MERS: Are Big Changes in Store?

Recently, a case was decided in Federal court that resolved a conflict between a law that has stood in Pennsylvania for more than 150 years, and modern lending practices.  If this case is allowed to stand, the impact of the decision will be felt throughout the residential mortgage industry.

Pennsylvania has a recording statute that was developed to provide notice of the identities of all who claim an interest in a parcel of real estate.  One of the driving goals behind the recording statute is to protect legitimate buyers from "secret" (i.e., unrecorded) liens or fraudulent claims of ownership. In layman’s terms, when parties convey any interest in real estate by a written instrument that has been witnessed and notarized must be recorded. Since 1875, the courts have held that mortgage assignments fall within this definition and must be recorded.

The Mortgage Electronic Registration Systems, Inc. (MERS) is an organization comprised, at least in part, of residential mortgage lenders.  Language in standard Fannie Mae/Freddie Mac mortgages nominates MERS as the lenders’ agent.  The members of MERS then will assign or transfer notes that are secured by mortgages.  MERS does not record the notes arguing that as agent for all lender members, the note is never actually transferred.

The Recorder of Deeds for Montgomery County sued MERS, in part claiming that MERS was violating Pennsylvania law by not recording these assignments. By not recording the assignments, it is difficult, if not impossible to correctly and accurately identify all individuals who have (or had) claims to the property; and identify what lender, at any particular point in time, actually holds the note. Further, there are no safeguards to protect innocent consumers if/when a lender fails to update its records in MERS. This leads to mortgage payments being misapplied and borrowers being placed in default. Additionally, the loss of revenue for the counties is substantial.

MERS argued that mortgages and promissory notes can legally exist separate from one another.  Thus, since Pennsylvania does not require promissory notes to be recorded, MERS is not violating the recording statute.

Pennsylvania recognizes a clear distinction between a promissory note and the mortgage that secures the note, and promissory notes do not need to be recorded when assigned or transferred. Prior decisions from the United States Supreme Court have held that notes and mortgages are inseparable. The District Court noted that the specific language in the Fannie Mae/Freddie Mac mortgages and notes reference each other so frequently that the mortgage and note truly are inseparable. As a result, the District Court found that "the assignment or transfer of a promissory note secured by a mortgage on real estate is, in Pennsylvania, equivalent to a mortgage assignment."  The corollary is all such transfers must be recorded.

There is little doubt that MERS will appeal this to the Third Circuit as this ruling fundamentally alters the MERS business model.  Some of the statistics cited in the case suggest that each mortgage-secured promissory note is transferred an average of four to 12 times.  When you think of the number of mortgages to which this will apply in each count in Pennsylvania, the recording fees quickly escalate to the tens of millions of dollars.  MERS is viable in all 50 states... MERS cannot afford to let this decision go unchallenged.

This case bears watching; its ultimate determination could have dramatic and far-reaching effects across the lending industry.  This will take time to travel through the appeals process (which could include having the case sent back to the District Court for further proceedings, only to begin the appeal process anew). For now, I would expect business to continue as normal.  But big changes could be on the horizon...