Thursday, April 15, 2010

Fannie Mae regulates foreclosure actions brought by MERS

On March 30, 2010, Fannie Mae issued an announcement (SVC-2010-05) which provided updates and clarifications to several loan servicing policies, including:

  • Document custodian requirements for government loan modifications
  • Foreclosure attorney fees for New Mexico and Vermont
  • Mortgage insurance cancellations on loan modifications
  • Foreclosure actions in the name of MERS
  • Flat File layout for Payment Reduction Plan loans
  • Balloon mortgage loans with conditional modification option
Of particular interest to practitioners in the area of foreclosure defense are the provisions pertaining to MERS. Fannie Mae has mandated that MERS must not be named as a plaintiff in any foreclosure action on a mortgage loan owned or securitized by Fannie Mae.  This is significant because it appears that Fannie Mae is acknowledging that MERS does not have the capacity or standing to bring foreclosure actions.  This also tends to support the inference that MERS may not have the capacity to assign loans as is so often the case.

Why does Fannie Mae takes this stance?  The answer to the question lies in the origin and function of MERS

MERS (short for Mortgage Electronic Recording System) was conceived and created by a tight-knit group of powerful mortgage industry insiders for the purpose of avoiding the fees local government require for the recording of mortgage assignments.  The details of how MERs would work were not ironed out until mid-1996, and two years later MERS, Inc., incorporated in Delaware as a non-stock corporation owned by mortgage banking companies that made initial capital contributions ranging from $10,000 to $1,000,000.  The primary goal of MERS was to lower costs for servicers, and among the first entities to utilize MERS extensively were none other than Fannie Mae and Freddie Mac.

Mortgage finance companies currently use the MERS' name to interact with the land title recording system (i.e. the county clerk) in one of two ways:  either by recording MERS' name as an assignee, or by recording MERS' name as the original mortgagee.  For instance, under the former recording strategy, the originating lender makes a traditional mortgage loan by lisiting itself as payee on the promissory note and as the mortgagee on the security instrument.  The loan is the assigned to a seller for repackaging through securitization for investors.  However, instead of recording the assignment to the seller or the trust that will ultimately own the loan, the originator pays MERS a fee to record an assignment to MERS in the county records.  MERS' counsel maintains that MERS becomes a "mortgagee of record" even though its ownership of the mortgage is fictional.

Although MERS records an assignment in the real property records, the promissory note which creates the legal obligation to repay the debt is not negotiated to MERS--MERS is never the holder of the note.  Everyone agrees that MERS is never entitled to receive a borrower's monthly payments, nor is MERs ever entitled to receive the proceeds of a foreclosure or deed of trust sale.   MERS has no actual financial interest in any mortgage loan.  MERS does not even provide lien releases of the mortgages it purports to own, instead referring title attorneys, refinancing lenders, and consumers to the loan's servicer.  MERS' revenue comes, not from the repayment of the loan or the disposition of collateral, but from the fees that the originator and other mortgage finance companies pay to MERS.  Once a loan is assigned to MERS, the public land title records no longer reveal who (or what) actually owns a lien on the property in question.

In addition to record keeping and recording system liaison roles, MERS has also become directly involved in consumer finance litigation.  Historically, the owner of the mortgage loan, or a servicer hired to collect borrower payments, sues the homeowner in a forelcosure action.  But, when MERS is listed in county records as the owner of a mortgage, courts have initially made the natural assumption that the appropriate plaintiff to bringing a foreclosure action is MERS.  In order to move foreclosures along as quickly as possible, MERS has allowed actual mortgagees and loan assignees or their servicers to bring forelcosure actions in MERS' name, rather than in their own name.  Thus, not only does the use of MERS' services allow financiers to avoid county recording taxes, it also allows them to list an obscure, apparently official institution as the instigator of a foreclosure.

By May of 2007, approximately 60 million loans had been recorded under MERS' name and more than half of the nation's existing residential loans are recorded under MERS' name.  Not satisfied, MERS' CEO insisted that "[o]ur mission is to capture every mortgage loan in the country."

The collapse of the nation's subprime mortgage lending industry has prompted courts to take a fresh look at the legal foundations of MERS' role in the land title recording and home foreclosure system--particularly, whether MERS owns title to mortgages either as a mortgagee or as assignee; and whether MERS has standing to bring foreclosure actions.  There appears to be a growing consensus among courts, and Fannie Mae in light of its recent announcement, that the answer to both of these questions is a resounding "no".

While the language in MERS boilerplate contracts is not particularly enlightening in answering these questions, basic economic principles of the law provide a simple answer to this puzzle.  The American legal tradition looks to the economic realities of a transaction in determining whether a business is a secured creditor or  mortgagee.  The most familiar application of this principal is found in Article 9 of the UCC which construes transactions that pose as "leases" as disguised purchase money loans based on the economic realities underlying these so-called "lease."  The UCC insists that the words used by the parties to a contract are not controlling when the words mischaracterize the underlying transaction.  Mortgages are no different, and courts will not blindly enforce its boilerplate provisions when they have no basis in reality.  MERS is not a mortgagee (or an assignee) simply because ink on paper makes this assertion--rather the law compels courts to look to the economic nature of the transaction to identify MERS' role.

The fundamental reality is that MERS is not a mortgagee with respect to any loan registered on its database MERS does not fund any loans.  No homeowner promises to pay MERS any money.  MERS is never the holder of the note or mortgage.  MERS is never entitled to receive the proceeds of a foreclosure sale--even when it commences foreclosure actions in its own name.

Therefore, it should be no surprise that Fannie Mae has mandated that MERS must not be named as a plaintiff in any foreclosure action on a mortgage loan which Fannie Mae owns or has securitized.

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