On August 28, 2009 the Kansas Supreme Court handed foreclosure advocates a major victory in the case Landmark National Bank v. Kesler.  The decision appears to be a fairly wonkish and dryly academic legal essay–and it is–but the implications could be monumental and could have some effect on more than 60 million mortgages in the United States.

Warning to the non-lawyer:  What follows is a somewhat technical discussion, and is probably more appropriate for lawyers or other mortgage industry professionals. The upshot of the Kansas decision is, well, it’s too soon to tell. It is clear that the MERS problem is growing, and will likely require some significant mortgage industry intervention to fix. Whether this decision offers any help to any particular person will depend on your situation. Obviously, a decision by the Kansas Supreme Court is binding only on Kansas courts, but this is a significant decision and may influence courts in other states. To my knowledge, no California court has yet dealt with the problem head on, though there have been some trial court decisions. (See, for example, Saxon Mortgage Services v. Ruthie B. Hillery, USDC, ND Cal. case no. C-08-4357 EMC. This decision is unpublished and not binding on any court, but it does suggest activity in the Northern District, and is probably just the beginning.)

So with that disclaimer out of the way…first some background.

MERS stands for Mortgage Electronic Registration System, and is a privately owned company that purports to acts as a “nominee” for millions of loans originated by lenders around the country.   (For the MERS home page, go here.  For a Wikipedia post on what MERS is, go here.)  I say “purports,” because that relationship is increasingly under attack in courtrooms great and small around the USA. Notably, the case referred to above, Landmark National Bank v. KeslerKansas Supreme Court, Case No. 98,489.

MERS was created in an attempt to simply the processes by which loans and mortgages are sold, securitized, assigned and enforced.  Basically the idea was to create a single “nominee” that would act in the place and stead of any one lender, so that when the need to enforce the loan terms or foreclose on the mortgage arose, the lenders wouldn’t have to chase around figuring out who owned what notes; they could just have MERS handle the entire transaction.

The Kansas Court, quoting a Nebraska court, described MERS as follows:

MERS is a private corporation that administers the MERS System, a national electronic registry that tracks the transfer of ownership interests and servicing rights in mortgage loans. Through the MERS System, MERS becomes the mortgagee of record for participating members through assignment of the members’ interests to MERS. MERS is listed as the grantee in the official records maintained at county register of deeds offices. The lenders retain the promissory notes, as well as the servicing rights to the mortgages. The lenders can then sell these interests to investors without having to record the transaction in the public record. MERS is compensated for its services through fees charged to participating MERS members.” Mortgage Elec. Reg. Sys., Inc. v. Nebraska Depart. of Banking, 270 Neb. 529, 530, 704 N.W.2d 784 (2005)

Good idea in principle. The problem that has come to the fore, however, is that MERS doesn’t actually own anything; it is just a named agent with a contractual power to enforce. And this is the problem that the Kansas Supreme Court  addressed…and which has more than a few mortgage-industry Chicken Little-sorts presaging that the sky will be falling soon.

The crux of the problem seems to be the pesky requirement that borrowers are entitled to know the identity of the person or lender to whom they owe money. That doesn’t seem unreasonable. If Larry lends money to Bob, and takes a promissory note, and Larry later sells that Note to Artie, Bob is entitled to know that, and only Artie can have the legal right to enforce the Note. If Bob has a problem with his loan, he needs to know the actual identity of the person with whom is in in a contractual relationship.

But the MERS system essentially does an end run around that requirement by saying that, “since we put MERS into the original note and deed of trust as a lender nominee, we don’t need to satisfy those notice and registration requirements. Courts around the country are increasingly saying “foul” top that arrangement.

Again, quoting from portions of the Landmark decision, in which that court quotes from other courts around the country…

The legal status of a nominee, then, depends on the context of the relationship of the nominee to its principal. Various courts have interpreted the relationship of MERS and the lender as an agency relationship. See In re Sheridan, ___ B.R. ___, 2009 WL 631355, at page 4 (Bankr. D. Idaho March 12, 2009) (MERS “acts not on its own account. Its capacity is representative.”); Mortgage Elec. Registration System, Inc. v. Southwest, ___ Ark. ___, ___, ___ S.W.3d ___, 2009 WL 723182 (March 19, 2009) (“MERS, by the terms of the deed of trust, and its own stated purposes, was the lender’s agent”); LaSalle Bank Nat. Ass’n v. Lamy, 2006 WL 2251721, at *2 (N.Y. Sup. 2006) (unpublished opinion) (“A nominee of the owner of a note and mortgage may not effectively assign the note and mortgage to another for want of an ownership interest in said note and mortgage by the nominee.”)

The relationship that MERS has to Sovereign is more akin to that of a straw man than to a party possessing all the rights given a buyer. A mortgagee and a lender have intertwined rights that defy a clear separation of interests, especially when such a purported separation relies on ambiguous contractual language. The law generally understands that a mortgagee is not distinct from a lender: a mortgagee is “[o]ne to whom property is mortgaged: the mortgage creditor, or lender.” Black’s Law Dictionary 1034 (8th ed. 2004). By statute, assignment of the mortgage carries with it the assignment of the debt. K.S.A. 58-2323. Although MERS asserts that, under some situations, the mortgage document purports to give it the same rights as the lender, the document consistently refers only to rights of the lender, including rights to receive notice of litigation, to collect payments, and to enforce the debt obligation. The document consistently limits MERS to acting “solely” as the nominee of the lender.

Indeed, in the event that a mortgage loan somehow separates interests of the note and the deed of trust, with the deed of trust lying with some independent entity, the mortgage may become unenforceable.

“The practical effect of splitting the deed of trust from the promissory note is to make it impossible for the holder of the note to foreclose, unless the holder of the deed of trust is the agent of the holder of the note. [Citation omitted.] Without the agency relationship, the person holding only the note lacks the power to foreclose in the event of default. The person holding only the deed of trust will never experience default because only the holder of the note is entitled to payment of the underlying obligation. [Citation omitted.] The mortgage loan becomes ineffectual when the note holder did not also hold the deed of trust.” Bellistri v. Ocwen Loan Servicing, LLC, 284 S.W.3d 619, 623 (Mo. App. 2009).

The Arkansas Supreme Court has noted:

“The only recorded document provides notice that [the original lender] is the lender and, therefore, MERS’s principal. MERS asserts [the original lender] is not its principal. Yet no other lender recorded its interest as an assignee of [the original lender]. Permitting an agent such as MERS purports to be to step in and act without a recorded lender directing its action would wreak havoc on notice in this state.” Southwest Homes, ___ Ark. at ___.

In any event, the legislature has established a registration requirement for parties that desire service of notice of litigation involving real property interests. It is not the duty of this court to criticize the legislature or to substitute its view on economic or social policy. Samsel v. Wheeler Transport Services, Inc., 246 Kan. 336, 348, 789 P.2d 541 (1990).

Essentially, the Court is saying that MERS has no rights to enforce. Of course, that could wind up being an overbroad interpretation, but the drums are beating nonetheless.  More will be revealed.

One of the best options for people facing foreclosure is the “deed in lieu of foreclosure,” or as it’s more frequently referred to, “deed in lieu.”

Essentially, this is the fancy legal term for what most folks would describe as “mailing the keys to the lender,” or as it’s being called lately, “jingle mail.”  Giving the the house back to the bank instead of waiting for it to foreclose.  There are some good reasons for doing this if you have the option.

The best reason for doing it is that you avoid any risk of the lender seeking a deficiency judgment for the amount by which the loan balance exceeds the property value.  (That’s assuming the lender has that right, which, in most cases in California at least, they probably don’t.  But that’s a whole different issue and beyond the scope of this post.)  The reason is that the deed in lieu documentation will include a release…That’s the quid pro quo that you get from the lender in exchange for saving themthe cost, legal expenses, time and procedural brain damage of having to go through the foreclosure process.   This is critical:  Do NOT do a deed in lieu if you don’t get the release!!!

The other good reason is that it expedites what is a painful and stressful process that most people would rather avoid.  You can be in and out fairly quick.

However, generally, it won’t work if you have more than one loan.  The reason is that, by taking the property by deed, rather than by foreclosure, the lender accepting the deed takes subject to the continuing obligation to pay any other existing encumbrances.  This is true whether the lender is in first, second or third position; if you get deeded a property, you take subject to the continuing obligation to pay other existing loans which are still of record.  In this current environment, most people have two or more loans, making the deed in lieu an impossibility. The foreclosure process actually wipes out junior deeds of trusts, or loans.

So if you’re considering a deed in lieu, or if some cocktail party lawyer has suggested it, before getting too excited about it, the two big questions to answer are whether you need it, or whether it is even possible.

There’s an old saying: Beware of Greeks bearing gifts.  It refers to the Trojan horse that the Greek army used to trick its way into Troy during the Trojan War.  It has come to refer to situations and people that hide fraud and trickery behind a friendly and perhaps even generous demeanor.

The hottest new business in California?  One guess….  Mortgage modification.  Everyone and their brother is now opening up “mortgage modification” companies.   They appear friendly and eager to “help you save your home,” but be careful.

For instance, one I recently heard about is American Home Mortgage Servicing Company.  This company is not licensed as a real estate broker by the California Department of Real Estate. (If you want to check whether the company that is pitching you to modify your mortgage is a licensed real estate broker, use the DRE license check tool here.) Therefore, it is not a licensed “mortgage broker” and is thus not legally licensed to modify mortgages.  It is not a law firm.  It is not a non-profit credit counselor.  In fact, a little research reveals that it is nothing but a debt collector.  An unlicensed debt collector phishing for people with financial difficulties, which it refer to as “customers.”  (For reasons unknown, California doesn’t require debt collectors to be licensed any more.  It does, however, require them to comply with the California Fair Debt Collection Practices Act.)

Do what I did.  Call their toll free number.  Once you get past the language preference, the first thing on the tape is:  “American Home Mortgage Servicing Company is a debt collector and may record and/or monitor calls.”  Then, follow the various links on their website as if you are looking to modify your mortgage. You will eventually wind up on a form that you need to fill out and return to them. Do not do this. This form is designed to solicit highly confidential financial information from you which will, in all likelihood, be used against you in the event that you default on your mortgage.

There is no need to provide this information at this stage of the conversation with anyone.  (I’m a bankruptcy attorney subject to very strict rules of confidentiality.  I usually have very good reasons to request this information from clients.  Yet I never solicit this level of detail from prospective clients until they are an actual client and I have a rational and business-related reason for collecting this information.)  How do I know this isn’t a bona fide form for dealing with a mortgage modification? Look at it.  It doesn’t even ask who your lender is.  How are they going to modify a loan or provide you with advice and an opinion on the criteria required to modify the loan if they don’t know who the lender is?  (Lenders’ criteria for modification are not uniform, and a loan that one lender may modify may not qualify under another lender’s program.)

Here’s the fact:  No one has authority to modify your mortgage except you and your mortgage lender.  Anyone who claims to be able to assist you in modifying your mortgage but doesn’t ask who holds that mortgage right out of the chute is probably up to something very different.  Fortunately, these people tell you: They are “debt collectors.”   I wouldn’t give them the name of my dog without a written disclosure of who they represent, what they are actually authorized to do and a written representation from them as to what exactly is going to be done with the information I provide them. I suspect that if you call them and make this demand as a precondition to your giving them any confidential financial information, they will hang up on you.

Who are these people?  Are they licensed? Are they supposed to be?  Who’s regulating these guys?

In short, no one. It’s the Wild Wild West.  The California Department of Real Estate is supposed be on it, but in practical reality, it looks more like substitute teacher day in 5th Grade, erasers flying, tongues wagging, the whole works.  And who can blame the CDRE?  They’re overwhelmed.  So it will fall on the consumer.  If you try to do this without counsel, make sure that the person you’re dealing with knows what she is doing and that you’re protected.

Here are the rules, at least regarding licensing:

First, in order to function as a “mortgage modification company” in California the company must first be licensed as a “real estate broker” by the California Department of Real Estate.  (California does not have a separate licensing category for “mortgage brokers” nor for “mortgage modifiers.”) Modifying a mortgage is essentially the functional equivalent of originating a mortgage, so the same licensing rules prevail.  (Here’s an interesting opportunity to get a fly-on-the-wall ear to brokers talking to each other about this topic.)

Next, in order to collect any fee in advance for “mortgage modification” services, the entity must be licensed by the DRE and must submit its contract for services for approval to the DRE.  So if someone tells you they’re a “mortgage modifier” and wants you to pay them for providing those services, first demand their DRE brokers’ license number and then check the DRE website to see if their contract has been approved yet by the DRE.  If it hasn’t, then tell them you’ll pay them if and when they get a result for you.

[Update:  Effective July 1, 2009, it is unlawful for a foreclosure consultant, as defined in Civil Code Section 2945.1 to engage in the foreclosure consultant business unless it has registered with the Attorney General’s Office at:  http://www.ag.ca.gov/register.php. All foreclosure consultants operating in California must post a $100,000 bond and register with Attorney General’s Office by July 1, 2009.  There is list of companies whose agreement has been approved. It’s very short. You can find it on this rather hard to find site called California Foreclosure Prevention Act.   There is also a list of companies that have not been approved by the Attorney General, although that strikes me as sort of foolish.  Given that scam artists work pretty hard to cut a low profile, its a bit like saying “raise your hand if you’re not here.”]

American Home Mortgage Servicing is not on that list.  American Home Mortgage Servicing is also not a licensed real estate broker in the State of California.  In fact, American Home Mortgage Servicing does not appear to be licensed to do anything more complicated than exist in the State of California.  And it’s a Delaware corporation so it’s not even domiciled here.  (Debt collectors no longer need to be licensed in California.)

(Here’s a link to the California Attorney General’s recent online posting about how to avoid being ripped off by foreclosure rescue scams.   And here’s another article/consumer warning by the DRE about scams offering to “cut your home payments in half.”)

There is a growing number of unscrupulous people out there right now looking to take advantage of people who are in financial extremis.  There are also tons of folks who, while maybe not slimeballs, are woefully unqualified to “modify” anything more complicated than a typo on a spelling test.

Current statistics suggest that only 5% of the people who attempt to modify their mortgages are actually succeeding right now, and of those? More than 50% re-default in the first 6 months!  I’m not going to blame all of that on slimeballs and idiots, but I can’t think of any argument that suggests that the presence of opportunistic and unscrupulous slimeballs and idiots posing as “mortgage modifiers” is helping matters.

But there are also a lot of good, qualified and experienced people who want to help, who charge a reasonable fee and who know what they’re doing.  (And I absolutely guarantee you that they don’t refer to themselves on their voicemail as “debt collectors.”) Some are mortgage brokers, some are attorneys, some are credit counselors.  None are debt collectors.   Look for non-profit credit counselors as a start.

I’m not suggesting that everyone who wants to investigate mortgage modification hire an attorney. But at least do a little homework and make sure the person or company you hire is qualified and licensed.  If they disclose that they are “debt collectors” run the other way.  Such people have nothing of value to offer you.

Now, I don’t mean to be overly flippant or anything, nor to be accused of promoting “irresponsible behavior” by advocating that people walk away from valid and legitimate debts, but I have to say that the single most effective “mortgage modification” tool for most borrowers these days is found the United States Bankruptcy Code.

So here–with a nod to Letterman for borrowed style points–counting backwards from 10 to 1, are the Top 10 Reasons why, more often than not, I advocate filing a bankruptcy petition instead of incurring the brain damage of trying to deal with banks.

(Lawyerly or, the obligatory “all things being equal” caveat:  This is true in many, but not all cases, and I’m assuming that the borrower has a fair and real choice between these two options.  Like with ANY legal remedy, it has to make sense for your particular circumstances, and, of course, the numbers have to crunch.   Bankruptcy is a technical and specialized area of law, so the decision should be made neither lightly, nor without expert guidance.  Things may also change over the coming months when–or more accurately, if–the lending industry gets its “mortgage modification” act together and actually raises their success ratio to something more respectable.  As it is now, in some areas, the default rate is as high (around 5%) as the “mortgage modification” success rate is low.  That’s a disgrace.

Anyhow, on with the Top 10 List.

10.    Bankruptcy doesn’t require you to bare your soul to some faceless, nameless banker only to have them tell you you’re not “qualified” for their mortgage modification program.  Of course, this is inane to start with:  If a borrower was “qualified” for the unaffordable, predatory loan that got them into the dilemma in the first place, how could they not be “qualified” for something more affordable now?   This is “bank logic” talking.  And it’s “bank logic” that caused this mess to begin with.  Arguing YOUR personal finance with a banker is like arguing about Halloween candy with an 8-year old. Generally, you can’t win this argument so why have it?  (For an absolutely classic example of this  absurd paradigm in action, check out this story on MSNBC.)

Recent reports suggest that only about 5% of attempted mortgage modifications are actually succeeding.  Success being defined as a negotiation that concludes with a new, supposedly more affordable mortgage. What about the other 95%?

First of all, the bank has probably squeezed another few months of interest payments out of the borrower as they strung them along leading you to believe that your “application” for a modification was being seriously considered.  And second, all the information you worked so hard to assemble for your banker will now to go into your “file,” to be used for who-knows-what-purpose.  Since I’m a lawyer, I’m paranoid by habit and profession.  I assume it goes into storage to be be puled out and used against you later when when the bank decides to sue you for a deficiency.

9. The lender doesn’t get a vote.  Generally, if you file a bankruptcy petition with a goal being to jettison a burdensome and onerous mortgage, barring something going seriously awry, you’re going to achieve that goal.  No matter what the bank has to say about it.  In the vast majority of cases, they don’t get to vote.

8. Bankruptcy is faster and will get you back on the road to financial recovery much faster than a bank sponsored “mortgage modification.”  Chapter 7 can be over and done with in as little as 3 to 4 months.  Chapter 13 can have you in an affordable payment plan even sooner.  In order to even qualify for a “mortgage modification” program right now, in most instances, you need to be at least 60 to 90 days delinquent before they’ll even talk to you.

Then, after you’ve prostrated yourself on the altar of some Loan Modification Committee of Third National Bank of Timbuktu trying to get a modification approved, or worse, had to deal with some newly minted “loss mitigation specialist,” you are likely to wait for another 3 to 6 months for any word.  Why?  Because they are up to their eyeballs in “loan modification requests” and they are noteager to make those painful modifications.  Banks are not modifying loans because they think it’s a good idea; they’re doing it because they have no choice.  But if they can suck a few more months of interest out of you then, in the bankers’ logic, they’re making lemonade out of lemons. It’s a get-what-we-can-while-we-can mentality.  If your financial statement leads them to believe that you’re a likely Chapter 7 candidate anyhow, it’s in their best interests to recover as much as they can before that happens.

7.     It’s (probably) cheaper.  This is a hard one to be sure of, but if you hire an attorney (or worse, one of these new “loan modification companies” that are popping up like weeds these days) to try to assist you with a mortgage modification application, and then pay him or her to run all that interference for you, your final bill is likely to be significant.  (And don’t shop for a mortgage banking/loan workout lawyer based on the low bidder.  You get what you pay for in the legal profession and there aren’t a whole lot of low cost lawyers who understand the law of mortgage and real estate finance.  (Mortgage, bankruptcy and insolvency law is not a first offense DUI or uncontested divorce where pretty much anyone with a bar card can get you through the process.  In banking law you get what you will get what pay for.)

In bankruptcy, most attorneys charge a fixed fee for taking the client all the way through the process, and those fees are subject to the approval (and possible adjustment) by the Bankruptcy Court.  Filing fees are relatively cheap, at present, $299 for a Chapter 7 and $234 for a Chapter 13.

Paying an attorney to try to get a home loan modification approved is tantamount to handing over a blank check.  As much as I love my profession and trust in the utmost integrity of my fellow members of the bar, only a fool gives a lawyer a blank check.

6. You don’t have to talk to any bankers.  Nothing personal to any of my banker readers (as if) but dealing with bankers is only slightly less painful and irritating than a root canal.  Contrary to what you may have heard, bankers don’t care about you.  Their job is to lend money and maximize their company’s return on investment, or, in this economy, minimize loss.  Converting an asset that is returning 8.5% interest into one that only returns 6.5% is going backwards.  Bankers created this mess.  I don’t believe it’s realistic to believe that they’re going to be the ones to fix it.

5. When bankruptcy is over, it’s over, and it feels very good.  Mortgage modifications are forever.  Or until you default again.

There is no doubt but that, in addition to the day they graduated from college, the day they were married, and the day their first child was born, other Red Letter Days in the lives of people who have endured financial stresses severe enough to make them consider bankruptcy, include the day they got their discharge and emerged from bankruptcy.  It’s like the relief one might expect to feel when you stop banging your head against a brick wall.  In my experience, I’ve never heard anyone who relieved themselves of mountains of unmanageable debt say they wish they hadn’t filed.  What I hear is that they wish they hadn’t waited so long.

4. You can’t get scammed by a bankruptcy court that’s giving you relief from the guy who scammed you in the first place.  LoanSafe.org is reporting that “loan modification scams” are one of the hottest new consumer ripoff industries.  I suppose they take a lot of different forms, but be careful.  At least lawyers have to be licensed, bankruptcy fees are subject to the supervision of the court, and loan modification scam artists generally don’t hang around in Federal court rooms wearing black robes.

3. The Bankruptcy discharge is forever.  More than half of mortgage modifications are headed for another default.  What do I mean by this? Well, first of all, a little background, and if you don’t want the background, skip the next paragraph and race to the “payoff.”

One of the Federal government’s official keeper of mortgage statistics is the Office of Thrift Supervision, known–as with any self-respecting government bureaucracy–by its acronym OTS. (OTS is a wholly owned subsidiary of the US Department of Treasury for those keeping track.)   Every quarter, OTS releases its “Mortgage Metrics” report, which is a 25 to 30 page impenetrable tome of economic gobbledy gook.  If you don’t believe me, here’s Q1 2008 and here’s Q2 2008.

Now the payoff:  The Mortgage Metrics Q3 2008 report will, when it is released, report that 53% of all mortgages that are modified wind up back in default.  This is what is being reported by sources that have seen it, or at least talked to people who have seen it.  My source?  MortgageDaily.com.

2. Bankruptcy is less stressful.  Financial fear and worry is one of the worst sources of stress that we can suffer from.  It’s only exacerbated when the cause of that stress is also the very roof over our heads.

1.     When it’s over, you get a REAL fresh start.  Bankruptcy is a financial reboot.  A whole new day.  Yes, if you are successful in completing a loan workout with your lender, there will be relief. Probably substantial relief.  But you also don’t get to start a rebuild, or get rid of other debts and liabilities that may threaten to drag you down again later.  If your oppressive mortgage is your only financial woe, then you may get some real relief from a mortgage modification attempt.  But those sorts of problems are not usually so isolated.

Again, I don’t mean to sound flip, nor to minimize the impact of having to file bankruptcy.  But if you are able to do so, and if your mortgage is only one part of a larger scheme of financial woes, what better way to “modify a mortgage” than to get rid of it?  Of course, this means that you will also lose the property, but in most of the cases that I’m reviewing these days, that isn’t a priority anymore. When the loan is $750,000 and the house is worth $600,000, what’s left to save?  (Those are Northern California numbers; your examples may vary if you live in other parts of the country.)

Upshot:  Know your options before you dive into a process that may not do as much for you as you hope it will.