The Banks’ Huge Eaton Loss: Showing the Note Owner

I’ve updated the post in a few places as marked. The analysis hasn’t changed.

The seminal Eaton v. Fannie Mae decision by the Massachusetts Supreme Judicial Court is not a huge banking industry win going forward. In fact, if the Legislature lets it stand, it’s a huge homeowner win. Forget the part about the decision applying in the future only; while I think it is wrong, it was doctrinally reasonable and arguably protects many innocent third parties.

Going forward, the really big deal is that the Court has taken the “show me the note” defense and made it “show me the note owner.”

“Show me the note owner” is really hard to do in an era of mass securitization fail. Securitization fail means the trust doesn’t own the loans. And if the trust doesn’t own the loans, then the servicer isn’t the agent of the note owner and can’t foreclose non-judicially. Moreover, as this Court’s earlier Ibanez decision revealed, securitization fail may have occurred more often in Massachusetts than elsewhere.

By requiring the non-judicially foreclosing servicer to have authority from the note owner to foreclose, the Court is strengthening foreclosure defense in Massachusetts. See, homeowners have tried to get the courts to take securitization fail seriously, and specifically the standing problem it creates for servicers. But generally judges hate hearing about how banks screwed up securitization, fearing it leads to undeserved free houses. In fact, a bankruptcy appellate court reviewing a Massachusetts case got basic doctrine wrong to reject the argument.

Securitization fail arguments should have a lot more traction now.

Update: The Ibanez decision already provides Massachusetts homeowners a way to challenge foreclosures on the basis of securitization fail by requiring a complete chain of title for the mortgage. Eaton gives a second bite at that apple by requiring the note owner or note owner’s agent to be the foreclosing party.

Note to Homeowners: 1) This decision applies in Massachusetts only; if you’re anywhere else, don’t read it as applying to your case. 2) The show me the note owner defense doesn’t mean securitization audits are a good investment. Anyone selling you a product that costs thousands of dollars and making promises that sound too good to be true is lying to you.  

How the Court Defined Mortgagee as Note Owner

Eaton appears to be a narrow statutory construction case–what does “mortgagee” mean in the nonjudicial foreclosure statute? Specifically, can someone assigned the mortgage, without proving anything else, foreclose non-judicially as mortgagee? And if not, is that a new enough statutory interpretation that it should only count going forward?

However, the Eaton court does more than interpret “mortgagee”; it also defines another term in the statute, note “holder.” And it’s that definition that produces the “show the note owner” defense.

The “holder” definition is noteworthy in another respect. Even though nonjudicial foreclosures are controlled by statute, not common law, the Justices don’t seem to be interpreting the statute when defining holder.

Step One: Mortgagee Means Holder

According to the Massachusetts non-judicial foreclosure statute, only a “mortgagee” can invoke the “power of sale” and foreclose. In Eaton, MERS assigned Eaton’s mortgage to mortgage servicer Green Tree, intending to confer its “mortgagee” status on Green Tree, and believed it had succeeded based on the banking industry’s interpretation of the Massachusetts statute. Green Tree did not take possession of the note or otherwise establish any connection to the underlying mortgage debt in the record. Green Tree invoked the power of sale and foreclosed.

Reviewing the statute, the Court said, well, yes, we see your argument that a mortgagee can be someone with just the mortgage, but we disagree; “mortgagee” can only be the note holder or the note holder’s agent. A bare mortgage is not enough.

For this step of its analysis, the Court employed very vanilla statutory construction: the Legislature means the same thing every time it uses the same word to talk about the same subject. And in other parts the of nonjudicial foreclosure statute, “mortgagee” meant the “holder of the note.” “Holder” is the word the legislature used; nowhere did it define a mortgagee as a note “owner.” As a result, the Justices decided a “mortgagee” in the power of sale section meant either the note holder or the holder’s agent.

That part of the decision–the servicer could be the holder’s agent–meant the servicer didn’t have to possess the note when starting the foreclosure, and is looser than many other states’ requirements. Looser, that is, if “holder” means what people reading it normally assume it to mean.

You see, “holder” is a term from a special body of law called the UCC, which courts have consistently treated as applicable to residential mortgage notes. And under the UCC holder does NOT mean note owner. That’s why foreclosure actions will be initiated by servicers claiming to be note “holders” even when they don’t claim to be note “owners”. (Or no longer claim to be note owners, like in the Wells Fargo bogus documents case I discussed the other day.)

If Eaton simply said a servicer could foreclose non-judicially whenever it was assigned the mortgage and it possessed the note as a holder, Massachusetts courts would be free to continue using a UCC definition of “holder” in foreclosure cases. Not that Massachusetts nonjudicial foreclosures usually involve note possessors of any sort, as the industry has relied on its mortgagee interpretation to foreclose without the note.

But elsewhere in the nation, homeowners have faced a lopsided playing field on the “holder” issue. Lopsided because holder status can be and is manufactured by adding endorsements to notes for litigation purposes, aka fabricating evidence. If UCC holder status were all that was needed in Massachusetts, then homeowners there would face the same problem–how do you litigate against someone who just fabricates evidence as needed?

note, the previous two paragraphs are slightly revised to clarify Massachusetts versus elsewhere.

But the Court avoided that problem by explicitly defining the word “holder” in the definition of mortgagee as note “owner,” rejecting the UCC definition of holder.

Step Two: Note Holder As Note Owner

Although much of Eaton is very conventional statutory interpretation, it’s a striking decision in one respect: the Court seems to reject the idea that the statute is the first and last word on the subject.

Indeed, the Court says:

It has long been recognized that statutes are a key source of authority generally governing mortgages. [Cites an 1833 case, and quotes from it "The law of mortgage in this [C]ommonwealth, is a mixed system, derived partly from the common law in regard to real property, partly from the rules and maxims of the English [C]ourts of [C]hancery, but principally from various statutes”]. Statutes play an especially significant role in connection with mortgage foreclosures effected under a power of sale. [Cites Ibanez] (see opinion at page 7; bold added.)

What the Justices are really saying here is: ‘even a non-judicial state, foreclosure is partly judicial, and that includes foreclosures done according to the so-called ‘statutory’ power of sale.’

The general claim that common law is relevant to mortgages in Massachusetts makes some sense, because of the deep roots of mortgage and foreclosure law in courts of equity, not law. But it’s a real assertion of power for the Justices to say it in connection with the statutory power of sale and non-judicial foreclosure statutes. In fact, it flies in the face of what most people would consider well settled law.

And nowhere is that assertion of power made more plain than at the very beginning of the opinion, when the Court writes its second footnote. Footnote 2 says:

FN2. The term “mortgage note” is used in this opinion to refer to the promissory note or other form of debt or obligation for which the mortgage provides security; and the term “note holder” is used to refer to a person or entity owning the “mortgage note.” (bold mine)

Even though the Justices use a passive sentence construction that leaves themselves out of it, the key part of that sentence means, “when we say ‘note holder’, we mean ‘note owner.’”

Normally when construing a term in a statute–and remember, this is all about who can use the statutory power of sale when doing a non-judicial foreclosure–the sentence would read “when the statute says ‘note holder’, it means ‘note owner.’ But the Court doesn’t pretend it’s construing the statute.

Footnote two, coupled with a page and a half discussion of Massachusetts common law that apparently has used the term note “holder” to mean owner at least as far back as 1859, makes it very clear that the Court is saying “under Massachusetts common law, note holder means note owner, and that is how we use it today.” By implication the Court is saying “we read the nonjudicial foreclosure statute to have incorporated the common law definition of ‘holder’”, but the Court doesn’t acknowledge any need to say something like that.

Reconciling Eaton with the UCC and Current Foreclosure Practice

As clearly defined in the Massachusetts common law as holder is, it has another definition in the UCC. Note holders need not be owners under the UCC, and the current common practice in foreclosure courts elsewhere is to end discussions about a servicer’s standing to foreclose when a servicer shows up with a properly endorsed note. A note possessor with a properly endorsed note is a “note holder” for the UCC.  But that can’t be according to Massachusetts’s highest court, that’s not enough in Massachusetts any more, now that the nonjudicial foreclosure statute has been interpreted as importing the common law definition of holder.

The Court, in footnote 26, thinks there’s no difficulty reconciling their decision with the UCC, and just as important, refuses to decide that the UCC even applies to foreclosures done according to the power of sale:

“FN26. Eaton asserts also that the result we reach here is compelled by the Uniform Commercial Code (UCC). She argues in substance that the note is a negotiable instrument, and that pursuant to art. 3 of the UCC, only certain categories of persons are entitled to enforce negotiable instruments. Under her view, because Green Tree did not fall within any of the categories of persons entitled to enforce negotiable instruments, it was not entitled to enforce the note through foreclosure. We need not resolve Eaton’s UCC argument. We perceive nothing in the UCC inconsistent with our view that in order to effect a valid foreclosure, a mortgagee must either hold the note or act on behalf of the note holder.

Unless the Court is trying to make a kind of pun–which it’s not–the Court is using its throne as atop Massachusetts common law to seize the word “holder” from the UCC. That is, the sentence looks different if it reads

“We perceive nothing in the UCC inconsistent with our view that in order to effect a valid foreclosure, a mortgagee must either own the note or act on behalf of the note owner.

The Permanent Editorial Board for the UCC has been dismayed by what it has seen as poor judicial rulings regarding the UCC and mortgage notes. So it put out a white paper last November to review the basics. Beyond clearly stating that a UCC note holder need not be a note owner, the UCC board quoted an official UCC comment that says:

The Uniform Commercial Code was drafted against the backdrop of existing bodies of law, including the common law and equity, and relies on those bodies of law to supplement its provisions in many important ways….while principles of common law and equity may supplement provisions of the Uniform Commercial Code, they may not be used to supplant its provisions, or the purposes and policies those provisions reflect… the Uniform Commercial Code preempts principles of common law and equity that are inconsistent with either its provisions or its purposes and policies.

Given the conflict in meaning between Massachusetts common law and the UCC regarding the word “holder”, it would have been much better if the Court had been explicit about how it saw the consistency. My best guess is it’s saying something like the Connecticut Supreme Court (a judicial foreclosure state) said last year: a UCC note holder that is not a note owner can sue for the money, but only a note owner (a Massachusetts common law note holder) can foreclose. That is, a UCC note holder can enforce the note, but not the mortgage. The UCC does not control.

Though most people would argue the Court is wrong, I don’t think the Court was being sloppy. The Court was unanimous, the case heavily briefed and watched, and the Court took its time writing the opinion. In addition, this Court dealt with Massachusetts real estate law very recently in Ibanez. The Court is deliberately asserting the common law’s relevance.

Note, the UCC Board paper discussion is an addition to the original version.

Show the Note Owner, Practically Speaking

So that’s Eaton, on my read at least. Securitization fail arguments should have more power to defeat nonjudicial foreclosures, because the Court says it’s not enough to be a bare UCC note holder. But as a practical matter, it will make little difference in most foreclosures, since they are uncontested.

When a servicer files an uncontested nonjudicial foreclosure, it can file an affidavit with the land records swearing it had authority from the note owner. But in the robosigning era of meaningless affidavits, I’ve no reason to think those affidavits will be truthful. Future litigation will ultimately decide what those affidavits have to look like to be taken seriously. And future litigation will answer the biggest question of all:

Do we now have a way to expose the systematic securitization fail that happened? Ordinary homeowners across America exposed the deep document fraud that’s called robosigning. Will Massachusetts homeowners advance justice further by tearing open the mass securities fraud in a way ‘our’ Department of ‘Justice’ and the SEC never have?

As a matter of law Eaton is a clear homeowner win, but as a practical matter only time will tell how much of a win it really is.

Note: I just learned about the Connecticut case, which should itself provide a method of exposing securitization fail in Connecticut. I do not know if foreclosure defense attorneys have been able to successfully use it to force servicers to ‘show the note owner.’ I’d appreciate any info from CT attorneys/litigants in the comments.

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