Secured Claims: MERS Strikes Again, Or Maybe Not

Tamir v. U. S. Trustee, 566 B.R. 278 (D. Me. 2016)

A chapter 11 debtor filed objections to proofs of claim filed by holders of his mortgage notes. He argued that the banks did not have secured claims because under state law they did not have standing to foreclose the related mortgages. After the bankruptcy court found in favor of the banks, the debtor appealed.

This case involved MERS (Mortgage Electronic Registration Systems) mortgages. MERS was designed to facilitate residential mortgage transactions by allowing lenders to track their mortgage portfolio transactions through registration with MERS. They avoided the need to record individual mortgage assignments in the land records by instead recording a mortgage identifying MERS as nominee for the lender as the mortgagee. In theory that is all that is required as long as the mortgage is held by a participant in the MERS system (at least until it comes time to enforce the mortgage).

However, use of a nominee to hold title has run into resistance in a number of jurisdictions – giving rise to a variety of state legal issues. This is relevant in bankruptcy because generally courts look to state law to define property rights. In this case the applicable state supreme court held that a party holding a mortgage solely by virtue of a MERS assignment did not have standing to foreclose the mortgage. According to the state supreme court, under the MERS form of mortgage MERS only had the authority to record the mortgage, not to assign it. Therefore, if the foreclosing lender’s ownership of the mortgage was based solely on a MERS assignment, the lender did not qualify as a “mortgagee” and thus did not have standing to foreclose.

Thus the issue in this appeal was whether the state supreme court opinion prevented a creditor from having a secured claim if its claim was secured by a mortgage that was assigned from MERS.

The debtor argued that the lenders could not hold secured claims since they lacked standing to foreclose (given that they held their mortgages as a result of MERS assignments). The bankruptcy court concluded that standing to foreclose did not determine the validity of a secured mortgage claim. Rather the noteholder’s beneficial ownership of the mortgage was sufficient.

On appeal the district court first addressed whether the debtor had standing. Bankruptcy (as opposed to Article III) standing requires that a person be “aggrieved” – meaning “one whose property is diminished, burdens are increased, or rights are impaired by order on appeal.” The it is often an issue in the case of a chapter 7 debtor. For example, they generally don’t have standing to object to an order regarding distribution of assets as they do not usually have a pecuniary interest.

However, the “paramount objective” of a chapter 11 is to reorganize and emerge from bankruptcy as profitable, and the status of a claim as secured or unsecured has significant consequences for that goal. A secured creditor has a number of advantages, such as the right to adequate protection, opportunity to request stay relief if the security is in jeopardy, payment of postpetition interest and attorney fees if the claim is over secured, and special protections in the case of a “cram down.” The court had no difficulty finding that the debtor had standing to appeal.

The debtor did not fare so well on his argument that the secured claims were unenforceable and should be disallowed because the creditors lacked standing to foreclose.

As a threshold matter the court noted that a mortgage note was a negotiable interest. Thus the enforceability of the banks’ interests in their notes was governed by the state Uniform Commercial Code. The court concluded that the banks had a right to enforce the notes. Even the debtor conceded that the banks had a right to payment. Thus they held allowed claims, and the only question was whether they were secured claims.

Under section 506 of the Bankruptcy Code “[a]n allowed claim of a creditor secured by a lien on property in which the estate has an interest… Is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property.” Further, “lien” is defined as a “charge against an interest in property to secure payment of adapter performance of an obligation.”

Under state case law separation of the mortgage and the note did not void either instrument. Rather if a note secured by a mortgage is transferred, the mortgagee and all claiming through it hold title in trust for the holder of the note. Further the state UCC “codifies the common-law rule that a transfer of an obligation secured by a security interest or other lien on personal or real property also transfers the security interest or lien.”

So the short answer to the question of how the state supreme court case on foreclosure standing affected the banks’ secured status was: “it does not.” Just because the banks might not have standing to foreclose their mortgages did not mean their secured claims were invalid. Accordingly the district court affirmed the bankruptcy court.

While the hope was that MERS would fulfill the same function for real estate mortgages that Cede & Co. does securities, in many instances the vagaries of state specific real estate law have thwarted that goal.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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