Residential Foreclosure Developments: Why We May See More Lawsuits and Settlements

Recent legal events may encourage more settlement of residential trust deed foreclosures or lead more lenders to sue borrowers whose real estate loans are in default, rather than proceed with trustee’s sales. These events include the Mortgage Electronic Registration Systems, Inc. (“MERS”) cases and the imposition of mandatory mediation statutes. Before discussing the impact of those events, let’s look at a few basics about mortgages and trust deeds.

1. Mortgages and Trust Deeds

Both mortgages and trust deeds are used to secure loans with real property. Trust deeds are more flexible, in Oregon, because a trust deed can be foreclosed in a lawsuit, like a mortgage, or by the trustee’s advertisement and sale. As a result of this flexibility, trust deeds have been the instrument of choice for loans in Oregon for decades. The chart below contrasts foreclosures by judicial proceeding or advertisement and sale.

Generally, at times when lenders have the capacity to deal with foreclosed property, lenders prefer predictability and a quick timetable. That favors proceeding with a trustee’s advertisement and sale pursuant to a trust deed. To the extent a lender is concerned that the value of the property is insufficient to recover the amount of the debt and the lender believes that the borrower has other sources of repayment of the balance of the debt, the lender may wish to pursue a judicial sale so that the lender will have the opportunity to pursue the deficiency against the debtor. For residential loans, because there is no deficiency allowed, that is never an issue.

Until recently, the low cost and quick speed of a foreclosure by advertisement and sale were factors that weighed heavily in lenders proceeding that way. What has changed?

2. MERS

MERS was created by the mortgage banking industry. Before MERS, a trust deed would recite that the borrower conveyed the property to the trustee who held title to the property as security, only, for the beneficiary, who was the lender. The lender often sold the note and trust deed. A document reflecting the assignment of the note and trust deed to the assignee would then be recorded. Any person could check the real estate records and see that the note originally given in favor of the lender and the trust deed had been assigned by the lender to an assignee. The assignee could reassign the note to others, with similar assignments recorded to reflect each reassignment. MERS changed this.

With MERS, the trust deed now generally reflects that the borrower conveys the property to the trustee as security for a note that the borrower gave to the lender. But the trust deed does not identify the lender as the beneficiary. It identifies MERS as the beneficiary, as the nominee for the lender Assignments of the trust deed do not occur. MERS keeps track of who owns the note. The MERS system enabled easier sales of the notes without any recording, in the state recording systems, of who had acquired the note. This reduced recording fees. However, it made it difficult, if not impossible, for the borrower or any other person to be able to track who holds the note.

3. MERS Foreclosures

As noted earlier, foreclosing by advertisement and sale is generally quicker and cheaper than a lawsuit. The particulars with regard to a trustee’s advertisement and sale are controlled by statutes in the state where the property is located. Those statutes vary somewhat from state to state. But the beneficiary decides whether to proceed with advertisement and sale. Traditionally, the holder of the note was either the original beneficiary or a successor beneficiary by virtue of a recorded assignment.

In order for MERS to be able to use advertisement and sale to foreclose, MERS’ position is that although it is not the person to whom the debt is owed, it is the beneficiary. This position has been rejected in Oregon and Washington. As a result, MERS cannot instigate foreclosures by advertisement and sale in those states. The Oregon Court of Appeals, on July 18, 2012, in Niday v. GMAC Mortgage, held that the beneficiary is the person to whom the monies are owed. That is the person for whose benefit the trust deed is given. The Oregon Supreme Court is reviewing that decision and has also been asked to determine if MERS is an appropriate beneficiary under the Oregon Trust Deed Act in a request from the US District Court for the District of Oregon.

The Washington Supreme Court in Kirstin v. MERS, decided on August 16, 2012, held that MERS is not a beneficiary because it is not the holder of the note. In essence, the decision is the same as the Oregon Court of Appeals. However, with the Washington Supreme Court being the highest court in that state, that decision is the law in Washington unless and until the Washington legislature passes a new law. In Oregon, we await our Supreme Court’s decision.

Other states don’t yet have a final decision. There are states where the ability of MERS to proceed with foreclosures on an advertisement and sale basis has not yet been halted and may not be. Nationally, the picture is muddy. Since the decisions are based on state law and the state statutes vary, we will likely face a myriad of decisions.

MERS loans are still “foreclosable,” but not by advertisement and sale. Both the Oregon Court of Appeals and the Washington Supreme Court, while concluding that MERS is not a beneficiary who can proceed with foreclosure by advertisement and sale, have expressly stated that that does not mean that the loans in which MERS is involved cannot be foreclosed judicially. Judicial foreclosures of mortgages are not creatures of statute like foreclosures by advertisement and sale. It appears very likely that MERS can foreclose judicially.

But, as discussed above, judicial foreclosure means more time and more expense. For assigned notes, which is most cases, if there are business records kept which reflect the assignments of the notes, judicial foreclosures could proceed, with records establishing the assignments being part of the evidence in the case. However, there may be situations where some of the intervening assignments have not been well documented. That may result in more witnesses or other evidence and, of course, even more time and expense, to make the required proof.

In the end, a process that would have required preparing and filing and serving documents and waiting 120 days to do an oral auction on the steps of the courthouse becomes a process of preparing and serving a lawsuit, dealing with discovery, filing a motion for summary judgment, perhaps having to go through trial, then obtaining a judgment which grants a short period (e.g. 30-60 days) for the debtor to pay off the debt, then allows the sheriff to sell the property, followed by the debtor having six months more to redeem the property. The additional cost and time and risk of adverse decision, depending on the facts of each case, makes judicial foreclosure far more burdensome to lenders.

4. Mandatory Mediation

To add to the situation, states have been enacting measures requiring mandatory mediation before a trustee can foreclose residential trust deeds by advertisement and sale. In Oregon, Senate Bill 1552 created a mandatory residential trust deed foreclosure mediation system. It affects lenders who have commenced more than 250 foreclosures of residences by advertisement and sale in the prior year. The lender and borrower meet with a mediator, with various documents required to be provided as part of the mediation. The lender must pay an additional $100 fee for filing of the notice of default. The Bill exposes a lender to fines for failure to comply. It adds time and expense. In short, it decreases the incentive for a lender to proceed non-judicially. This adds to the pressure from the MERS problems, for large scale lenders to simply go direct to judicial foreclosure, though it may also push lenders to the alternatives discussed below.

Mandatory foreclosure mediation statutes have an intended and very direct and substantial impact on large scale lenders. However, small lenders get caught, too. Lenders who lend occasionally and take trust deeds on homes of their borrowers may still have to deal with burdens from the mandatory foreclosure mediation program. While lenders who do not do 250 foreclosures by advertisement and sale in a year are exempt from the program, they must prepare exemption documents and file them appropriately and timely. If they fail to timely or appropriately file or make a mistake in the document, the foreclosure may not be valid. As a result, title insurers may be unwilling to insure title to property foreclosed by exempt lenders without some proof of the proper filing of the exemption document. What constitutes such proof remains to be established.

So, even for the small lender, the burden of proceeding with foreclosure by advertisement and sale has become greater and a judicial foreclosure may give the small lender more confidence.

5. Alternatives/Opportunities

If Lenders have to proceed with judicial foreclosures, their costs increase dramatically, both in terms of out-of-pocket expenditures and delay in being able to offer foreclosed homes to new purchasers. That should lead lenders to look for means to resolve these troubled loans and avoid that cost and delay. Lenders might be expected to be more open to short sales and to deeds in lieu of foreclosure. To the extent possible, they may also be more open to adjustment of loans. But the volume of loans in default, for a large lender, could, notwithstanding the additional time and cost, lead a large lender to conclude that it is easier to start foreclosure lawsuits and then particularly address only those where the borrower is motivated enough to appear and defend.

6. Conclusion

The impact of the MERS cases in Oregon and Washington, and mandatory mediation, dramatically reduces the opportunity for large lenders to foreclosure residential loans by advertisement and sale. It remains to be seen whether the effect is to encourage alternative resolutions of defaulting residential loans, or a massive increase in the number of lawsuits seeking foreclosure.

Alan brings more than 30 years of experience as an attorney, arbitrator and mediator to serve his real estate industry clients. A skilled mediator, he also works to bring opposing parties together to resolve disputes outside of the courtroom. You can contact Alan directly a AMS@SamuelsLaw.com.

Accessibility