Tag Archives: priority

MERS Victorious

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Montgomery_County_Courthouse_Pennsylvania_-_Douglas_Muth

Montgomery County, PA Courthouse

The U.S. Court of Appeals for the Third Circuit ruled in favor of MERS in Montgomery County v. MERSCORP, (August 3, 2015, No. 15-1219) (Barry, J.). MERS, for the uninitiated,

is a national electronic loan registry system that permits its members to freely transfer, among themselves, the promissory notes associated with mortgages, while MERS remains the mortgagee of record in public land records as “nominee” for the note holder and its successors and assigns. MERS facilitates the secondary market for mortgages by permitting its members to transfer the beneficial interest associated with a mortgage—that is, the right to repayment pursuant to the terms of the promissory note—to one another, recording such transfers in the MERS database to notify one another and establish priority, instead of recording such transfers as mortgage assignments in local land recording offices. It was created, in part, to reduce costs associated with the transfer of notes secured by mortgages by permitting note holders to avoid recording fees. (4, footnote omitted)

I, along with others, had filed an amicus brief in this case. The court states that

We acknowledge the arguments of the Recorder and her amici contending that MERS has a harmful impact on homeowners, title professionals, local land records, and various public programs supported in part by the fees collected by Pennsylvania’s recorders of deeds. In this appeal, however, we are not called upon to evaluate how MERS impacts various constituencies or to adjudicate whether MERS is good or bad. Just as the Seventh Circuit observed in Union County, while the Recorder is critical of MERS in several respects, “[her] appeal claims only that MERSCORP is violating [state law] by failing to record its transfer of mortgage debts, thus depriving the county governments of recording fees. That claim—the only one before us—has no merit.” 735 F.3d at 734-35. (13)

MERS has had a lot of success in cases like this, but the fact remains that it was implemented in a flawed fashion with little to no input from a broad range of constituencies. Regulators and legislators should pay renewed attention to MERS to ensure that the ownership and servicing of residential mortgages are tracked in a way that protects consumers from abusive behavior by sophisticated mortgage market players who rely on opaque mechanisms like MERS.

LawProfs in MERS Litigation

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The Legal Services Center of Harvard Law School (through Max Weinstein et al.); Melanie Leslie, Benjamin N. Cardozo School of Law; Joseph William Singer, Harvard Law School; Rebecca Tushnet, Georgetown University Law Center and I filed an amicus brief in County of Montgomery Recorder v. MERSCorp Inc, et al. (3rd Cir. No. 14-4315). The brief argues,

MERS represents a major departure from and grave disruption of recording practices in counties such as Montgomery County, Pennsylvania, that have traditionally ensured the orderly transfer of real property across the country. Prior to MERS, records of real property interests were public, transparent, and provided a secure foundation upon which the American economy could grow. MERS is a privately run recording system created to reduce costs for large investment banks, the “sell-side” of the mortgage industry, which is largely inaccessible to the public. MERS is recorded as the mortgage holder in traditional county records, as a “nominee” for the holder of the mortgage note. Meanwhile, the promissory note secured by the mortgage is pooled, securitized, and transferred multiple times, but MERS does not require that its members enter these transfers into its database. MERS is a system that is “grafted” onto the traditional recording system and could not exist without it, but it usurps the function of county recorders and eviscerates the system recorders are charged with maintaining.

The MERS system was modeled after the Depository Trust Company (DTC), an institution created to hold corporate and municipal securities, but, unlike the DTC, MERS has no statutory basis, nor is it regulated by the SEC. MERS’s lack of statutory grounding and oversight means that it has neither legal authority nor public accountability. By allowing its members to transfer mortgages from MERS to themselves without any evidence of ownership, MERS dispensed with the traditional requirement that purported assignees prove their relationship to the mortgagee of record with a complete chain of mortgage assignments, in order to foreclose. MERS thereby eliminated the rules that protected the rights of mortgage holders and homeowners. Surveys, government audits, reporting by public media, and court cases from across the country have revealed that MERS’s records are inaccurate, incomplete, and unreliable. Moreover, because MERS does not allow public access to its records, the full extent of its system’s destruction of chains of title and the clarity of entitlements to real property is not yet known.

Electronic and paper recording systems alike can contain errors and inconsistencies. Electronic systems have the potential to increase the accessibility and accuracy of public records, but MERS has not done this. Rather, by making recording of mortgage assignments voluntary, and cloaking its system in secrecy, it has introduced unprecedented and perhaps irreparable levels of opacity, inaccuracy, and incompleteness, wreaking havoc on the local title recording systems that have existed in America since colonial times. (2-3)

Laches Upends Priority of Mortgagee in Utah

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Professor Wilson Freyermuth posted this summary of the Utah Supreme Court’s opinion, Insight Assets, Inc. v. Farias, ___ P.3d ___, 2013 WL 3990783 (August 6, 2013), to the DIRT listserv:

Synposis:   Although vendor purchase money mortgagee may generally have a superior claim to priority over a third-party purchase money mortgagee under the Restatement, vendor purchase money mortgagee was barred from asserting that priority by the doctrine of laches.

Facts:  In 2004, the Phalens sold land in Ogden, Utah to the Boecks for $88,000.  The Boecks financed the purchase with a $70,300 institutional mortgage loan from First Franklin Financial Corp. (First Franklin) and $17,600 in seller purchase money mortgage financing from the Phalens.  At closing, the Boecks executed deeds of trust to First Franklin and the Phelans.  After closing, the title company recorded the two deeds of trust together, but with First Franklin’s deed of trust being recorded first.  First Franklin later assigned its mortgage to Wells Fargo.

After closing, the Boecks defaulted to both Bank and to Sellers.  In June 2005, Wells Fargo foreclosed on the property and acquired the property by a trustee’s deed.  The Phelans did not attempt to foreclose on the property.  Wells Fargo sold the property, which ultimately passed by intervening conveyances to Farias.

In 2009, the Phelans assigned their interest under their deed of trust to Insight Assets (“Insight”), who executed a substitution of trustee, recorded a notice of default, and instituted foreclosure proceedings.  Farias sought summary judgment, claiming that he had held free and clear title as a bona fide purchaser.  The district court entered judgment for Farias, and Insight appealed.

On appeal to the Utah Supreme Court, Insight argued that as a matter of law, the Phelans’ seller deed of trust was entitled to priority over First Franklin’s deed of trust under Restatement (Third) of Property — Mortgages § 7.2(c) (“A purchase money mortgage given to a vendor of real estate, in the absence of a contrary intent of the parties to it and subject to the operation of the recording acts, has priority over a purchase money mortgage on that real estate given to a person who is not its vendor.”).  By contrast, Farias made three arguments:  (1) that First Franklin did not know of the Phelans’ seller purchase money mortgage and thus the Restatement rule should not apply; (2) that even if First Franklin did know of the seller purchase money mortgage, that knowledge was irrelevant because Farias was a bona fide purchaser who took free and clear of the mortgage; and (3) that Insight’s claims was otherwise barred by the doctrine of laches.

Analysis:  The Supreme Court of Utah rejected Farias’s bona fide purchase argument, noting (correctly and obviously) that the recording act cannot protect Farias against a prior properly-recorded mortgage.  The Court also noted that while the Restatement rule generally gives a vendor purchase money mortgage priority over a third-party purchase money mortgage, that rule was subject to a caveat — “where only one of the parties has notice of the other,” the recording acts should govern and award priority to the party lacking notice.

Insight argued that its vendor purchase money mortgage should still prevail, because (a) First Franklin had actual knowledge of the Phelans’ seller purchase money mortgage and (b) the title company’s knowledge of the Phelans’ seller purchase money mortgage was imputed to First Franklin.  The court did not reach this argument, however, concluding that Insight’s priority claim was barred under the equitable doctrine of laches. Although Insight did file its notice of default within the applicable six-year statute of limitations, the court stated that this did not preclude the possible application of laches.  The court concluded that application of laches was appropriate due to the Phelans’ lack of diligence and Farias’s resulting injury.  The court noted that during the five years between the Boecks’ default and the Phelans’ assignment to Insight, the Phelans “took no action to clarify or assert their rights to the property.” The court held that this was inaction unreasonable because the Restatement rule involves a “multi-factor balancing test under which priority is determined by ‘the circumstances of the given case, the equities, and the effect of the recording act.’” Thus, in the court’s view, the Phelans “could not have rationally assumed that their interest had priority” without having brought an action to establish that priority.  By failing to bring such a claim during the Wells Fargo foreclosure proceedings, the Phelans “risked forfeiting their security interest entirely.”

The court also concluded that Farias would be injured if Insight’s untimely claim was allowed to proceed, noting that Farias had negotiated the price for his home without considering the $17,600 debt owed to Insight and that when Farias purchased the home years after the Phelans’ default, “it was reasonable for him to infer from [their] inaction that their security interest had been extinguished” by the Wells Fargo foreclosure.  The court also noted that the passage of time had harmed Farias by making it difficult to gather evidence in his defense, as First Franklin was now out of business (making it difficult for Farias to locate records or former employees who might have information relevant to the question of First Franklin’s knowledge).

Comment:  This is the second 2013 periodic development involving a case where the title company recorded a third-party purchase money mortgage prior to a vendor purchase money mortgage.  In the earlier case, Insight LLC v. Gunter, the Idaho Supreme Court rejected the Restatement rule and held that the third-party mortgage had priority under the recording act.  As noted in the critique of Gunter, https://dirt.umkc.edu/February%202013/InsightLLCvGunter.pdf, that decision wrongly opened the door for purchase money lenders to structure closings in a fashion likely to disadvantage the unsuspecting purchase money seller, particularly where the purchase money lender knew of the purchase money seller and could have easily required a subordination agreement as a condition of making the purchase money loan.  Gratifyingly, the Utah court rejected the reasoning of Gunter, noting that the Restatement rule is the appropriate starting principle for vendor vs. third party lender purchase money priority disputes.

The Utah court’s judgment regarding the application of laches is harder to evaluate without the ability to review the factual record in greater detail.  On the one hand, the court is correct to note that because the Restatement rule is subject to the application of the recording act if the third party mortgagee lacks notice of the vendor mortgagee (or vice-versa), then the Phelans couldn’t be certain of their priority over First Franklin without a court decree.  On the other hand, Farias’s actions also seem similarly unreasonable.  Because the Phelans’ mortgage was recorded (and could have been entitled to priority over the First Franklin mortgage), Farias also couldn’t have been certain he was getting clear title without a court decree.  It’s not obvious where the equities lie here.