No Securitization, No Foreclosure
The couple involved, the Horaces, took out a predatory mortgage with Encore Credit Corp in November, 2005. Apparently Encore sold their loan to EMC Mortgage Corp, who then tried to securitize it in a Bear Stearns deal. If the securitization had been done properly, in February 2006 the trust created to hold the loans would have acquired the Horace loan. Once the Horaces defaulted, as they did in 2007, the trustee would have been able to foreclose on the Horaces.
And that's why this case is so big: the judge found the securitization of the Horace loan wasn't done properly, so the trustee -- LaSalle National Bank Association, now part of Bank of America (BAC) -- couldn't foreclose. In making that decision, the judge is the first to really address the issue, head-on: If a screwed-up securitization process meant a loan never got securitized, can a bank foreclose under the state versions of the Uniform Commercial Code anyway? This judge says no, finding that since the securitization was busted, the trust didn't have the right to foreclose, period.
Since the judge's order doesn't explain, how should people understand his decision? Luckily, the underlying documents make the judge's decision obvious.
The key contract creating the securitization is called a "Pooling and Servicing Agreement" (pooling as in creating a pool of mortgages, and servicing as in servicing those mortgages.) The PSA for the deal involving the Horace mortgage is here and has very specific requirements about how the trust can acquire loans. One of the easiest requirements to check is the way the loan's promissory note is supposed to be endorsed -- just look at the note.
But wait, argued the bank, it doesn't matter if if the trust owns the loan -- it just has to be a "holder" under the Alabama version of the UCC (Uniform Commercial Code), and the trust is a holder. The problem with that argument is securitization trusts aren't allowed to simply take property willy-nilly. In fact, to preserve their special tax status, they are forbidden from taking property after their cut-off dates, which in this case was February 28, 2006. As a result, if the trust doesn't own the loan according to the PSA it can't receive the proceeds of the foreclosure or the title to the home, even if it's allowed to foreclose as a holder.
Holder Status Can't Solve Standing Problem
Allowing a trust to foreclose based on holder status when it doesn't own the loan would seem to create yet another type of clouded title issue. I mean, it's absurd to say the trust foreclosed and took title as a matter of the UCC, but to also have it be true that the trust can't take title as a matter of its own formational documents. And what would happen to the proceeds of the foreclosure sale? That's why people making this type of argument keep pointing out that the UCC allows people to contract around it and PSAs are properly viewed as such a contracting around agreement.
I'm sure the bank's side will claim the judge was wrong, that he disagreed with another recent Alabama case that's been heavily covered, US Bank vs. Congress. And there is a superficial if flat disagreement: In this case, the judge said the Horaces were beneficiaries of the PSA and so could raise the issue of the loan's ownership; in Congress the judge said the homeowners weren't party to the PSA and so couldn't raise the issue.
But as Adam Levitin explained, the Congress decision was procedurally weird, and as a result the PSA argument wasn't about standing, as it was in Horace and generally would be in foreclosure cases (as opposed to eviction cases, like Congress). And what did happen to the Congress proceeds? How solid is that securitization trust's tax status now anyway?
In short, in the only case I can find that has ruled squarely on the issue, a busted securitization prevents foreclosure by the trust that thinks it owns the loan. Yes, it's just one case, and an Alabama trial level one at that. But it's still significant.
Homeowners Right to Raise Securitization Issue
As far as right-to-raise-the-ownership issue, I think the Horace judge was just being "belt and suspenders" in finding the homeowners were beneficiaries of the PSA. Why do homeowners have to be beneficiaries of the PSA to raise the issue of the trust's ownership of their loans? The homeowners aren't trying to enforce the agreement, they're simply trying to show the foreclosing trust doesn't have standing. Standing is a threshold issue to any litigation and the homeowners axiomatically have the right to raise it.
As Nick Wooten, the Horaces' attorney, said:
All that remains for the Horaces, a couple with a special needs child and whose default was triggered not only by the predatory nature of the loan, but also by Mrs. Horace's temporary illness and Mr. Horace's loss of overtime, is to ask a jury to compensate them for the mental anguish caused by the wrongful foreclosure."This is just one example of hundreds I have seen where servicers were trying to force through a foreclosure in the name of a trust that clearly had no interest in the underlying loan according to the terms of the pooling and servicing agreement. This conduct is a fraud on the borrower, a fraud on the investors and a fraud on the court. Thankfully Judge Johnson recognized the utter failure of the securitization transaction and would not overlook the fact that the trust had no interest in this loan."
Perhaps BofA will just want to cut a check now, rather than wait for that verdict. (As of publication BofA had not returned a request for comment.)
No one is suggesting the Horaces get a free house; they still owe their debt, and whomever they owe it to has the right to foreclose on it. Wooten explained to me that the depositor --in this case, the Bear Stearns entity --i s probably that party. Moreover if the Horaces wanted to sell and move, they'd have to quiet title and would be wise to escrow the mortgage pay off amount, if that amount can be figured out. But for now the Horaces get some real peace, even if a larger mess remains.
Much Bigger Than A Single Foreclosure
The Horaces aren't the only ones affected by the issues in this case.
Homeowners everywhere that are being foreclosed on by securitization trusts -- many, many people -- can start making these arguments. And if their loan's PSA is like the Horaces, they should win. At least, Wooten hopes so:
The issues stretch past homeowners to investors, too."Judge Johnson stopped a fraud in progress. I am hopeful that other courts will consider more seriously the very serious issues that are easily obscured in the flood of foreclosures that are overwhelming our Courts and reject the systemic and ongoing fraud that is being perpetrated by the mortgage servicers. Until Courts actively push back against the massive documentary fraud being shoveled at them by mortgage servicers this fraudulent conduct will not end."
Investors in this particular mortgage-backed security, take note: What are the odds that the Horace note is the only one that wasn't properly endorsed? I'd say nil, and not just because evidence in other cases, such as Kemp from New Jersey, suggests the practice was common. This securitization deal was done by Bear Stearns, which other litigation reveals was far from careful with its securitizations. So the original investors in this deal should speed dial their lawyers.
And investors in bubble-vintage mortgage backed securities, the ones that went from AAA gold to junk overnight, might want to call their attorneys too; this deal was in 2006, and in the securitization frenzy that followed processes can only have gotten worse.
Some investors are already suing, but the cases are at very early stages. Nonetheless, as cases like the Horaces' come to light, the odds seem to tilt in investors' favor -- meaning they seem increasingly likely to ultimately succeed in forcing banks to buy back securities or pay damages for securities fraud connected with their sale. And that makes the Bank Bailout II scenario detailed by the Congressional Oversight Panel more possible.
The final, very striking feature of this case is what didn't happen: No piece of paper covered in the proper endorsements --an allonge -- magically appeared at the eleventh hour. The magical appearance of endorsements, whether on notes or on allonges, has been a hallmark of foreclosures done in the robosigning era. And investors, as you pursue your suits based on busted securitizations, that's something to watch out for.
My, but the banks made a mess when they forced the fee-machine of mortgage securitizations into overdrive. The consequences are still unfolding, but one consequence just might be a whole lot of properties that securitization trusts can't foreclose on.