A controversial procedure used by lenders to store mortgage documents is not illegal — and not enough to stop home foreclosures, a federal appellate court ruled Wednesday.
In a case with national implications, the 9th U.S. Circuit Court of Appeals rejected arguments by several Arizona homeowners that their mortgage lenders had committed fraud through the use of a centralized system to store deeds of trust. That process separates the deed from the actual promissory note. And in Arizona, a lender needs both to begin foreclosure proceedings.
But Judge Conseulo Callahan, writing for the unanimous three-judge panel, said the Mortgage Electronic Registration System is a legitimate way for lenders to store deeds when the loans are transferred from one lender to another.
More to the point, Callahan said the borrowers cannot show that they were misinformed about the operation of MERS, that they relied on any misinformation and, specifically, that they were injured based on any misinformation. She specifically rejected the claim that the system is a “sham” and that it denied the homeowners the ability to contact the people holding the loan to seek a new payment schedule.
The ruling, unless overturned, is a major setback for borrowers who have argued that lenders are illegally foreclosing on their homes.
Callahan said when someone takes out a home loan, the borrower executes two documents: a promissory note to repay and a deed of trust — essentially the mortgage — that transfers title to the property in the event of default.
Laws in Arizona and elsewhere require the lender to record that deed in the county where the property is located. Subsequent sales or assignments also have to be recorded in county records.
In recent years, though, the transfer of loans became popular, with lenders bundling groups of loans and selling them to investors as mortgage-backed securities. Callahan said MERS was set up as a private firm by buyers and sellers of loans to avoid the need to record multiple transfers of the deed. It serves as the nominal holder of record for the original lender and any subsequent buyers of the loan.
It is in the default process where the controversy arises.
Lenders can begin foreclosure proceedings in their own name or appoint a trustee. But Callahan said the trustee needs the authority to act as the holder of both the deed and the promissory note
“The deed and note must be held together because the holder of the note is only entitled to repayment, and does not have the right under the deed to use the property as a means of satisfying repayment,” she wrote. “Conversely, the holder of the deed alone does not have a right to repayment and, thus, does not have an interest in foreclosing on the property.”
The plaintiffs, in filing suit, said the MERS system impermissibly splits the note and deed.
Lawyers for the homeowners also contend that because MERS does not have a financial interest in the mortgage, its status as a beneficiary is a “sham.” That is because MERS is not involved in originating the loan, does not have any right to payments and does not service the loan.
But Callahan said the claim of fraud by the homeowners is flawed.
She said there are no allegations that they were misinformed about MERS’ role as a beneficiary or the possibility that their loans would be resold and tracked through the MERS system. But the judge said that’s not the only problem with their lawsuit.
“The plaintiffs have failed to show that the designation of MERS as a beneficiary caused them any injury by, for example, affecting the terms of their loans, their ability to repay the loans, or their obligations as borrowers,” Callahan wrote. And she rejected arguments that the homeowners were “deprived of the right to attempt to modify their toxic loans, as the true identity of the actual beneficial owner was intentionally hidden.”
The judge said that “bare assertion” is not backed by any facts that any of the homeowners was stymied by the MERS system to contact the relevant party to modify their loans.”
“Even if we were to accept the plaintiffs’ premises that MERS is a sham beneficiary and the note is split from the deed, we would reject the plaintiffs’ conclusion that, as a necessary consequence, no party has the power to foreclose,” Callahan wrote. She said such a claim could succeed only where MERS initiated foreclosure in its own name, or where the designation of MERS violates state recording and foreclosure statutes, neither of which is at issue here.
“The trustees initiated foreclosure in the name of the lenders,” the judge said. “Even if MERS were a sham beneficiary, the lenders would still be entitled to repayment of the loans and would be the proper parties to initiative foreclosure after the plaintiffs defaulted on their loans.”
Callahan and her colleagues also dismissed claims that the homeowners were the victims of “wrongful foreclosure,” saying there is no basis for that.
“Such claims are typically available after foreclosure and are premised on allegations that the borrower was not in default, or on procedural issues that resulted in damages to the borrower,” she wrote.