Utah Foreclosure Litigation Calls Into Question Validity of MERS Transfers

There a really good article about foreclosure litigation written by Tom Harvey in the Salt Lake Tribune over the weekend. These lawsuits, and others like them, could have far-ranging implications for lenders and borrowers in the ongoing foreclosure crisis.  From the article:

“A Utah court case in which the owner of a Draper townhouse got clear title to the property, even though he still owed $132,000 on it, raises new legal and financial questions about a property-records database created by mortgage bankers.

The award of a title free of liens means that whoever owns the promissory note on the Draper property — likely a group of faraway investors — no longer has the right to foreclose to collect on a delinquent loan. Indeed, the townhouse owner has sold the property and kept the money. Those who own the promissory note probably don’t even know what occurred.”

In the case in question, the borrower filed a “quiet title action”.  In this type of suit, the filer seeks to establish absolute ownership of a property, quieting any claims against the property by any other party.  The court ruled that ownership of the promissory note for the mortgage was not properly transferred due to an electronic system of recording mortgages.  The success of such lawsuits will likely engender even more litigation and could prove costly for lenders.

The Mortgage Electronic Registration System (MERS) is essentially a database that is supposed to hold the names of anybody that has an interest in a mortgage, including those that have bought into mortgage backed securities (MBS).  The system would allow loan investors to avoid paying fees when loans are sold, and helped to facilitate the sale of MBS.  According the the article, 31 million loans were registered through MERS.

When someone takes out a mortgage, they sign a promissory note that requires them to repay the loan.  The person who has the promissory note is entitled to payments on the loan and is able to foreclose on the property if payments are not made.  It is a well-established rule of property law that the holder of a promissory note must be in possession of the note in order for ownership to be valid.    The problem is that in many cases, notes were not transferred during the securitization process.  This means that it could be difficult or impossible to say who the holder of the note is, and who has standing to foreclose upon a house.  Now lawyers are increasingly challenging the validity of foreclosures on properties that were transferred through MERS.  The issue is going to the Supreme Court in Utah and the article says that:

“If MERS is not able to start a foreclosure action, there there will be a brick wall put up over all nonjudicial foreclosures prosecuted in this state”.

This would obviously be a huge problem for Utah, and I imagine there will not be such a broad ruling.  Lawsuits such as these (like the Ibanez decision in Massachusetts) could have huge implications, and will bear watching over the coming weeks and months.  It seems as though the big mortgage lenders are finding themselves at the center of a pincer movement with rulings such as this on one side, and pushback from investors and regulators on the other side.  Ultimately I suspect the pressure will cause lenders to make concessions to borrowers and investors alike, we will monitor the situation as it progresses.