Ibanez and Securitization Fail

The Ibanez foreclosure decision by the Massachusetts Supreme Judicial Court has gotten a lot of attention since it came down on Friday. The case is, not surprisingly being taken to heart by both bulls and bears. While I don't think Ibanez is a death blow to the securitization industry, at the very least it should make investors question the party line that's been coming out of the American Securitization Forum. At the very least it shows that the ASF's claims in its White Paper and Congressional testimony are wrong on some points, as I've argued elsewhere, including on this blog. I would argue that at the very least, Ibanez shows that there is previously undisclosed material risk in all private-label MBS.

The Ibanez case itself is actually very simple. The issue before the court was whether the two securitization trusts could prove a chain of title for the mortgages they were attempting to foreclose on.  

There's broad agreement that absent such a chain of title, they don't have the right to foreclose--they'd have as much standing as I do relative to the homeowners. The trusts claimed three alternative bases for chain of title:

(1) that the mortgages were transferred via the pooling and servicing agreement (PSA)--basically a contract of sale of the mortgages

(2) that the mortgages were transferred via assignments in blank.

(3) that the mortgages follow the note and transferred via the transfers of the notes.

The Supreme Judicial Court (SJC) held that arguments #2 and #3 simply don't work in Massachusetts. The reasoning here was heavily derived from Massachusetts being a title theory state, but I think a court in a lien theory state could easily reach the same result. It's hard to predict if other states will adopt the SJC's reasoning, but it is a unanimous verdict (with an even sharper concurrence) by one of the most highly regarded state courts in the country.  The opinion is quite lucid and persuasive, particularly the point that if the wrong plaintiff is named is the foreclosure notice, the homeowner hasn't received proper notice of the foreclosure.

Regarding #1, the SJC held that a PSA might suffice as a valid assignment of the mortgages, if the PSA is executed and contains a schedule that sufficiently identifies the mortgage in question, and  if there is proof that the assignor in the PSA itself held the mortgage. (This last point is nothing more than the old rule of nemo dat--you can't give what you don't have. It shows that there has to be a complete chain of title going back to origination.)  

On the facts, both mortgages in Ibanez failed these requirements. In one case, the PSA couldn't even be located(!) and in the other, there was a non-executed copy and the purported loan schedule (not the actual schedule--see Marie McDonnell's amicus brief to the SJC) didn't sufficiently identify the loan. Moreover, there was no proof that the mortgage chain of title even got to the depositor (the assignor), without which the PSA is meaningless: 

Even if there were an executed trust agreement with the required schedule, US Bank failed to furnish any evidence that the entity assigning the mortgage – Structured Asset Securities Corporation [the depositor] — ever held the mortgage to be assigned. The last assignment of the mortgage on record was from Rose Mortgage to Option One; nothing was submitted to the judge indicating that Option One ever assigned the mortgage to anyone before the foreclosure sale.

So Ibanez means that to foreclosure in Massachusetts, a securitization trust needs to prove: 

(1) a complete and unbroken chain of title from origination to securitization trust

(2) an executed PSA

(3) a PSA loan schedule that unambiguously indicates that association of the defaulted mortgage loan with the PSA. Just having the ZIP code or city for the loan won't suffice. (Lawyers:  remember Raffles v. Wichelhaus, the Two Ships Peerless?  This is also a Statute of Frauds issue--the banks lost on 1L contract issues!)  

I don't think this is a big victory for the securitization industry--I don't know of anyone who argues that an executed PSA with sufficiently detailed schedules could not suffice to transfer a mortgage. That's never been controversial. The real problem is that the schedules often can't be found or aren't sufficiently specific. In other words, deal design was fine, deal execution was terrible. Important point to note, however: the SJC did not say that an executed PSA plus valid schedules was sufficient for a transfer; the parties did not raise and the SJC  did not address the question of whether there might be additional requirements, like those imposed by the PSA itself.

Now, the SJC did note that a "confirmatory assignment" could be valid, but (and this is s a HUGE but), it:

"cannot confirm an assignment that was not validly made earlier or backdate an assignment being made for the first time. Where there is no prior valid assignment, a subsequent assignment by the mortgage holder to the note holder is not a confirmatory assignment because there is no earlier written assignment to confirm."

In other words, a confirmatory assignment doesn't get you anything unless you can show an original assignment. I'm afraid that the industry's focus on the confirmatory assignment language just raises the possibility of fraudulent "confirmatory" assignments, much like the backdated assignments that emerged in the robosigning depositions.  

So what does this mean?  There's still a valid mortgage and valid note. So in theory someone can enforce the mortgage and note. But no one can figure out who owns them. There were problems farther upstream in the chain of title in Ibanez (3 non-identical "true original copies" of the mortgage!) that the SJC declined to address because it wasn't necessary for the outcome of the case. But even without those problems, I'm doubtful that these mortgages will ever be enforced. Actually going back and correcting the paperwork would be hard, neither the trustee nor the servicer has any incentive to do so, and it's not clear that they can do so legally. Ibanez did not address any of the trust law issues revolving around securitization, but there might be problems assigning defaulted mortgages into REMIC trusts that specifically prohibit the acceptance of defaulted mortgages. Probably not worthwhile risking the REMIC status to try and fix bad paperwork (or at least that's what I'd advise a trustee). I'm very curious to see how the trusts involved in this case account for the mortgages now.  

The Street seemed heartened by a Maine Supreme Judicial Court decision that came out on Friday, Harp v. JPM Chase. If they read the damn case, they wouldn't put any stock in it.  

In Harp, a pro se defendant took JPM all the way to the state supreme court. That alone should make investors nervous--there's going to be a lot of delay from litigation. Harp also didn't involve a securitized loan. But the critical difference between Harp and Ibanez is that Harp did not involve issues about the validity of chain of title. It was about the timing of the chain of title. Ibanez was about chain of title validity.  In Harp JPM commenced a foreclosure and was subsequently assigned a loan. It then brought a summary judgment motion and prevailed. The Maine SJC stated that the foreclosure was improperly commenced, but it ruled for JPM on straightforward grounds: JPM had standing at the time it moved (and was granted) summary judgment. Given the procedural posture of the case, standing at the time of summary judgment, rather than at the commencement of the foreclosure was what mattered, and there was no prejudice to the defendant by the assignment occurring after the foreclosure action was brought, because the defendant had an opportunity to litigate against the real party in interest before judgment was rendered. The Maine Supreme Judicial Court also indicated that it might not be so charitable with improperly foreclosing lenders that were not in the future; JPM benefitted from the lack of clear law on the subject. In short, Harp says that if the title defects are cured before the foreclosure is completed, it's ok. There's a very limited cure possibility under Harp, which means that the law is basically what it was before: if you can't show title, you can't complete the foreclosure.  

What about MERS?  The Ibanez mortgages didn't involve MERS.  MERS was created in part to fix the problem of unrecorded assignments gumming up foreclosures in the early 1990s (and also to avoid payment of local real estate recording fees). In theory, MERS should help, as it should provide a chain of title for the mortgages. Leaving aside the unresolved concerns about whether MERS recordings are valid and for what purposes, MERS only helps to the extent it's accurate.  And that's a problem because MERS has lots of inaccuracies in the system. MERS does not always report the proper name of loan owners (e.g., "Bank of America," instead of "Bank of America 2006-1 RMBS Trust"), and I've seen lots of cases where the info in the MERS system doesn't remotely match with the name of either the servicer or the trust bringing the foreclosure. That might be because the mortgage was transferred out of the MERS system, but there's still an outstanding record in the MERS system, which actually clouds the title. I'm guessing that on balance MERS should help on mortgage title issues, but it's not a cure-all. And it is critical to note that MERS does nothing for chain of title issues involving notes.    

Which brings me to a critical point: Ibanez and Harp involve mortgage chain of title issues, not note chain of title issues. There are plenty of problems with mortgage chain of title. But the note chain of title issues, which relate to trust law questions, are just as, if not more serious. We don't have any legal rulings on the note chain of title issues. But even the rosiest reading of Ibanez cannot provide any comfort on note chain of title concerns.  

So who loses here? In theory, these loans should be put-back to the seller. Will that happen? I'm skeptical.  If not, that means that investors will be eating the loss. This case also means that foreclosures in MA (and probably elsewhere) will be harder, which means more delay, which again hurts investors because there will be more servicing advances to be repaid off the top. The servicer and the trustee aren't necessarily getting off scot free, though. They might get hit with Fair Debt Collection Practices Act and Fair Credit Reporting Act suits from the homeowners (plus anything else a creative lawyer can scrape together). And mortgage insurers might start using this case as an excuse for denying coverage. REO purchasers and title insurers should be feeling a little nervous now, although I doubt that anyone who bought REO before Ibanez will get tossed out of their house if they are living in it. Going forward, though, I don't think there's a such thing as a good faith purchaser of REO in MA.  

You can't believe everything you read. Some of the materials coming out of the financial services sector are simply wrong. Three examples:

(1) JPMorgan Chase put out an analyst report this morning claiming the Massachusetts has not adopted the UCC. This is sourced to calls with two law firms. I sure hope JPM didn't pay for that advice and that it didn't come from anyone I know. It's flat out wrong. Massachusetts has adopted the uniform version of Revised Article 9 of the UCC and a non-uniform version of Revised Article 1 of the UCC, but it has adopted the relevant language in Revised Article 1. There's not a material divergence in the UCC here.  

(2) One of my favorite MBS analysts (whom I will not name), put out a report this morning that stated that Ibanez said assignments in blank are fine. Wrong. It said that they are not and never have been valid in Massachusetts:  

"[In the banks'] reply briefs they conceded that the assignments in blank did not constitute a lawful assignment of the mortgages. Their concession is appropriate. We have long held that a conveyance of real property, such as a mortgage, that does not name the assignee conveys nothing and is void; we do not regard an assignment of land in blank as giving legal title in land to the bearer of the assignment."  

A similar line is coming out of ASF.  Courtesy of the American Banker:  

Perplexingly, the American Securitization Forum issued a press release hailing the court's ruling as upholding the validity of assignments in blank. A spokesman for the organization could not be reached to explain its interpretation.

ASF's credibility seems to really be crumbling here. It's one thing to disagree with the Massachusetts SJC.  It's another thing to persist in blatant misstatements of black letter law.

(3) Wells and US Bank, the trustees in the Ibanez case, immediately put out statements that they had no liability. Really? I'm not so sure. Trustees certainly have very broad exculpation and very narrow duties. But an inability to produce deal documents strikes me as such a critical error that it might not be covered. Do they really want to litigate a case where the facts make them look like such buffoons? Do they really want daylight shed on the details of their operations? Indeed, absent an executed PSA, I don't think the trustees have any proof of exculpation. They might be acting, unwittingly, as common law trustees and thus general fiduciaries. I think they'll settle quickly and quietly with any investors who sue.  

Finally, what are the ratings agencies going to do? It seems to me that any trust with Massachusetts loans that doesn't have a publicly filed, executed PSA with a reviewable loan schedule should be on a downgrade watch. Very few publicly filed PSAs are executed and even fewer have publicly filed loan schedules.  That doesn't mean they don't exist, but somewhere off-line, but if I ran a rating agency, I'd want trustees to show me that they've got those papers on at least a sample of deals. Of course should and would are quite different--the ratings agencies, like the regulators, are refusing to take the securitization fail issue as seriously as they should (and I understand that it is a complex legal issue), but I think they ignore it at their (and our) peril.  

Comments

[Transor Z]

I'm going to go with a big migration toward captive title insurance and policies containing sneaky little outs.

[Steve Diamond]

Adam,

Very helpful post.

You wrote: "deal design was fine, deal execution was terrible".

But I get the impression that that industry's profit margins depended on the precisely the kind of execution that led to these sloppy results. The late Tanta, who came out of the industry, described on her blog a while ago what happened to her when she tried slowing down one of these deals precisely to correct such a chain of title problem. It cost the client thousands but probably saved them much more than that. But she caught hell for intervening.

[Brian]

I see several explanations that you have included being very prophetic to the future issues. When the note, assignments and indorsements are added to a case like this regarding the mortgage, we will have returned to the roots of property law. Mugwumps must eventually choose.

[Angelo]

Prof.
They have stated the the assignments of the mortgage in blank convey nothing, but what did it say about the note being assigned in blank to a New York trust. It has been long standing law that notes assigned in blank are indeed valid. I would love to see some case law or law journals about this topic. If you indeed have some please forward these articles to me.
Thanks for all your work and insight.
[email protected]

[Adam Levitin]

Angelo: notes assigned in blank are fine as between me and you. There's an open question whether a trust can hold bearer paper. The issue there is that nothing would indicate it to be trust property as opposed to the trustee's property. And this is particularly a problem when there are multiple trusts with the same trustee. Thus, trustees don't hold cash. They hold bank accounts (not bearer paper).

Transor Z: My guess is that the title insurance risk is already on the books of the banks' captive affiliates via reinsurance. There's probably a kickback move going on there as well as a regulatory capital play--a lot of captive reinsurance is done out of Vermont, and my read of VT captive regulation is that capital requirements are essentially outsourced to the captive's auditor, which is to say they are virtually non-existent.

[matthew]

Based on the fact that it is a complicated legal issue, I tend to think the ratings agencies and regulators ignore these problems at our peril much more so than their own. Which isn't comforting.

[Wandering Mind]

There is an aspect of the Massachusetts case which is troubling to me, given the confusion over assignment of notes (as opposed to mortgages).

The court observed that if the mortgage is held by one entity via assignment and the note is held by a different entity, then the current holder of the mortgage is acting as a trustee for the true owner of the note. The true owner of note then has a cause of action against the mortgage holder to obtain the proceeds of the foreclosure auction.

However, given the rampant failure to properly transfer notes, it seems to me that there should be some rule requiring that the true creditor be established prior to allowing the foreclosure to proceed.

Not to do so invites the possibility that, post-foreclosure, more than one creditor will be dunning the debtor in a deficiency proceeding.

[sheryl moore]

what a great day that this finally has gotten some attention . my note does not match my mortgage i find that a real problem that my note is in a tranch claiming to have better ratingd? lower swap payments for risk ect. i am in litigation now with boa and i intend to win

[jpe]

" There's an open question whether a trust can hold bearer paper."

Is there any caselaw on point? I haven't found much on this topic, but if identification of the res is the issue, I'd think that a recital of the property would be identification enough.

[Angelo]

Thanks for the quick response prof.
I understand and agree with the concept that trusts should not be allowed to hold bearer paper, but is there any case law that supports this legal theory? I have been searching lexis and still haven't been able to find any cases to site. If you can point me to some it would be greatly appreciated.

[MinnItMan]

"I'd think that a recital of the property would be identification enough."

"The "property" means the mortgagee's real estate rights pursuant to the security interest/instrument, correct?

I don't understand how USBank's lawyers thought the Option1 assignment was going to work for them. I guess not very much beats nothing, but it seems they were making a UCC debt argument for a real estate issue destined to fail.

As for Tranzor, the title insurers need transaction volume, but insuring REO is going to be way more expensive for them. It's one thing to eat a quiet title you "know" that you will win, and that's a big cost (I'd estimate they need ten policy premiums per QT). To insure deals where you might well lose when a QT is necessary, is what they're facing (I'd estimate that's at least 100-to-one).

I agree with Adam that buyers are going to not have BFP status, although I'm not sure I agree that it will only be prospective. My take on the decision was that the court was saying "everybody knows this, has known this and should know this," despite the title theory discussion which I didn't find all that persuasive or necessary for the result.

I don't see any way out. Cash purchasers are taking a huge risk, especially because, in my experience most are really "cash" purchasers - there is usually some diguised daisy chain short-term finance behind that cash. Assuming a longer term outlook for would-be landlords, I think they are risking pretty disasterous landlord breaches in the event of a title failure, in addition to total loss of the purchase.

The mother-load risk, IMO, is that nobody knows what the risk is 6 months, 1 year, two years out, of title insurance simply not being available.

The last time I checked, none of the title insurers have reserves of more the $1B, and I could see that easily being eaten up by existing claims for policies issued prior to all this, particularly to the extent they did foreclosure policies - which was the growth area a few years ago. On the other hand, if they did a good job underwriting those, maybe it won't be such a problem. I don't know.

[Richard Vetstein]

Adam, superb article; probably the best I've read.

As a MA real estate attorney, I've been following the case on my blog (http://massrealestatelawblog.com).

Having experience with actual clients and cases, I believe that the third party purchasers of foreclosed properties with Ibanez type defects may pose a significant liability to the servicers and lenders. Those folks now have a complete failure of title. They are not, nor ever will be, BFPs, because the court held the foreclosures void ab initio--as if they never occurred. Similar to a forgery--no BFP theory in play.

So these innocent victims now don't hold title to the homes they've lived in and improved and paid taxes on more the last several years. And what's the prospect of curing the title issues? Slim to none unless they can track down the former owner and pay him off with a deed (which I've done in one case--offered a HDTV to the guy!).

The title insurance companies are going to have major claims. Everyone in the chain will get sued, and these are big claims. Several hundred thousand dollar claims for homes in Massachusetts. Times what?

Then say California follows Ibanez and now all hell will break loose, both on the servicer/trustee liability side and on the "BFP" side.

Good lord!

Richard D. Vetstein, Esq.

[Richard Vetstein]

Adam, have you thought about the effect of how lenders can simply re-foreclose?

If the borrowers remain in default, the servicers can (and that's the big ?) get their assignments in order, and start over. In cases where the assignments are executed and recorded after the first foreclosure, this is a potential cure.

Richard D. Vetstein

[Marcin]

Wouldn't one possible solution be for everyone who might hold title to a murky mortgage to assign it to a single party, in return for a share of the realisation? Accordingly, the assignee will definitely have title.

[d daxx]

I would like to obtain either a copy or some means,less expensive, to be able to read the amicus brief in the foreclosure case. My pension is too small to be able to pay 125.00 as requested just to obtain a copy of the brief.
Is there a way to either pay less or to be able to read the amicus brief?

[Mike Dillon]

D Daxx, who is requesting that you pay $125.00 for the briefs?

[Transor Z]

@D Daxx

All of the materials are available here in .pdf -- for free:

http://www.ma-appellatecourts.org/display_docket.php?dno=SJC-10694

Enjoy.

[Adam Levitin]

Does anyone have a copy of the PSA for the Ibanez mortgage (SASCO Series 2006-Z)? I know there was an unexecuted copy located; I'm curious to look at some of its terms.

Adam

[Adam Levitin]

Please disregard the request. I got the Ibanez and LaRace mortgages mixed up. Ibanez was the case where the PSA couldn't be found. LaRace was ABFC 2005-OPT1, and that PSA is easy enough to find (in an unexecuted version).

[CambridgeKnitter]

This is easily the best discussion I have seen on this subject. I have been a real estate lawyer and title examiner in the Boston/Cambridge area for more than twenty years. During the last downturn I did foreclosures for at least a year. Conditions have definitely changed since then.

Richard Vetstein is partly right above about how to fix the problems, but I think there's a relatively simple way to go about this, yet no one I've seen or talked to seems to have thought about it: redo the entries.

The normal way of doing a foreclosure in Massachusetts is to do it by two independent means, entry and exercise of the power of sale. In three years after recording, the certificate of entry ripens into fee title and thus cleans up various irregularities that could have crept into the exercise of the power of sale. Some if not all of the title insurance companies latched onto this while awaiting the SJC decision, but they did it incorrectly in my opinion. They took the position that it wasn't necessary to hold the mortgage at the time a lender made an entry, so after-acquired assignments would magically make it OK and not impede its ripening. I don't see how anyone could have read Judge Long's decision that way, nor do I see how anyone could read the SJC's decision that way.

My prescription is to make sure that the assignments are in place now, since the mortgage still exists under current Massachusetts law. Deeds, for example, from the successful bidder to a new owner after the auction, act as assignments, since they convey whatever the grantor had, whether a fee interest or a mortgagee interest. I would also counsel double-checking the powers of attorney so beloved of the foreclosure mills and national lenders to be sure that they are actually properly drafted (my pet peeve: the entity, not some officer or authorized signer, must grant the power of attorney, i.e., be the subject of the very first sentence of the instrument) for any assignments currently on record. Then grab a couple of buddies, do an entry and record a certificate of entry at the registry of deeds. If no one shows up to challenge you in the next three years, you are home free.

Right after the decision came out, people were going on about redoing auctions. Why? What happens if it turns out differently the second time? What if there have been deeds (mortgage assignments in my analysis) since then? I have had clients get deeds from the foreclosed mortgagors, which definitely fixes the problem, but that won't always be possible.

[Transor Z]

@CambridgeKnitter:

Stay tuned...

http://www.boston.com/business/articles/2011/01/18/mass_lawmakers_consider_foreclosure_regulations/?p1=Local_Links

[Richard Vetstein]

@cambridgeknitter

Wouldn't you then have to wait another 3 years for the new entry to ripen? That's a long time...

I just heard about a new method. The third party purchaser asks the Land Court for a declaratory judgment that the foreclosure, while technically improper, transferred the mortgagees rights in the mortgage to the new owner. Then the new owner conducts his own foreclosure and bids the highest. I assume a title company must be involved to provide those funds.

See here: http://www.massachusettslandusemonitor.com/commentary/sjc-follow-up/

Rich Vetstein