Author Archives: David Reiss

Mass. Appeals Court Applies Eaton Retroactively

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The intermediate appeals court of Massachusetts applied Eaton retroactively in Lyons v. MERS et al., 11-P-560 (June 5, 2013) notwithstanding the Mass. Supreme Court’s holding that Eaton would only apply prospectively. Eaton held that “a mortgagee may foreclose under a power of sale only if it either holds the note or is acting under the direction or as the agent of the note holder.” (1)

The intermediate appeals court found that it would be inequitable to do otherwise:  “Not only was the present case on appeal when Eaton was decided, the Lyonses actually brought their action before Eaton had even been decided in the trial court. Because the Lyonses are in an identical situation to the plaintiffs in Eaton, not a ‘somewhat similar[]’ position,” the court held “that the rule of Eaton is applicable to the Lyonses’ case, and reverse[d] the judgment” of the trial court. (1, citations omitted)

Mass. Trial Court Upholds MERS Foreclosure

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Judge Cutler granted MERS and Countrywide’s motion to dismiss plaintiff Lyons challenge to the validity of a foreclosure deed arising from a foreclosure sale conducted by MERS in Lyons v. MERS et al. Misc. 09 416377 (Jan. 4, 2011). The court held that “the Plaintiffs expressly granted the Mortgage to MERS (as nominee for the Lender), with the power of sale. As a result of this grant, MERS needed no assignment” from Countrywide.” (3) The court found that “such an arrangement is entirely consistent with the express terms of the Mortgage, as well as with Massachusetts law.” (3) The court found it intolerable to reach a result where “the logic of a denial of MERS’s foreclosure right as mortgagee would lead to anomalous and perhaps inequitable results, to wit, if MERS cannot foreclose though named as mortgagee, then either [the lender] can foreclose though not named as mortgagee or no one can foreclose, outcomes not reasonably or demonstrably intended by the parties.” (3) Not sure that those are the only possibilities (for instance, MERS could assign the mortgage to its beneficial owner), but there you have it.

REMIC Armageddon on the Horizon?

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Brad Borden and I have warned that an unanticipated tax consequence of the sloppy mortgage origination practices that characterized the boom is that MBS pools may fail to qualify as REMICs.  This would have massively negative tax consequences for MBS investors and should trigger lawsuits against the professionals who structured these transactions. Courts deciding upstream and downstream cases have not focused on this issue because it is typically not relevant to the dispute between the parties.

Seems that is changing. Bankruptcy Judge Isgur (S.D. Tex.) issued an opinion in In re: Saldivar, Case No. 11-1-0689 (June 5, 2013)) which found, for the purposes of a motion to dismiss, that “under New York law, assignment of the Saldivars’ Note after the start up day [of the REMIC] is void ab initio.  As such, none of the Saldivars’ claims” challenging the validity of the assignment of their mortgage to the REMIC trust  “will be dismissed for lack of standing.” (8)

If this case holds up on appeal, it will have a massive impact on many purported REMICs which had sloppy practices for transferring mortgages to the trusts. That is a big “if,” as the case relies upon Erobobo for its take on the relevant NY law. Erobobo, a NY trial court opinion, itself reached a controversial result and is hardly the last word on NY trust law. The Court also acknowledges that additional evidence may be proffered relating to a subsequent ratification of the conveyance of the mortgage, but for the purposes of a motion to dismiss, the homeowners have met their burden.

For those few REMIC geeks out there, it is worth quoting from the opinion at length (everyone else can stop reading now):

The Notice of Default indicates that the original creditor is Deutsche Bank, as Trustee for Long Beach Mortgage Loan Trust 2004-6. The Trust is a New York common law trust created through a Pooling and Servicing Agreement (the “PSA”). Under the PSA, loans were purportedly pooled into a trust and converted into mortgage-backed securities. The PSA provides a closing date for the Trust of October 25, 2004. As set forth below, this was the  date on which all assets were required to be deposited into the Trust. The PSA provides that New York law governs the acquisition of mortgage assets for the Trust.

The Trust was formed as a REMIC trust. Under the REMIC provisions of the Internal Revenue Code (“IRC”) the closing date of the Trust is also the startup day for the Trust. The closing date/startup day is significant because all assets of the Trust were to be transferred to the Trust on or before the closing date to ensure that the Trust received its REMIC status. The IRC provides in pertinent part that:

“Except as provided in section 860G(d)(2), ‘if any  amount is contributed to a REMIC after the startup day, there is hereby imposed a tax for the taxable year of the REMIC in which the contribution is received equal to 100 percent of the amount of such contribution.”

26 U.S.C. § 860G(d)(1).

A trust’s ability to transact is restricted to the  actions authorized by its trust documents. The Saldivars allege that here, the Trust documents permit only one specific method of transfer to the Trust, set forth in § 2.01 of the PSA. Section 2.01 requires the Depositor to provide the Trustee with the original Mortgage Note, endorsed in blank or endorsed with the following: “Pay to the order of Deutsche Bank, as Trustee under the applicable agreement, without recourse.” All prior and intervening endorsements must show a complete chain of endorsement from the originator to the Trustee.

Under New York Estates Powers and Trusts Law § 7-2.1(c), property must be registered in the name of the trustee for a particular trust in order for transfer to the trustee to be effective. Trust property cannot be held with incomplete endorsements and assignments that do not indicate that the property is held in trust  by a trustee for a specific beneficiary trust.

The Saldivars allege that the Note was not transferred to the Trust until 2011, resulting in an invalid assignment of the Note to the Trust. The Saldivars allege that this defect means that Deutsche Bank and Chase are not valid Note Holders.

(2-4, footnotes and citations omitted) The Court agreed, at least while “accepting all well-pleaded facts as true.” (5)

(HT April Charney)

The Mortgage Interest Deduction: A Taxing Expenditure

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The Congressional Budget Office has issued a report, The Distribution of Major Tax Expenditures in the Individual Income Tax System,  which evaluates the mortgage interest deduction and the state and local tax deduction among other tax expenditures.  It finds (consistent with all previous findings) that they accrue disproportionately — grossly so — to the wealthy.  The mortgage interest deduction has a budgetary effect of $70 billion and the state and local tax deduction has a budgetary effect of $77 billion. (6, Table 1) (to be clear, budgetary effect is not the same as lost revenue; read the report for an explanation of the difference)

Itemized deductions such as these “provide the largest benefits — in both absolute dollars and relative to income — to the highest-income taxpayers.  Those tax expenditures benefit only the roughly one-third of taxpayers who itemize their deductions, and lower-income taxpayers are much less likely than higher-income taxpayers to do so.” (17)  The CBO “estimates that the top quintile will receive almost three-quarters of the benefit of the deduction in 2013, including 15 percent accruing to the top percentile.” (18)

I and many, many others have argued that this is not a good state of affairs but the real estate industry are very well organized around this issue.  Real estate brokers are particularly focused on this because a reduction in these deductions would likely lead to a significant and permanent reduction in their income.  Smaller deductions would make owning a home less financially attractive and thereby push down prices.  Brokers typically get paid by a percentage commission of the sales price.  So they would suffer not just during a transition period (as sellers in the transition period would) but for all time.

So there is no reason to believe that we will see reform around these regressive tax expenditures in the near future, but it should always be kept on the table as part of a tax reform package, particularly if it is implemented in some incremental way (for example, capping the value of the deductions individually or as part of a basket of deductions).

Effect of Qualified Mortgages on Credit Availability: Little to None

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The Congressional Research Service has issued a somewhat opaque report, The Ability-to-Repay Rule: Possible Effects of the Qualified Mortgage Definition on Credit Availability and Other Selected Issues, that summarizes the Ability-to-Repay Rule.  More importantly, it offers a bit of an evaluation of the impact of the new regulatory regime for mortgages on the availability of credit.

According to the CFPB, “close to 100% of the 2011 mortgage market would have been in compliance with the” Ability-to-Repay Rule. (9) The CFPB thus believes that the rule will “have a minimal effect on access to credit.”  (9) The report reviews two alternative estimates, one by CoreLogic and another by Amherst Securities, that offer a less optimistic forecast.

CoreLogic uses 2010 data for its analysis. The CRS appears to agree with me that the CoreLogic report is misleading, but it does report that CoreLogic believes that nearly half of all mortgages will not meet the Qualified Mortgage rules once temporary compliance options for the rule expire.  I do not credit the CoreLogic report and would discount its findings for the reasons that I have given previously and for the additional reasons contained in the CRS report.

Amherst takes a look at jumbo mortgages in 2012 and finds that a significant portion of them would not comply with the rule. I have not seen the Amherst report, so I can only respond to what I read about it in the CRS report.  The bottom line appears that about eight percent of jumbos are likely not to comply with the rule.  Given that jumbos make up about 10% of the mortgage market (at least according to CoreLogic), we are talking about one percent of the total residential mortgage market.  Many of those non-complying mortgages do not comply because of limitations on debt-to-income ratio.  Thus, it would appear that the affected borrowers could get mortgages for smaller amounts that would comply with the rule.

I think it is safe to say that based on what we know now, the rule will have an extremely modest effect on credit availability.

NY Federal Magistrate Issues Declaratory Ruling That Note Transfer Is Effective

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Magistrate Judge Gold issued an opinion in Robinson v. H & R Block Bank, 12-Civ-4196 (EDNY, May 29, 2013).  Professor Dale Whitman posted a commentary about it on the Dirt listserv and he has given us permission to cross-post it here.

Synopsis: Transfer of note and mortgage were effective, despite defects in allonge and mortgage assignment.

This brief opinion by a federal magistrate neatly disposes of a couple of attacks on a secondary market sale of a mortgage. In 2005 Robinson obtained a mortgage loan from Option One. In 2006 he also obtained a second mortgage loan from the same lender. In 2007, he and Option One agreed to consolidate the two loans into a single loan, and Robinson signed a new note and mortgage for the combined balance.

Option One then sold the loan to H & R Block Bank, delivering the note to Block, but it made two errors in doing so. The first was that the endorsement of the note (which was a “special” endorsement to Block) was placed on an allonge, but the allonge was merely placed behind the note in the file, and was not physically affixed (by stapling) to the note until Block did so in 2013.

However, under the New York version of UCC Article 3, “An indorsement must be written by or on behalf of the  holder  and on the instrument or on a paper so firmly affixed thereto as to become a part thereof.” UCC 3-202(2). Hence, the endorsement on the allonge was not effective as of the date the note was delivered, and in effect the note was unendorsed.

Second, although Option One recorded an assignment of the mortgage to Block in 2008, it mistakenly referred to the original 2005 mortgage rather than the consolidated mortgage of 2007. This error was discovered in 2012, and a “correction assignment” was then recorded with a reference to the correct mortgage.

Later in 2012 Robinson filed an action against Option One and Block, claiming fraud in the mortgage transfer. The court correctly observes that there is no evidence whatever of fraud in any literal sense, but treats the plaintiff’s claim as on attacking the validity of the transfer. Even so, it concludes that the errors were harmless and that Block has the right to foreclose the mortgage.

With respect to the unattached allonge, the court observes that

Any alleged defect concerning the allonge, however, would be immaterial, because an assignment may be made under New York law by physical delivery and not only by written indorsement.  … [S]ee also In re Idicula, 484 B.R. 284, 288 (Bankr.S.D.N.Y.2013) (“An assignment of the note and mortgage can be effectuated by a written instrument or by physical delivery of the instrument from assignor to assignee.”).

On this point the court is plainly correct.  Under the current version of the Article 3 (New York has not adopted it, but it’s the relevant version for most DIRT readers), one can become a “holder” only by taking delivery of an endorsed note. However, a person with possession of a negotiable note, but without an endorsement, can be a “nonholder with the rights of a holder” under UCC 3-301(2). The 2011 PEB report on mortgage notes explains it this way:

[This can] occur if the delivery of the note to that person constitutes a “transfer” (as that term is defined in UCC Section 3-203, because transfer of a note “vests in the transferee any right of the transferor to enforce the instrument.” Thus, if a holder (who, as seen above, is a person entitled to enforce a note) transfers the note to another person, that other person (the transferee) obtains from the holder the right to enforce the note even if the transferee does not become the holder.

What’s more, “the transferee has a specifically enforceable right to the unqualified indorsement of the transferor.” See UCC § 3-203(c). Thus, since the note in this case was indisputably delivered, the absence of a valid endorsement really doesn’t matter.

The second error, the mortgage assignment with a reference to the wrong mortgage, was equally unimportant. First, it was corrected by a refiling. But even that was unnecessary for purposes of transferring the right to foreclose the mortgage. The reason is the ancient rule that “the mortgage follows the note.” Thus, whoever, has the right to enforce the note (Block, in this case) has the right to foreclose the mortgage as well — whether they have a mortgage assignment or not. As the court says,

Neither is it required that mortgage assignments are recorded, or that they even be in writing, as long as the mortgage and note are actually delivered. In re Feinberg, 442 B.R. 215, 223 (Bankr.S.D.N.Y. 2010) (noting that the holder’s “possession of the note and mortgage attests to their delivery and is sufficient evidence of a valid mortgage assignment”).

 The reference to “possession of the mortgage” is a bit peculiar; there is no legal principle that suggests that possession of the actual mortgage document has any legal relevance at all. It is possession of the note that is of critical importance, assuming that the note is negotiable (and it’s clear that this court is making that assumption).

This is a doctrine that is widely misunderstood. Many people have the incorrect belief that somehow, having a recorded chain of mortgage assignments is essential to the right to foreclose the mortgage. Not so, except in perhaps a dozen states where assignments are necessary to carry out nonjudicial foreclosures. (New York, of course, has no nonjudicial foreclosure, and no requirement for assignments at all.)

This is not to suggest that recording a mortgage assignment isn’t a good idea. It can accomplish two significant things for the assignee: (1) It will prevent the assignor from fraudulently releasing or satisfying the mortgage in the public records, allowing the borrower to sell the property free and clear to a bona fide purchaser; and (2) it will ensure that the assignee is entitled to notice of any litigation that might be filed affecting the real estate, such as an eminent domain action or a code enforcement proceeding. But it isn’t necessary to foreclose.

The bottom line: two common errors, often raised by foreclosure defense counsel, are simply red herrings: a failure to endorse the note, and a failure to record an assignment of the mortgage. On the other hand, failure to deliver the note would have been a huge problem for the Bank in this case — but fortunately, the note was indeed delivered.

 

(HT Mike Siris)

NY Appellate Court Rules Modification Not Enforceable in Foreclosure

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The Appellate Division ruled in Wells Fargo Bank, N.A. v. Meyers, 2013 Slip Op. 03085 (2d Dep’t), that a failure to negotiate a loan modification in good faith, which is required under NY foreclosure law, does not support the unilateral imposition of a mortgage modification.

The uncontested facts in this case read like one of the well-publicized Alice-in-Wonderland tales of homeowners trying to negotiate a modification with a Red-Queen-like loan servicer:

  • Wells Fargo alleges that it is the holder of the note and mortgage but later says that Freddie Mac is
  • Wells Fargo tells the homeowners to default in order to get into the loan modification program and then forecloses, although the Wells Fargo representative states that they “had no idea” why the foreclosure had been initiated. (4)
  • Wells Fargo repeatedly loses documents sent by the homeowners
  • Wells Fargo changes the terms of its modification offer because of a “miscalculation” (4)

The Court upholds the finding that Wells Fargo did not negotiate in good faith.  One can only imagine how homeowners feel dealing with such a bureaucratic counter-party:  is it grossly incompetent or slyly malevolent?

The Appellate Division notes that the statute at issue provides, “Both the plaintiff and defendant shall negotiate in good faith to reach a mutually agreeable resolution, including a loan modification, if possible” (8, quoting CPLR 3408[f]).  This provision contains no remedies, however, for the failure to do so.  The Court then identifies a variety of sanctions that have been employed against mortgagees/servicers pursuant to this statute.  These include

  • barring them from “collecting interest, legal fee, and expenses” (10)
  • imposing exemplary damages
  • staying the foreclosure
  • imposing a monetary sanction

The Court also noted that it determined in another case that cancelling the mortgage and note was too severe a sanction, one that was not authorized by law.  The Court found that the remedy in this case, imposing a modification, was also inappropriate.  The court stated that to do so would be to rewrite a contract that had voluntarily been entered into in violation of the Contracts Clause of the United States Constitution.  The court also states that such a unilateral action “is without any source for its authority” and appears inconsistent with CPLR 3408 itself. (12) It is is unclear to me whether the Court is reading the Contracts Clause properly, but I agree that the trial court’s remedy seems extreme on these facts.

 

(Hat tip Wilson Freyermuth)