A proposal for a National Mortgage Registry: MERS done right.

• Author: Whitman, Dale A.
• Position: Mortgage Electronic Registration System - Abstract through I. The Traditional Mortgage Transfer Process C. Transfer of the Note 2. Non-judicial Foreclosure Decisions That Disregard Article 3, p. 1-36

Abstract: In this Article, Professor Whitman analyzes the existing legal regime for transfers of notes and mortgages on the secondary market, and concludes that it is highly inconvenient and dysfunctional, with the result that large numbers of market participants simply did not observe its rules during the huge market run-up of the early and mid-2000s. He also considers Mortgage Electronic Registration System (MERS), which was designed to alleviate the inconveniences of repeatedly recording mortgage assignments, but concludes that it was conceptually flawed and has proven to be an inadequate response to the problem. For these reasons the legal system was ill-prepared for the avalanche of foreclosures that followed the collapse of the mortgage market in 2007, and continues to be beset by litigation and uncertainty. This Article then provides a conceptual outline for an alternative National Mortgage Registry, which would supplant the present legal system and would provide convenience, transparency, and efficiency for all market participants. He concludes with a draft of a statute that could be enacted by Congress to create such a registry.

Contents I. THE TRADITIONAL MORTGAGE TRANSFER PROCESS A. Apparent Separation of Note and Mortgage B. The Uses of Recorded Mortgage Assignments 1. Prevention of Fraud by the Transferor 2. Assurance of Receiving Notice of Legal Proceedings 3. Recordation of Assignments as a Practical Necessity for Future Title Examiners 4. Recordation of Assignments as a Statutory Prerequisite to Foreclosure 5. Conclusion: What are Assignments Worth? C. Transfer of the Note D. The Cost of Following the Rules II. THE ADVENT AND FALLACIES OF MERS A. A Weak Legal Foundation B. Separation of Mortgage from Note C. Use of Multiple "Corporate Officers " D. Foreclosure in the Name of MERS E. Transparency F. Loan Tracking Accuracy III. FEATURES OF A NATIONAL MORTGAGE LOAN REGISTRY A. Federal Preemption B. What is Being Registered? C. Initial Recording of Mortgages D. Registration or Recording? E. Electronic Registration and Transfer and the Problem Of Document Authenticity F. Registration of Servicing G. Capturing the Entire Loan File H. Transparency I. Fees J. Notice of Registered Information K. A Bureaucratic Home L. The Holder in Due Course Doctrine M. Constitutionality IV. CONCLUSION. Appendix: Draft Statute **********

The law of the United States governing transfers of mortgages on the secondary market and foreclosures by secondary market investors is in a dismal state. In this Article I propose to explore those deficiencies and to present a proposal for an alternate legal regime that I believe would be far more functional and efficient.

The need for such a system--a nationwide registry of mortgage ownership --has already been recognized. In its recent white paper, "The U.S. Housing Market: Current Conditions and Policy Considerations," the Federal Reserve Board commented:

A final potential area for improvement in mortgage servicing would involve creating an online registry of liens. Among other problems, the current system for lien registration in many jurisdictions is antiquated, largely manual, and not reliably available in cross-jurisdictional form. Jurisdictions do not record liens in a consistent manner, and moreover, not all lien holders are required to register their liens. This lack of organization has made it difficult for regulators and policymakers to assess and address the issues raised by junior lien holders when a senior mortgage is being considered for modification. Requiring all holders of loans backed by residential real estate to register with a national lien registry would mitigate this information gap and would allow regulators, policymakers, and market participants to construct a more comprehensive picture of housing debt. (1) Section I of this Article will discuss the traditional methods by which mortgages were traded on the secondary market in the United States prior to the mid-1990s and will attempt to illuminate why participants in the market found these methods lacking and generally discontinued using them. Section II will explain why and how MERS was set up in the mid-1990s and why it has largely failed to achieve the purposes which many envisioned for it. Section III will present an alternative to MERS--one that would not suffer from its deficiencies, and would achieve the results MERS could not accomplish. It will analyze the policy and legal questions that must be answered in creating such a new system. Finally, an appendix to this article will provide a draft of a statute that would create such a new system.

1. THE TRADITIONAL MORTGAGE TRANSFER PROCESS

Mortgage borrowers in the United States are nearly always asked to sign two documents, one of them an evidence of the obligation to repay the debt, and the other a security agreement encumbering the real estate. In former times, a bond was sometimes used as the debt instrument, but today a promissory note is virtually always employed. (2) The security instrument may be a mortgage, a deed of trust, or (in Georgia) a security deed. While these different names for security instruments may portend differences in foreclosure procedure, for most purposes of mortgage law they are treated as identical.

1. Separation of Note and Mortgage

   Borrowers probably wonder why two documents are used instead of one. Why are the note and the mortgage not combined into a single document, as is usually done with consumer credit contracts? The reason is partly tradition, and perhaps partly that the drafter wished to make the note negotiable in order to take advantage of the Holder in Due Course doctrine (which permits the holder of the note to take free of many defenses that the maker might raise), and could not accomplish this negotiability if the terms of the mortgage were incorporated into the note. (3) Therefore, modern practice is to have two separate documents, (4) though on rare occasions in the past the two were incorporated together. (5)

   However, the use of two documents raises a troublesome prospect: that they could be transferred to two different parties. As we will see, the courts labor diligently to prevent this result from occurring unless it is very clearly the intention of the transferor, and for good reason. If a legal separation of the note and mortgage occurs, the Comment in the Mortgages Restatement explains the results as follows:

   [Separating the obligation from the mortgage results in a practical loss of efficacy of the mortgage.... When the right of enforcement of the note and the mortgage are split, the note becomes, as a practical matter, unsecured. This result is economically wasteful and confers an unwarranted windfall on the mortgagor. It is conceivable that on rare occasions a mortgagee will wish to disassociate the obligation and the mortgage, but that result should follow only upon evidence that the parties to the transfer so agreed. The far more common intent is to keep the two rights combined. Ideally a transferring mortgagee will make that intent plain by executing to the transferee both an assignment of the mortgage and an assignment, indorsement, or other appropriate transfer of the obligation. But experience suggests that, with fair frequency, mortgagees fail to document their transfers so carefully. This section's purpose is generally to achieve the same result even if one of the two aspects of the transfer is omitted. (6) Not only does the note become unsecured if the note and mortgage are separated, but "[t]he mortgage becomes useless in the hands of one who does not also hold the obligation because only the holder of the obligation can foreclose." (7) This outcome follows from the universally-agreed principle that "a mortgage may be enforced only by, or in behalf of, a person who is entitled to enforce the obligation the mortgage secures." (8) It is apparent that any situation that results in the holding of the note and mortgage by two independent parties is likely to prove bitterly frustrating to both of them - one because his or her obligation has become unsecured, and the other because she or he holds a mortgage that can never be foreclosed.

   To accomplish what is nearly always the intended purpose of the parties, the Restatement thus provides that "[a] transfer of an obligation secured by a mortgage also transfers the mortgage unless the parties to the transfer agree otherwise." (9) The common way of expressing this principle is to say, "the mortgage follows the note." (10) Hence, a transfer of the note will transfer the mortgage with it automatically in the absence of a contrary agreement. On this point the Restatement is supported by a host of authority, (11) much of it taking an even stronger position: that it is legally impossible to separate the mortgage from the note, even by means of a contrary agreement. (12)

   Suppose a mortgagee creates a situation in which holding of the note and mortgage seem to be bifurcated, by transferring the note to another but carelessly or malevolently retaining the mortgage or transferring it to a separate and independent party. What could the holder of the note do about it? If the holder of the mortgage refused to assign the mortgage to the noteholder voluntarily, the noteholder could bring an action in equity to compel such an assignment, (13) or simply apply to the equity court for a decree that the mortgage was deemed to be held for the benefit of the noteholder. (14) The noteholder could then foreclose the mortgage as readily as if he or she held a paper assignment of it. (15)

2. The Uses of Recorded Mortgage Assignments

   If a person to whom a note, secured by a mortgage, is transferred without an accompanying assignment of the mortgage itself, can then foreclose the mortgage, what is the purpose of mortgage assignments? A quite plausible argument can be made that they are simply unnecessary, except perhaps as a quick and simple way to prove to a...