Massachusetts Home Seizures Threatened in Loan Case: Mortgages

The highest court in Massachusetts is poised to rule as soon as this month on a foreclosure case that could lead to a surge in claims from home owners seeking to overturn seizures.

The justices are deciding whether to uphold a lower court ruling that gave a Boston home back to Henrietta Eaton after Sam Levine, a 25-year-old Harvard Law School student, argued in front of the nation’s oldest appellate court that the loan servicer made mistakes when it foreclosed because it didn’t hold the note proving she was obliged to pay the mortgage.

“If the Massachusetts court says this defense works, that would have a huge ripple effect across the country,” said Kurt Eggert, a professor at Chapman University School of Law in Orange, California.

A ruling in favor of Eaton would show how a $25 billion settlement reached this month with state and federal officials still leaves banks exposed to liabilities tied to home repossessions. It also underscores the challenge of resolving a foreclosure process that Federal Reserve Chairman Ben S. Bernanke said in a study last month is plaguing the housing recovery.

At issue in Eaton v. Federal National Mortgage Association, also known as Fannie Mae, are two documents borrowers sign to get a home loan. The first is the mortgage establishing the right to seize a property. The second is the promissory note that creates an obligation to pay the debt. While the servicer had the mortgage when it foreclosed, it didn’t have the note. One without the other is known as a naked mortgage.

Foreclosure Challenges

Home-loan financiers such as government-controlled Fannie Mae and Freddie Mac typically separate the two documents when bundling home loans into securities to sell to investors. Almost $6 trillion in mortgage-backed bonds have been issued in the last three years.

“The banks will have to find ways to reunify them and establish the same party holds both the note and mortgage,” said Richard Vetstein, a real-estate lawyer in Framingham, Massachusetts. “It’s going to open up foreclosures to challenges all over the place.”

The Massachusetts Supreme Judicial Court justices signaled last month they may rule in favor of Eaton when they asked parties in the case to submit briefs arguing whether such a decision should be applied retroactively or only to future lending. If retroactive, it would cloud the titles of the 40,000 Massachusetts properties seized in the last five years and while the ruling only applies to the state, it could serve as a model for homeowners trying to overturn foreclosures in other states.

Harvard Legal Aid

Applying a ruling retroactively would be “a direct threat to orderly operation of the mortgage market,” the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, holders of more than half of all outstanding mortgages, said in a court brief.

Eaton, who has lived in the two-bedroom home in Boston’s Roslindale neighborhood for more than a decade, began fighting an attempt by Fannie Mae to evict her in 2010 after students from the Harvard Legal Aid Bureau knocked at her door as part of a foreclosure outreach project. Last year, the state’s Superior Court invalidated the foreclosure.

Levine was able to represent Eaton before the Massachusetts Supreme Judicial Court in October because he acted under the supervision of attorneys David Grossman and Esme Caramello, who run the Harvard Legal Aid Bureau. Levine declined to comment because the case is pending.

Right to Foreclose

Fannie Mae, owned by taxpayers, and Green Tree Servicing LLC, the company that foreclosed on the property, argued the loan documents signed by Eaton gave Reston, Virginia-based Mortgage Electronic Registration Systems Inc. the right to foreclose. Her signature also gave MERS the ability to transfer that right to third parties such as Green Tree, the companies said. Walter Investment Management Corp., a mortgage servicer and investor, bought St. Paul, Minnesota-based Green Tree last year.

“The language of the mortgage is clear and manifests the parties’ intent to empower a third party -- not the lender -- with the right to foreclose,” Washington-based Fannie Mae and Green Tree wrote in court papers.

For the purposes of Eaton’s motion, Fannie Mae and Green Tree admitted they didn’t possess the original note at the time of the foreclosure. They produced a photocopy of it with an endorsement in blank, so-called bearer paper that is much like an endorsed blank check.

Dollar Bill Copies

Copies of promissory notes aren’t enough to establish rights, just as copies of dollar bills wouldn’t be honored by a bank, said Kathleen Engel, a professor at Suffolk University Law School in Boston. If an original note can’t be found, attorneys must file a lost-note affidavit and provide evidence to establish a claim.

In last year’s decision, the lower Massachusetts court said it wasn’t troubled by the separation of the two documents after homeowners signed them. The problem was the failure to rejoin them before foreclosing on a property.

“Massachusetts courts have historically held that one must hold both the mortgage and the mortgage note before initiating foreclosure,” Superior Court Justice Frances McIntyre in Boston wrote in a June 17 decision. “This rule flows from the fact that a mortgage, by definition, is simply a security for the note.”

One document without the other is known as a “naked mortgage,” said Adam Levitin, a professor at the Georgetown University Law Center. Without the promissory note, the right to foreclose is unenforceable because the homeowner doesn’t owe money to the mortgage holder, he said in a court brief.

“If a naked mortgagee could foreclose, the foreclosure would not discharge the note,” he wrote.

Fraudulent Affidavits

Federal Reserve Governor Sarah Bloom Raskin last month criticized “sloppy and deceptive” foreclosure practices in a speech to the Association of American Law Schools in Washington.

“The dockets of federal courts, bankruptcy courts, and state courts include numerous cases involving a wide range of troubling issues, such as claims of missing or forged promissory notes” and other abuses such as fraudulent affidavits, she said.

About 5 million homes have been lost to foreclosure in the U.S. since 2006, according to Irvine, California-based RealtyTrac Inc. Lenders slowed the pace of seizures last year as they negotiated with attorneys general across the U.S. over allegations of faulty and fraudulent paperwork used to repossess homes.

$25 Billion Settlement

The backlog may improve following the $25 billion settlement announced Feb. 9 with the five largest U.S. mortgage lenders. The agreement will provide mortgage relief to homeowners and sets requirements for how the banks conduct foreclosures and service loans. State and federal officials will continue to investigate misconduct in the bundling of mortgages into securities.

The Massachusetts Supreme Judicial Court last year ruled on two other foreclosure cases. Both handed properties back to owners because of botched foreclosures. In each case, the servicers didn’t hold the mortgages when they seized the properties.

In an October decision on Bevilacqua v. Rodriguez, the Massachusetts Supreme Judicial Court handed a foreclosed apartment building back to a prior owner five years after its sale to an investor who turned it into condominiums. The high court’s ruling meant people who bought the condo units lost their homes with no compensation. The brick building now stands vacant, its front door blocked with piles of old mail.

In a January 2011 case, U.S. Bank v. Ibanez, the high court handed back two other properties to former owners. One couple, Mark and Tammy LaRace, moved back into their Cape Cod-style house in Springfield and “put their pictures back on the walls” two years after they were evicted, said Glenn Russell, one of the attorneys who won the case.

“If you’re going to take someone’s home away, you’ve got to prove you have the right to do it, and you have to follow the law when you do it,” Russell said.

    Before it's here, it's on the Bloomberg Terminal. LEARN MORE