Securitization Chain-of-Title: The US Bank v.

Congress Ruling

posted by Adam Levitin

Over on Housing Wire, Paul Jackson is crowing that chain-of-title issues in mortgage
securitization are overblown because an Alabama state trial court rejected such
arguments in a case ironically captioned U.S. Bank v. Congress.

But let’s actually consider whether the opinion matters, what the court actually did and
did not say, and whether it was right.

Jackson and Yves Smith at Naked Capitalism have a running feud over the seriousness of
chain-of-title problems, and I think that explains why Jackson is so worked up over this
decision. My own take is that it is much ado about nothing. Before anyone gets too
excited one way or the other about this case, let’s remember that this is a ruling by one
judge in an Alabama state trial court decision. It was unlikely to get much notice
anywhere else in the country, but for the securitization industry grasping for a legal
victory to parade around. This court ruling doesn’t have precedential value anywhere,
including in Alabama, and its persuasive value is very low too, both on account of it
being an Alabama state trial court and because of the quality of its analysis. Put
differently, this ain’t an Ibanez type ruling, where a leading state supreme court issues a
very thoughtful unanimous opinion.

Perhaps the most important thing to note about the opinion is what isn't there. There was
no consideration of the chain-of-title issue in the opinion. Let me repeat, the court said
nothing about whether there was proper chain-of-title in the securitization. Instead, the
court avoided dealing with it. That means that this ruling isn't grounds for sounding the
"all clear" on chain-of-title. At best, it is grounds for arguing that homeowners won't be
able to raise chain-of-title problems. As we've seen with Ibanez, that's clearly incorrect,
and a closer look at the Congress ruling shows that it might be an Alabama special, not
applicable elsewhere.

Alabama is a “non-judicial” foreclosure state. That means foreclosures are done by

private sale. In Congress the securitization trustee held a sale and received a quitclaim
deed from the mortgagee MERS. The securitization trustee then brought an ejectment
action against the homeowner. The decision was in the ejectment action, not the
foreclosure.

The court used this procedural posture to wiggle around having to address the chain-of-
title issues. The homeowner’s argument was that the note and mortgage had never been
properly and timely transferred to the securitization trust per the method required by the
pooling and servicing agreement (PSA) and were, therefore, not trust property, so the
trust had no interest in the mortgage and therefore lacked standing to bring a foreclosure:
“without proof that U.S. bank was the owner of the Note, it has no standing and therefore
the trial court has no subject matter jurisdiction over the case.”
The court played on the procedural posture of the case to reject this argument. First, the
court explained that because this was an ejectment action, not a foreclosure, the question
of ownership of the note was not an issue of standing, but an affirmative defense for
which the homeowner had the burden of proof. The trial court here was citing to a recent
Alabama appellate court decision (reversing a previous Alabama appellate decision) that
concluded that standing is satisfied by virtue of the bank being named party on the
foreclosure deed. That’s just crazy given that the foreclosure deed is a nonjudicial sale.
[G.S.—maybe this explains why your shop saw your notaries' seal forged on those
foreclosure deeds.]

Crazy or not, however, this meant that the homeowner wasn’t actually challenging the
trust's standing. From there it was a small step for the court to say that the homeowner
couldn’t invoke the terms of the PSA because she wasn’t a party to it.

If the homeowner were able to bring a standing challenge, there’d really be no way to
avoid addressing the PSA on its own terms because that is what determines whether the
securitization trust has an interest in the mortgage in the first place. This procedural move
of saying that the homeowner wasn’t challenging standing was what decided the case. It
certainly made it possible for the court to decide everything under Alabama law, rather
than address the New York law that governs the PSA: “This is an action for ejection from
Alabama real property, brought against an Alabama resident in an Alabama court.”
[Translation: boy, don’t you bring down any of that fancy New York lawyering to
Alabama.]

It’s worth noting that this is not the only decision to say that the homeowner has no
ability to invoke the PSA. There’s an unpublished Sixth Circuit ruling in a case called
Livonia, involving a commercial mortgage. In that case, the court said that a litigant who
is not party to an assignment cannot challenge the assignment, unless there's a concern
about double enforcement (i.e., that someone else might claim to be the note holder). If
one traces back the caselaw cited as precedent in Livonia, one will see that it is fairly
inapposite--my take is that this is a decision where the law clerks cited some 19th century
caselaw language without fully understanding the particular context of those cases. But
even if the precedent is well-founded, given the prevelance of warehouse fraud, the
double enforcement problem is real, and more importantly, there’s another critical
borrower interest in ensuring that litigation is against the proper party. Securitization
trusts have very different ability and incentives to settle a foreclosure case by modifying a
loan than a portfolio lender. That means borrowers do have an interest in the validity of
the assignment and thus standing to litigate over it.

More generally, I find the argument that there's no standing to argue over chain of title
misplaced. Perhaps the most fundamental defense to a foreclosure is to argue that the
party bringing the action isn’t the creditor. That’s a standing question, and there’s simply
no way to examine it without getting into the PSA.

There’s also a secondary issue in Congress that is also worthy of comment (I could go on
and on about the rubberbanded allonge issue as well, but gosh that'd be dry and
technical): The court wrote that “U.S. bank was the ‘holder’ of the Congress note and
therefore had the legal right to foreclose on the Congress property.” The concept of
“holder” is a UCC Article 3 concept. It goes to the ability to enforce the note. UCC 3-
301. A holder is simply a party in possession of a note made out to that party or to bearer.
UCC 1-201(b)(20). Thus, a thief of a bearer note is a “holder” of the note for UCC
purposes, and therefore entitled to enforce the note.

But recall that the note is separate from the security instrument, and the securitization
trustee isn’t trying to enforce just the note. It is trying to enforce the security instrument
that accompanies the mortgage, and the enforceability of security interests in real
property isn’t governed by UCC Article 3 and with good reason—mortgages aren’t
negotiable, even if the notes themselves are. The commercial benefits from enhanced
liquidity of debt do not trump concerns about protecting homeowners’ rights to
occupancy.

Unlike an action on a note, which is an action at law, mortgage foreclosure is an equitable

action—it is the cutting off the borrower’s equity of redemption. Most states have
abandoned the formal law/equity division, but the principles still stand, even if the court
structure does not. While a thief can enforce bearer paper, the idea that a thief could
enforce a mortgage is laughable. If you don’t have clean hands, don’t expect relief in
equity.

The Alabama court just seemed to assume that if a party is a UCC Article 3 holder of a
note, it can enforce an associated mortgage. My own take is that enforcement of the
mortgage—that is foreclosure—is a separate issue that requires a separate analysis. The
court couldn’t have gone down this path, however, because clean hands leads right back
to the chain-of-title question.

So to recap, I don’t think there’s much to get excited about with Congress. If the
homeowner had prevailed, the banks would have been saying “it’s just an Alabama state
trial court,” and it might well have been overturned on appeal. But that doesn’t mean that
the chain-of-title issue isn’t real. It just means that there’s still a search for the proper
channel on which to advance the argument.

In the end, I see Paul Jackson as toeing the "nothing to see here folks" line that's coming
out of thesell-side banks and American Securitization Forum, but numerous buy-side
people (read MBS investors) have told me that they think there’s a serious problem with
the securitization documentation. The problem that they have is that they don’t know
what to do about it—they are trying to figure out a way that this can be used to put the
mortgages back to the banks without it tanking the entire financial system. In other
words, the banks are being protected by the too-big-to-fail problem. That’s letting them
externalize their violations of their securitization contracts on MBS investors.