photo: Michael Slatoff via Flickr

photo: Michael Slatoff via Flickr

The bankruptcy court in the Southern District of New York wiped out a $400,000+ mortgage, leaving the house with no debt on it, but a screwed up title. It’s a sign of bigger things to come, and a situation which deserves continued attention. As reported by The New York Times:

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

This is a potential test case which fleshes out both case law and my theory about mortgages assigned and registered by service companies. A while back I told you about a case in Kansas where the judge opined,

Indeed, an assignment of a mortgage without the debt transfers nothing. 55 Am. Jur. 2d, Mortgages § 1002. Thus, the mortgagee, who must have an interest in the debt, is the lender in a typical home mortgage

The Kansas judge said if the interest in land is separated from the note, a foreclosure cannot be processed on the house, though the debt still exists and the note becomes an unsecured note.

And I wondered if that meant that

Understand the possible implications of this. If other states take the same approach as Kansas, that means the splitting of the debt from the mortgage note effectively cancels the “mortgage interest” that is the power over the real property and converts the debt to a simple unsecured personal debt just on a promissory note. Which means they couldn’t take your house in foreclosure, though they can sue you personally on the debt, just like any other unsecured creditor can. I am assuming, without going to deep into it today, that as a personal debt, it may be dischargeable in bankruptcy. But we will have to wait for a few test cases to prove this.

You’ll recall that in a mortgage situation there are two important documents: the loan note, which is a promissory note, and the mortgage document itself which secures the promissory note by giving an “interest in land,” sort of like a lien. In the SDNY case, the servicer of the loan contended that the promissory note had been transferred to the party for whom the servicer worked. However, the debtor’s lawyer pushed back on the claim, demanding proof that the servicer’s client actually owned the promissory note:

In answer, Mr. Shaev received a letter stating that PHH was the servicer of the loan but that the holder of the note was U.S. Bank, as trustee of a securitization pool. But U.S. Bank was not a party to the action.

Mr. Shaev then asked for proof that U.S. Bank was indeed the holder of the note. All that was provided, however, was an affidavit from Tracy Johnson, a vice president at PHH Mortgage, saying that PHH was the servicer and U.S. Bank the holder.

Among the filings supplied to support Ms. Johnson’s assertion was a copy of the assignment of the mortgage. But this, too, was signed by Ms. Johnson, only this time she was identified as an assistant vice president of MERS, the Mortgage Electronic Registration System. This bank-owned registry eliminates the need to record changes in property ownership in local land records.

Another problem was that the document showed the note was assigned on March 26, 2009, well after the bankruptcy had been filed.

Now a New York bankruptcy judge has extinguished a debt because the alleged holder of the promissory note, U.S. Bank, cannot prove that it actually owns the note.

I have been highly critical of Mortgage Electronic Registration System (MERS), the mortgage registry service company established by the mortgage industry to electronically record loan assignments. MERS is often shown in public records as the holder of the mortgages they listed, or as the nominee for the mortgage holder. While claiming to be a wonderful, super-efficient filing system, my anecdotal experience has been that MERS appears to be a big disorganized warehouse for paper never been properly filed or catalogued. MERS seems to know what paper it took in, but not what happened to it thereafter. As MERS handled mortgage assignments, the link between the the original lender, the current true owner of the debt and current servicer of the debt often became unclear.

Until recently, homeowners did not realize that they should avail themselves of the “prove the mortgage” laws that exist in most states. Rep. Marcy Kaptur of Ohio has been encouraging homeowners to demand foreclosing parties “prove the mortgage.”

These laws force the entity wishing to foreclose on your house prove both the debt and the interest in land by bringing the ORIGINAL blue ink signature versions into court.

If they cannot prove them, they have no standing to sue you. This provision only works if the homeowner makes a formal demand for it. There is usually a provision that allows for the bank to put in a lost or destroyed paperwork affidavit, but courts are finally waking up and scrutinizing those affidavits, which are usually so weak factually as to be virtually worthless.

All of which means this SDNY bankruptcy case is BIG news for beleaguered homeowners, and may give them the kind of leverage they need to finally get their lenders to renegotiate their loans in a good faith way.

I’m sure the appeal from the SDNY decision will be closely watched by many.

[Earlier posts in this series and related links at Kouril’s Foreclosure Fraud Resources]

Cynthia Kouril

Cynthia Kouril

Cynthia Kouril is a former Special Assistant United States Attorney in the Southern District of New York under several different U.S. Attorneys, former counsel to the Inspector General for the N.Y.C. Department of Environmental Protection where she investigated threats to the New York City water supply and other environmental crimes, as well as public corruption and fraud against the government, former Examining Attorney at the N.Y.C. Department of Investigation and former Capital Construction Counsel at New York City Parks and Recreation.
She is now in private practice with a colleague whom she met while at the USA Attorney's Office. Ms. Kouril is a member of the Steering Committee, National Committeewoman and Regional Coordinator for the New York Democratic Lawyers Council, a member of the Program Committee of the Federal Bar Council and a member of the Election Law Committee at the Association of the Bar of the City of New York. She is active in several other Bar Associations.
Most important of all, she is a soccer mom.