Securitization Chain-of-Title: The US Bank v. Congress Ruling
Over on Housing Wire, Paul Jackson is crowing that chain-of-title issues in mortgage securitization are overblown because an Alabama state trial court rejected such arguments in a case ironically captioned U.S. Bank v. Congress.
But let’s actually consider whether the opinion matters, what the court actually did and did not say, and whether it was right.
Perhaps the most important thing to note about the opinion is what isn't there. There was no consideration of the chain-of-title issue in the opinion. Let me repeat, the court said nothing about whether there was proper chain-of-title in the securitization. Instead, the court avoided dealing with it. That means that this ruling isn't grounds for sounding the "all clear" on chain-of-title. At best, it is grounds for arguing that homeowners won't be able to raise chain-of-title problems. As we've seen with Ibanez, that's clearly incorrect, and a closer look at the Congress ruling shows that it might be an Alabama special, not applicable elsewhere.
Alabama is a “non-judicial” foreclosure state. That means foreclosures are done by private sale. In Congress the securitization trustee held a sale and received a quitclaim deed from the mortgagee MERS. The securitization trustee then brought an ejectment action against the homeowner. The decision was in the ejectment action, not the foreclosure.
The court used this procedural posture to wiggle around having to address the chain-of-title issues. The homeowner’s argument was that the note and mortgage had never been properly and timely transferred to the securitization trust per the method required by the pooling and servicing agreement (PSA) and were, therefore, not trust property, so the trust had no interest in the mortgage and therefore lacked standing to bring a foreclosure: “without proof that U.S. bank was the owner of the Note, it has no standing and therefore the trial court has no subject matter jurisdiction over the case.”
The court played on the procedural posture of the case to reject this argument. First, the court explained that because this was an ejectment action, not a foreclosure, the question of ownership of the note was not an issue of standing, but an affirmative defense for which the homeowner had the burden of proof. The trial court here was citing to a recent Alabama appellate court decision (reversing a previous Alabama appellate decision) that concluded that standing is satisfied by virtue of the bank being named party on the foreclosure deed. That’s just crazy given that the foreclosure deed is a nonjudicial sale. [G.S.—maybe this explains why your shop saw your notaries' seal forged on those foreclosure deeds.]
Crazy or not, however, this meant that the homeowner wasn’t actually challenging the trust's standing. From there it was a small step for the court to say that the homeowner couldn’t invoke the terms of the PSA because she wasn’t a party to it.
If the homeowner were able to bring a standing challenge, there’d really be no way to avoid addressing the PSA on its own terms because that is what determines whether the securitization trust has an interest in the mortgage in the first place. This procedural move of saying that the homeowner wasn’t challenging standing was what decided the case. It certainly made it possible for the court to decide everything under Alabama law, rather than address the New York law that governs the PSA: “This is an action for ejection from Alabama real property, brought against an Alabama resident in an Alabama court.” [Translation: boy, don’t you bring down any of that fancy New York lawyering to Alabama.]
It’s worth noting that this is not the only decision to say that the homeowner has no ability to invoke the PSA. There’s an unpublished Sixth Circuit ruling in a case called Livonia, involving a commercial mortgage. In that case, the court said that a litigant who is not party to an assignment cannot challenge the assignment, unless there's a concern about double enforcement (i.e., that someone else might claim to be the note holder). If one traces back the caselaw cited as precedent in Livonia, one will see that it is fairly inapposite--my take is that this is a decision where the law clerks cited some 19th century caselaw language without fully understanding the particular context of those cases. But even if the precedent is well-founded, given the prevelance of warehouse fraud, the double enforcement problem is real, and more importantly, there’s another critical borrower interest in ensuring that litigation is against the proper party. Securitization trusts have very different ability and incentives to settle a foreclosure case by modifying a loan than a portfolio lender. That means borrowers do have an interest in the validity of the assignment and thus standing to litigate over it.
More generally, I find the argument that there's no standing to argue over chain of title misplaced. Perhaps the most fundamental defense to a foreclosure is to argue that the party bringing the action isn’t the creditor. That’s a standing question, and there’s simply no way to examine it without getting into the PSA.
There’s also a secondary issue in Congress that is also worthy of comment (I could go on and on about the rubberbanded allonge issue as well, but gosh that'd be dry and technical): The court wrote that “U.S. bank was the ‘holder’ of the Congress note and therefore had the legal right to foreclose on the Congress property.” The concept of “holder” is a UCC Article 3 concept. It goes to the ability to enforce the note. UCC 3-301. A holder is simply a party in possession of a note made out to that party or to bearer. UCC 1-201(b)(20). Thus, a thief of a bearer note is a “holder” of the note for UCC purposes, and therefore entitled to enforce the note.
But recall that the note is separate from the security instrument, and the securitization trustee isn’t trying to enforce just the note. It is trying to enforce the security instrument that accompanies the mortgage, and the enforceability of security interests in real property isn’t governed by UCC Article 3 and with good reason—mortgages aren’t negotiable, even if the notes themselves are. The commercial benefits from enhanced liquidity of debt do not trump concerns about protecting homeowners’ rights to occupancy.
Unlike an action on a note, which is an action at law, mortgage foreclosure is an equitable action—it is the cutting off the borrower’s equity of redemption. Most states have abandoned the formal law/equity division, but the principles still stand, even if the court structure does not. While a thief can enforce bearer paper, the idea that a thief could enforce a mortgage is laughable. If you don’t have clean hands, don’t expect relief in equity.
The Alabama court just seemed to assume that if a party is a UCC Article 3 holder of a note, it can enforce an associated mortgage. My own take is that enforcement of the mortgage—that is foreclosure—is a separate issue that requires a separate analysis. The court couldn’t have gone down this path, however, because clean hands leads right back to the chain-of-title question.
So to recap, I don’t think there’s much to get excited about with Congress. If the homeowner had prevailed, the banks would have been saying “it’s just an Alabama state trial court,” and it might well have been overturned on appeal. But that doesn’t mean that the chain-of-title issue isn’t real. It just means that there’s still a search for the proper channel on which to advance the argument.
In the end, I see Paul Jackson as toeing the "nothing to see here folks" line that's coming out of thesell-side banks and American Securitization Forum, but numerous buy-side people (read MBS investors) have told me that they think there’s a serious problem with the securitization documentation. The problem that they have is that they don’t know what to do about it—they are trying to figure out a way that this can be used to put the mortgages back to the banks without it tanking the entire financial system. In other words, the banks are being protected by the too-big-to-fail problem. That’s letting them externalize their violations of their securitization contracts on MBS investors.