By Adam Leitman Bailey and Dov Treiman
In Homer’s Odyssey, the protagonist, Odysseus, is called upon to sail his crew through the Straits of Messina, passing between two legendary monsters, Scylla and Charibdis. 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 it altogether.
Most of the nation is, thanks to the still writhing tendrils of the economic collapse of 2008, part of the larger real estate crisis setting forth the Scylla of further economic collapse by making the foreclosure procedure so difficult for banks that they refuse to issue residential mortgages at all or the Charibdis 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 on thousands, if not millions of people. Exacerbating the problem, there is no one to captain the ship.
Although not the cause of the 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-like transactions nationally, with a registry entailing some 60 million residential mortgages. The authors and sponsors of this national system intended both to simplify and to centralize the tracking process of rights regarding each mortgage-like instrument.
MERS attempts to attain this centrality and uniformity despite the fact that states differ as to whether they have “mortgages” or “deeds of trust,”1 on how such instruments are recorded, and as to what the remedies are to the promise in the event of a default by the promissor. MERS’s uniformity is further compromised by the fact that each of the 50 state highest courts must decide for itself, as must the federal system decide for itself, exactly what a MERS transaction 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.2
At the peak of MERS’s popularity, although precise statistics varied amongst various states, some 50% of mortgages and deeds of trust written in some jurisdictions involved MERS.3 In a non-MERS mortgage, there is a borrower-mortgagor and a lendermortgagee. 4 In a non-MERS deed of trust, there is a borrower-grantor, a lender-beneficiary, and a trustee. The lender keeps the promissory note in its files and it or its title company records a copy of the mortgage or deed of trust in the county registry. In this scenario, the lender owns both the promissory note and the mortgage or deed of trust. The lender may sell both, but should keep them together.
In a MERS transaction, the lender still lends the money and 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, recorded in the county registry as the bank’s so-called nominee. MERS neither does the recording itself nor has physical possession of the mortgage, deed of trust, or promissory note.5However, the lender, known as an “originator,” sells the note and, at times, informs MERS of the sale.6 MERS is available to transfer the mortgage or rights under the deed of trust to the vendee of the note, should it become an issue. If such a transfer does become necessary, MERS sells its subscribers a vice-presidency in MERS to effect the transfer. MERS transfers nothing itself. If a subscriber requests it to do so, MERS just makes entries in its database.
Nationally, there are well over 3,000 recording offices, but only one MERS. Non-MERS records across the nation are located generally in county recording offices with considerably varying rules about how the recording is to take place.7 Although the governmental recording fees are considerably modest compared to the monies involved in the transactions the mortgages are securing, MERS vastly cuts into these fees as its members pass mortgages among themselves as relay race batons, thus depriving government and saving the banking industry roughly $1 billion since the initiation of MERS. Probably with considerable justification, local governments have bitterly complained about this loss of income and point out that recording fees were a way of funding governmental programs having nothing to do with the recording process. It was, prior to MERS, in essence, a real property tax most heavily imposed on those most well off, but actually used as general revenue of local and State government.8
Further, the MERS system hides from borrowers the history of their mortgages. While some states have systems like New York City’s ACRIS9 system to make fully indexed land records readily available and searchable to anyone with an internet connection, MERS does not allow non-members access to any of its records.10 MERS ensures that borrowers know nothing beyond to whom they should be sending their check. Furthermore, when there are errors in MERS and the same mortgage gets assigned to more than one financial institution, the homeowner has no way of figuring out who actually has the superior right without resorting to the court system, which itself may not be able to untangle the MERS threads.
There are current calls to replace the 3,000 office system with something both national in scope and governmental in administration. While 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
In a case of New York’s first impression, Bank of New York v. Silverberg11, ruled that since MERS never was either the owner of Mr. Silverberg’s promissory note nor ever had physical possession of it, MERS had no assignable interest in the mortgage in its favor as “nominee” and therefore its assignment to Bank of New York was void. With that assignment void, the court found Bank of New York to lack “standing” to bring a foreclosure action.
In 2006, the Silverbergs had executed a mortgage in favor of MERS with an underlying note in favor of 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 this later agreement, MERS assigned the consolidation agreement to Bank of New York who brought a foreclosure action.
Since 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, and the court found the bank lacked “standing” to bring a foreclosure action. “Physical possession” is key, it being sufficient to establish ownership – rather like cash.12
Under established doctrine, not only in New York, but in all United States jurisdictions recognizing mortgages,13 separate ownership of a mortgage and note voids the mortgage.14 However, in MERS transactions, we see that the mortgagee, MERS, was never the lender and was never the promisee on the promissory note. Thus, it could well be argued that MERS mortgages are not mortgages at all, but are, at most, unsecured monetary loans to the borrower. In Matter of MERSCORP, Inc. v. Romaine,15 New York’s high court determined that the Suffolk County Clerk did not have the discretion to refuse to record MERS mortgages, but never really addressed the question as to whether a MERS mortgage is indeed a mortgage at all. It merely held that the county clerk was obliged to record everything that looks like a mortgage and left unresolved whether MERS’s mortgage-lookalikes really were enforceable mortgages. While a finding that a MERS mortgage is no mortgage at all does not, in theory, deprive the bank of all remedies, it does mean that the judgment a bank would acquire for nonpayment of the loan would not necessarily have any particular seniority as a lien against the promisor’s real property. It may be so far down in the priorities of pure seniority that it may be completely unenforceable as a practical matter.
Yet another level of complexity is added when one realizes that a vast amount of MERS loans originated during the housing boom, a period in which the banks were extremely sloppy about keeping track of the original promissory notes. This got sloppier still among the banks that failed. For banks seeking to foreclose on these housing bubble mortgages, Silverberg adds additional procedural and evidentiary hurdles to overcome to make sure that they can prove possession or ownership of the note underlying the mortgage prior to the commencement of the foreclosure action. In the case of the 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. However, fears that Silverberg ended the world are vastly overstated.
While Silverberg was a case of first impression in New York, other jurisdictions across the country had earlier cases that no doubt influenced the New York decision.
Similar rulings against MERS had come down across the country. For example, the Michigan Court of Appeals held in Residential Funding Co. v. Saurman16 that MERS cannot foreclose by advertisement. In Michigan, the Foreclosure by means of Advertisement statute requires the party foreclosing the mortgage to 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 held that MERS did not meet Michigan’s statutory requirements as a party either owning or having an interest in the debt. Thus, MERS could not foreclose by advertisement. The court did not address the issue of whether MERS would be able to foreclose in a judicial proceeding.
Likewise, in Landmark National Bank v. Kesler,17 the Supreme Court of Kansas affirmedthe lower court’s ruling that MERS was not anecessary party to a foreclosure in which MERSwas designated the nominee-mortgagee for thelender. As in Michigan, the Supreme Court ofKansas determined that MERS did not haveany ownership interest in the underlying debtand, therefore, did not have any right to enforcethe mortgage. In fact, the Court noted that, ina different jurisdiction18, MERS had previouslyargued that it was not allowed to enforce themortgage. Therefore, as a simple nomineemortgagee,MERS was not a necessary party inthe Kansas foreclosure proceeding.
In the most definitive stand against MERS prior to Silverberg, the Maine Supreme Judicial Court19 had held that MERS lacks standing to institute a foreclosure through judicial proceedings. 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. The Court held that MERS did not qualify as a mortgagee and lacked the standing required to institute a foreclosure proceeding.
Favorable Decisions to MERS
However, not all states had taken a position against MERS, most notably perhaps, the state of Minnesota. 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.”20 Clearly, Minnesota has recognized, for the purposes of recording, MERS’s operations as acceptable.
Minnesota’s favorable position towards MERS is further detailed in Jackson v. MERS21 where 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.
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 included in the statutory requirements. The Minnesota Supreme Court found that the assignment of a promissory note was not included and, therefore, held that MERS Members did not have to record a promissory note assignment before MERS could commence a foreclosure by advertisement.
In a 2011 California case22 in which the borrower challenged MERS’s ability, as nominee, to assign the promissory note to the foreclosing party, the California Court of Appeal for the Second District held that, where 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. This, of course, is the California common law on deeds of trust and is thus clearly distinct from the previously cited national common law on true mortgages.
However, seated in the national capital of the financial industry, New York’s courts’ influence on the national home financing industry is substantially in excess of New York’s 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 Member’s Certifying Officers to initiate foreclosures in MERS’s name. MERS effectively rescinded the authority of the Certifying Officers through an amendment to Rule 8 of its “Rules of Membership.” Rule 8, entitled “Required Assignments for Foreclosure and Bankruptcy”, outlines the new steps a Member must take to initiate a foreclosure proceeding. Mainly, the note owner must cause a Certifying Officer to assign the Security Instrument from MERS to the note owner’s servicer. Further, the servicer must then record the assignment with the governmental recording office before any foreclosure proceeding can take place.
With the recent changes, members might find it particularly prudent also to become familiar with Rule 7, entitled “Disciplinary Actions”. The amendment to Rule 8 provides that, as of September 1, 2011, Members could be sanctioned pursuant to 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 MERS.”23 Members have an opportunity to respond to the citation for violation and they receive thirty days to correct the violation. In regards to foreclosures, a MERS Member can avoid sanctions by withdrawing the filing of the proceeding within three weeks after bringing the action.
Close analysis of Silverberg raises questions whether these steps do anything to cure 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 more than anything else. If, as in Silverberg, it was the MERS involvement in the first place that made the mortgage unforeclosable, the courts may well find the MERS taint to be incurable. The question to be presented is simply this: Once a mortgage is impaired by having its ownership separated from the ownership of the note, can that tear in title be repaired by uniting the ownership of the two documents?
In the months leading up to the amendment, MERS had already begun taking steps to withdraw from the foreclosure process. MERS rapidly began to assign 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 JP Morgan Chase, had already ceased foreclosing in MERS’s name.
The MERS rule changes should successfully remove MERS from the courtroom. However, MERS will not completely disappear from the foreclosure process. MERS will continue to assign the necessary mortgage documents to the various loan servicers and foreclosing parties.
Pending and Proposed Legislation
While the courts have not had major pronouncements after Silverberg, State legislatures are also examining the issues it raises. As the various statehouses across the nation see domination by the left and by the right, we can expect red state legislatures to step in, like Minnesota to create legal doctrines 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 Charibdis lay.
New York, for example, is considering legislation that would go beyond Silverberg and make a homeowner’s objection to MERS’s involvement in the mortgage transaction an issue that the homeowner can raise far later than the normal deadlines in New York litigation. Some observers regard this legislation with considerable trepidation as it may have the effect of requiring a second suit after the foreclosure action. Moreover, and perhaps an even greater concern, is that the legislation, and its other lender-unfriendly provisions, may scare away lenders from offering mortgage financing on New York properties.
We hear alarm bells on both sides of the aisle: those who fear the economic devastation that could ensue from mass foreclosures and those who fear the economic devastation that could ensue from shutting down the mortgage financing industry. The likely result is that as state leigslatures are left free to forge their own solutions, precisely four categories of those solutions emerge: (1) doing nothing and letting the common law sort things out; (2) reinvigorating the procedures in favor of plaintiffs in foreclosure actions; (3) strengthening the defenses to foreclosure actions; (4) 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 will undoubtedly lead to enactments that will move America away from the two-theory stasis it currently has24 to such a vast array of different variations on these theories, that practice in one state may well ill prepare lawyers for what they can expect to encounter in others. This will lead to multiplied costs to lenders who will need to have individual experts in each jurisdiction where they do business and, even without other factors, will contribute to a greater cost of credit to consumers. Clearly this is a result that benefits no one.
In analyzing any proposed legislation, we must realize that there are two broad categories of financing documents they address: documents issued prior to the passage of the legislation and those entered afterwards. As to the former, there can be constitutional constraints on how far the legislation can go. As to the latter, constraints will come from the marketplace as no State dares to pass legislation that is so lender unfriendly as effectively to require all land purchases in the State to be on a cash only basis.
Yet, in all of this, we need to recall that the entire crisis emerges not from the existence of the MERS system, but from its use. Lenders who 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 they are simply too slow.25 Even the MERS advantage of making a mortgage a freely transferable security for investors can remain in place, provided only that the mortgage or deed in trust always be physically transferred along with the underlying note in each such transfer.
Many foreclosing banks are already citizens of states other than the state where the property is located. This can trigger for them an entitlement to bring their foreclosure proceeding in federal district court rather than the state courts. Were a court to find the foreclosure law of the State where the property is located to be procedural rather than substantive, the answer for the bank to get a bullet proof foreclosure proceeding might be the simple expedient of starting it in federal court. Indeed, even if the bank is not already a noncitizen of the state where the property is located, it could sell the mortgage to another bank that is or create a bank of a new citizenship for the very purpose.26
An Outdated System
No one can seriously dispute that the land title recording system designed in the 1600’s 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 the electronic records are principally photographs of pieces of paper. While optical character recognition technology – a computer reading a document and recognizing the contents as meaningful text in a specific language—has come an amazingly long way since the last quarter of the 20th Century, handwritten notes on real estate transactions remain completely indecipherable to computers. Therefore, as long as there are any handwritten notations on real estate records (other than the signature of the grantor and notary), the system remains essentially locked into paper and photographs of paper. And so long as the system is paper-based, electronic indexing would be limited to what the recording clerk sees or believes he or she sees printed on the document. The all-important description, being as it is heavily based on numbers, will continue, at least to some extent, to rely on the accuracy of a clerk transcribing those numbers. Thus, any contemplated upgrade of the 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 could read.
More radical proposals include the elimination of the States’ county recording offices and replacing them with single statewide registries. While there is merit to such a proposal, it must be noted that in most of those same recording offices also archive the judicial records that so largely impact on titles, not just judgments, but also things like 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 of paper.27 We are therefore unprepared to endorse that radical a move in the short term.
Whatever 21st Century recording system there is, it must have certain characteristics in order to fix the problems that MERS was created to address and solve the problems that MERS created by its existence.28
Title records must once again become transparent. MERS creates an entry in the title records that is essentially a place holder and gives the researcher no clue as to who the real parties in interest are and therefore no one to contact with any problems or concerns.
The public has to be able to research title chains without having to pay some private company for its own proprietary records.
The system has to be thoroughly indexed, thoroughly indexable, and amenable to new inventions in indexing techniques. In a modern system, a deed from Leonardo da Vinci should be equally easy to find under “L,” “D,” or “V.” Any truly modern system would automatically compare all instruments offered for recording and flag partial and total overlaps with previous instruments or intrinsic invalidity in the instrument itself.29
Creating Modern Systems
Land records should be available as a repository of copies not only of mortgages, but of their underlying promissory notes with legal incentives to the recording of both so as 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 with respect to both, would avoid much mischief—provided, as with every recorded instrument, that sufficient safeguards30 against fraud were imposed as well.31
The fundamental flaw in MERS was always that it could come up with creative ways to work around the 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 computer storage space being so amazingly cheap nowadays – $100 for a trillion bytes on the open market – there is no amount of data that could be thrown at the recording offices that they would be unable to record in a timely manner, provided only that the data were given to them in pure electronic form, via some kind of upload. Having that data would enable the computerized recorders to index documents by every single word contained in them. While metes and bounds are in some circles regarded as themselves terribly outdated, a properly designed computer system would not only be able to process metes and bounds and compare them to other conveyances to find boundary conflicts,32 but would also be able to include any other kind of property identification system that could ever be invented, including section, block, and lot systems, the grantor/grantee system, and anything else.33
Private Industry Indexing
MERS was seen as an answer to both the “too slow” and the “too cumbersome,” but any State could enact its own system that is neither and, by making the laws sufficiently MERSunfriendly, could eliminate the other MERS motive, too expensive.34 The State could decide for itself not only what the market can bear, but what it should.35 However, in doing so, the State would have to consider the simple fact that institutional lenders are not the only ones to give mortgages. Folks selling their homes to those who cannot or will not get institutional financing also often take back mortgages. Any new law would also have to accommodate their needs. Even without new legislation, title companies can inform the purchaser’s attorney that if MERS is involved, the mortgage will be excepted from the title insurance policy. Purchasers’ attorneys would have to make sure that the contract of sale protects the purchaser against the consequences of such a refusal.
At the dawn of the 1980’s, computers came in two categories: department store sized behemoths suited only for governmental and large corporate use and toys for hobbyists. Into this world quietly slipped the PC with its revolutionary idea of “open architecture,” meaning that not only were the thousands of lines of computer code that operated these machines written in a way that any competent computer programmer could read them, but they were so written than any competent computer programmer could extend them and make the machine do things the original designer had never dreamed of. Most market analysts credit “open architecture” with the explosive growth of PC’s, now numbering some one billion in the world at large. By contrast, our current land records are essentially a closed system. Title companies have invested millions of dollars into reading these documents and figuring out what they mean for title in this State. But with the kind of recording system we described above, all of the data would be instantly open architecture. Title companies could make untold billions of dollars by simply designing computer programs that would log on to the publicly published digital land records, read them, and index them in any variety of creative new ways that could, in effect, produce a rudimentary title report in a matter of seconds.
Obviously, creating a statewide system of uniform multiple electronic indexing input from transactional attorneys’ desks would both save the State enormous funds and provide the public with a vastly more secure and useful title recording system. It cannot be denied that such a system would require substantial safeguards against fraud, things like a mechanism to alert overseers that a problem may arise when two deeds are recorded for the same property; signature verification; social security number verification; powers of attorney validated by licensed title professionals; and photographic identification scanned in with the documents offered for recording.36
Such an enhanced recording system could also handle the recording of promissory notes along with their mortgages, incentivized by a statutory rebuttable presumption that the owner stated on the recording is the current owner unless there is a recorded assignment of the note enjoying the same presumption. Logically, one would prepare any such assignment so as to assign both the note and the mortgage. That kind of recorded note system with ACRIS style indexing and access would make MERS— created chiefly for achieving speed—hopelessly obsolete and provide both lenders and the public with real value for their recording fees pouring once again into government coffers.
Both mortgage recording and foreclosure systems across America are currently broken. Fixing the latter inevitably requires fixing the former. Clearly no federal fix is in the offing, but inspired leadership in state capitals can go a long way, if not in curing the consequences of not having fixed the systems sooner, at least in erecting a system that will sustain commerce and secure titles in the future.