Game Changer: New York State Appellate Court Issues Decision With Potentially Devastating Impact On Mortage Industry

As any proud member of the Hokie Nation knows, special team's success can devastate your opponents by rapid momentum reversal and scoring. On June 13, 2011, the Supreme Court for the State of New York, Appellate Division, issued an opinion in the case of Bank of New York v. Silverberg that could have the same effect, only this time it is defaulted borrowers that are blocking mortgagees' punts.

The case involved an effort by Bank of New York ("BNY") to foreclose a residential mortgage where BNY was the undisputed holder of the mortgage, but where BNY was not the holder of the note. The borrower defendants successfully argued that BNY had no standing to foreclose because, in effect, a mortgage without a note is a nullity. Mortgages, they argued, are merely security for a note and, without proof of the existence of a debt owed, BNY could not demonstrate an interest in the action sufficient to confer standing. Thus, for the moment at least, the borrowers prevailed.

While the case was ostensibly about standing and the elements required to foreclose on a mortgage, the most interesting and potentially devastating part of the case is related to how BNY came to be a mortgagee who did not also hold the note. Enter Mortgage Electronic Registration Systems, Inc. or "MERS" as it is more commonly known. For those of you who regularly live and work in this space, you are already familiar with MERS and may already be familiar with the issues raised by the Silverbergs in their dispute with BNY. For those that aren't the MERS system, its history, purpose, industry scope and the related importance of this case requires too lengthy an explanation for a reasonable blog post. However, Justice Leventhal does an excellent job outlining it in his opinion, and I commend his explanation and recitation to you.

What one must take from this decision are the following points: (1) it appears consistent with the law; (2) given the realities of the past 8-10 years in the mortgage industry, the practice of multiple sales of mortgages, the advent and practical implications (on record keeping) of securitized mortgages; (3) the misapprehension - by many - of the basic elements of assignment law and application of the U.C.C.; and (4) the fact that MERS is the mortgagee on something approaching 60 million mortgages in the United States; and (5) courts may not adjust the law of commercial paper and property rights merely because a generation in the finance industry devised a method to save money by bypassing local filing fees and streamlinging their ability to transfer mortgages.

If the logic and analysis in this case is picked up by judges and courts in other jurisdictions, and we believe that (at least to some degree) it will be, the impact upon mortgagees who are MERS assignees could be...well...at least as substantial as an ill timed blocked punt.

Now, to be clear, we at BB&R believe that BNY can take steps to "fix" the situation in which it currently finds itself vis-a'-vis the Silverbergs by obtaining the original note and convincing its current holder to assign it to BNY. However, that will require some effort and, if BNY or other mortgagees are required to do it with respect to all MER's assigned mortgages, it will require substantial effort and expense, and there is no guarantee that many mortgageds will even be able to identify the note holder so as to effect a transfer. If BNY is successful in finding the note and getting it assigned, then it can win. In the mean time, the Silverbergs keep their residence free of charge. Probably not a great trend for the real estate industry.

New Rules: Bring Originals

In recent months, we have all read much about the thwarting of mortgage lenders' and servicers' efforts to foreclose on defaulted notes when judicial and quasi-judicial officers demand original notes and deeds of trust as evidence of an existing debt.

Initially, borrowers met with some sporatic success by pressing this "show me the note" defense. This defense entails borrowers that are actually in default contesting foreclosure proceedings by arguing that lenders and servicers produce the original note and deed of trust, implying that an authenticated but non-certified copy of both is somehow incompetent evidence of the existence of a debt. And, in the wake of the robo-signing scandal in which some lenders and servicers have been caught using affidavits that were signed in mass and without appropriate review, some courts have embraced the "show me the note" defense.

However, in at least one trial court in North Carolina there now exists a perceived requirement that a foreclosing party's evidence of existence of a debt is insufficient as a matter of law unless it includes the original note and deed of trust. In the particular referenced court, it was not the borrower that raised the issue. Rather, the court did it, suo sponte. This despite an appellate court decision that was brought to the court's attention, holding that an affidavit supporting the existence of a debt and that authenticates copies of the note and deed of trust is sufficient and competent evidence of existence of a debt.

So, for any North Carolina practitioners who read this post, "new rules" may be afoot in North Carolina, and they may stay there for a while, so if the original note and deed of trust are available, it may be a good idea to bring them to any foreclosure hearing or appeal...just in case. However, the problem is that many of these mortgages were bought and sold several times. Some of them were even sliced up and made part of the dreaded securitized mortgages that brought down Bear Stearns, Lehman Bros. and that almost brought down AIG and a slew of other major banks. So, as one might expect, actually putting hands on an original note or deed of trust may be a bit more difficult than it sounds.

Meanwhile, the borrower opposing the foreclosure in the North Carolina court...the one that hasn't paid a penny against the loan since 2009 avoided foreclosure (at least today) and, for now, the lender continues to carry the debt.