GSE Investors’ Hidden Win

Judge Brown

The big news yesterday was that the US Court of Appeals for the DC Circuit ruled in the main for the federal government in Perry Capital v. Mnuchin, one of the major cases that investors brought against the federal government over the terms of the Fannie and Freddie conservatorships.

In a measured and carefully reasoned opinion, the court rejected most but not all of the investors’ claims.  The reasoning was consistent with my own reading of the broad conservatorship provisions of the Housing and Economic Recover Act of 2008 (HERA).

Judge Brown’s dissent, however, reveals that the investors have crafted an alternative narrative that at least one judge finds compelling. This means that there is going to be some serious drama when this case ultimately wends its way to the Supreme Court. And there is some reason to believe that a Justice Gorsuch might be sympathetic to this narrative of government overreach.

Judge Brown’s opinion indicts many aspects of federal housing finance policy, broadly condemning it in the opening paragraph:

One critic has called it “wrecking-ball benevolence,” James Bovard, Editorial, Nothing Down: The Bush Administration’s Wrecking-Ball Benevolence, BARRONS, Aug. 23, 2004,; while another, dismissing the compassionate rhetoric, dubs it “crony capitalism,” Gerald P. O’Driscoll, Jr., Commentary, Fannie/Freddie Bailout Baloney, CATO INST., (last visited Feb. 13, 2017). But whether the road was paved with good intentions or greased by greed and indifference, affordable housing turned out to be the path to perdition for the U.S. mortgage market. And, because of the dominance of two so-called Government Sponsored Entities (“GSE”s)—the Federal National Mortgage Association (“Fannie Mae” or “Fannie”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “Freddie,” collectively with Fannie Mae, the “Companies”)—the trouble that began in the subprime mortgage market metastasized until it began to affect most debt markets, both domestic and international. (dissent at 1)

While acknowledging that the Fannie/Freddie crisis might justify “extraordinary actions by Congress,” Judge Brown states that

even in a time of exigency, a nation governed by the rule of law cannot transfer broad and unreviewable power to a government entity to do whatsoever it wishes with the assets of these Companies. Moreover, to remain within constitutional parameters, even a less-sweeping delegation of authority would require an explicit and comprehensive framework. See Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.”) Here, Congress did not endow FHFA with unlimited authority to pursue its own ends; rather, it seized upon the statutory text that had governed the FDIC for decades and adapted it ever so slightly to confront the new challenge posed by Fannie and Freddie.

*     *     *

[Congress] chose a well-understood and clearly-defined statutory framework—one that drew upon the common law to clearly delineate the outer boundaries of the Agency’s conservator or, alternatively, receiver powers. FHFA pole vaulted over those boundaries, disregarding the plain text of its authorizing statute and engaging in ultra vires conduct. Even now, FHFA continues to insist its authority is entirely without limit and argues for a complete ouster of federal courts’ power to grant injunctive relief to redress any action it takes while purporting to serve in the conservator role. See FHFA Br. 21  (2-3)

What amazes me about this dissent is how it adopts the decidedly non-mainstream history of the financial crisis that has been promoted by the American Enterprise Institute’s Peter Wallison.  It also takes its legislative history from an unpublished Cato Institute paper by Vice-President Pence’s newly selected chief economist, Mark Calabria and a co-author.  There is nothing wrong with a judge giving some context to an opinion, but it is of note when it seems as one-sided as this. The bottom line though is that this narrative clearly has some legs so we should not think that this case has played itself out, just because of this decision.

Possession of Note Confers Standing to Foreclose


Dale Whitman posted this discussion of Aurora Loan Services, LLC v. Taylor, 2015 WL 3616293 (N.Y. Ct. App., June 11, 2015) on the DIRT listserv:

There is nothing even slightly surprising about this decision, except that it sweeps away a lot of confused and irrelevant language found in decisions of the Appellate Division over the years. The court held simply holds (like nearly all courts that have considered the issue in recent years) that standing to foreclose a mortgage is conferred by having possession of the promissory note. Neither possession of the mortgage itself nor any assignment of the mortgage is necessary. “[T]he note was transferred to [the servicer] before the commencement of the foreclosure action — that is what matters.” And once a note is transferred, … “the mortgage passes as an incident to the note.” Here, there was a mortgage assignment, the validity of which the borrower attacked, but the attack made no difference; “The validity of the August 2009 assignment of the mortgage is irrelevant to [the servicer’s] standing.”

The opinion in Aurora makes it clear that prior Appellate Division statements are simply incorrect and confused when they suggest that standing would be conferred by an assignment of the mortgage without delivery of the note. See, e.g., GRP Loan LLC v. Taylor 95 A.D.3d at 1174, 945 N.Y.S.2d 336; Deutsche Bank Trust Co. v. Codio, 94 A.D.3d 1040, 1041, 943 N.Y.S.2d 545 [2d Dept 2012].) For an excellent analysis of why these decisions are wrong, see Bank of New York Mellon v. Deane, 970 N.Y.S.2d 427  (N.Y. Sup. Ct. 2013).

The Aurora decision implicitly rejects such cases as Erobobo, which suppose that the failure to comply with a Pooling and Servicing Agreement would somehow prevent the servicer from foreclosing. In the present case, the loan was securitized in 2006, but the note was delivered to the servicer on May 20, 2010, only four days before filing the foreclosure action. This presented no problem at all the court. If the servicer had possession at the time of the filing of the case (as it did), it had standing. (I must concede, however, that the rejection is only implicit, since the Erobobo theory was not argued in Aurora.)

If there is a weakness in the Aurora decision, it is its failure to determine whether the note was negotiable, and (assuming it was) to analyze the application UCC Article 3’s “person entitled to enforce” language. But this is not much of a criticism, since it is very likely that under New York law, the right to enforce would be transferred by delivery of the note to the servicer even if the note were nonnegotiable.

It has taken the Court of Appeals a long time to get around to cleaning up this area of the law, but its work is exactly on target.

Assignments Not Standing up

The District Court of Appeal of the State of Florida (4th Dist.) ruled in Murray v. HSBC Bank USA et al., (No. 4D13-4316, Jan. 21, 2015) that HSBC did not have standing to foreclose. This case highlights the difficulties that so many judges have in applying the UCC appropriately in foreclosures. The Court quotes the trial court as stating,

     To me, that’s the only issue in the case; can this Court enter a judgment on what you say is that possession is enough without the [i]ndorsement.

      In every other respect they have it. They got the mortgage. They got the records. They got the servicing. They got the whole thing. They just don’t have the [i]ndorsement, and is that fatal?

       In other words do you have to go and get, and then start over again? That’s the question. I don’t know the answer. (2, n.1)

It is well documented that many, many courts have trouble applying the relevant provisions of the UCC in harmony with the relevant provisions of the state foreclosure procedure statute.

The District Court of Appeal goes to great efforts to get it right here, given that the trial court apparently punted on the analysis. I found the the Appendix to the opinion to be of particular of interest. It carefully walks through the chain of transfers to identify the “missing piece” that results in the HSBC’s lack of standing. It also distinguishes these transfers from those between servicers, which some courts conflate with transfers between those with the right to enforce a mortgage.

From a law reform perspective, I wonder what should be done to get courts to apply the law as it is written, instead of just trying to get the gist of it right. Given that the Permanent Editorial  Board of the UCC has issued guidance in this area, I don’t think the issue is lack of clarity. Rather, I think it is just straightforward complexity — judges have a hard time going through all of the steps of the analysis. Can this area of law be simplified so that courts can achieve more just and equitable results? I wonder if Dale Whitman has any ideas . . ..

Whitman on Foreclosing on E-Note

Professor Dale Whitman posted a commentary on Good v. Wells Fargo Bank, 18 N.E.3d  618 (Ind. App. 2014) on the Dirt listserv. The case addresses whether a lender foreclosing a mortgage securing an electronic note must provide proof that it had “control” of the note when it filed the foreclosure action. This is an interesting new take on an old issue. Dale’s commentary reads:

By now, everyone is familiar with the requirements of UCC Article 3 with respect to enforcement of negotiable notes. Article 3 requires either proof that the party enforcing the note has possession of the original note, or as an alternative, requires submission of a lost note affidavit. With conventional paper notes, it has become common for courts in judicial foreclosure states to require, as a condition of standing to foreclose, that the note holder or its servicer have had possession of the note on the date the foreclosure complaint or petition was filed. This requirement is problematic if (as is often true) the endorsement on the note is undated. In such cases, the servicer will usually be expected to provide additional proof (commonly in the form of affidavits of employees of the holder and/or servicer) that the note had been delivered to the foreclosing party before the date of filing of the action. See, e.g., Deutsche Bank N.T. v. Beneficial New Mexico, Inc., 335 P.3d 217 (N.M. App. 2014); Boyd v. Wells Fargo Bank, N.A., 143 So.3d 1128 (Fla.App. 2014); U.S. Bank, N.A. v. Faruque, 991 N.Y.S.2d 630 (N.Y.App.Div. 2014).

Suppose, however, that the note was electronic rather than paper. Such notes are enforceable under eSign and UETA, but these statutes modify the concepts of delivery and possession. Because an electronic note can be reproduced as many times as desired, and each copy is indistinguishable from the original, eSign creates the concept of the note as a “transferrable record.” Such records must have the following characteristics:

1.  The record must be held within a system in which “a single authoritative copy of the record (the note) exists, which is unique, identifiable, and unalterable.”

2.  To have the equivalent of possession of such a note, if it has been transferred, a person must have “control” in the sense that the system for tracking such notes must reliably establish that the person enforcing the note is the one to whom the record was transferred.

3.  Finally, if the record has been transferred, the authoritative copy of the record itself must indicate the identity of the person who whom it was most recently transferred.

See 15 U.S.C. sec. 7021.

There are very few cases thus far involving foreclosures of mortgages securing e-notes, and little authority on exactly what the holder must prove in order to properly foreclose. In the Good case Wells Fargo was acting as servicer for Fannie Mae, the holder of an e-note that was registered in the MERS e-registry. (MERS’ role with e-notes is very different than for paper notes. In paper note transactions, MERS does not take possession of the note and has no dealings with it, but in e-note transactions, MERS operates a registry to track who has control of the note.)

Accompanying its foreclosure complaint, Wells filed an affidavit by one of its officers, stating that Wells was the servicer, that it maintained a copy of the note, and that its systems provided controls to assure that each note was maintained accurately and protected against alteration. Finally, it stated that the paper copy it submitted with the foreclosure complaint was a true and correct copy of the original e-note.

Unfortunately for Wells, the court found that this affidavit was woefully inadequate to establish Wells’ standing to foreclose the mortgage. Here is the court’s list of particulars:

1.  The affidavit stated that Wells possessed the note, but the court couldn’t tell whether it meant the electronic note or a paper copy.

2.  The affidavit did not assert that Wells had “control” of the record, either by maintaining the single authoritative copy itself in its own system, or by being identified as having control of the single authoritative copy in the MERS registry system.

3.  In fact, Wells never even mentioned the MERS registry system in its affidavit, even though it is obvious from the facts that the note was being tracked within that system.

Wells tried to repair the damage at trial; an employee of Wells testified that Wells was in control of the note, currently maintained it, and serviced the loan. But the court found that this testimony was “conclusory” (as indeed it was) and was insufficient to establish that Wells had control of the note.

Comment: The court provides an extremely useful road map for counsel representing a servicer in the judicial foreclosure of a e-note. The statute itself provides (in 15 U.S.C. 7021(f)) that the person enforcing the note must provide “reasonable proof” that it was in control of the note, and the court felt this must be detailed information and not merely a bare statement.

While the case involved a judicial foreclosure, one might well ask how the “reasonable proof” requirement would be satisfied in a nonjudicial foreclosure. In about eight states, the courts have held (with paper notes) that their nonjudicial foreclosure statutes do not require any assertion or proof of possession of the note. But it is arguable that, if the note is electronic rather than paper, eSign overrides this conclusion by virtue of its express requirement of “reasonable proof.” And since eSign is a federal statute, it is quite capable of preempting any contrary state legislation.  On the other hand, the “reasonable proof” requirement only applies “if requested by a person against which enforcement is sought.” In a nonjudicial foreclosure proceeding, how would the borrower make such a request? These are interesting, but highly speculative questions.

Is Freddie the “Government” When It’s In Conservatorship?

Professor Dale Whitman posted a commentary on Federal Home Loan Mortgage Corp. v. Kelley, 2014 WL 4232687, Michigan Court of Appeals (No. 315082, rev. op., Aug. 26, 2014)  on the Dirt listserv:

This is a residential mortgage foreclosure case. The original foreclosure by CMI (CitiMortgage, apparently Freddie Mac’s servicer) was by “advertisement” – i.e., pursuant to the Michigan nonjudicial foreclosure statute. Freddie was the successful bidder at the foreclosure sale. In a subsequent action to evict the borrowers, they raised two defenses.

Their first defense was based on the argument that, even though Freddie Mac was concededly a nongovernmental entity prior to it’s being placed into conservatorship in 2008 (see American Bankers Mortgage Corp v. Fed Home Loan Mortgage Corp, 75 F3d 1401, 1406–1409 (9th Cir. 1996)), it had become a federal agency by virtue of the conservatorship with FHFA as conservator. As such, it was required to comply with Due Process in foreclosing, and the borrowers argued that the Michigan nonjudicial foreclosure procedure did not afford due process.

The court rejected this argument, as has every court that has considered it. The test for federal agency status is found in Lebron v. Nat’l Railroad Passenger Corp, 513 U.S. 374, 377; 115 S Ct 961; 130 L.Ed.2d 902 (1995), which involved Amtrak. Amtrak was found to be a governmental body, in part because the control of the government was permanent. The court noted, however, that FHFA’s control of Freddie, while open-ended and continuing, was not intended to be permanent. Hence, Freddie was not a governmental entity and was not required to conform to Due Process standards in foreclosing mortgages. This may seem overly simplistic, but that’s the way the court analyzed it.

There’s no surprise here. For other cases reaching the same result, see U.S. ex rel. Adams v. Wells Fargo Bank Nat. Ass’n, 2013 WL 6506732 (D. Nev. 2013) (in light of the GSEs’ lack of federal instrumentality status while in conservatorship, homeowners who failed to pay association dues to the GSEs could not be charged with violating the federal False Claims Act); Herron v. Fannie Mae, 857 F. Supp. 2d 87 (D.D.C. 2012) (Fannie Mae, while in conservatorship, is not a federal agency for purposes of a wrongful discharge claim); In re Kapla, 485 B.R. 136 (Bankr. E.D. Mich. 2012), aff’d, 2014 WL 346019 (E.D. Mich. 2014) (Fannie Mae, while in conservatorship, is not a “governmental actor” subject to Due Process Clause for purposes of foreclosure); May v. Wells Fargo Bank, N.A., 2013 WL 3207511 (S.D. Tex. 2013) (same); In re Hermiz, 2013 WL 3353928 (E.D. Mich. 2013) (same, Freddie Mac).

There’s a potential issue that the court didn’t ever reach. Assume that a purely federal agency holds a mortgage, and transfers it to its servicer (a private entity) to foreclose. Does Due Process apply? The agency is still calling the shots, but the private servicer is the party whose name is on the foreclosure. Don’t you think that’s an interesting question?

The borrowers’ second defense was that Michigan statutes require a recorded chain of mortgage assignments in order to foreclose nonjudicially. See Mich. Comp. L. 600.3204(3). In this case the mortgage had been held by ABN-AMRO, which had been merged with CMI (CitiMortgage), the foreclosing entity. No assignment of the mortgage had been recorded in connection with the merger. However, the court was not impressed with this argument either. It noted that the Michigan Supreme Court in Kim v JP Morgan Chase Bank, NA, 493 Mich 98, 115-116; 825 NW2d 329 (2012), had stated

to set aside the foreclosure sale, plaintiffs must show that they were prejudiced by defendant’s failure to comply with MCL 600.3204. To demonstrate such prejudice, they must show they would have been in a better position to preserve their interest in the property absent defendant’s noncompliance with the statute.

The court found that the borrowers were not prejudiced by the failure to record an assignment in connection with the corporate merger, and hence could not set the sale aside.

But this holding raises an interesting issue: When is failure to record a mortgage assignment ever prejudicial to the borrower? One can conceive of such a case, but it’s pretty improbable. Suppose the borrowers want to seek a loan modification, and to do so, check the public records in Michigan to find out to whom their loan has been assigned. However, no assignment is recorded, and when they check with the originating lender, they are stonewalled. Are they prejudiced?

Well, not if it’s a MERS loan, since they can quickly find out who holds the loan by querying the MERS web site. (True, the MERS records might possibly be wrong, but they’re correct in the vast majority of cases.) And then there’s the fact that federal law requires written, mailed notification to the borrowers of both any change in servicing and any sale of the loan itself. If they received these notices (which are mandatory), there’s no prejudice to them in not being able to find the same information in the county real estate records.

So one can postulate a case in which failure to record an assignment is prejudicial to the borrowers, but it’s extremely improbable. The truth is that checking the public records is a terrible way to find out who holds your loan. Moreover, Michigan requires recording of assignments only for a nonjudicial foreclosure; a person with the right to enforce the promissory note can foreclose the mortgage judicially whether there’s a chain of assignments or not.

All in all, the statutory requirement to record a chain of assignments is pretty meaningless to everybody involved – a fact that the Michigan courts recognize implicitly by their requirement that the borrower show prejudice in order to set a foreclosure sale aside on this ground.

Should The Mortgage Follow The Note?

The financial crisis and the foreclosure crisis have pushed many scholars to take a fresh look at all sorts of aspects of the housing finance system. John Patrick Hunt has added to this growing body of literature with a posting to SSRN, Should The Mortgage Follow The Note?. It is an interesting and important article, taking a a fresh look at the legal platitude, “the mortgage follows the note” and asking — should it?!? The abstract reads,

The law of mortgage assignment has taken center stage amidst foreclosure crisis, robosigning scandal, and controversy over the Mortgage Electronic Registration System. Yet a concept crucially important to mortgage assignment law, the idea that “the mortgage follows the note,” apparently has never been subjected to a critical analysis in a law review.

This Article makes two claims about that proposition, one positive and one normative. The positive claim is that it has been much less clear than typically assumed that the mortgage follows the note, in the sense that note transfer formalities trump mortgage transfer formalities. “The mortgage follows the note” is often described as a well-established principle of law, when in fact considerable doubt has attended the proposition at least since the middle of the last century.

The normative claim is that it is not clear that the mortgage should follow the note. The Article draws on the theoretical literature of filing and recording to show that there is a case that mortgage assignments should be subject to a filing rule and that “the mortgage follows the note,” to the extent it implies that transferee interests should be protected without filing, should be abandoned.

Whether mortgage recording should in fact be abandoned in favor of the principle “the mortgage follows the note” turns on the resolution of a number of empirical questions. This Article identifies key empirical questions that emerge from its application of principles from the theoretical literature on filing and recording to the specific case of mortgages.

The article does not answer the core question that it asks, but it certainly demonstrates that it is worth answering.

Whitman on Servicer Lies

Professor Dale Whitman posted a commentary on Quintana v. Bank of America, No. CV 11–2301–PHX, 2014 WL 690906 (D.Ariz. Feb. 24, 2014) (not reported in F.Supp.2d) on the Dirt listserv:

Synopsis: A borrowers who is “jerked around” by a mortgage servicer may have claims in fraud or on other theories.

Karoly Quintana’s home mortgage loan was serviced by Bank of America, When she began having difficulty making her payments in 2009, she was told by B of A that she would have to miss three payments to be considered for a loan modification, and that the servicer would forbear foreclosure while it did so. She missed the payments and applied for a modification, but (she alleged) B of A did not consider it, and instead accelerated her loan and commenced foreclosure.

Quintana filed a suit in federal court to stop the foreclosure. In March 2012 the suit was dismissed voluntarily on the assurance that B of A would again consider a loan modification, but again it did not do so. (Oddly, B of A’s counsel conceded these facts.)

The court held that the allegations of both the 2009 and 2012 conduct of B of A stated claims of fraud, sufficient to withstand a motion to dismiss. The statements that she would be considered for a modification were false, she relied upon them, and was damaged. Her damages were the expenditure of additional attorney’s fees, and the court found this sufficient, even though in general attorneys’ fees are not recoverable in a fraud action.

The court also held that the plaintiff’s count for breach of the implied covenant of good faith and fair dealing survived a motion to dismiss. While the loan documents did not require the servicer to consider the mortgage modification or to forbear foreclosure, when it promised to do so and then did not, it breached the implied covenant. The promise was only oral, and B of A asserted it was inadmissible under the Statute of Frauds, but the court found that Quintana’s detrimental reliance (in missing the payments) provided a basis for promissory estoppel, overcoming the Statute of Frauds defense.

However, the court dismissed Quintana’s claim under the Arizona Consumer Fraud Act (on the ground that it was barred by the 1-year statute of limitations). There’s a convoluted argument about whether B of A can be liable under the FDCPA, but the court ultimately refused to dismiss that claim.

Comment: Borrowers have often tried to claim that they should have received loan modifications, but have not in fact received them. In general, of course, there’s no legal right to a modification. But this court holds that a false promise to consider a modification is enough to make out a claim of fraud.