A Long Awaited Ruling On Challenge By MERS Ends In Anticlimax
By: Doug Owens
REAPS Legislative Committee
The Washington Supreme Court recently decided a challenge by two homeowners that attacked the system of “collateralized debt obligations” that has arisen during the past twenty years. Under this system, when a person borrows against a home, the promissory note and deed of trust that secures that note are “bundled” into one of many trusts. Shares in these trusts are then sold to institutional investors such as insurance companies and pension funds.
In Washington, mortgages are structured as a promissory note containing the obligation of the borrower to repay the loaned funds and a deed of trust that secures that obligation. The deed of trust is in form a deed by the borrower to a trustee, and the lender is called the “beneficiary”. The terms of the deed of trust are that if the borrower does not repay the loan or otherwise breaks any of the covenants of the deed of trust, then the trustee has the power to sell the property at auction and apply the proceeds to pay the beneficiary. A promissory note is by its nature a negotiable instrument of the same type as a check. It is negotiated by having the person to whom the obligation is owed, called the holder, endorse it to someone else in exchange for something, usually money.
[stextbox id=”black”]“This case may produce more litigation if additional facts are developed on the record before the federal court.”[/stextbox]
In order to attempt to keep track of the many notes and deeds of trust that underlie the investments of the big investors, a system called Mortgage Electronic Registration System was created in the 1990s. This system allowed the users to transfer massive numbers of deeds of trust among lenders and investment trusts without the cumbersome process of recording the transfers locally. In mortgages handled by MERS, that entity rather than the lender is usually named the beneficiary of the deed of trust.
Many lenders have gone out of business or been acquired by others in “shotgun” weddings arranged by regulators. In the process sometimes the promissory notes and the deeds of trust are separated. Many homeowners are in financial difficulty due to the recession and the values of their homes have plummeted leaving them “under water.” When they are unable to pay their mortgage payments, in MERS handled mortgages, MERS typically initiates a nonjudicial foreclosure.
One condition of foreclosure is that it may be initiated only by the “holder of the instrument or document evidencing the obligations secured by the deed of trust.” Two homeowners sued in federal court and argued that MERS was not a lawful beneficiary because it was not the “holder” of their promissory notes and it could not name the holder of those notes.
The federal court referred this question to the Washington court for decision on this point of law. Against the argument made by MERS that Washington law allows MERS to be an “agent” of the holder of the promissory note and that this is sufficient to authorize MERS to begin nonjudicial foreclosures, the court held that the plain language of Washington’s law required that only the “actual holder” of the promissory note was eligible to begin such proceedings.
The Washington court anticlimactically threw up its collective hands and said that it needed more information on the specific transactions involved in the federal case in order to answer. The Washington Supreme Court did proceed to the third question the federal court asked, which was whether the homeowners would have a case under the Consumer Protection Act against MERS for deceptively claiming to be the beneficiary in instituting foreclosure proceedings. The court said it was possible that the homeowners would have such a case, depending on whether or not they could prove that they were injured by the deception involved. This case may produce more litigation if additional facts are developed on the record before the federal court. In addition, we may expect the lending industry to be in Olympia clamoring for a legislative “fix.” The preceding is intended as education and may not be construed as legal advice.
About the author…
Doug Owens practices real estate law and general business law from his office in Seattle. He offers a 20% discount for REAPS members and he can be reached at (206) 985-6679 or firstname.lastname@example.org.
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