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Federal Court In Pennsylvania Strikes At The Heart Of The Residential Mortgage System; Can Commercial Syndicated Loans And Mortgage Securitizations Survive Unscathed?

mondaq.com | July 11, 2014

By Timothy Anderson

On June 30, 2014, the United States District Court for the Eastern District of Pennsylvania issued an important decision on Pennsylvania's recording statutes in the case of Montgomery County, Pennsylvania, Recorder of Deeds, on its own behalf and on behalf of all others similarly situated v. MERSCORP, Inc., and Mortgage Electronic Registration Systems, Inc., No. 11-CV-6968 (E.D. Pa. 2014). Although the immediate effect of the decision is to eviscerate the electronic system for registering residential mortgages known as MERS, the reasoning (if upheld on the inevitable appeal) may affect syndicated loan transactions, the securitization of commercial mortgages, and the recording of documents in Pennsylvania generally.
The Montgomery County Recorder Case

The Recorder of Deeds of Montgomery County, Pennsylvania brought this lawsuit on behalf of herself and all other Pennsylvania recorders of deeds, alleging that MERS violates 21 P.S. §351, which provides that land conveyances shall be publicly recorded in the county recorder of deeds offices. The district court described the MERS system in residential mortgage finance transactions as follows:

MERS [is named] in the mortgage instrument, "as the mortgagee (as nominee for the lender and its successors and assigns)."... The attendant promissory note is sold on the secondary mortgage market and may, over its term, have many owners. Sale of the note onto the secondary mortgage market principally takes two forms. In one, relatively straightforward, transaction, a lender who retains a note as part of its own loan portfolio transfers the note to another party for that party to hold for its own account or portfolio. ... In the other, a more complex process called securitization, the note is transferred, along with many other notes, through several different entities into a special purpose vehicle, typically a trust; the trust then issues securities backed by the trust corpus, i.e., the notes, to investors. ... Regardless of the secondary market route which the note takes, MERS remains the named mortgagee as "nominee" for the subsequent owners of the note as long as the note is held by a MERS member.

The district court first announced that §351, and its predecessors as far back as 1863, make recording of conveyances mandatory. The court then acknowledged the contrary lines of Pennsylvania cases describing mortgages variously as conveyances or liens for different purposes. Citing Pines v. Farrell, 848 A.2d 94 (Pa. 2004), however, the district court found that mortgages and mortgage assignments (and mortgage satisfactions and releases) are conveyances subject to the recording mandate of §351. The district court then found that a mortgage and the note it secures are inseparable, such that a transfer of the note effects a transfer of the mortgage. Thus, the district court declared that the failure to create and record documents evidencing the transfers of promissory notes secured by mortgages on real estate in Pennsylvania violates §351. In a footnote, the district court volunteered that this failure also violates 21 P.S. §§444 and 621, the so-called "stale instrument statues," which require that conveyances be recorded within 90 days and mortgages be recorded within six months, respectively.

The Montgomery County Recorder case strikes at the heart of the modern system for selling residential mortgage loans on the secondary market. But how might it affect commercial syndicated loans and mortgage securitizations?

Commercial Syndicated Loans

A commercial syndicated loan is a credit facility that is provided by a group of lenders and is structured, arranged and administered by one or several banks, one of which is the "lead bank" and also a lender. The lead bank serves as the collateral agent for the lenders and is named as the mortgagee, for the benefit of the lenders, on any mortgage securing the loan. The original lenders are not named in the mortgage and their interests in the loan may be transferred on a secondary market. Loan sales on the secondary market generally contemplate transfer of all of the rights and obligations of the lenders in the credit facility, including all rights under any collateral documents such as mortgages. The lenders are not named in the mortgage and the mortgagee remains the same notwithstanding transfers. As a result, the secondary loan market does not treat the transfer of rights as an assignment of the mortgage itself.

Unlike the residential MERS system, there is no electronic book entry system for tracking the ownership of commercial secured debt and no club that lenders must join to participate in the ownership and trading of commercial mortgage debt. But in other respects, a commercial syndicated loan is very much like a MERS residential loan. Like MERS in the residential system, the collateral agent in the syndicated loan market serves as the agent for lenders. Like the notes in the residential system, the lenders' interests in the syndicated loan transfer freely and remain secured by the mortgage notwithstanding transfers. Under the reasoning of the district court that the obligation and the mortgage are inseparable, the failure to create and record documents evidencing the transfers of interests in the syndicated loan could be argued to violate §351 and the stale instrument statutes.

Commercial Mortgage Securitizations

In commercial mortgage securitizations, loans secured by mortgages are originated by a lender. The loans and mortgages are then pooled and transferred to a trust. The trust issues series of rated bonds that may vary in yield, duration and payment priority. Payments of principal and interest on the pooled loans are paid to the bondholders, starting with those holding the highest-rated bonds, then to the holders of the next-highest-rated bonds, and so on. If there is a shortfall in contractual loan payments from the borrowers, or if the trustee liquidates the mortgaged property and does not generate sufficient proceeds to meet payments on all bond classes, the holders of the highest-rated bonds are paid first.

Although the mortgages may be assigned of record to a trust, and assignments are often executed and held for recording if necessary, the parties typically rely on the provisions of Article 9 of the Uniform Commercial Code (UCC), which define a "security interest" to include the sale of a promissory note, and govern the "attachment" and "perfection" of a sale of a promissory note and of the liens and security interests that secure it, including a mortgage. Sections 9-203(g) and 9-308(e) of the Pennsylvania UCC, taken together, provide that to the extent a mortgage secures a promissory note, if a party takes the steps necessary under the UCC to acquire a perfected security interest in (which in this context includes assignment of) the promissory note, that party acquires a perfected security interest in (i.e., an assignment of) the related mortgage. Article 9 allows for automatic perfection of a purchaser's interest in a promissory note by the filing of a financing statement or possession of the promissory note by the secured creditor. Therefore, solely under Article 9 of the UCC, recordation of an assignment of mortgage is not considered necessary to create or perfect a security interest in a mortgage securing a note against claims of purchasers from or creditors of the assignor of the note and mortgage. Since these provisions of Article 9 of the UCC, as currently codified, were enacted after §351 and the stale instrument statutes, it can be argued that Article 9 repealed §351 and the stale instrument statutes for transactions covered by Article 9.

The district court in the Montgomery County Recorder case was not presented with this argument. The district court did, however, mention §9-203(g) of the Pennsylvania UCC as being in accord with the general proposition that a mortgage and the note it secures are inseparable. Following the district court's logic, therefore, assigning a promissory note and mortgage by delivering the note to the trustee and filing a financing statement, without also assigning the mortgage of record, would violate §351 and the stale instrument statutes.

Unanswered Questions

An appeal of the district court's decision in the Montgomery County Recorder case is inevitable. A stay pending appeal is likely. The MERS system is at stake, at least in states that treat mortgages and assignments of such mortgages as conveyances, the recording of which is mandatory. If the district court's decision is upheld on appeal, there remain questions of implementation. Should mortgage assignments be recorded retroactively? If a mortgage assignment is tendered for a transfer that is stale, will the recorder reject it under the stale instrument statutes? (The same questions apply to omitted assignments in syndicated loans and mortgage securitizations.) Will Congress step in and impose uniform rules under the Commerce Clause? If so, will the Supreme Court allow the federalization of state real estate law? Will the Pennsylvania General Assembly step in and amend the recording and stale instrument statutes?

Also unanswered are broader questions about the recording of documents other than mortgages. The Montgomery County Recorder case is a rare reference to the recording and stale instrument statutes, other than decisions on the competing rights of holders of unrecorded interests versus good-faith purchasers for value. How do these statutes apply to real estate transactions generally? Deeds, memoranda of lease and other documents are often placed in escrow for long periods of time, or withheld from recording for one reason or another. If they are tendered for recording more than 90 days after the notarial acknowledgment, should the recorder reject them? A good argument can be made that the date of delivery is the relevant date for starting the 90-day clock, but how will the recorder know the date of delivery? Are there drafting techniques to avoid rejection of documents as stale?


The Montgomery County Recorder case is about recording fees. But the court's reasoning could destroy the viability of (or at least cast a long shadow over) loan structures in which mortgages are held by agents and trustees.


Back to July 2014 Archive

CFLA was founded by the Nation's Leading Foreclosure Defense Attorneys back in 2007 to serve the Foreclosure Defense Industry and fight pervasive Bank Fraud. Since opening our virtual doors, CFLA has rapidly expanded to become the premier online legal destination for small businesses and consumers. But as the company continues to grow, we're careful to hold true to our original vision. For us, putting the law within reach of millions of people is more than just a novel idea—it's the founding principle, just ask Andrew P. Lehman, J.D.. With convenient locations in Houston and Los Angeles, you can contact Our National Account Specialist and General Manager / Member Damion W. Emholtz at 888-758-2352 for a free Mortgage Fraud Analysis or to obtain samples of work product, including cutting edge Bloomberg Securitization Audits, Litigation Support, Quiet Title Packages, and for more information about our Nationally Accredited and U.S. Department of Education Approved "Mortgage Securitization Analyst Training Certification" Classes (3 days) 24 hours for approved CLE & MCLE Credit (Now Available Online).

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