Mass Court May Rule on Retroactivity of some Foreclosures Tied to 'Naked Mortgages'

Another next major marker in the convoluted foreclosure landscape will probably come in the next few weeks when the Massachusetts Supreme Judicial Court (SJC) is expected to rule on Eaton v. Federal National Mortgage Association (Fannie Mae).  This is another in a series of cases challenging the right of various lenders and nominees to foreclose on delinquent mortgages based on assertions that those parties do not own or at least cannot prove they own the enabling legal documents. 

Eaton raises an additional point that has excited interest - whether or not that foreclosure can be challenged and compensation enforced on a retroactive basis or whether such retroactivity exacts too high a cost or permanently clouds title.

The details of the case are fairly standard, involving a note given by Henrietta Eaton to BankUnited and a contemporaneous mortgage to Mortgage Electronic Registration Systems (MERS).  The mortgage was later assigned by MERS to Green Tree servicing and the assignment did not reference the note.  The Eaton Home was subsequently foreclosed upon by Green Tree which assigned its rights under the foreclosure to Fannie Mae which sought to evict Eaton.  Eaton sued, charging that the loan servicer did not hold the note proving that Eaton was obliged to pay the mortgage.

The Massachusetts Superior Court relied on a January, 2011 ruling in U.S. Bank V. Ibanez in which the court held that the assignment of a mortgage must be effective before the foreclosure in order to be valid and that as holder of the note separated from the mortgage due to a lack of effective assignment, the Plaintiffs had only a beneficial interest in the mortgage note and the power of sale statute granted foreclosure authority to the mortgagee, not to the owner of the beneficial interest.   

In Eaton the lower court said it was "cognizant of sound reason that would have historically supported the common law rule requiring the unification of the promissory note and the mortgage note in the foreclosing entity prior to foreclosure. Allowing foreclosure by a mortgagee not in possession of the mortgage note is potentially unfair to the mortgagor. A holder in due course of the promissory note could seek to recover against the mortgagor, thus exposing her to double liability."

In its brief to the Supreme Judicial Court, Fannie Mae contests the lower court ruling on the grounds that:

1.  Requiring unity of the note and mortgage to foreclose would create a cloud on the Title and result in adverse consequence for Massachusetts homeowners.

2.  A ruling requiring unity of the note and mortgage to conduct a valid foreclosure should be limited to prospective application only (because)

A.  Such a ruling was not clearly foreshadowed and

B.  Retroactive application could result in hardship and injustice.

The case has been the impetus for filings of nearly a dozen amicus briefs from groups such as the Land Title Association, Real Estate Bar Association, and foreclosure law firms, most in response to a SJC request for comment on whether any ruling should be applied retroactively and if so what the impact would be on the title of some 40,000 homes foreclosed in the last few years.   

Of particular interest is a brief filed by the Federal Housing Finance Agency, conservator of both Fannie Mae and Freddie Mac which some observers said might be the first time the agency had intervened in a particular foreclosure case.

FHFA asked the court to apply any decision to uphold the lower court decision prospectively rather than retrospectively.  It's argument:  applying a ruling retroactively would be "a direct threat to orderly operation of the mortgage market."   FHFA also said "Retroactive application of a decision requiring unity of the note and the mortgage for a valid foreclosure would impose costs on U.S. Taxpayers and would frustrate the statutory objectives of Conservatorship." 

"There presently is no mechanism or requirement under Massachusetts law to record the identity of the person entitled to enforce the note at the time of foreclosure," FHFA said.  "Therefore, a retroactive rule requiring unity of the note and mortgage for a valid foreclosure would potentially call into question the title of any property with a foreclosure in its chain of title within at least the last twenty years."

A contrary opinion was advanced in a brief filed by Georgetown University Law School Professor Adam Levitin who called the ruling that a party cannot foreclose on a "naked mortgage" (one separated from the note) merely a restatement of commercial law and "to the extent that the mortgage industry has disregarded a legal principle so commonsensical and uncontroversial that it has been encapsulated in a Restatement, it does so at its peril."

Levitin argues that it is impossible to know how widespread the problem of naked mortgages may be either in Massachusetts or nationwide so this should temper any evaluation of the impact of retroactivity.  He also states that there are several factors "that should assuage concerns about clouded title resulting from a retroactively applicable ruling requiring a unity of the note and mortgage."  He points out that adverse possession, pleading standards, burdens of proof and equitable defenses such as laches all combine to make the likelihood of challenging past foreclosure unlikely and sharply limiting the retroactive effect of a ruling.

Kathleen M. Howley and Thom Weidlich, writing for Bloomberg noted that a decision to uphold the lower court "could lead to a surge in claims from home owners seeking to overturn seizures."

According to Howley and Weidlich, the SJC ruled last year on two foreclosure cases that handed properties back to owners on naked mortgage grounds.  The Ibanez case, referenced above dealt with two single family houses, but in Bevilacqua v. Rodriguez the court handed an apartment building back to the previous owner five years after the foreclosure.  In the interim a developer had purchased the building and turned it into condos.  The condo owners lost their units without compensation and the building now stands vacant. 

The decision may be available before month's end and as Massrealestateblog.com said, "For interested legal observers of the foreclosure crisis, it really doesn't get any better than this".