substantive rights are controlled by the substantive laws of the state or territory where the property is located, but federal procedural rules are uniform under the Federal Rules of Civil Procedure.
Although precise statistics vary among states, at the peak of MERS’s popularity up to 50% of mortgages and deeds of trust written in some jurisdictions involved MERS. Because some major banks are leaving MERS, the number of new MERS mortgages issued annually appears to be decreasing, but any reasonable analysis of these figures requires adjusting the meaning of these numbers to reflect the decrease in mortgage issuance generally as a result of the still-faltering national economy.
In a non-MERS mortgage, there is a borrower-mortgagor and a lender-mortgagee. In a non-MERS deed of trust, there is a borrower-grantor, a lender-beneficiary, and a trustee. In both scenarios, the borrower is receiving money and putting the borrower’s house up as collateral to repay it; the lender keeps the promissory note in its files; the lender or its title company records a copy of the mortgage or deed of trust in the applicable land records; and the lender owns both the promissory note and the mortgage or deed of trust. The lender may sell both the note and the mortgage or deed of trust, but it should keep them together.
In a MERS transaction, the borrower still executes a promissory note in favor of the lender, but the borrower executes the mortgage or deed of trust in favor of or for the benefit of MERS as the bank’s so-called “nominee,” and causes the instrument to be recorded in the applicable land records or recorder’s office. MERS itself neither records the instrument nor has physical possession of the mortgage, deed of trust, or promissory note. Early drafts of the proposal that evolved into MERS called for MERS to be the depository of the mortgages and notes as well. That idea was abandoned, however, because it became apparent that a core goal of MERS—that it be cheap to create, maintain, and operate—would be sacrificed by MERS acting as the depository of such files. If the lender, known as an “originator,” sells a note it might inform MERS of the sale (except for paying MERS its fees, nothing is mandatory in the MERS world); but the mortgage or deed of trust stays in favor of MERS. MERS can transfer the mortgage or deed of trust to the purchaser of the note, should it be necessary, by selling to the note purchaser, as its subscriber, a vice-presidency in MERS to effect the transfer. MERS transfers nothing itself in the public records. The transfer is effectuated simply by an entry in the MERS database.
There are well over 3,000 public land recording offices nationally, but only one MERS. Non-MERS records across the nation are generally located in county recording offices with considerable variation in recordation rules. Numerous observers have called for the elimination of county-based recording in favor of state-based recording or national land record recording. The county system was originally founded on the idea that land records should be available within a single day’s horse ride within the jurisdiction where the records are found. That theory is outdated in light of modern transportation systems, unnecessary in light of the ubiquity of the Internet, and contrary to actual fact where the more sparsely populated counties of the American West and Alaska include many more square miles than the horse theory would allow. North Slope County in Alaska has a land area of 89,000 square miles. Thirty-nine states of the Union are smaller than that. Bill Kearney, Adding Up the Effects of Oil and Gas Development in Alaska, In Focus, Winter/Spring 2003, available at www.infocusmagazine.org/3.1/env_alaska.htm. By contrast, New York County in New York is 36 square miles, including water. Although governmental recording fees are modest compared to the monies involved in the transactions secured by the mortgages, MERS vastly cuts into these fees because its members pass mortgages among themselves without recordation, thus depriving the public recording offices and saving the banking industry roughly $1 billion since the initiation of MERS. Local governments have bitterly complained about this loss of income, probably with considerable justification; and point out that recording fees fund myriad governmental programs having nothing to do with the recording process. Before MERS, recording fees were, in essence, a real property tax used as general revenue of local and state governments. Attorneys general from several cash-starved states are suing MERS to recover the lost funds or prevent further losses.
The MERS system obscures from borrowers the transfer history of their mortgages. Some states make fully indexed land records readily available and searchable to anyone with an Internet connection, for example, New York City, under its “Automated City Register Information System” (ACRIS). (In New York City, the City Register, instead of its county clerks, keeps the land records, probably because New York City comprises five counties.) In many other jurisdictions, computer-based searches are available, but researchers must make the trip to the county clerk’s office to access the computer system. In some farming-based counties, the records are still kept nearly exclusively on paper. Regardless of the difficulty of searching them, however, all of these records are public. In contrast, MERS does not allow nonmembers access to any of its records. MERS ensures that borrowers know nothing about the holder of their mortgage beyond the name of the payee. Furthermore, when there are errors in MERS and the same mortgage is simultaneously assigned to more than one financial institution, the homeowner has no way of determining who actually has the superior right without resorting to the court system, which itself may not be able to untangle the MERS threads.
As an alternative method of achieving the objects of MERS, there are current calls to replace the 3,000-office system with something both national in scope and governmental in administration. Although such a system remains beyond the horizon, calls in some states to have single statewide systems are becoming more urgent. But, for now, that part of the crisis remains in stasis.
Attacks on MERS
The court in Bank of New York v. Silverberg, 926 N.Y.S.2d 532 (App. Div. 2011), a case of first impression in New York, ruled that, because MERS was neither the owner of a promissory note nor ever had physical possession of it, MERS had no assignable interest in the mortgage made in its favor as “nominee.” Therefore, an assignment to Bank of New York through the MERS system was void, and Bank of New York lacked standing to bring a foreclosure action.
The basic facts in the Silverberg case are as follows: In 2006, Mr. and Mrs. Silverberg executed a mortgage in favor of MERS with an underlying note in favor of the originating bank, Countrywide Home Loans. In 2007, they executed a second, similar set of documents, together with a consolidation agreement to which Countrywide was not a party. When the Silverbergs defaulted on the consolidation agreement, MERS assigned the consolidation agreement to Bank of New York, which brought a foreclosure action.
Because the court found that MERS lacked physical possession of the note or an assignment of it, it also lacked the authority to assign the consolidation agreement to Bank of New York, and the court found that Bank of New York thus lacked standing to bring a foreclosure action. “Physical possession” is key to establishing ownership of a negotiable instrument such as a note—rather like cash. See Levy v. Louvre Realty Co., 118 N.E. 207, 209 (N.Y. 1917); Curtis v. Moore, 152 N.Y. 159, 162 (1897); Strause v. Joseph thal, 77 N.Y. 622 (1897); Fryer v. Rockefeller, 63 N.Y. 268, 276 (1875).
Under established doctrine in U.S. jurisdictions recognizing mortgages, separate ownership of a mortgage and note voids the mortgage. Carpenter v. Longan, 83 U.S. 271 (1872). In MERS transactions, however, the mortgagee, MERS, was never the lender and was never the payee on the promissory note. Thus, it could well be argued that loans secured by MERS mortgages are not mortgage loans at all, but are instead unsecured monetary loans to the borrower. In MERSCORP, Inc. v. Romaine, 861 N.E.2d 81 (N.Y. 2006), New York’s high court determined that the Suffolk County Clerk did not have the discretion to refuse to record a MERS mortgage but never directly addressed the question of whether a MERS mortgage is enforceable as a mortgage. It merely held that the county clerk was obliged to record everything that looks like a mortgage. Although a finding that a MERS mortgage is not a mortgage would not, in theory, deprive the bank of all remedies, it does mean that the judgment acquired by the bank on account of nonpayment of the loan would not have any particular seniority as a lien against the borrower’s real property.
Yet another level of complexity is added by the fact that a vast number of MERS loans originated during the housing boom, when banks were often extremely sloppy about keeping track of the original promissory notes. For banks seeking to foreclose on these housing bubble mortgages, the holding in Silverberg adds additional procedural and evidentiary hurdles because the foreclosing bank must be able to prove possession or ownership of the note underlying the mortgage before the commencement of the foreclosure action. In the case of failed banks, this might include the daunting task of following the paper trail from one bank to the next to find the current owner of the note. Fears that Silverberg ended the world are vastly overstated, however.
Although Silverberg was a case of first impression in New York, earlier cases in other jurisdictions no doubt influenced the New York decision. For example, the Michigan Court of Appeals held that MERS cannot foreclose by advertisement. Residential Funding Co. v. Saurman, 807 N.W.2d 412 (Mich. Ct. App. 2011). In Michigan, the statute permitting foreclosure by means of advertisement requires that the foreclosing party either own or have an interest in the underlying debt that is secured by the mortgage. In this case, the court found that MERS did not stand to receive any benefit from the debt being paid and did not have a financial interest in the note. As a result, the court reasoned that MERS did not meet Michigan’s statutory requirements as a party either owning or having an interest in the debt and therefore could not foreclose by advertisement. The court did not address the issue of whether MERS would be able to foreclose in a judicial proceeding. Although the Michigan Supreme Court went on to reverse this holding, the lower court’s decision had already made its influential impact. Residential Funding Co. v. Saurman, 805 N.W.2d 183 (Mich. 2011).
Likewise, the Supreme Court of Kansas affirmed the lower court’s ruling that MERS was not a necessary party to a foreclosure in which MERS was designated the nominee-mortgagee for the lender. Landmark Nat’l Bank v. Kesler, 216 P.3d 158 (Kan. 2009). As in Michigan, the Supreme Court of Kansas determined that MERS did not have any ownership interest in the underlying debt and, therefore, did not have any right to enforce the mortgage. In fact, the court noted that in a different jurisdiction MERS had previously argued that it was not allowed to enforce the mortgage. See Mortgage Elec. Reservation Sys., Inc. v. Nebraska Dep’t of Banking & Fin., 704 N.W.2d 784 (Neb. 2005).
In the most definitive stand against MERS before Silverberg, the Maine Supreme Judicial Court held that MERS lacks standing to institute a foreclosure through judicial proceedings. Mortgage Elec. Reservation Sys., Inc. v. Saunders, 2 A.3d 289, 295 (Me. 2010). In this case, the mortgage defined MERS as a nominee. The court found that, in its limited role as nominee, MERS did not have possession of the note or any interest in the debt obligation and accordingly did not qualify as a mortgagee and lacked the standing required to institute a foreclosure proceeding.
Decisions Favorable to MERS
Not all states have taken a position against MERS, however. For example, in 2008 Minnesota amended its recording act to broaden the authority of nominees. The amendment, commonly referred to as “the MERS statute,” allows nominees to record “[a]n assignment, satisfaction, release, or power of attorney to foreclose.” Minn. Stat. § 507.413(a). Clearly, Minnesota has recognized that MERS’s standard operations are acceptable for the purpose of recording.
Minnesota’s favorable position toward MERS is further detailed in Jackson v. Mortgage Electronic Registration Systems, 770 N.W.2d 487, 498 (Minn. 2009), in which the court had to determine whether a MERS member was required to record the assignment of a promissory note before MERS could commence a foreclosure by advertisement. Id. at 501. Notwithstanding Minnesota’s statutory recognition of MERS’s authority to record, Minnesota’s foreclosure by advertisement statutes require certain assignments to be recorded. The court had to decide whether the assignment of a promissory note was required under the foreclosure-by-advertisement statutory requirements. The Minnesota Supreme Court found that the assignment of a promissory note was not required and, therefore, held that MERS members did not have to record a promissory note assignment before MERS could commence a foreclosure by advertisement.
In addition, in a 2011 California case, Ferguson v. Avelo Mortgage LLC, 126 Cal. Rptr. 3d 586 (Ct. App. 2011) (as modified on June 20, 2011), the borrower challenged MERS’s ability, as nominee, to assign the promissory note to the foreclosing party. The California Court of Appeals for the Second District held that when a deed of trust allows MERS to act on behalf of the lender, MERS has the authority to assign the promissory note. The court noted that California law regarding nonjudicial foreclosure does not require possession of the note under a deed of trust. But California common law on deeds of trust is clearly distinct from the previously cited national common law on true mortgages.
Seated in the national capital of the financial industry, New York courts’ influence on the national home financing industry is disproportionate compared to New York’s relative percentage of the national land area, national population, or even national financial transactions. So when New York spoke through Silverberg, MERS certainly listened. On July 22, 2011, MERS officially revoked the authority granted to its members’ certifying officers to initiate foreclosures in MERS’s name. MERS accomplished this by an amendment to Rule 8 of the MERSCORP, Inc., “MERS System Rules of Membership.” Rule 8, entitled “Foreclosure and Bankruptcy,” outlines the new steps a MERS member must take to initiate a foreclosure proceeding. In short, the note owner must cause a certifying officer to assign the security instrument from MERS to the note owner’s servicer, and such servicer must record the assignment of the mortgage in the governmental recording office before any foreclosure proceeding can commence.
With recent changes, prudent MERS members also should become familiar with Rule 7, entitled “Disciplinary Actions.” The amendment to Rule 8 provides that, as of September 1, 2011, members can be sanctioned under Rule 7 for improper use of MERS’s name in a foreclosure proceeding. According to Rule 7, sanctions range from removal as a member to fines to “any other fitting requirements that may be determined by MERSCORP Holdings.” Members have an opportunity to respond to the citation for violation and have 30 days to correct the violation. For foreclosures, a MERS member can avoid sanctions by withdrawing the filing of the proceeding within three weeks of bringing the action.
Close analysis of Silverberg raises questions about whether these steps are effective in curing the infirmity in the MERS-tainted transactions or whether these steps are more about trying to keep the name of MERS out of the names of cases. If, as in Silverberg, it was the MERS involvement itself that made the mortgage unforeclosable, the courts may well find the MERS taint to be incurable. The question is simply this: once a mortgage is impaired by having its ownership separated from the ownership of the note, can that defect in title be subsequently repaired by uniting the ownership of the two documents?
In the months leading up to the amendment to the MERS Rules of Membership, MERS had already begun taking steps to withdraw from the foreclosure process by rapidly assigning deeds of trust to banks that service loans or trustees that oversee mortgage pools. It is likely that some of this change can be attributed to the fact that Fannie Mae, Freddie Mac, and other large lenders and loan servicers (such as JPMorgan Chase) had already ceased foreclosing in MERS’s name.
The MERS rule changes might successfully remove MERS from the courtroom. MERS will not disappear completely from the foreclosure process, however, because MERS will have to continue to assign the necessary mortgage documents to the various loan servicers and foreclosing parties.
Pending and Proposed Legislation
Although the courts have not made any major pronouncements after Silverberg, various state legislatures also are examining the issues it raises. As statehouses across the nation are politically polarized, we can expect to see red state legislatures step in, like Minnesota, to create statutes shoring up MERS mortgages and blue state legislatures, like New York, to codify the holdings in cases like Silverberg. This is precisely where the problems of Scylla and Charybdis lie.
New York, for example, is considering legislation that would go beyond Silverberg and permit a homeowner to object to MERS’s involvement in the mortgage transaction much later in the litigation than normal procedure in New York would permit. Assemb. B. A629D-2011, 2011-12 Reg. Sess. (N.Y. 2012). Some observers regard this legislation with considerable trepidation because it may have the effect of permitting a second suit after the foreclosure action. Perhaps a greater concern is that this legislation, with its lender-unfriendly provisions, may scare away lenders from offering mortgage financing on New York properties.
Alarm bells are sounding on both sides of the aisle: those who fear economic devastation resulting from mass foreclosures and those who fear economic devastation resulting from hampering the mortgage financing industry. As state legislatures are free to forge their own solutions, four categories of solutions emerge: doing nothing and letting the common law sort things out; reinvigorating the procedures in favor of plaintiffs (that is, the lenders) in foreclosure actions; strengthening the defenses to foreclosure actions on behalf of borrowers; and trading off new plaintiff strengths for newly strengthened defenses. A plurality of states is likely to follow the first of these four courses. The other three will be hotly debated in a few states and may result in enactments that will move America away from the current two-theory stasis of (1) classic mortgages and (2) deeds of trust. Those jurisdictions that do not recognize mortgages and instead have deeds of trust have received many complaints of thinly disguised consumer fraud, and there have been calls in some deed-of-trust jurisdictions to shift over to mortgages or otherwise require supervision of the deed of trust foreclosure process.
Practice in one state may ill-prepare lawyers for what they can expect to encounter in others. Lenders will need to have individual experts in each jurisdiction where they do business, which will contribute to a greater cost of credit to consumers. Clearly this result benefits no one.
In analyzing any proposed legislation, it must be realized that such legislation must address both financing instruments issued before the passage of the legislation and those issued afterwards. For the former, constitutional constraints limit the effect of such legislation. For the latter, marketplace constraints will prevent states from passing legislation that is extremely lender-unfriendly.
It should be recalled that the crisis emerged not from the existence of the MERS system but from its use. Lenders that use the classic recording methods for new transactions should find those deals as safe and secure as they have been for centuries. But the problem remains that these methods are simply too slow. Many recording offices nationwide using the classical system were as much as two years behind in their classical method of recording. To sustain the kind of vibrant mortgage market seen during the housing boom, classical recording methods have to speed up to carry the load. The MERS advantage of making a mortgage a freely transferable security for investors (without the delay, if any, caused by recordation) can remain in place, provided only that the mortgage or deed in trust always be physically conveyed along with the underlying note in each such transfer.
Many foreclosing banks are citizens of states other than the state where the property is located, potentially entitling them to bring their foreclosure proceeding in federal district court rather than a state court. Were a federal court to find the applicable state foreclosure law procedural rather than substantive, the answer for the bank to get a bulletproof foreclosure proceeding might be the simple expedient of starting it in federal court. Indeed, even if the bank is already a citizen of the state where the property is located, it could sell the mortgage to another bank that is not; or create a bank that is a citizen of a different state for the very purpose of creating federal diversity jurisdiction. One bank can handle 49 states, and the other bank can handle the single state of which the first bank is a citizen, creating a more substantively uniform foreclosure process for the lender satisfying some of the objectives of MERS.
An Outdated System
No one can seriously dispute that the United States land title recording system designed in the 1600s is now hopelessly behind the needs of the brisk hour-by-hour business of the 21st century. The system is, by law, paper based across the nation. Even electronic records are photographs of pieces of paper. Although optical character recognition technology—which permits a computer to read a document and recognize the contents as meaningful text in a specific language—has come a long way since the last quarter of the 20th century, handwritten notes on real estate transaction documents remain completely indecipherable to computers. Therefore, as long as there are any handwritten notations on real estate instruments (other than the signatures), the recording system remains essentially locked into paper or photographs of paper. So long as the system is paper based, electronic indexing is limited to what the recording clerk sees, or believes he or she sees, printed on the document. The all-important legal description, being heavily based on numbers, will continue, at least to some extent, to rely on the accuracy of a clerk transcribing those numbers. Thus, any upgrade of the recording system to 21st century modernity would have to require, at a minimum, that the documents be presented to the recording office both as photographs of paper and as textual electronic files setting forth the contents of the documents as plain text that any computerized word processor can read.
More radical proposals include the elimination of the states’ county recording offices in favor of single statewide registries. Although such a proposal has merit, most of those same county recording offices also archive the judicial records of various matters such as judgments and probate files. The overhaul of the system of all of the documents affecting title to any statewide system would be a truly massive undertaking and a good many of those documents would indeed require that they be preserved, even in digital format, as mere photographs or images of paper.
Whatever modern recording system is adopted, it should have characteristics that both fix the problems that MERS was created to address and solve the problems that MERS created by its existence. See Tanya D. Marsh, Foreclosures and the Failure of the American Land Title Recording System, 111 Colum. L. Rev. 1 (2011), available at http://ssrn.com/abstract=1737857. The chain of title as it relates to a MERS mortgage must become transparent. The recordation of a MERS mortgage creates an entry in the title records that is essentially a placeholder, but gives a researcher no guidance about the real parties in interest to contact with problems or concerns relating to the mortgage. The public should be able to research title chains without having to pay a private company for copies of its own proprietary records. The system should be indexed, indexable, and amenable to innovations in indexing techniques. In a modern system, a deed from Leonardo da Vinci should be equally easy to find under “L,” “D,” or “V.” A modern system should automatically compare all instruments offered for recording and flag partial and total overlaps with previous instruments or intrinsic invalidity in the instrument itself. Truly modern systems would assign some kind of numerical identification tag to every square inch of the earth’s surface, including three dimensional cubic inches when necessitated by condominium developments and other vertical conveyancing schemes.
Creating Modern Systems
Land records should serve as a repository for mortgages and their underlying promissory notes, with legal incentives to recording both to eliminate the problem of lost paper. A change in substantive law declaring that a recorded assignment of the note and mortgage would serve as prima facie proof of the authority of the assignee for both, would avoid much mischief—provided, as with every recorded instrument, that sufficient safeguards against fraud were imposed as well. See Adam Leitman Bailey, Title Litigation: Expense of Theft Prevention Dwarfed by Cost of Fraud, N.Y.L.J., Apr. 8, 2009.
The fundamental flaw in MERS was always that it could come up with creative ways to work around various laws, but it could never directly influence what those laws would be. If, for example, a legislature were simply to outlaw any MERS-like transactions in its state, all that MERS could do to prevent it would be to lobby. The state, however, is in a position to change the laws, at least for transactions inside the boundaries of that state. With the low cost of computer storage—$100 for a trillion bytes on the open market—recording offices can record large amounts of data in a timely manner, provided that the data are provided in electronic form via computer upload. Uploaded data would enable computerized recorders to index documents by every single word contained in them.