Foreclosure used to be a cut and dried procedure. Those were the days when you got a mortgage loan from a bank and that bank held your promissory note, usually for 30 years, while you paid it down. At settlement you also signed a document known as a lien instrument, either a mortgage or a deed of trust, depending on what state you’re in. If you defaulted, the bank could foreclose on your real property, sell it, and recoup its investment. It was clean and simple and there were not many defenses available to the homeowner borrower. But that classic mortgage/foreclosure situation changed. It changed because banks started playing a game of musical chairs with home loans during the recent real estate bubble, roughly from the year 2000 through 2007, by “securitizing” it.
Instead of simply holding your note in its vault, banks began to use people’s loans as investment securities. Under the commercial law of each state, a promissory note (also known as a debt instrument) is a negotiable instrument. This means that the note itself represents value that can be negotiated in commerce, much like a check. “Negotiated” means that notes can be sold. Upon being sold a note is conveyed, i.e., assigned or transferred, to a new owner. This is done by indorsing the note. An indorsement is a stamp upon the note itself (or on a paper affixed to the note called an “allonge”). The stamp states, “Pay to the order of ___________. Without recourse.” It then recites the name of the entity that is conveying with a space for a person to sign who represents that entity and includes his or her title. (The indorsement is rarely, if ever, dated, though it certainly ought to be.) If it is indorsed to a specific entity, then only that entity owns your note; if it is indorsed in blank – that is, if the buyer or new owner is not named – then whoever possesses that original note is presumed to be its owner. That is the way that promissory notes are transferred or assigned (i.e., “negotiated”) in commerce. If the indorsement is blank the note is “bearer paper”; if the indorsement names a specific entity, then the note is called “order paper.” But this is just the beginning, the first hurdle when trying to find out who sold and who really owns your (soon-to-be securitized) note.
When a loan is securitized the note is commonly indorsed in blank. This allows whoever is in possession of the original note to claim ownership as a “holder.” When “securitized” a note commonly changes hands an average of four times. This seemingly allows many subsequent transferees who obtain possession of the original note to either resell it or enforce the note as bearer paper. As just mentioned, a new owner becomes what is called a “holder” of your loan and only a holder owns your loan and can enforce your note. Enforcing the note not only means that the holder has the right to foreclose if you default, it also means it can enforce all of the terms and conditions of the note, including the right to receive your payments. But all of this dry background, based on the commercial law of your state, is not the end of the story. It is only the beginning.
As stated above, Wall Street wanted the banks to turn these loans into securities. They did this by bundling them into packages of perhaps 1000 loans and offering them as a securitized trust package to investors. In this way Wall Street saw a way to reap huge profits. Now your note did not simply sit in the vault of the original lender, it became a negotiable instrument actively used to earn investors and those handling the investment transactions lots and lots of money.
At settlement you probably agreed to allow your loan to be assigned, but you never agreed to allow your loan to become a security and be bought and sold for the purposes of enriching other entities unknown to you. Now, if others are getting rich off of your indebtedness, doesn’t it stand to reason that new rights might inure to your benefit as a result of your debt instrument being unwittingly placed into the hands of those who are reaping financial gains from it?
To understand the new foreclosure defenses of homeowners, one must look to the chain of custody of the promissory note as it proceeds through the securitization process. Why? – because, as mentioned above, when “securitized” a note commonly changes hands an average of four times. In order for the loan to enter the securitization process it must be made a part of a securitized trust. As mentioned already, loans are bundled together. This bundling is known as “pooling.” The bank that originated your loan (the “originator”) sells your note (by ultimately indorsing it in blank). Your loan then starts its long journey into the bowels of a securitized trust pool, a black hole where the usual laws of commerce are further enhanced via federal (SEC) regulation.
The pool is first assigned a trust certificate number and offered to investors in a prospectus, as required under Securities and Exchange Commission regulations. The securitized trust is in turn subject to a pooling and security agreement (PSA) that is set forth in the prospectus. The prospectus is supposed to provide details about the investment offering for sale to the public so that an investor can make an informed investment decision. However, the nitty-gritty that sets forth the inter-relationships between the actors in the Trust is almost always exiled to a supplementary document called a Free Writing Prospectus, or FWP. The FWP often contains a flowchart entitled “Transaction Structure” reflecting in detail each step from origination of the sale to the asset pool.
The PSA has stringent transfer requirements that apply to your loan as it changes hands from one new owner/holder to another. These PSA transfer requirements are even more stringent than the commercial law of each state. Usually they require the note to be indorsed in blank but to list on the Note all the intervening indorsements for a complete chain of title. Thus, it must be shown that the transfer requirements were strictly adhered to as your note, i.e., your loan, changed hands. In the rush to harvest profits from your loan, these transfer requirements were rarely if ever adhered to.
Surprisingly, most foreclosure plaintiffs (usually attorneys who style themselves “substitute trustees” for the purported owner of the debt instrument) do not know the intricacies of these transfer requirements. More importantly, what plaintiffs’ attorneys fail to grasp is that if the transfer requirements are not adhered to, then no ownership interest is conveyed. This means that whoever purports to own and hold your loan – and authorize enforcement by appointing substitute trustees to foreclose – in reality owns and holds nothing and has no authority to appoint substitute trustees or to do anything else to enforce the note.
New Defenses: Show Me the Note and Show Me the Chain-of-Custody Indorsements on the Note
The first thing a homeowner borrower might do who has stopped paying his or her mortgage, or received a Notice of Intent to Foreclose, is to contact a reputable company specializing in the forensic examination of the loan settlement papers. The examination should be ordered promptly as it may take up to sixty days to complete. Very often, RESPA (Real Estate Settlement Procedures Act) or TILA (Truth in Lending Act) violations are detected. Violations of such federal statutes can impute consequences to the originator bank that may be sufficient to “taint” the validity of the loan. Having such powerful evidence at the ready can be a useful tool that one can use to convince a bank to sit up and take notice of a borrower. Banks who previously stonewalled borrower efforts to contact them and negotiate with them may suddenly seem quite receptive to what you have to say.
The next “new” defense that a homeowner has is to insist that the plaintiff produce the original note for inspection in court. Because possession is indicative of ownership when the note is indorsed in blank, then it seems both logical and just that presentment of the original should be required, especially if the homeowner raises the issue as a defense. In fact, there is often a provision in the foreclosure rules for requesting supplemental documents that are (theoretically at least) in possession and control of the plaintiff or secured party and this provision can be used as a basis for requiring presentment of the original note.
Secondly, the note must be inspected for indorsements. These indorsements must indicate the chain of custody of that note from the originator to the entity claiming to own the note in the foreclosure proceeding. The defendant should come to court with the PSA and demand that the indorsements on the note indicate clearly that the note has been properly transferred in accordance with the transfer requirements contained in that PSA. Plaintiffs’ attorneys regularly march into court baldly proclaiming ownership when the copy of the note they filed into the court record recites a completely different entity. Let me repeat – they only need to present a copy of that note in order to foreclose on the purported debt and take away the borrower’s property!
An informed defendant must demand strict proof by way of demanding the original note that indicates thereon the proper indorsements all along the chain-of-custody of that note. Following this methodology it can often be established that the defendant is in fact not in default to a foreclosing plaintiff because that purported owner of the debt has absolutely no ownership rights and therefore no standing whatsoever to have access to the court for the purpose of foreclosing on the borrower defendant. That is, the court lacks subject matter jurisdiction when a plaintiff has no standing to sue you. The imposter is NOT a bona fide holder of your note. The poseur entity suing you is only a “pretender lender,” and its enforcer attorneys should be run out of town on a rail for not doing their due diligence to determine whether the “bankster” they represent is actually the legal owner of the debt.
Still, the plaintiff is left in a bind. Because the originator of the loan has indorsed the note in blank, it is no longer (and can no longer ever be) the owner; and because the note was never negotiated properly from that point onward, no one in the chain of custody can establish valid ownership. The note is effectively in a black hole wherein there can be no owner or holder of the note. The debt is not so much discharged as unenforceable. Why? – because it has almost never been properly indorsed according to the PSA requirements.
It may be argued, however, that perhaps the first entity that bought your loan, the first transferee is a bona fide holder. That is, the first indorsement by the originator was effective under the commercial law to transfer the note and convey ownership before the loan was placed into the securitization trust; subsequent transfers were ineffective because they did not comport with the PSA transfer requirements. What about that argument? Perhaps that first transferee is a bona fide holder who has standing to demand payments and foreclose on the homeowner borrower.
But what if, as often is the case, that first valid transferee was FannieMae or FreddieMac? These hybrid government entities are not known for foreclosing on homeowners. Can they do so via an agent such as the current servicer? There is a section in the commercial law that allows for a nonholder in possession of the instrument who has the rights of a holder to enforce the debt instrument. See UCC 3-301(ii). Could the plaintiff argue that the bona fide holder, e.g., FannieMae or FreddieMac can execute a power of attorney appointing, for example, the servicer who receives a borrower’s monthly payments as attorney-in-fact for purposes of foreclosing upon a homeowner? There is case law that says NO. In Maryland a secured party is “any person who has an interest in property secured by a lien or any assignee or successor in interest to that person. The term includes: (1) the mortgagee; [and] (2) the holder of a note secured by a deed of trust.” Maryland Rule 14-202(k)(1)(2).
What is known is that these defenses, at a minimum, can certainly slow down the foreclosure process – and rightfully so. After all, taking a home from a person or a family is serious business. And doesn’t defective foreclosure have Constitutional implications? Do not citizen homeowners have a right to be secure in their homes by being afforded the due process guaranteed to them under the 5th and 14th Amendments to the U.S. Constitution (not to mention their respective state constitutions)?
Indorsement Mills
The setting up of “indorsement mills” is one devious way banks are trying to cover themselves for their failure to have had notes indorsed according to the state commercial law and/or the PSA transfer requirements. An “indorsement mill” is a place where clerical staff sit around all day stamping and signing indorsements onto original notes. These indorsements should have been performed and completed long ago, of course, when the note was repeatedly negotiated as it proceeded through the securitization process. Indorsement mill staff have been “deputized” as V.P.s (“Vice Presidents” of, e.g., Option One or Deutsche Bank or Citi Residential Lending) when in fact they all work for an entity such as Nationwide Title Clearing or some similar entity. The banks are of course cashing in on the fact that indorsements do not need to be dated – as unbelievable as that may sound. And so, I suppose the rationale is something like, “Well, if they need not be dated, then let’s just get them on there!”
Is this legal? Or more importantly perhaps, are the indorsements legally enforceable? Banks apparently seem to think that such indorsement mills are legitimate and what they are doing there has legal efficacy. Courts, on the other hand, may have a very different opinion on the matter. But, in order for it to be made an issue, the question needs to be asked in court: “Were these indorsements stamped on the note as it was negotiated through the securitization process or were these indorsements provided after-the-fact?” As none of these indorsements have dates, in order to authenticate them in a court of law it would be necessary for each of the persons having indorsed them to appear in court and testify and be cross-examined as to that fact. An attorney/substitute trustee has no personal knowledge on this point and cannot testify as to its authenticity. Can a defendant borrower insist that this be done? Most certainly. Will the judge permit it? It depends upon how interested the judge is in adhering to the rules of evidence. Foreclosure proceedings are not traditionally long, drawn-out affairs. It may require a countercalim and/or an appeal.
Require Proof that the “Defaulted” Loan Has Not Already Been Paid, either by Default Insurance or by TARP Money
There is one more defense in the trick-bag of the Defendant. When a loan was securitized, very often the various players – from the intermediate holders to the investors – covered their risk by purchasing default insurance. This would enable them to recoup the major portion of their investment, even if they suddenly find that they “have no chair to sit in when the music stops.”
AIG was in the business of providing just such insurance. During the recent sub-prime mortgage meltdown AIG paid and paid big, until they almost toppled over. But the federal government rescued AIG, propping them up by providing TARP money to them and other financial institutions; whatever money was needed to cover losses was provided. That is, in the “security trust casino,” banks can gamble all they want and if they lose, they can still cover their losses; they can still walk out of the casino almost unscathed.
What this means for a homeowner is that a short period of time after the mortgage payments stop (unbeknownst to the borrower) the note holder – as well as others claiming an interest – may already have collected most of the balance of what is owed. In fact, as bizarre as it may sound, the claim may already have been paid not to just one party, but perhaps to three parties, each of whom had a default insurance policy in place. Could it be that your loan has been paid – three times over? Some things are stranger than fiction and this is one of them. Insurance is another concern of the securitized trust that is addressed in the PSA.
Thus the homeowner defendant must insist that any third party payments be divulged to the court as a condition precedent to a judge allowing a foreclosure to proceed. The mechanism for any such request might be in the form of a sworn affidavit from the bona fide holder and the substitute trustees attesting that no such third party payments have been made. Willful (or even negligent) misrepresentation of this fact, should result in a total forfeiture of the holder’s lien or security interest, and should include severe penalties to both the holder and the substitute trustees (who are almost always attorneys). Committing a fraud on the court, especially by officers of the court, should carry grave consequences.
Summary
The foreclosure defenses discussed herein can usually buy more time for the homeowner. And obviously, they are designed to put homeowners in a better bargaining position so that they have leverage to force a HAMP modification, or a modification based on prior RESPA or TILA violations. But more importantly, these defenses are meant to put the foreclosing plaintiffs on notice that they cannot just mindlessly steamroll over the rights of homeowners with the usual, cookie-cutter documents. Empowering defendant homeowners in this way allows them to demand that, if banks intend to take their homes away, everything better be in perfect order, substantively and procedurally. The foreclosure defenses are not designed to help people live in their homes mortgage-free, although in some cases that could very well end up being the case – and if that happens then banks have only themselves to blame.
If a homeowner is hoping to be in the best possible position (i.e., staying in one’s home without ever having to pay another mortgage payment, giving new definition to the expression being “home-free”) at this writing it seems that this could result from one of only four possible scenarios.
1.) The bona fide owner/holder of you note does not have the original note (it has been lost, stolen, or otherwise destroyed) and cannot prove that it was in its possession at the time it was lost, stolen or otherwise destroyed; or,
2.) The bona fide owner/holder of the original note does not wish to sue and foreclose upon the homeowner because to do so would be an admission against interest. Lenders are now being sued by certificate holders whose investments lost money due to just the sort of negligence that turned these lenders into owner/holders by legal default. To foreclose would be to admit that they, indeed, however unwittingly, retained their ownership interest when in fact they were supposed to have transferred that ownership interest to other entities in the securitized trust; or,
3.) The bona fide owner/holder is a financial institution that is no longer in business; or,
4.) After a so-called “default,” a claim was made against the default insurance, and/or the loss from the “default” was offset by TARP funds provided by the federal government. If the bona fide holder of a homeowner’s loan has already been paid in full, then that holder is certainly not entitled to be paid yet again. Case closed.
What homeowners should take away from all of this is that if they are foreclosed upon they should not accept that situation at face value. They need to make the foreclosing plaintiff prove who owns their loan. Without proof as to who owns the loan there can be no default. They might just as well say that you are in default to the man-in-the-moon. Make them produce the note, demand the chain-of-custody of that note, and require them to prove that each purported holder of your note has indorsed it correctly. Only when all of this documentary evidence is presented to the court might there then be an actual foreclosure by a party validly authorized to take your home from you.
In the rush to reap huge profits and fees, the improper short-cuts taken by financial institutions (and now by their enforcers) must result in some very hard lessons learned. These folks are now looking for ways to make sure that at least one bona fide holder can find a seat in their game of musical chairs. Be that as it may, when servicing lenders themselves cannot tell you who owns your original note, and when lawyers and judges don’t understand this convoluted securitized trust business, it is up to the homeowner borrower to educate his- or herself and to take charge themselves.
So, borrowers need to know their rights in foreclosure (or need to start educating their attorneys) in order to defend themselves and save their homes. After all, one’s home is certainly worth fighting for, is it not? Boning up helps one to resist the old-style “steam-roller and cookie-cutter” practices that foreclosure firms have grown so accustomed to prior to more homeowner-friendly revisions to foreclosure statutes and rules being undertaken by legislatures across the country.
1. Declare an end to American Empire. Withdraw troops from military adventures in all foreign territories.
