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Sunday, November 06, 2011

MERS Update: Multidistrict litigation decision

by Calculated Risk on 11/06/2011 07:00:00 PM

CR Note: This is a guest post from albrt.

Howdy folks, this is albrt. I'm trying to get back in the habit of writing for CR once in a while, so this is an update on MERS and its role in the ongoing housing finance mess. Background posts on MERS from a couple of years ago are here and here.

The item that inspired me to start posting again was the October 3 decision by Federal District Court Judge James Teilborg of Arizona, dismissing the 72 cases in the MERS multidistrict litigation.


A federal "multidistrict litigation" case (commonly called an "MDL") is set up to resolve a question that has come up in a large number of courts. The first thing that happens in an MDL case is that someone requests a panel of federal judges to look at the cases, and they decide whether it would make sense to centralize the cases with one judge to address the common issues.

All of these cases were brought by borrowers to defeat or reverse a foreclosure, which means the borrower is the plaintiff and one or more entities on the lender side are the defendants. Generally a borrower brings a case like this because the house is located in a state where foreclosures can be done without going to court, often based on a document called a deed of trust rather than a true mortgage.

The lender defendants in six cases, including MERS, requested centralization in Arizona. The MDL panel decided to send cases involving allegations that "various participants in MERS formed a conspiracy to commit fraud and/or that security instruments are unenforceable or foreclosures are inappropriate due to MERS's presence as a party." The panel did not send claims involving other allegedly unlawful loan origination or collection practices.

When an MDL is opened up, other federal judges can send cases that appear to qualify, so the MDL eventually grew from 6 to 72 cases.

By the way, Judge Teilborg is the same judge who dismissed a similar case by a plaintiff named Cervantes, and his decision was recently upheld by the 9th Circuit. The MDL panel specifically chose to send the cases to Judge Teilborg "because he presided over Cervantes." The 9th Circuit's decision in September may have had a lot to do with the timing of this decision in October.

Judge Teilborg's Decision

Judge Teilborg considered motions to dismiss 20 of the MDL cases, and dismissed each of them. Judge Teilborg then dismissed the remaining 52 complaints, but ordered the plaintiffs to take their best collective shot at submitting a "consolidated amended complaint" that avoided the shortcomings identified in the previous 20 complaints. The October 3rd order dismissed the consolidated complaint, and dismissed each of the 72 MDL claims with prejudice. At least some of the cases are apparently still alive in other courts based on claims that were not covered by the MDL decision.

The Fraud Issues

The fraud issues were essentially disposed of by earlier rulings, including Cervantes, and did not figure prominently in the October 3 MDL decision. Federal court rules require fraud allegations to be specific. Fraud is a hard claim to prove - to simplify it a little, the plaintiff needs to identify false statements, and explain how the plaintiff was harmed by relying on the statements.

The 9th Circuit said:

Although the plaintiffs allege that aspects of the MERS system are fraudulent, they cannot establish that they were misinformed about the MERS system, relied on any misinformation in entering into their home loans, or were injured as a result of the misinformation. If anything, the allegations suggest that the plaintiffs were informed of the exact aspects of the MERS system that they now complain about.
The 9th Circuit apparently based the latter observation on the deed of trust itself, which said MERS would be the beneficiary and the note could be transferred without notice, which was basically what happened.

The Invalidation Issue

Judge Teilborg summarized the issue like this:
Fundamentally, all of Plaintiffs' claims turn on their contention that naming MERS as a beneficiary on the deeds of trust, and the subsequent operation of the MERS system, splits the MERS deeds of trust from their promissory notes and renders these notes unsecured and unenforceable. . . . The documents alleged to be false would only be false if there is legal merit to these arguments; the wrongful foreclosures would only be wrongful if one of these theories holds.
Judge Teilborg decided that naming MERS as a beneficiary on a deed of trust does not permanently destroy the security interest and completely bar foreclosure. That eliminated the second major MDL claim, although Judge Teilborg recognized that some of the plaintiffs might be able to get some relief based on narrower allegations about what happened in their specific cases.

Miscellaneous Points

The plaintiffs argued that the deeds of trust in some of these cases could qualify as "false documents" for the purpose of an Arizona Statute prohibiting the recording of false documents. In addition to ruling that the documents could not be considered "false" based on general MERS invalidity, Judge Teilborg said "robosigning" was an issue between the parties to the assignment, and was not something the borrowers could sue over. I'm not sure this is right. Although courts in non-judicial foreclosure situations have generally have not upheld a broad "show me the note" doctrine, in at least some situations borrowers may have a right to know that the person foreclosing can prove title to the loan and the deed of trust.

Judge Teilborg also decided that the foreclosures could not be wrongful unless the plaintiffs had not defaulted. The plaintiffs argued that a foreclosure can be wrongful in other ways. The law is unclear on this point, and a decision from a state court while the MDL decision is up on appeal could change the outcome.

My Conclusions

I would be the last person to argue that banks did nothing wrong in the last ten years. I am very critical of the banks, and of the way the Bush-Obama administration has dealt with the banks. However, I am in about 90% agreement with Judge Teilborg that the plaintiffs in the MDL litigation were wrong about their two central arguments.

I haven't seen any evidence that the banks were intentionally trying to fool borrowers when they developed MERS. The banks were trying to avoid recording fees, and they were trying to develop a system for offloading inherently bad loans onto the buyers of mortgage backed securities and derivatives. I don't think the banks cared at all about borrowers.

Judge Teilborg also seems to me to be correct about automatically invalidating MERS mortgages. It is clear that there are many foreclosure cases where the wrong party has done the wrong thing, sometimes spectacularly wrong. Many of those foreclosures should be halted until things are sorted out. But even in the worst case scenario a judge can probably figure out who owns what, and eventually allow somebody to foreclose if the borrower isn't paying. That will be costly, but there is no reason why the mortgage should be permanently invalidated.

With 72 cases in this MDL, it is certainly possible that one or more plaintiffs will succeed in persuading the 9th Circuit that Judge Teilborg overlooked something. But there isn't any broad legal doctrine of "Bank error in your favor! Collect 1 free house." Screwed up paperwork makes things more difficult for borrowers in some respects, but it can also work in the borrower's favor in negotiations for a modification, or especially in bankruptcy. It rarely ends up completely and permanently invalidating the bank's security interest.

In fact, some folks may remember the case of Olga, whose mortgage was invalidated in bankruptcy. The lender appealed, and from what I can tell by looking at later court documents the parties reached a settlement including a mortgage modification. Even Olga does not appear to have gotten a free house.

Some lenders have apparently learned at least part of the lesson, and have stopped filing foreclosures in the name of MERS. If MERS assigns the deed of trust to the correct entity, that should resolve a lot of the complications by reuniting the mortgage and the note.

If folks have questions, I can try to address them in a follow-up post.