Where's the Note: New version of article

[Prof]

Here's a new version of the "missing note" article:

WHO’S GOT THE NOTE?
A NEW VERSION OF “WHERE’S WALDO?

(MORTGAGE FORECLOSURE IN AN AGE OF SECURITIZATION: MISSING ORIGINAL NOTES AND OTHER
PROBLEMS FOR CREDITORS)

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STATE BAR OF TEXAS

ADVANCED CONSUMER BANKRUPTCY COURSE 2009



September 17-18 – Houston, Texas
(Video – October 15-16 – Dallas, Texas)


CHAPTER 17




TABLE OF CONTENTS

I. MISSING NOTES 1
A. Persons Who May Enforce Notes – § 3-301 1
B. UCC SECTION 3-309 2
C. Who’s the Holder – The UCC Issues 2
1. Generally 2
2. Brief Review of UCC Provisions 2
D. The Rules 3
1. In Bankruptcy Court 3
2. Standing and Party-in-Interest; the Difference Between Bankruptcy and District Court 3
E. A Brief Aside: Who is Mers? 4
F. Rules of Evidence – A Practical Problem 4
G. Foreclosure or Relief from Stay 4
H. Relief from Stay Proceedings 5
II. OTHER PROBLEMS FOR THE FORECLOSING CREDITOR 6
A. Servicing Company Abuses 6
1. Generally 6
2. The Texas and Other Fifth Circuit Cases 7
III. THE ETHICAL ISSUE 7
A. The Lender 7
B. The Debtor’s Counsel 7
IV. SUMMARY 8
V. RECENT LEGISLATION – DOES IT MAKE A DIFFERENCE? 8
VI. NOTE ON MADDENING COMPLEXITY OF SECURITIZATION 8

TABLE OF AUTHORITIES


Cases
Deutsche Bank Nat’l Trust Co. v. Steele, 2008 WL 111227 (S.D. Ohio) January 8, 2008 6
Greer v. O’Dell, 305 F.3d 1297, 1302-03 (11th Cir. 2002) 4
HSBC Bank USA, N.A. v. Valentin, 21 Misc. 3D 1124(A), 2008 WL 4764816 (Table) (N.Y. Sup.) November 3, 2008 7
HSBC Bank, N.A. v. Valentin, 2l N.Y. Misc. 3d 1123(A), 2008 WL 4764816 (Table) (N.Y. Sup.), Nov. 3, 2008 5
In re Allen, 2007 WL 174708 (Bankr. SD. Tex. 2007) 8
In re Beers, 2009 WL 1025402 (Bankr. N.J. 2009) 8
In re Cabero-Mejia, 402 B.R. 335 (Bankr. C.D. Ca. 2008) 8
In re Foreclosure Cases, 521 F.Supp. 3d 650, 653 (S.D. Ohio, 2007) (citations omitted) 4
In re Hayes, 393 B.R. 259 (Bankr. D. Mass. 2008) 6
In re Hwang, 396 B.R. 757 (Bankr. C. D. Cal. 2008) 3
In re Mounce, 390 B.R. 233 (Bankr. W.D. 2008) 8
In re Parsley, 384 B.R. 138 (Bankr. S.D. Tex. 2008) 8
In re Pawson, Case No. 05-18239 (Bankr. S.D. N.Y. 2009 7
In re Porcheddu, 338 B.R. 729 (Bankr. S.D. Tex. 2006) 8
In re Sanchez, 372 B.R. 289 (Bankr. S.D. Tex. 2007) 8
In re Schwartz, 366 B.R.265 (Bankr. D. Mass. 2007) 5
In re Stewart, 391 B.R. 327 (Bankr. E.D. La. 2008) 8
In re Vargas, 396 B.R. 511 (Bankr. C.D. Cal. 2008) at 520. 4
In re Wilburn, 404 B.R. 841 (Bankr. S.D. Tex. 2009) 8
Liberty Savings Bank v. Redus, 2009 WL 41857 (Ohio App. 8 Dist.), January 8, 2009 3
Maxwell v. Fairbanks Capital Corp., (In re Maxwell), 281 B.R. 101 (Bankr. D. Mass 2002) 7
Nosek v. Ameriquest Mortgage Company (In re Nosek), 286 Br. 374 (Bankr D Mass. 2008) 6
U.S. Bank, N.A. v. Cook, 2009 WL 35286 (N.D. Ill. January 6, 2009) 6
United States v. Butner, 440 U.S. 48 (1979) 2
Wells Fargo Bank, N.A. v. Byrd, 897 N.E.2d 722 (Ohio App. 1 Dist, 2008) 5

Statutes, Rules & Secondary Sources
“Helping Families Save Their Homes Act of 2009”, Pub. L. No. 111-22, 123 Stat. 1632 8
“Why Toxic Assets are so Hard to Clean Up,” Wall Street Journal, A13 (June 20, 2009) 8
15 U.S.C. § 1640(a) (2006) 8
F. R. Bankr. P. 9014 3
F.R Civ. Pro. 11 (F.R. Bankr.Pro. 9011) 7
F.R. Civ. Pro. 17 4
F.R. Evid. 801 4
F.R.Bankr.Pro. 4001 3
F.R.Civ. Pro. 17 3
Porter, Katherine M., “Misbehavior and Mistake in Bankruptcy Mortgage Claims,” 87 Tex. L. Rev. 121 (2008) 1
Tex. Prop. Code §51.0001 4
T-I-L at § 404 (a)(1) 8
T-I-L at § 404 (a)(2) 8
Truth in Lending Act (“T-I-L”), 15 U.S.C. § 1641 et seq. 8

MORTGAGE FORECLOSURE IN AN AGE OF SECURITIZATION: MISSING ORIGINAL NOTES AND OTHER PROBLEMS FOR CREDITORS

* Author’s Note: The first version of this paper was prepared with Judge Samuel L. Bufford, United States Bankruptcy Judge, Central District of California, Los Angeles, California. That Paper, titled Where’s The Note, Who’s The Holder?, was presented at the Spring Meeting of the American Bankruptcy Institute in Washington, D.C., April 3, 2009.

The second version was presented at the 2009 “Advanced Real Estate Law Court in July 2009. This version contains references to the recently enacted “Helping Families Save Their Homes Act of 2009.” The research on this statute was done by Alan Gretzinger, a third year law student at the University of Texas School of Law.

INTRODUCTION

In an era where a very large portion of mortgage obligations have been securitized, by assignment to a trust indenture trustee, with the resulting pool of assets being converted into and sold as mortgage backed securities, foreclosure becomes an interesting exercise, particularly where judicial process is involved. We are all familiar with the securitization process. The steps, if not the process, are simple. A borrower goes to a mortgage lender. The lender finances the purchase of real estate. The borrower signs a note and mortgage or deed of trust. The original lender sells the note and assigns the mortgage to an entity that securitizes the note by combining the note with hundreds or thousands of similar obligation to create a package of mortgage backed securities, which are then sold to investors as bonds. The mortgage note payments are those received or “serviced” by an agent call a “servicing company.”

The total mortgage debt in the U.S. is about $14.6 trillion. There are approximately $8.9 trillion in mortgage related securities. Around these financial arrangements grew up a number of derivatives, the most important of which is the swap, which allegedly can be used to hedge risk but in fact can be used to speculate on changes in the direction of price movement. The swap is an agreement of counterparties to exchange cash flow streams (or “legs”) based upon notional or nominal face amount used to calculate payments. This is “notional,” because the face value does not change hands. For explanations of these transactions, see http://www.enwikipedia.org/wiki/Mortgag ... d_security. When derivatives such as swaps are taken into account, then the entire volume of these investments probably exceeded tens of millions of dollars before the collapse of the home real estate bubble.

The vast flow of notes into the maw of the securitization industry meant that a lot of mistakes were made. When the borrower defaults, the party seeking to enforce the obligation and foreclose on the underlying collateral (usually the servicing company) sometimes cannot find the note. A lawyer sophisticated in this area has speculated to one of the authors that perhaps a third of the notes “securitized” have been lost or destroyed. There is little empirical evidence, but what there is suggests that about forty percent of the notes may be missing. Porter, Katherine M., “Misbehavior and Mistake in Bankruptcy Mortgage Claims,” 87 Tex. L. Rev. 121 (2008) (hereafter “Porter at ___”).

Servicing companies are also notoriously slip-shod in their accounting or bookkeeping and other practices. See “Is Misconduct in Bankruptcy Fueling the Foreclosure Crisis?” 27 Am. Bankr. Inst. J. 10, 42-45 (June 2008). (The article quotes Prof. Porter’s testimony before the US. Senate Judiciary Committee in 2008.)

The cases discussed below certainly indicate very starkly that both of these sources may be correct.

I. MISSING NOTES

A. Persons Who May Enforce Notes – § 3-301

Persons who may enforce notes under § 3-301 include two categories of persons who have possession of the instrument: holders – persons in physical possession with proper endorsements of order paper – and transferees in possession who are not holders but “have the rights of a holder . . . .” Only two categories of persons who do not have actual possession may enforce a note. Those persons who qualify under §3-309 and §30418(d). §3-309 covers lost or missing notes and is discussed below.

§3-148(d) is very narrow in scope. Where an instrument is paid by mistake and payment is either recover or acceptance revoked by the payor, the instrument “is deemed not to have been paid . . . and is treated as dishonored and the person from whom payment is recover has rights as a persons entitled to enforce the dishonored instrument” even though he or she does not have possession of the instrument. This provision is designed to clarify the impact of certain of the payment rules of Art. 4 dealing with checks.

Where the party seeking to enforce is only a transferee, a few other sections and provisions must be considered. A “transfer” is physical delivery intended to give the transferee the right to enforce, including the rights of a holder in due course. §3.203(a)&(b). In order to enforce, then, a transferee must show physical possession. A mere receipt showing transfer of ownership is not enough. §3.203, comment 2. There must also be evidence of intent to transfer enforcement rights. Id., comment 2. If the transferee has no endorsement, it can “shelter if it can show its transferor was a holder or holder in due course.” Id., comment 3.

To summarize, ordinarily, except for §3-309, if a person wants to enforce a note, he, she or it had better be able to produce the original.

B. UCC SECTION 3-309

Where the note is simply missing, UCC §3-309 provides a simple solution. A holder or transferee is entitled to enforce an instrument which has been lost, destroyed or stolen may enforce the instrument. If the court is concerned that some third party may show up and attempt to enforce the instrument against the payee, it may order adequate protection. But, and however, a person seeking to enforce a missing instrument must be a person entitled to enforce the instrument, and that person must prove both the instrument’s terms and that person’s right to enforce the instrument. §3-309 (a)(1) & (b). To get there, the person asserting rights under §3-309 must show that it is a person entitled to enforce under §3-301 and was, at the time the instrument was lost, either a holder or a transferee under §3-301.

C. Who’s the Holder – The UCC Issues

1. Generally

Enforcement of a note always requires that the person seeking to collect show that it is the holder or a transferee who took from a holder. A holder is an entity that has acquired the note either as the original payor or transfer by endorsement of order paper or physical possession of bearer paper. These requirements are set out in Article 3 of the Uniform Commercial Code, which has been adopted in every state, including Louisiana, and the District of Columbia. Even in bankruptcy proceedings, State substantive law controls the rights of note and lien holders, as the Supreme Court pointed out almost forty years ago in United States v. Butner, 440 U.S. 48, 54-55 (1979).

However, as Bankruptcy Judge Bufford has recently illustrated, in the cases discussed below, in the bankruptcy and other federal courts, procedure is governed by the Federal Rules of Bankruptcy and Civil Procedure. And, procedure may just have an impact on the issue of “who,” because, if the holder is unknown, pleading and standing issues arise.

2. Brief Review of UCC Provisions

Article 3 defines what a negotiable instrument is and defines how ownership of those pieces of paper is transferred. For the precise definition of “negotiable instrument”, see § 3-104(a) (“an unconditional promise or order to pay a fixed amount of money, with or without interest . . . .”) The instrument may be either payable to order or bearer and payable on demand or at a definite time, with or without interest.

Ordinary negotiable instruments include notes and drafts (a check is a draft drawn on a bank). See § 3-104(e).

Negotiable paper is transferred from the original payor by negotiation. §3-301. “Order paper” must be endorsed; bearer paper need only be delivered. §3-305. However, in all cases, for the note to be enforced, the person who asserts the status of the holder must be in possession of the instrument. See UCC § 1-201 (20) and comments.

The original and subsequent transferees are referred to as holders. Holders who take with no notice of defect or default are called “holders in due course,” and take free of many defenses. See §§ 3-305(b).

Transferees who take under § 3-301 – persons that the holder intends to have the rights the holder has – are not helped in the context of the missing note problem. While a transferee can certainly utilize §3.309, the transferee who has lost possession, like a holder who has lost possession, must prove the terms of the instrument and that it has the right to enforce (e.g., is an agent, etc.). In other words, both must prove actual receipt and possession and not just some transfer of title without evidence of transfer of possession. The proof is obviously the same as the proof required under §3.309, so where the instrument cannot be found, §3-203 and 3-301 add nothing to §3.309.

NOTE: Those who went through the bank and savings and loan collapse of the 1980’s are familiar with these problems. The FDIC/FSLIC/RTC sold millions of notes secured and unsecured, in bulk transactions. Some notes could not be found and enforcement sometimes became a problem. Of course, sometimes we are forced to repeat history. For a recent FDIC case, see Liberty Savings Bank v. Redus, 2009 WL 41857 (Ohio App. 8 Dist.), January 8, 2009.

D. The Rules

1. In Bankruptcy Court

Judge Bufford addressed Rules of Procedure issues this past year. See In re Hwang, 396 B.R. 757 (Bankr. C. D. Cal. 2008). First, there are the pleading problems that arise when the holder of the note is unknown. Typically, the issue will arise in a motion for relief from stay in a bankruptcy proceeding.

According F.R.Civ. Pro. 17, “[a]n action must be prosecuted in the name of the real party in interest.” This rule is incorporated into the rules governing bankruptcy procedure in several ways. As Judge Bufford has pointed out, for example, in a motion for relief from stay, filed under F.R.Bankr.Pro. 4001 is a contested matter, and is governed by F. R. Bankr. P. 9014, which makes F.R. Bankr. Pro. 7017 applicable to such motions. F.R. Bankr. P. 7017 is, of course, a restatement of F.R. Civ. P. 17. In re Hwang, 396 B.R. at 766. The real party in interest in a federal action to enforce a note, whether in bankruptcy court or federal district court, is the owner of the note. (In securitization transactions, this would be the trustee for the “certificate holders.”) When the actual holder/owner of the note is unknown, it is impossible – not difficult but impossible – to plead a cause of action in a federal court (unless the movant simply lies about the ownership of the note). Unless the name of the actual note holder can be stated, the very pleadings are defective.

2. Standing and Party-in-Interest; the Difference Between Bankruptcy and District Court

Often, the servicing agent for the loan will appear to enforce the note. Assume that the servicing agent states that it is the authorized agent of the note holder, which is “Trust Number 99.” The servicing agent is certainly a party in interest, since a party in interest in a bankruptcy court is a very broad term or concept. See, e.g., Greer v. O’Dell, 305 F.3d 1297, 1302-03 (11th Cir. 2002).

However, the servicing agent may not have standing in the United State District Court, for the term “party in interest” does not apply outside of the bankruptcy context: “Federal Courts have only the power authorized by Article III of the Constitutions and the statutes enacted by Congress pursuant thereto. ... [A] plaintiff must have Constitutional standing in order for a federal court to have jurisdiction.” In re Foreclosure Cases, 521 F.Supp. 3d 650, 653 (S.D. Ohio, 2007) (citations omitted). The Ohio cases arose following removal of a state foreclosure proceeding to federal court on the basis of diversity; they are not bankruptcy proceedings.

The servicing agent does not have standing unless it can prove that it is a transferee, for only a person who is the holder or transferee of the note has standing to enforce the note – and only the holder is the real party in interest. The servicing agent may have authority to enforce the note if it is acting as an agent for the holder, but the agent must act in the name of its principal under F.R. Civ. Pro. 17. Again, all federal lawsuits must be presented in the name of the real party in interest. See, e.g., In re Hwang, 2008 WL 4899273 at 8.

The servicing agent must show both transferee status and act in the name the real party in interest, which requires the servicing agent to show that its principal is the actual holder. See, e.g., In re Vargas, 396 B.R. 511 (Bankr. C.D. Cal. 2008) at 520.

E. A Brief Aside: Who is Mers?

For those of you who are not familiar with the entity known as MERS, a frequent participant in these foreclosure proceedings:

MERS is the “Mortgage Electronic Registration System, Inc. “MERS is a mortgage banking ‘utility’ that registers mortgage loans in a book entry system so that ... real estate loans can be bought, sold and securitized, just like Wall Street’s book entry utility for stocks and bonds is the Depository Trust and Clearinghouse.” Bastian, “Foreclosure Forms,” State Bar of Texas 17th Annual Advanced Real Estate Drafting Course, March 9-10, 2007, Dallas, Texas. MERS is enormous. It originates thousands of loans daily and is the mortgagee of record for at least 40 million mortgages and other security documents. Id.

MERS cannot, by its very nature, be either the holder of a note or the servicing agent. All MERS does is handle recordation of the lien documents. Supposedly, for example, the MERS entries will show that it is the trustee or substitute trustee under a Deed of Trust. As the cases below will reflect, however, that is often not the case. In some situations, MERS may not have any idea who the current holder might be. MERS also allegedly records defaults, but the admissibility of its records should generally be denied.

F. Rules of Evidence – A Practical Problem

The securitization structure – with or without MERS – also poses practical evidentiary problems where the party asserting a right to foreclose must be able to show a default. At In re Vargas, 396 B.R. at 517-19, Judge Bufford made a finding that the witness called to testify as to debt and default was incompetent. All the witness could testify was that he had looked at the MERS computerized records. The witness was unable to satisfy the requirements of the Federal Rules of Evidence, particularly Rule 803, as applied to computerized records in the Ninth Circuit. See id. at 517-20. The low level employee could only testify that the MERS screen shot he reviewed reflected a default. That really is not much in the way of evidence, and not nearly enough to get around the hearsay rule. F.R. Evid. 801.

G. Foreclosure or Relief from Stay

In a foreclosure proceeding in a judicial foreclosure state, in a request for injunctive relief in a non-judicial foreclosure state, or in a motion for relief proceeding in a bankruptcy court, the courts are dealing with and writing about these problems very frequently.

In many if not almost all cases, the party seeking to exercise the rights of the creditor will be a servicing company. Servicing companies will be asserting the rights of their alleged principal, the note holder, which is, again, often going to be a trustee for a securitization package. The mortgage holder or beneficiary under the deed of trust will, again, very often be MERS.

Even before reaching the practical problem of debt and default, mentioned above, the moving party must show that it holds the note or (1) that it is an transferee (agent) of the holder and that (2) the holder (transferee) remains the holder.

Some states, like Texas, have passed statutes that allow servicing companies to act in foreclosure proceedings as a statutorily recognized agent of the noteholder. See, e.g., Tex. Prop. Code §51.0001. However, that statute refers to the servicer as the last entity to whom the debtor has been instructed to make payments. This status is certainly open to challenge. The statute certainly provides nothing more than prima facie evidence of the ability of the servicer to act. If challenged, the servicing agent must show that the last entity to communicate instructions to the debtor is still the holder of the note. See, e.g., HSBC Bank, N.A. v. Valentin, 2l N.Y. Misc. 3d 1123(A), 2008 WL 4764816 (Table) (N.Y. Sup.), Nov. 3, 2008.

The Ohio judicial foreclosure cases have resulted in a ruling that is very significant for both sides of the argument. In a judicial foreclosure, where the debtor objects, if the foreclosing party cannot show ownership or authority, dismissed without prejudice. Since the real party in interest, the owner of the note, is not before the court, a final adjudication in favor of the debtor is not possible. Wells Fargo Bank, N.A. v. Byrd, 897 N.E.2d 722 (Ohio App. 1 Dist, 2008).

H. Relief from Stay Proceedings

SOME RECENT CASE LAW

These cases are arranged by state, for no particular reason.

Massachusetts

In re Schwartz, 366 B.R.265 (Bankr. D. Mass. 2007):

Schwartz concerns a Motion for Relief to pursue an eviction. Movant asserted that the property had been foreclosed upon prior to the date of the bankruptcy petition. The pro se debtor asserted that the Movant was required to show that it had authority to conduct the sale. Movant, and “the party which appears to be the current mortgagee…” provided documents for the court to review, but did not ask for an evidentiary hearing. Judge Rosenthal sifted through the documents and found that the Movant and the current mortgagee had failed to prove that the foreclosure was properly conducted.

Specifically, Judge Rosenthal found that there was no evidence of a proper assignment of the mortgage prior to foreclosure. However, at footnote 5, Id. at 268, the Court also finds that there is no evidence that the note itself was assigned and no evidence as to who the current holder might be.

Nosek v. Ameriquest Mortgage Company (In re Nosek), 286 Br. 374 (Bankr D Mass. 2008):

Almost a year to the day after Schwartz was signed, Judge Rosenthal issued a second opinion. This is an opinion on an order to show cause. Judge Rosenthal specifically found that, although the note and mortgage involved in the case had been transferred from the originator to another party within five days of closing, during the five years in which the chapter 13 proceeding was pending, the note and mortgage and associated claims had been prosecuted by Ameriquest which has represented itself to be the holder of the note and the mortgage. Not until September of 2007 did Ameriquest notify the Court that it was merely the servicer. In fact, only after the chapter 13 bankruptcy had been pending for about three years was there even an assignment of the servicing rights. Id. at 378.

Because these misrepresentations were not simple mistakes: as the Court has noted on more than one occasion, those parties who do not hold the note of mortgage do not service the mortgage do not have standing to pursue motions for leave or other actions arising form the mortgage obligation. Id at 380.

As a result, the Court sanctioned the local law firm that had been prosecuting the claim $25,000. It sanctioned a partner at that firm an additional $25,000. Then the Court sanctioned the national law firm involved $100,000 and ultimately sanctioned Wells Fargo $250,000. Id. at 382-386.

In re Hayes, 393 B.R. 259 (Bankr. D. Mass. 2008):

Like Judge Rosenthal, Judge Feeney has attacked the problem of standing and authority head on. She has also held that standing must be established before either a claim can be allowed or a motion for relief be granted.

Ohio

In re Foreclosure Cases, 521 F.Supp. 2d (S.D. Ohio 2007):

Perhaps the District Court’s orders in the foreclosure cases in Ohio have received the most press of any of these opinions. Relying almost exclusively on standing, the Judge Rose has determined that a foreclosing party must show standing. “n a foreclosure action, the plaintiff must show that it is the holder of the note and the mortgage at the time that the complaint was filed.” Id. at 653.

Judge Rose instructed the parties involved that the willful failure of the movants to comply with the general orders of the Court would in the future result in immediate dismissal of foreclosure actions.

Deutsche Bank Nat’l Trust Co. v. Steele, 2008 WL 111227 (S.D. Ohio) January 8, 2008:

In Steele, Judge Abel followed the lead of Judge Rose and found that Deutsche Bank had filed evidence in support of its motion for default judgment indicating that MERS was the mortgage holder. There was not sufficient evidence to support the claim that Deutsche Bank was the owner and holder of the note as of that date. Following In re Foreclosure Cases, 2007 WL 456586, the Court held that summary judgment would be denied “until such time as Deutsche Bank was able to offer evidence showing, by a preponderance of evidence, that it owned the note and mortgage when the complaint was filed.” 2008 WL 111227 at 2. Deutsche Bank was given twenty-one days to comply. Id.

Illinois

U.S. Bank, N.A. v. Cook, 2009 WL 35286 (N.D. Ill. January 6, 2009):

Not all federal district judges are as concerned with the issues surrounding the transfer of notes and mortgages. Cook is a very pro lender case and, in an order granting a motion for summary judgment, the Court found that Cook had shown no “countervailing evidence to create a genuine issue of facts.” Id. at 3. In fact, a review of the evidence submitted by U.S. Bank showed only that it was the alleged trustee of the securitization pool. U.S. Bank relied exclusively on the “pooling and serving agreement” to show that it was the holder of the note. Id.

Under UCC Article 3, the evidence presented in Cook was clearly insufficient.

New York

HSBC Bank USA, N.A. v. Valentin, 21 Misc. 3D 1124(A), 2008 WL 4764816 (Table) (N.Y. Sup.) November 3, 2008:

In Valentin, the New York court found that, even though given an opportunity to, HSBC did not show the ownership of debt and mortgage. The complaint was dismissed with prejudice and the “notice of pendency” against the property was cancelled.

Note that the Valentin case does not involve some sort of ambush. The court gave every HSBC every opportunity to cure the defects the Court perceived in the pleadings.

California

In re Vargas, 396 B.R. 511 (Bankr. C.D. Cal. 2008);
and

In re Hwang, 396 B.R. 757 (Bankr. C.D. Cal. 2008):

These two opinions by Judge Bufford have been discussed above. Judge Bufford carefully explores the related issues of standing and ownership under both federal and California law.

II. OTHER PROBLEMS FOR THE FORECLOSING CREDITOR

A. Servicing Company Abuses

1. Generally

Every lawyer who deals with this area understand that there is another “elephant in the room” – servicing company abuse and incompetence. Professor Porter has spent a great deal of time analyzing actual cases – 1,700 recent chapter 13 filings. Her conclusion was that the majority of mortgage companies do not comply with bankruptcy law, either inadvertently or because they don’t know how or because they cannot. Porter at 121.

Professor Porter’s case law examples include Maxwell v. Fairbanks Capital Corp., (In re Maxwell), 281 B.R. 101 (Bankr. D. Mass 2002), where the bankruptcy court stated that Fairbanks “repeatedly fabricated the amount of the Debtor’s obligation to it out of thin air.” The court found that Fairbanks had imposed extreme penalty and penalty interest charges, and high charges for forced insurance. Id. at 117-18. Accounting errors, misapplication of payments, miscalculation of escrows are the innocent sounding mistakes. Porter at 134-36. Other, less innocent events include violation of the various consumer protection acts. See generally, Porter at 125 and following.

The United States Trustee offices are becoming very active in this area. See, e.g., In re Pawson, Case No. 05-18239 (Bankr. S.D. N.Y. 2009), where the U.S. Trustee was instrumental in forcing Chase Home Finance LLC to enter into a consent agreement. Chase has agreed to hire an experienced bankruptcy attorney to review all motions for stay before filing. The US. Trustee offices are also seeking sanctions for substantive abuses including incorrect statements, mail fees, fax fees, unnecessary forced insurance and the like. Since these usually appear on proofs of claim, the US. Trustees have invoked F.R Civ. Pro. 11 (F.R. Bankr.Pro. 9011) to impose sanctions on counsel. Illustrative cases include In re Beers, 2009 WL 1025402 (Bankr. N.J. 2009) and In re Cabero-Mejia, 402 B.R. 335 (Bankr. C.D. Ca. 2008).

2. The Texas and Other Fifth Circuit Cases

The following cases from the Fifth Circuit all deal with the misconduct of the lender, the servicer, or the attorney for one or the other:

In re Jones, 391 B.R. 577 (E.D. La. 2008).

In re Wilburn, 404 B.R. 841 (Bankr. S.D. Tex. 2009).

In re Hight, 393 B.R. 484 (Bankr. S.D. Tex. 2008).

In re Stewart, 391 B.R. 327 (Bankr. E.D. La. 2008).

In re Mounce, 390 B.R. 233 (Bankr. W.D. 2008).

In re Parsley, 384 B.R. 138 (Bankr. S.D. Tex. 2008).

In re Sanchez, 372 B.R. 289 (Bankr. S.D. Tex. 2007).

In re Allen, 2007 WL 174708 (Bankr. SD. Tex. 2007).

In re Porcheddu, 338 B.R. 729 (Bankr. S.D. Tex. 2006).

Almost all of these cases involve sanctions of one sort or another, and some are quite severe.

III. THE ETHICAL ISSUE

A. The Lender

For attorneys, the ethical framework has been discussed above in the context of Rules 11 ad 9011 of the Federal Rules of Procedure and Federal Rules of Bankruptcy Procedure. But for attorneys and bankers, the ethical issues are really deeper. Filing false, misleading, or inaccurate claims, bad accounting processes, sloppy bookkeeping, and the like all result in cheating the most vulnerable – people about to lose their homes to foreclosure. The lending industry should fee nothing but shame. No one needs to belabor or elaborate. This conduct is simply wrong. And, these cases often involve the Brahmins of the banking world, not the bottom feeders.

B. The Debtor’s Counsel

Debtor’s lawyers in chapter 13 cases, in particular, operate on a limited budget and with limited resources. Yet, failure to investigate and challenge the lending community is a violation of the fundamental ethical duty of effective representation. How does a consumer lawyer with a fixed fee take on Mega Bank?

In part, the consumer bankruptcy practice works because lender lawyers and consumer lawyers work things out. But, if lenders cannot be trusted, what happens?

IV. SUMMARY

The cases, cited and Prof. Porter’s study and article illustrate enormous problems in the loan servicing industry. These problems arise in the context of securitization and illustrate the difficulty of determining the name of the holder, the assignee of the mortgage, and the parties with both the legal right under Article 3 and standing under the Constitution to enforce notes, whether in state court or federal court. These cases and Prof. Porter’s work also show that lenders, as often as not, cheat.

Interestingly, with the exception of Judge Bufford and a few other judges, there has been less than adequate focus upon the UCC title issues than on the abuses of services and lenders. The next round of cases may and should focus upon both.

V. RECENT LEGISLATION – DOES IT MAKE A DIFFERENCE?

On May 20, 2009, President Obama signed into law the “Helping Families Save Their Homes Act of 2009”, Pub. L. No. 111-22, 123 Stat. 1632 (the “Act”). Section 404(a) of the Act amends the Truth in Lending Act (“T-I-L”), 15 U.S.C. § 1641 et seq., to require any creditor who purchases or is otherwise assigned a mortgage loan to provide the borrower with written notice of the transfer within thirty days. Within the meaning of the Act, a mortgage loan includes any consumer credit transaction that is secured by the principal dwelling of a consumer. Act at § 404 (a)(2). Such written notice must provide: (a) the identity, address, and telephone number of the new creditor; (b) the date of the transfer; (c) how to reach an agent or party having authority to act on behalf of the new creditor; (d) the location of the place where the transfer of ownership of the debt is recorded; and (e) any other relevant information regarding the new creditor. Act at § 404 (a)(1).

Section 404(b) of the Act creates a private right of action against any creditor who fails to comply with the new notice requirement. In such a private action, a creditor may be liable for actual damages, attorney’s fees and court costs, and twice the amount of any finance charge in connection with the transaction. 15 U.S.C. § 1640(a) (2006). However, a creditor is not liable if he can show by a preponderance of the evidence that the violation was unintentional and resulted from a bona fide error, notwithstanding the maintenance of procedures reasonably adapted to avoid any such error. Id. at § 1640(c). Additionally, a creditor who willfully and knowingly fails to provide the required disclosure may be held criminally liable and fined up to $5,000 or imprisoned up to one year, or both. Id. at § 1611.

While this statute might avoid some of the problems described above, the impact will perhaps be negligible. First, for compliance could and probably will be limited. Second, this notice does not avoid the central issue of identifying a holder or transferee. Many purchasers may assume that they are holders or transferees. Without the actual note, however, the puzzle has no solution.

VI. NOTE ON THE MADDENING COM-PLEXITY OF SECURITIZATION

A recent Wall Street Journal attempts to describe the “sheer complexity” of mortgage securitization. Scott, Kenneth E., and Taylor, John B., “Why Toxic Assets are so Hard to Clean Up,” Wall Street Journal, A13 (June 20, 2009). The focus of the article is on increased transparency, which the authors argue “will unleash the market mechanisms needed to clean … up” these “toxic assets.”

Whether the authors are correct about the “clean up”, and transparency could be debated, the article does an excellent job of describing the securitization process.

For home loans, the wizards on Wall Street created “residential mortgage-backed securities” (RMBS). Large numbers of residential mortgages were placed into a pool, or rather, to be more accurate, the notes secured by those mortgages are pooled. These pools were then “sliced” into “tranches” based upon potential returns, and the tranches were sold separately. The tranches were treated as if each tranche was a separate or new instrument. The equivalent tranches of several pools might be sold as “Collateralized Mortgage Obligations” (CMOs)(these are bonds) or the tranches might be combined with other tranches of other types of debt, including commercial mortgages, student loans, etc., called “Collateralized Loan Obligations” (CLOs). When CMOs and CLOs were combined, the result was referred to as a Collateralized Debt Obligation (CDO). When two or more CDOs were combined, the result was called a CDO².

In this scheme, the title to the individual notes should remain in the hands of an indenture trustee for the original pool, and the indenture trustee for the bonds actually sold to investors (based upon the CDO or CDO²) would only own an interest in a portion of each of the underlying notes.

The Wall Street Journal article focuses on the difficulty of determining the value of these complex pools of assets to determine the value of the bonds after issuance, analysis of a potentially massive number of underlying assets must be analyzed:

[A]ssume [a] CDO² held 100 CLOs, each holding 100 RMBS comprising a mere 2,000 mortgages [each] – the number now rises to 20 million.

In other words, to understand the hypothetical CDO² described above, it is necessary to review 20 million mortgages or, if tranched, the expected return on portions of 20 million mortgages.

The focus of this CLE article is on the location of a note. The Wall Street Journal article shows the difficulty of locating the actual assets – the notes – that have been securitized.

[Nikki]

15 seconds on Yahoo turned up the article with the author's name.

If that's you, Prof, your secret identity (and along with it -- all your super powers) is blown.

[Prof]

15 seconds on Yahoo turned up the article with the author's name.

If that's you, Prof, your secret identity (and along with it -- all your super powers) is blown.

Since most of you have no doubt noticed that I live in San Antonio, am originally from S.C., and went to Clemson and UNC, even without the article, it should have taken anyone with the ability to GOOGLE about 5 minutes to find my name, business address, etc.

Comments and criticisms on the article are welcome, by the way. There is certainly one major error or typo -- and my young summer clerk and I both missed it -- in that the total amounts of securitized debt is in the 100's of BILLIONS -- not 10's of millions. JRB has previously commented and so have my friends here in Texas. Maybe, on the 4th go around, I'll submit it as an op-ed piece somewhere.

What this article really does not explore is how to utilize this to avoid the lien on the house --the mortgage/deed of trust. At state law, I think a debtor may only be able to get a foreclosure proceeding in state court dismissed or perhaps be able to get an injunction in a non-judicial foreclosure state. Avoidance of the lien may require a bankruptcy proceeding. I've got to go back and see if I think a declaratory judgment action would work in Texas (or a Trespass to try title action).

One problem -- a lawyer certainly can't take a case like this on contingency very easily in Texas, since the homestead is exempt from any sort of lien the lawyer could get, and usually there is no other source of payment.

[Judge Roy Bean]

Thanks again Prof - seeds of lucidity take time to germinate but in time we all bask in the shade and even harvest the fruits.

[ASITStands]

Questions for 'Prof:' (or anyone else)

When the original lender sells the note, how much are they actually paid for the note?

Is it sold for 'present value' or something less than face amount?

Are the monthly payments applied to 'pay down' the individual notes within the trust?

Is the note eventually paid in total, or is it the mortgage that is eventually paid?

In the event of default, must a note be removed from the trust? Does it unwind the trust?

In foreclosure, must the note be held by the same entity that holds the mortgage?

[Prof]

Questions for 'Prof:' (or anyone else)

When the original lender sells the note, how much are they actually paid for the note?
These would have been sold at face.
Is it sold for 'present value' or something less than face amount?
Face; notes have a present value of the stated amount. The term "present value" refers to the current value of a sum to be paid in the future; e.g., the present value of $100 to be paid in one year is about $96. With notes, the present value is the face and the future value is the face plus accrued interest.

Are the monthly payments applied to 'pay down' the individual notes within the trust?
Payments from the borrower would pay down each individual note.
Is the note eventually paid in total, or is it the mortgage that is eventually paid?
When a note is paid in full, any lien, including mortgages or personal property security agreements and financing statements must be released. The mortgage is the document creating a lien or claim to collateral (dirt) to secure the repayment of the debt; the debt is memorialized by the note. Most home mortgages are for purchase money, although there are home improvement, HELOC, and other mortgages that can be placed on a home depending on state law. A refinancing of a purchase money loan remains a purchase money loan under all state laws that I know about.
In the event of default, must a note be removed from the trust? Does it unwind the trust?
No, a default of one or more instruments in the trust does not unwind the trust. Various mechanisms are used, but the defaulted note would be liquidated by foreclosure, discount to a third party buyer, etc., with the proceeds placed into the hands of the trustee for application to the dividends/distributions due the owners of the issued bonds. In some transactions, there may be repurchase obligations by the seller/transferee of the note. This is, as I understand it, common with securitizations of car loans and student loans, so that if a loan goes into default, the original seller, say GMAC for a car loan, must repurchase the loan.

In foreclosure, must the note be held by the same entity that holds the mortgage?When the foreclosure occurs, the party foreclosing must be an authorized agent of the mortgage holder (or trustee under the deed of trust). However, that person must be acting for the true holder or a transferee with the rights of a holder. The holder of the note must be a the secured party under the mortgage/deed of trust (or the transferee of the note must have authority to act to enforce the note/claims against the collateral).

[ASITStands]

Questions for 'Prof:' (or anyone else)

When the original lender sells the note, how much are they actually paid for the note?
These would have been sold at face.
Is it sold for 'present value' or something less than face amount?
Face

Ok. Now I'm confused. Let's say a buyer enters into a loan of $300,000 on a home. Are you saying, "When the lender sells the note, they receive $300,000 from the trust (or investors)?"

That would mean the lender has already been paid for the note! And, in the event the buyer does not default on the mortgage, the trust would be paid for purchasing the note at face.

The obvious conclusion some would "jump to" would be that the note gets paid twice, but that's not true, because the note is paid once when it's purchased by the trust, and the trust is paid for its purchase when the mortgage is retired through monthly payments. Got it!

Are the monthly payments applied to 'pay down' the individual notes within the trust?
Payments from the borrower would pay down each individual note.
Is the note eventually paid in total, or is it the mortgage that is eventually paid?
When a note is paid in full, any lien, including mortgages or personal property security agreements and financing statements must be released.

Got it!

In the event of default, must a note be removed from the trust? Does it unwind the trust?
No, a default does not unwind the trust. Various mechanisms are used, but the defaulted note would be liquidated by foreclosure, discount to a third party buyer, etc., with the proceeds placed into the hands of the trustee for application to the dividends/distributions due the owners of the issued bonds.

In foreclosure, must the note be held by the same entity that holds the mortgage?
When the foreclosure occurs, the party foreclosing must be an authorized agent of the mortgage holder (or trustee under the deed of trust). However, that person must be acting for the true holder or a transferee with the rights of a holder.

Explain these last points.

How is the defaulted note liquidated by foreclosure?

Is being sold at discount to a third-party buyer the same as being sold at 'present value?'

What requirements make the foreclosee an authorized agent? Assignment?

Must the note be in the possession of the entity foreclosing, as holder in due course?

EDIT: And, thanks! I understand it much better now.

[Prof]

I edited my original answers, above, to make these issues clearer. However, I'll also answer below.

Questions for 'Prof:' (or anyone else)

When the original lender sells the note, how much are they actually paid for the note?
These would have been sold at face.
Is it sold for 'present value' or something less than face amount?
Face

Ok. Now I'm confused. Let's say a buyer enters into a loan of $300,000 on a home. Are you saying, "When the lender sells the note, they receive $300,000 from the trust (or investors)?"

A note secured by a mortgage is usually a very long term note at a stated interest rate -- typical terms would be $300,000 paid in equal installments for 30 years at 8% interest (or whatever interest rate is the current rate on the date the note is executed; of course, there are variable rates, baloon notes, etc. As long as the note is secured by a home worth $300,000 net on a foreclosure, the note is fully secured. There is no reason why anyone would sell such a note at a discount. The note is sold to a new holder. The note is not paid off. The orginal note would be payable to PAYEE MORTGATE LOAN CO. by MAKER HOME OWNER. MAKER makes payments to the holder of the note, whether it is PAYEE or if PAYEE has INDORSED TO TRUST INDENTURE TRUSTEE. MAKER HOME OWNER hasn't paid off the note. The note has been sold to a new owner who is entitled to receive the stream of payments. That is why these are styled negotiable instruments. They are designed/intended to be bought and sold.

That would mean the lender has already been paid for the note! NO! See above.
And, in the event the buyer does not default on the mortgage, the trust would be paid for purchasing the note at face. That is exactly what happens. The new owner/holder picks up the stream of payments which MAKER originally agreed to pay to PAYEE/LENDER
The obvious conclusion some would "jump to" would be that the note gets paid twice, but that's not true, because the note is paid once when it's purchased by the trust, and the trust is paid for its purchase when the mortgage is retired through monthly payments. Got it! NOT QUITE; WHEN THE NOTE IS TRANSFERED BETWEEN HOLDERS, IT IS PURCHASED, NOT "PAID." Payments reduce the balance due on the note, and come from the maker/payor to the payee.

Are the monthly payments applied to 'pay down' the individual notes within the trust?
Payments from the borrower would pay down each individual note.
Is the note eventually paid in total, or is it the mortgage that is eventually paid?
When a note is paid in full, any lien, including mortgages or personal property security agreements and financing statements must be released.

Got it!

In the event of default, must a note be removed from the trust? Does it unwind the trust?
No, a default does not unwind the trust. Various mechanisms are used, but the defaulted note would be liquidated by foreclosure, discount to a third party buyer, etc., with the proceeds placed into the hands of the trustee for application to the dividends/distributions due the owners of the issued bonds.

In foreclosure, must the note be held by the same entity that holds the mortgage?
When the foreclosure occurs, the party foreclosing must be an authorized agent of the mortgage holder (or trustee under the deed of trust). However, that person must be acting for the true holder or a transferee with the rights of a holder.

Explain these last points.
OK. When a note goes into default, and is accelarated, the note holder in a real property deal acts under the mortgage in a lien state or instructs the trustee to act in a deed of trust state to liquidate the collateral (the house) and apply the proceeds to the note. If the note never goes into default, the payments liquidate the debt. Assume, for our purposes, that we are in a deed of trust state. The holder of the debt instructs the trustee under the deed of trust to sell the property at public auction. Only the person entitled to collect on the note has the authority to instruct the trustee, so that trustee, or the debtor/maker/obligor on the note, is legally able to insist that the person who is trying to cause the foreclosure to show that it is the person who owns/holds the note signed by the HOME OWNER MAKER. At the very least, the person instructing foreclosure must show that it is a transferee under the UCC.

How is the defaulted note liquidated by foreclosure?
At foreclosure, the proceeds of the sale of the real property are applied in satisfaction or partial satisfaction of the note. The lender/holder/owner/transferee can "credit bid" the outstanding debt up to the balance due on the note plus fees, charges, expenses, taxes paid, etc. In a credit bid situtation, the lender winds up with title to the realty, and the "credit bid" is applied to reduce the debt. If a third party wants to bid, it pays the lender cash, gets a deed, and the lender applies the cash to the debt. If the amounts bid under either scenario are not sufficient, there is a DEFICIENCY claim which -- depending on state law -- may be asserted. However, a deficiency is just a claim, and, to be enforced, must be reduced to judgment in a lawsuit, like any other debt.

Is being sold at discount to a third-party buyer the same as being sold at 'present value?'No, see the discussion in the first answer. Discounts to present value represent the current value of a sum to be paid in the future. Home loans are for a fixed amount today, which bear interest because payments will be made over time. For example, if you expect to get $100 for Christmas, it has a present value of less than $100, because you will not get it for several months. A discount for present value would be applied, for example, the the total value of rents on a building to be collected over "X" years.

What requirements make the foreclosee an authorized agent? Assignment?
The article goes into this at some depth, but some sort of agency/sale/assignment is necessary and the holder or assignee must show that the holder has title or that the assignee/transferee is acting for a holder (with title).

Must the note be in the possession of the entity foreclosing, as holder in due course?

Not necessarily; the entity doing the foreclosing might be, for example, a trustee in a deed of trust state, who is the trustee for the holder/transferee.

EDIT: And, thanks! I understand it much better now.

[Prof]

Additional response:

Notes are frequently discounted to present value when the interest on the note is below market rate.

Notes are also discounted because the borrower is in default or the borrower has financial problems (note how investment grade corporate bonds fluctuate because of interest rate changes or changes in the economics of the issuing company).

The biggest discounts (and the best deals) are often when banks are liquidated and the FDIC puts out pools of notes (some secured, some unsecured) for bid. I am in the process of discussing a problem with a client, whose very large note (8 figures) was discounted out by the FDIC last week. If he could have raised 25% of the balance due on this fully performing, fully secured, obligation, he could have probably bought it in himself. As it is, the note is up for renewal in the winter, and it is fully secured by real property. If it is not renewed, and cannot be refinanced, he faces foreclosure on a lot of dirt. Interesting problem.