US: mortgage foreclosure litigation

From time to time, as societal and economic issues have warranted, the US federal government has become involved in relief efforts intended to render assistance to struggling homeowners fighting foreclosure.

Stemming from the mortgage meltdown of 2008 and beyond, the Home Affordable Modification Program (HAMP) allowed for the deceleration of loans in foreclosure and compulsory refinancing on terms more favorable to the mortgagee, provided mortgagors met certain financial conditions, including specific income-to-payment ratio and loan-to-value ratio criteria.

For those not qualified, an alternative called the Home Affordable Refinance Program, or HARP, which involves refinancing of delinquent mortgages, as the name suggests, even where the homeowners were ‘underwater’ on the LTV ratio.

The compulsory aspect of the requirement of a given mortgage holder to comply with HAMP was the subject of some jurisprudential controversy. After all, the government was not, strictly speaking, a party to the original mortgage transaction, so how could a mortgage lender be forced to accept the terms imposed by the federal government?

Many institutional lenders sounded of sanctimony in claiming undue government interference and overreaching, though they weren’t necessarily complaining when the government bailed them out in promulgating TARP. Indeed, the mortgage lenders were the beneficiaries of extensive government funding in association with the bailout of the financial sector in general under TARP, under which the HAMP program was promulgated.

Ultimately, the courts determined the mortgage lender was a third-party beneficiary under HAMP and thereby bound to accept the terms thereof in the Wigood case (Wigood vs Wells Fargo Bank, N.A., 673 F.3d 547 (7^th Cir. 2012) in particular and the denouement of the controversy in general.

The bad news for homeowners in default is HAMP and HARP are now redundant and the relief protocols which enforced a moratorium on foreclosures have terminated. The good news is there’s already a move afoot to implement new relief programs in the aftermath of the covid-19 created financial woes. The same legal principles derived from Wigood are still valid and presumably dictate we will be able to avail our clients of them. The legal community will stay tuned as a new round of round of distressed property litigation commences.

Even though a given homeowner has standing as a third-party beneficiary of the government programs intended for relief, the astute practitioner will nonetheless want to avail themselves of all valid defenses to the enforceability of the note and mortgage. After all, history teaches the invocation of these benefits takes considerable time and effort in wrangling with the lenders whose role is supposed to include liaison with the government in securing these stipends. But the necessity to litigate cases such as Wigood clearly suggests many foreclosure plaintiffs are not properly motivated to avail themselves of these programs. It is therefore necessary defense counsel, in many instances, create this motivation. And this may well involve making it more difficult to foreclose the mortgage than would otherwise be necessary.  

In this regard, claims and defenses applicable to the defense of a given foreclosure action will often relate to the issue of standing. The following endeavors to digest some aspects of this line of defense for practical reference:

Historic backdrop

Historically, mortgage lending was a low-risk endeavor and a mainstay of conservative investment portfolios based on traditional lending practices. The prudent lender, typically a bank or mortgage company, lent exclusively to those with high credit and then generally retained ownership of the mortgage.

However, with growing impatience with these safe but slow-yielding lending practices, a shifting paradigm occurred which gave rise to the practice of mortgage securitization lending. In startling contrast to the old school, it occurred to industry shakers that returns on the mortgage investing process could be dramatically accelerated and extended by sequestering the loan initiation component from the investment/ownership of the asset(s); enlisting the participation of non-traditional investors, particularly private equity; and dramatically relaxing credit-related standards to encourage sub-prime lending to less creditworthy borrowers.

By the time all of this had played out, banks and lenders became mere originators of mortgage loans, who would almost invariably assign the paper to third-party investors, often private equity firms, which then bundle the mortgage(s) collectively with others and use them as collateral for mortgaged backed securities (MBSs), however denominated, issuing them for investment.

Of critical importance, it was the separation of the mortgage origination function from actual ownership of the mortgage that led to the feeding-frenzy of lending to sub-prime candidates. The banks and mortgage companies had little or no financial risk and thus no incentive to ensure the long-term viability of the mortgage loan performance.

By 2008, as defaults cascaded, the flaws in this way of doing things were exposed and the mortgage market eventually bubble burst, sending shock waves reverberating throughout the US economy and beyond. Domestically alone, the collective net worth of US households declined by 13 trillion dollars, the stock market fell to half its pre-crisis peak, gross domestic product dropped to forty percent (40 per cent) of its previous high and subjectively, untold human angst occurred.

Applicability and defenses

Against this backdrop, it becomes easier to see why some of the traditional legal safeguards in place to prevent irregularities in the handling of negotiable instruments deserve renewed respect and adherence. These include, most particularly, observance of the laws concerning proper standing to enforce these instruments. Only then will the financial industry be sufficiently dissuaded from playing fast and loose with the handling of investment securities, mortgage-backed ones.

In this regard, a fundamental principle of any lawsuit is one must having standing in order to initiate it. Standing, in a legal sense, is defined broadly as capacity to maintain an action as plaintiff. In most litigation, standing to sue is not in question. For example, rarely will a defendant question whether an injured motorist has the ability to sue the other driver. Rather, the issues generally will have to do with who was at fault and how severe the injury really is.

In the foreclosure context, however, things can be very different. In the law of negotiable instruments, any documents establishing collateral for the debt will follow the assignment of the debt itself. Thus, a mortgage will follow any transfer of the promissory note which it secures. Such a transfer will generally be transacted by a simple endorsement of the promissory note, either in blank or to a specific transferee. The mortgage that secures it will then, by law, be assigned to the transferee of the note, whether or not its assignment is actually recorded of record.

A publicly recorded assignment of the mortgage is important but this importance generally has more to do with the perfection and priority of the mortgage vis a vis competing titular interests in the same real property.

Where the owner of the note is also its holder and it is in default, standing is proper to foreclose. If the note is most recently endorsed in blank, then its holder will also be deemed its owner for standing purposes. The foreclosure may proceed if all else is satisfactory.

However, this is where issues of standing can often arise. The owner of the note is generally not its holder. In this era of mortgage securitization, mortgages are bundled and traded around much like stocks and bonds, so at any given time, it is difficult or impossible to know who owns it and there are often discrepancies in this regard.

Plaintiff problems in foreclosure

·       Endorsement to a third party is not joined in the foreclosure case

The burden is on the plaintiff to establish standing once it’s been called into question in the pleadings. Usually, a promissory note will have been transferred to an institutional investor such as a hedge fund or other private equity concern without any record in the lawsuit or publicly. Again, the plaintiff will generally be a mortgage lender or bank, not the actual investor-owner of the paper. On the note, unless the plaintiff is the loan originator without subsequent third-party assignees, or unless there’s a blank endorsement in the most recent chain of note transfers, signed by a qualified representative of the most recent transferor, standing may be improper.

·       Possible exception: servicing agent with authority to foreclose

Under some authority, a legal servicing agent, properly appointed in a written agreement, may have standing to sue in foreclosure. Such a servicing agent should be properly identified and specifically vested with authority to engage in such legal proceedings on behalf of the note owner.

·       Note endorsement not verifiable

Often the note’s most recent endorsement, or any endorsement in the chain of ownership, will contain a signature that cannot be verified. The endorsement should identify the signer and their status as an authorized representative of the transferor. Digital signatures, though not necessarily defective in themselves, can be improper where they lack back-up verification as to identity and authority.

The Mortgage Electronic Registration Service (MERS) was specifically created by the finance industry to keep digital track in the chain of ownership of a given mortgage instrument at any given time. As a corollary, it was also deemed, by the industry, to have authority to transact the type of transfers at issue here. Unfortunately, it was created with little or no traditional legal authority or justification. Rather, it was created as a matter of convenience in an attempt to circumvent cumbersome but long-standing common law and statutory protocols, designed to safeguard the integrity of these conveyances. Moreover, in virtually every transfer, MERS is named as the ‘nominee’ of the party it purports to represent, generally the transferor of a given instrument. The authority of a ‘nominee’ to do such a thing is nowhere defined at common law or statutorily. As of this writing, there still exists significant legal controversy involving what, if any properly vested authority, MERS has to transact conveyances on behalf of specified entities without their formal record involvement in any chain of transfer.  

Many jurisdictions, including Florida, generally require banks to produce the note at the time of the foreclosure. The plaintiff must prove its right to foreclose by additional items along with the complaint, including a certification that the bank is in possession of the original promissory note. But if the note has been lost, the bank can provide a lost note affidavit with a clear chain of all endorsements, transfers, or assignments of the promissory note.

Going forward

Foreclosure defense attorneys must be well-versed in these issues and thus have the ability to advance these defenses related to them. And although the homeowner is unlikely to wind up owning free and clear, counsel for such a defendant in foreclosure must not lack the legal weapons with which to wage battle, otherwise there may be very little leverage to negotiate a satisfactory resolution.

Austin N. Aaronson is an attorney at Aaronson Law Group aaronsonlawgroup.com