More Bank Foreclosure Woes – The Ibanez Case

There is more news concerning banks and foreclosures. First, though it is not clear what this signifies, R.K. Arnold, the former CEO of MERS, has retired. Also, and the subject of this post, is an important Massachusetts court case which definitely has implications in that state for the foreclosure process going forward. It also appears to provide grounds in Massachusetts for anyone who has lost a house because of a foreclosure action to bring suit if there is reason to believe that the financial institution involved did not clearly hold the mortgage at the time of the foreclosure. It may also have implications for foreclosures in other states as other state courts consider the opinion of the Massachusetts Supreme Judicial Court.

U.S. Bank and Wells Fargo lost in their appeals to the Massachusetts Supreme Court of a lower court's ruling that the foreclosure sales of houses were invalid. The banks were the only bidders for the foreclosed properties; the two cases had been combined since they raised similar legal issues. The lower court ruled, and the Massachusetts Supreme Court agreed, that the foreclosures were improper because the banks could not show that they held the mortgages at the time of the foreclosures. These two cases, which do not appear to involve MERS, indicate that the paperwork problems of the banks will have real effects.

It is impossible to read the various filings in this case and not be appalled at the extraordinary sloppiness of the two banks with respect to these two home mortgage loans. The details of these cases and the arguments surrounding the issue are to be found in these filings. A list of them with links can be found at this blog post of "foreclosuresblues."

With respect to the sloppy paperwork, the brief filed for Ibanez quotes a lawyer for U.S. Bank telling the lower court in reply to a question concerning the legality of holding a foreclosure sale in the absence of an assignment of the mortgage as saying: "It was really never identified as a problem…admittedly, it's their own fault, the securitized industry, you know, has been caught with their 'pants down' so to speak…" Further, the lawyer for U.S. Bank is quoted as saying: "I tell you for our law firm we do just what you say, we have changed our practice…and we don't start the Notice of Sale process until we do the assignment and get it on record." (p.3 of Ibanez brief.)

The Attorney General of Massachusetts filed an amicus brief opposed to the banks. At the end of the brief, there is this observation: "As the Land Court points out, the banks were the only bidders at the foreclosure sales and they purchased these properties for less than the market values stated in their own appraisals, an advantage they may have gained because of the defects in their notices…This was particularly damaging to Mr. Ibanez, as U.S Bank bid for and purchased the Ibanez property for some $16,000 less than the amount of the outstanding loan, leaving a significant deficiency…Thus, the plaintiffs profited from the risks they took, at the expense of each of the borrowers. Having reaped the benefits of their casual attitude toward ensuring they possessed valid assignments of the mortgages, it is not unjust that plaintiffs should now bear the costs of their errors." (Martha Coakley is the Attorney General of Massachusetts. She lost an election to the U.S. Senate to Scott Brown for the seat held for years by Ted Kennedy.)

Felix Salmon of Reuters is wringing his hands over this decision in a January 7 post. He notes that the decision is retroactive, which may well prompt litigation in Massachusetts, and, while the decision only applies to that state, it will be looked at by the courts of other states. Salmon writes: "If a similar decision comes down in California, which is a non-recourse state, the resulting chaos could be massive. People who are current on their mortgage and perfectly capable of paying it could simply make the strategic decision to default, if and when they find out or suspect that the chain of title is broken somewhere. They would take a ding to their credit rating, but millions of people will happily accept a lower credit rating if they get a free house as part of the bargain."

It is not clear whether that is true. Presumably, even if the note and the mortgage have been separated, some entity does own the note, which may now be an unsecured loan. The ability of a creditor to compel payment on this note outside of bankruptcy probably differs from state to state; and, in bankruptcy, I would guess that the bankruptcy judge would have some latitude about how to deal with this.

But it is true that this poses a big problem for the banks. While the federal regulators are no doubt trying to figure out what they can do about this, they are faced with an important constraint – it is state law, not federal, which is relevant in these cases.

Salmon concludes – "Maybe we'll muddle through this somehow – that's still probably the base-case scenario. But maybe we won't. And if we don't, the downside here, to the banking system and to the economy as a whole, could hardly be larger." I suspect that Salmon's worst case scenario of wholesale defaults on mortgages by perfectly solvent homeowners who nevertheless are able to retain title and remain in their homes will be avoided, but there is plenty to worry about. That is not to say that the court was wrong in its decision; banks cannot be above the law. One result of this decision if other state courts with laws similar to those in Massachusetts come to similar conclusions is that it may encourage banks to pursue loan modifications more actively.

Meanwhile, in another case, the Massachusetts Supreme Court is considering whether people who bought houses which have been sold by financial institutions which did not have the right to foreclose on the properties are in fact owners of the houses they thought they had purchased.