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5th Cir. Rejects Borrower’s Challenges to MERS, Pooling and Servicing Agreement, Other Claims

Deed of trustThe U.S. Court of Appeals for the Fifth Circuit recently held that an assignment of a mortgage deed of trust (“DOT”) from Mortgage Electronic Registration Systems (“MERS”) to an assignee (“Assignee”) was valid under Texas law, because MERS was specifically named as a beneficiary in the DOT and was vested with the power to exercise the rights set forth in the DOT.  Therefore, the Court held, MERS was a valid beneficiary under the Texas Property Code and contract law, and the assignment from MERS to Assignee was valid.

The Fifth Circuit further held that the Borrowers lacked standing to challenge the applicable pooling and servicing agreement because they were not parties or third-party beneficiaries of that agreement.  The Fifth Circuit also held that the assignment of the DOT did not violate Texas’s false lien statute, because MERS was a valid beneficiary and could assign the DOT.  Therefore, Assignee’s assertion that it had a right to foreclose was not false.

In so ruling, the Fifth Circuit affirmed the district court’s dismissal of the Borrowers’ complaint, in which the Borrowers attempted to challenge Assignee’s ability to foreclose.

A copy of the opinion is available at: Link to Opinion.

In 2006, the Borrowers purchased a house in Texas with a loan, executing a promissory note in favor of the lender (“Lender”) and its successors and assigns secured by the DOT.  The DOT named MERS as a beneficiary and Lender’s nominee, granting MERS the right to act on Lender’s behalf and to foreclose.

In 2011, MERS assigned the DOT to the Assignee. The Borrowers later defaulted, and the Assignee initiated foreclosure proceedings. The Borrowers sued the Assignee, MERS, seeking an injunction and declaratory relief preventing the Assignee from foreclosing, and also brought a false-lien claim under Texas state law. The district court granted the Assignee’s motion to dismiss for failure to state a claim.

The Borrowers raised two issues on appeal.  First, they argued that MERS’s assignment of the DOT to the Assignee was void, such that the Assignee cannot foreclose. They contended the assignment was void because Texas law does not permit MERS — as a book-entry system — to act as a beneficiary of a DOT. They alternatively maintained that New York law governs the validity of the assignment, under which the assignment was supposedly void because it violated the Trust’s pooling and service agreement (“PSA”).

Next, the Borrowers argued that MERS’s assignment of the DOT to the Assignee created a false lien in violation Texas’s false-lien statute — Section 12.002.

As you may recall, borrowers have limited standing to challenge their lenders’ assignments of their promissory notes and DOTs. “In Texas [] an obligor cannot defend against an assignee’s efforts to enforce the obligation on a ground that merely renders the assignment voidable at the election of the assignor . . . .” Rienagel v. Deutsche Bank Nat’l Trust Co., 735 F.3d 220 (5th Cir. 2013). But an obligor has standing to challenge an assignee’s efforts to enforce the obligation on a ground that would render the assignment void.  Id.

The Fifth Circuit noted that the Borrowers have standing to challenge Assignee’s efforts to foreclose if the Borrowers’ claim would render the assignment void rather than voidable. The Borrowers failed to make that showing.

The Fifth Circuit noted that the DOT specifically named MERS as a beneficiary with the right to “exercise any or all of those interests” in the DOT. The Borrowers conceded that language but claim that Chapter 51 of the Texas Property Code (“Chapter 51”) does not allow MERS to act as a beneficiary. They contended that Chapter 51 includes book-entry systems as eligible mortgagees only to allow book-entry systems to aid in administering foreclosures, not to act as beneficiaries.

The Fifth Circuit rejected a similar claim in Harris County v. MERSCORP Inc., 791 F.3d 545 (5th Cir. 2015).  There, various Texas counties claimed MERS fraudulently misrepresented itself as the beneficiary of DOTs recorded in the counties. The DOTs — using language identical to the language in the Borrowers’ DOT — named MERS as a beneficiary with the right to exercise all of the interests in a DOT. The counties contended MERS had no interest in the debts or promissory notes and thus could not be a beneficiary of the DOTs. The Fifth Circuit concluded MERS had committed no fraudulent misrepresentation because it was a valid beneficiary as a matter of contract law and under Chapter 51. Id. at 558–59.

The Fifth Circuit reasoned that the DOTs explicitly designated MERS as a beneficiary, the borrowers agreed to the DOTs, and it was immaterial that MERS had no interest in the promissory notes or debts because Texas law treats a DOT and a note as separate instruments. See id. at 558.

Further, the Fifth Circuit observed that Chapter 51 grants MERS authority to act as a beneficiary of DOTs by including book-entry systems in Chapter 51’s definition of “mortgagees” capable of initiating foreclosure.

The Borrowers agreed to a DOT that explicitly designated MERS as the beneficiary with a right to exercise all the interests in the DOT.  Accordingly, as a beneficiary, MERS had the right to assign the DOT. Therefore, MERS’ acting as the beneficiary did not render the transfer to the Assignee void.

The Fifth Circuit next addressed the Borrowers’ argument that the assignment to the Assignee was void because it violated the trust’s PSA.

The Fifth Circuit noted that its decision in Reinagel, 735 F.3d at 228, directly defeats this argument under Texas law.  In that case, the Fifth Circuit held that home-loan borrowers—such as the Borrowers—had no standing under Texas law to enforce a PSA because they were neither parties to the PSA nor intended third-party beneficiaries under it. Id.

The Fifth Circuit stated that even if the borrowers had standing to enforce the PSA as intended third-party beneficiaries, their cause of action would be for breach of the PSA. Id. The assignment would thus be voidable but not void.

Therefore, the borrowers lacked standing under Texas law to challenge the lender’s efforts to foreclose on the ground that it violated the PSA. The Borrowers failed to offer any theory to distinguish themselves from the borrowers in Reinagel, so their claim under Texas law that the assignment is void because it violated the PSA failed.

The Fifth Circuit next addressed the Borrowers’ argument that New York law governs whether the alleged PSA violation renders the transfer void, because the trust is a common-law trust formed under New York law and the PSA states it should be construed in accordance therewith. They argued an assignment that violates the PSA is void—rather than voidable—under New York’s Estate Powers & Trust Law § 7-2.4,7 so they have standing to challenge Assignee’s efforts to foreclose. This appeal to New York law, however, was unavailing.

The Borrowers relied on the unreported New York trial-court decision in Wells Fargo Bank, N.A. v. Erobobo, No. 31648/2009, 2013 WL 1831799 (N.Y. Sup. Ct. Apr. 29, 2013). There, a trustee accepted assignment of a note and mortgage after the trust was closed, which violated the trust’s PSA. Id. at *8. The court below concluded that Section 7-2.4 rendered void any conveyance made in violation of a PSA. Id. The Appellate Division reversed: “[A] mortgagor whose loan is owned by a trust[] does not have standing to challenge the [assignee’s] possession or status as assignee of the note and mortgage based on purported noncompliance with certain provisions of the PSA.” This case cut directly against the Borrowers’ standing argument, even assuming New York law applied.

Assuming the Borrowers had standing to challenge violations of a PSA, New York courts have not applied Section 7-2.4 in the manner the Borrowers would hope but instead have treated a trustee’s act in violation of the trust as voidable but not void. According to the Fifth Circuit, even under New York law, any alleged violation of the PSA would render MERS’s assignment of the DOT to Assignee at most voidable but not void. It therefore made no difference which state’s law applies.

The Borrowers also argued the Assignee violated Texas’s false-lien statute— Section 12.002—by falsely asserting the right to foreclose. As you may recall, to state a claim under Section 12.002, a plaintiff must plead facts showing that the defendant (1) made, presented, or used a document with knowledge that it was a fraudulent lien or claim against real or personal property or an interest in real or personal property, (2) intended that the document be given legal effect, and (3) intended to cause the plaintiff physical injury, financial injury, or mental anguish.

The Fifth Circuit found that the Borrowers failed to state a claim under Section 12.002. The Borrowers argued that Assignee’s attempt to foreclose was an assertion of a false lien because MERS could not validly assign Assignee the right to foreclose. Without a valid assignment, Assignee could only falsely assert the right to foreclose. The Fifth Circuit categorized the false-lien claim as entirely derivative of their first claim that the assignment to Assignee was invalid.

As the Fifth Circuit previously noted, the assignment was valid. Therefore the Assignee’s lien (the right to foreclose) was in no way fraudulent. The DOT explicitly designated MERS as a beneficiary with the right to foreclose and gave MERS the right to assign the DOT. MERS validly assigned the DOT to Assignee, so there was no fraudulent lien.

Accordingly, the Fifth Circuit affirmed the district court’s dismissal.

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The attorneys of Maurice Wutscher are seasoned business lawyers with substantial experience in business law, financial services litigation and regulatory compliance. They represent consumer and commercial financial services companies, including depository and non-depository mortgage lenders and servicers, as well as mortgage loan investors, financial asset buyers and sellers, loss mitigation companies, third-party debt collectors, and other financial services providers. They have defended scores of putative class actions, have substantial experience in federal appellate court litigation and bring substantial trial and complex bankruptcy experience. They are leaders and influencers in their highly specialized area of law. They serve in leadership positions in industry associations and regularly publish and speak before national audiences.