Fannie Mae, Freddie Mac, MERS, Mortgage Electronic Registration System, Mortgage note, Promissory note, UCC, Uniform Commercial Code
In recently times, a lot of issues have been raised on a number of legal theories questioning whether securitization trusts, either those created by private financial institutions or those created by government sponsored enterprises, such as Ginnie Mae, Fannie Mae or Freddie Mac, have valid legal title to the seven trillion dollars of mortgage notes in those trusts. In an effort to contribute thorough and well-researched legal analysis to the discussion of these theories. The writing provides a detailed overview of the legal principles and processes by which mortgage loans are typically held, assigned, transferred and enforced in the secondary mortgage market and in the creation of mortgage-backed securities (“MBS”). These principles and processes have centuries-old origins, and they have continued to be sound and validated since the advent of MBS over forty years ago.
While the real property laws of each of the 50 U.S. states and the District of Columbia affect the method of foreclosing on a mortgage loan in default, the legal principles and processes discussed in this post result, if followed, in a valid and enforceable transfer of mortgage notes and the underlying mortgages in each of these jurisdictions. To be thorough, this post undertakes a review of both common law and the Uniform Commercial Code (the “UCC”) in each of the 50 U.S. states and the District of Columbia. One of the most critical principles is that when ownership of a mortgage note is transferred in accordance with common securitization processes, ownership of the mortgage is also automatically transferred pursuant to the common law rule that “the mortgage follows the note.” The rule that “the mortgage follows the note” dates back centuries
and has been codified in the UCC. In essence, this means that the assignment of a mortgage to a trustee does not need to be recorded in real property records in order for it to be a valid and binding transfer. In summary, these traditional legal principles and processes are fully consistent with today’s complex holding, assignment and transfer methods for mortgage loans and those methods are legally effective for participants in the secondary mortgage market to transfer mortgage loans.
1. Basic Principles
The two core legal documents in most residential mortgage loan transactions are the promissory note and the mortgage or deed of trust that secures the borrower’s payment of the promissory note. In a typical “private-label” mortgage loan securitization, each mortgage loan is sold to a trust through a series of steps.
A mortgage note and a mortgage may be sold, assigned and transferred several times between the time the mortgage loan is originated and the time the mortgage loan ends up with the trust. The legal principles that govern the assignment and transfer of mortgage notes and related mortgages are determined, in significant part, by the Uniform Commercial Code (“UCC”), which has been adopted by all 50 states and the District of
The residential mortgage notes in common usage typically are negotiable instruments. As a general matter, under the UCC, a negotiable mortgage note can be transferred from the transferor to the transferee through the indorsement2 of the mortgage note and the transfer of possession of the note to the transferee or a custodian on behalf of the transferee. An assignment of the related mortgage is also typically delivered to the transferee or its custodian, except in cases where the related mortgage identifies the Mortgage Electronic Registration System (“MERS”) as the mortgagee. Such assignments generally are in recordable form, but unrecorded, and are executed by the transferor without identifying a specific transferee – a so-called assignment “in blank.” Intervening assignments, in some cases, may be recorded in the local real estate records.
In some mortgage loan transactions, MERS becomes the mortgagee of record as the nominee of the loan originator and its assignees in the local land records where the mortgage is recorded, either when the mortgage is first recorded or as a result of the recording of an assignment of mortgage to MERS. This means that MERS is listed as the record title holder of the mortgage. MERS’ name does not appear on the mortgage note, and the beneficial interest in the mortgage remains with the loan originator or its assignee. The documents pursuant to which MERS acts as nominee make clear that MERS is acting in such capacity for the benefit of the loan originator or its assignee. When a mortgage loan is originated with MERS as the nominal mortgagee (or is assigned to MERS post-origination), MERS tracks all future mortgage loan and mortgage loan servicing transfers and other assignments of the mortgage loan unless and until ownership or servicing is transferred (or the mortgage loan is otherwise assigned) to an entity that is not a MERS member. In this way, MERS serves as a central system to track changes in ownership and servicing of the mortgage loan. Fannie Mae, Freddie Mac and Ginnie Mae, among other governmental entities, permit mortgage loans that they purchase or securitize to be registered with MERS.
2. Transfer of Promissory Notes Secured by Mortgages
The law of negotiable instruments developed over the centuries as a way to encourage commerce and lending by making such instruments, including negotiable mortgage notes, as liquid and transferable as possible. The UCC, with state-specific variations, in significant part governs the assignment and transfer of mortgage notes. Article 3 of the UCC applies to the negotiation and transfer of a mortgage note that is a “negotiable instrument,” as that term is defined in Article 3. In addition, Article 9 of the UCC applies to the sale of “promissory notes,” a term that generally includes mortgage notes.
In addition, as a general matter, the securitization of a loan under a typical pooling and servicing agreement provides both for the negotiation of negotiable mortgage notes (by indorsement and transfer of possession to the securitization trustee or the custodian for the trustee) and for an outright sale and assignment of all of the mortgage notes and mortgages. Thus, whether the mortgage notes in a given securitization pool are deemed “negotiable” (as we believe most typically are) or “non-negotiable” will have little or no substantive effect under the UCC on the validity of the transfer of the notes. The typical securitization process effects valid transfers of the mortgage notes and related mortgages in accordance with the provisions of Articles 3 and 9 of the UCC.
Under the UCC, the transfer of a mortgage note that is a negotiable instrument is most commonly effected by (a) indorsing the note, which may be a blank indorsement that does not identify a person to whom the mortgage note is payable or a special indorsement that specifically identifies a person to whom the mortgage note is payable, and (b) delivering the note to the transferee (or an agent acting on behalf of the transferee). As residential mortgage notes in common usage typically are “negotiable instruments,” this is the most common method to transfer the mortgage note. In addition, even without indorsement, the transfer can be effected by transferring possession under the UCC. Moreover, the sale of any mortgage note also effects the transfer of the mortgage under Article 9. Securitization agreements often provide both for (a) the indorsement and transfer of possession to the trustee or the custodian for the trustee, which would constitute a negotiation of the mortgage note under Article 3 of the UCC and (b) an outright sale and assignment of the mortgage note. Thus, regardless of whether the mortgage notes in a securitization trust are deemed “negotiable” or “non-negotiable,” the securitization process generally includes a valid transfer of the mortgage notes to the trustee in accordance with the explicit requirements of the UCC.
In addition, Article 3 of the UCC permits a person without possession to enforce a negotiable mortgage note where the note has been lost, stolen, or destroyed. Courts have consistently affirmed the use of the salient provisions of the UCC to enforce lost, stolen or destroyed negotiable mortgage notes that are owned by a securitization trust when the trust or its agent has proved the terms of the mortgage notes and their right to enforce the mortgage notes.
3. Assignment and Transfer of Ownership of Mortgages
As stated above, when a mortgage loan is assigned and transferred as part of the securitization of the mortgage loan in the secondary market, both the mortgage note and the mortgage itself are typically sold, assigned, and physically transferred to the trustee that is acting on behalf of the MBS investors or a trustee designated document custodian pursuant to a custody agreement. The assignment and transfer are usually
documented in accordance with a pooling and servicing agreement.
When a mortgage note is transferred in accordance with common mortgage loan securitization processes, the mortgage is also automatically transferred to the mortgage note transferee pursuant to the general common law rule that “the mortgage follows the note.” The rule that “the mortgage follows the note” has been codified in the UCC, but the rule’s common law origins date back hundreds of years, long before the creation of the UCC. As stated in the official comments to UCC § 9-203(g), the section “codifies the commonlaw rule that a transfer of an obligation secured by a security interest or other lien on personal or real property also transfers the security interest or lien.” UCC § 9-203 cmt. 9. All states follow this rule.
In addition to the codification under UCC § 9-203(g), reported court cases in nearly every state and non-UCC statutory provisions in some states make clear that “the mortgage follows the note.” Regarding the impact of these UCC provisions, one treatise states: “Article 9 makes it as plain as possible that the secured party need not record an assignment of mortgage, or anything else, in the real property records in order to perfect its rights in the mortgage.” J. McDonnell and J. Smith, Secured Transactions Under the Uniform Commercial Code, § 16.09[b]. Indeed, courts in several states have affirmed and applied the “mortgage follows the note” rule in cases where the mortgage assignment was not recorded by the transferee and even when there was no actual separate written assignment of the mortgage.
Common securitization practices are consistent with the general rule that “the mortgage follows the note”: pursuant to the pooling and servicing agreement that governs an MBS, and the language of assignment typically contained in such an agreement, the mortgage note and the mortgage itself are sold, assigned, transferred and delivered to the trustee, and the transferor also typically delivers a written assignment of the mortgage that is in blank in recordable form. Courts have held that the language of sale and assignment contained in a pooling and servicing agreement, along with the corresponding transfer, sale, and delivery of the mortgage note and mortgage, are sufficient to transfer the mortgage to the transferee/trustee or its designee or nominee.
The creation of an interest in or lien on real property, including a mortgage, is governed by the non-UCC law of the state in which the property is located. Likewise, the enforceability of mortgages (including the right and method to foreclose) is subject to all of the conditions precedent and requirements that are set forth in the particular mortgage itself and in all applicable state and local laws. Those conditions precedent and procedural requirements vary from mortgage to mortgage and from state to state. Thus, ownership of a mortgage (i.e., without notice to the mortgagor or the public, without judicial proceedings (where required), without satisfaction of other conditions precedent or procedural requirements in the mortgage itself or in applicable state law), does not always give the holder of the mortgage the legal ability to foreclose on the mortgage. Though a discussion of the other necessary prerequisites to foreclosure is beyond the scope of this Executive Summary and the White Paper, the fact that other steps may need to be taken by the owner of a mortgage note, or the owner of a mortgage, is neither unique nor surprising in our legal and regulatory system and does not diminish an otherwise legally effective transfer of the mortgage note and mortgage.
The use of MERS as the nominee for the benefit of the trustee and other transferees in the mortgage loan securitization process has been a subject of litigation in recent years regarding a mortgage note holder’s right to enforce a mortgage loan registered in MERS. Some cases address the authority or ability of MERS or transferees of MERS to foreclose on a mortgage for which MERS is or was the mortgagee of record. As a general matter, the assignment and transfer of a mortgage to MERS as nominee of and for the benefit of the beneficial owner of the mortgage does not adversely impact the right to foreclose on the mortgage. Decisions in many jurisdictions support this conclusion.
There are several minority decisions that, in some form, have taken issue with MERS. But none of these decisions, to our knowledge, has invalidated a mortgage for which MERS is the nominee, and none of these decisions has challenged MERS’ ability to act as a central system to track changes in the ownership and servicing of mortgage loans.
Finally, it is important to recognize that the UCC does not displace traditional rules of agency law. Under general agency law, an agent has authority to act on behalf of its principal where the principal “manifests assent” to the agent “that the agent shall act on the principal’s behalf and subject to the principal’s control, and the agent manifests assent or otherwise consents so to act.” Accordingly, the UCC does not prevent MERS or others, including loan servicers, from acting as the agent for the note holder in connection with transfers of ownership in mortgage notes and mortgages. In short, principles of agency law provide MERS and loan servicers another legal basis for their respective roles in the transfer of mortgage notes and mortgages.
In summary, the longstanding and consistently applied rule in the United States is that, when a mortgage note is transferred, “the mortgage follows the note.” When a mortgage note is transferred and delivered to a transferee in connection with the securitization of the mortgage loan pursuant to an MBS pooling and servicing agreement or similar agreement, the mortgage automatically follows and is transferred to the mortgage note transferee, notwithstanding that a third party, including an agent/nominee entity such as MERS, may remain as the mortgagee of record. Both common law and the UCC confirm and apply this rule, including in the context of mortgage loan securitizations.
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