Dirt Lawyers and Dirty REMICs: A Debate

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Dirt Lawyers and Dirty REMICs: A Debate

Dirt Lawyers and Dirty REMICs: A Debate

David J. Reiss, Brooklyn Law School
Bradley T. Borden, Brooklyn Law School
Joshua Stein, Joshua Stein PLLC

Abstract

 

In mid-2013, Professors Bradley T. Borden and David J. Reiss published an article in the American Bar Association’s PROBATE & PROPERTY journal (May/June 2013, at 13), about the disconnect between the securitization process and the mechanics of mortgage assignments. The Borden/Reiss article discussed potential legal and tax issues caused by sloppiness in mortgage assignments.

 

Joshua Stein responded to the Borden/Reiss article, arguing that the technicalities of mortgage assignments serve no real purpose and should be eliminated. That article appeared in the November/December 2013 issue of the same publication, at 6.

 

Stein’s response was accompanied by a commentary from Professors Borden and Reiss, which also appeared in the November/December 2013 issue, at 8.

 

Suggested Citation

David J. Reiss, Bradley T. Borden, and Joshua Stein. “Dirt Lawyers and Dirty REMICs: A Debate” Probate & Property (2013).

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4 Responses to “Dirt Lawyers and Dirty REMICs: A Debate”

  1. Judson Witham says:

    Look up DIRT DEALING Felonious Colonious

  2. brian d says:

    SECURITIZATION FAILURE

    A mortgage securitization is created when a group of [several thousand] mortgages, commercial or residential, are pooled into a security known as a Mortgage Backed Security (MBS). The MBS is sold as a security and is usually traded on the Over the Counter “pink sheet” market. These securities are likewise registered with the Securities and Exchange Commission.
    The basic economic principles of the secondary mortgage market apply to MBS transactions. The MBS investors, known as trust-certificate-holders, pay the aggregator of the mortgage pool, also known as the “seller”, a premium for the present value of the future cash flow from the mortgage pool. This is commonly known as the “discount”. The seller’s profit comes from the “spread”. The investor’s benefit is receiving stable cash flow from an investment grade security.
    Real Estate Mortgage Investment Conduit or “REMIC”
    However, RMBS (Residential Mortgage Backed Securities) transactions are different from traditional loan sale transactions in one remarkable way. RMBS transactions are so designed that they are subject to income-tax taxation at the investor level only. REMIC trusts avoid entry-level taxation. The millions of dollars of income generated annually by the thousands of mortgages in the mortgage pool are taxed at the investor-certificate holder level only.
    To accomplish this, the mortgage pool must be set up as a Real Estate Mortgage Investment Conduit or “REMIC”. If the mortgage pool is not set up as a REMIC, the income from the pool could and would be taxed twice by the IRS (and the states), once at the pool level and then again at the certificate-holder level. It is therefore crucial that the REMIC rules governing RMBS trust construction are followed to the letter of the law. REMICs are created as New York common law trusts so that the trust assets are insulated from creditors who may seek to “claw back” trust assets that were transferred from insolvent transferors.
    To achieve REMIC status, the RMBS must meet three specific criteria:
    1) First, the RMBS mortgage pool must be static. Once it is created it cannot accept any new assets into the pool. The assets must be specifically identified and vested in the trust within a statutory [IRC §860(d)] time frame.
    2) Second, the trust must take good title, in its name, to the assets (mortgages and notes) deposited into the trust.
    3) Third, the assets in the trust must be insulated from creditors. This is accomplished with a series of fully documented sales (negotiations) starting from the originator and culminating with a sale from the Depositor to the Trustee on behalf of the Trust. If this series of sales is properly done, the trust assets cannot be reached by creditors in the event the seller/originator of the loans that constitute the corpus of the trust files for bankruptcy. This is called “bankruptcy remoteness”.
    In order for the RMBS transaction to meet all three criteria a trust must be created. The trust creation document is usually referred to as a Pooling and Servicing Agreement (“PSA”). The PSA is the document that both creates the trust and governs all trust activities. Securitization failure or REMIC failure occurs when the loans intended for the trust fail to be vested within the trust in accordance with the rules set forth in the trust document.
    NEW YORK AND DELAWARE ARE UNIQUE AS THESE STATES REQUIRED THAT ALL TRUST ASSETS BE IN THE TRUST AT CLOSING AND ANY ACT IN CONTRAVENTION TO THE TRUST IS VOID.
    New York and Delaware law are unique in that these two jurisdictions provide a protective “void” cocoon over the trust to protect the beneficiaries [certificate holders]. The void ab initio of New York and Delaware law operates to exclude from a trust, as a matter of law, those assets that would or could threaten a trust asset’s[s’] tax fee pass through status and/or bankruptcy remote status. California and other states do not have such holdings as any acts there may be voidable or void. It is such confusion that creates odd holdings in states such as California.
    Securitization failure destroys the marketability of title to real property. EPTL §7-2.4 in the context and construction of New York’s trust law as a whole and why it is relevant to foreclosure. Courts must also understand the historical context and application of ultra vires acts of a trustee being null and void ab initio. Without understanding the reason for applying the statute, EPTL §7-2.4 appears to be a draconian rule, with a resulting draconian “remedy” for what appears to be a ministerial error by REMIC trustees and those parties that created and funded the REMIC trusts.
    The failure by the above-mentioned participants to abide by the terms of the REMIC trust is anything but a ministerial error. Ultra vires acts of REMIC trustees result in devolution of title to every deed that was and will be passed in a REMIC foreclosure. The ultimate outcome of these ultra vires acts is that every deed passed pursuant to a REMIC foreclosure is a nullity rendering the transferees of title holding nothing more than a worthless deed; thus the necessity of applying EPTL §7-2.4 in its literal interpretation.
    Several jurisdictions interpret New York Estates Powers and Trust Law Section 7-2.4 in the context of securitization failure. These courts have declared that transfers to the trust that violated the terms of the REMIC Pooling and Servicing Agreements are therefore void ab initio. If the transfers to the respective trusts are void then millions of foreclosures have been and are being prosecuted by parties that have no interest in the underlying note obligations. Likewise, many liens and deeds of trust were, and are now, in the hands of entities that do not possess the right to enforce the equitable remedy of foreclosure.

    Section 7-2.4 states:

    If the trust is expressed in the instrument creating the estate of the trustee, every sale, conveyance or other act of the trustee in contravention of the trust, except as authorized by this article and by any other provision of law, is void.

    New York shares the void rather than voidable position with only one other jurisdiction, Delaware. Nearly all REMICs were created under the laws of these two jurisdictions to comply with the Internal Revenue Code REMIC statute’s dual requirement that the REMIC trust insulates the beneficiaries from creditors (bankruptcy remoteness) and that the trusts are “closed”.
    Very often the transfer of the loan to the trust occurred years after the specified “cutoff date” date, if at all. Pursuant to New York and Delaware law the acceptance by the trust in contravention of the terms of the trust is void.
    As a practical matter the transfer date is an evidentiary issue that would require discovery and a determination at a motion for accelerated judgment or trial. All the information pertaining to the factual issue is in the exclusive possession of the foreclosing entity or their predecessors in interest. The public real property record may contain some information relevant to the date of transfer of the loan. However, the record of document transfers between the participants is wholly proprietary to the trustee and the appointed trustee document custodian(s).
    HISTORIC REVIEW IS RELEVANT WHY ACTS IN CONTRAVENTION TO THE TRUST DOCUMENTS ARE VOID.
    The legal principles and policy considerations of EPTL §7-2.4 date back to ancient common law. EPTL §7-2.4 was born out of those sections of the New York Code that dealt with title to real and personal property owned by a trust. In 1966 the enactment of EPTL §14-1.1 repealed all those laws and were consolidated into one statute, EPTL §7-2.4. The New York Code contained special provisions that stated the common law principal that any person with actual knowledge of the fact that real or personal property was owned by or titled to a trust was charged with constructive knowledge of the terms of the trust.
    “WIDOWS AND ORPHANS LAWS” CREATED TO PROTECT INNOCENT PEOPLE AND ENSURE TRUSTEE’S UNDERSTOOD THE LEGAL DOCUMENTS.
    These were known colloquially as the “widows and orphans laws”. These laws were written so that an evil, corrupt and mean spirited trustee could not unlawfully sell trust assets to an “innocent” purchaser to the detriment of the trust’s purpose. The converse is also held to apply wherein a trustee exceeds its authority to acquire assets. Any purchaser/seller of assets to or from a trust is charged with having knowledge that the transfer was with the trustee’s powers. In In The Matter of Pepi, 268 A.D.2d 477 (2nd Dept. 2000) the court held:
    Since the appellants had reason to know that the conveyance was made in contravention of the trust, the transaction is void (see, EPTL 7–2.4; see also, National Surety Co. v. Manhattan Mortgage Co., 185 App.Div. 733, 736–737, 174 N.Y.S. 9, affd. 230 N.Y. 545, 130 N.E. 887; Boskowitz v. Held, 15 App.Div. 306, 310–311, 44 N.Y.S. 136, affd. 153 N.Y. 666, 48 N.E. 1104).

    This principle of common law prevented a seller of property to a trust or a purchaser of property from a trust in contravention of the terms of the trust to be able to claim bona fide purchaser status. These principles were recognized in National Surety v. Manhattan Mortgage Co., 185 A.D. 733 (2nd Dept. 1919), Affirmed 230 N.Y. 545 (Ct. App. 1920). In that case, Manhattan Mortgage, the third party defendant, was held liable for the malfeasance of the trustee because it had actual knowledge that the property interest transferred was held in trust. The Court’s decision used common law from other Court of Final Review level decisions to support its reasoning. The Court stated:
    “In Clark v. Whitaker, 19 Conn. 319, (Connecticut Supreme Court, 1889), it was held: ‘Where a party was not personally engaged in the acts of taking possession, using, and disposing of the property in question, but co-operated with the principal actor, by aiding and abetting him in doing those acts, and subsequently recognized and approved of them; he was held to be chargeable with the conversion.’ In Moore v. Eldred, 42 Vt. 13, (Vermont Supreme Court, 1869) it was held that if one, having reason to believe that personal property in the possession of another person has not been lawfully acquired, advises or co-operates with such person to induce him to make a sale of it, he may be held liable directly as for a conversion. In Cone v. Ivinson, 4 Wyo. 230, 35 Pac. 933, (Supreme Court Wyoming, 1894) it is held that one who instigates a conversion is as much a principal as the one performing the act of conversion.’ These authorities are directly in point, because a trustee who wastes the property of an estate, and is guilty of a devastavit, converts that property and may be held liable in an action for conversion. Whether or not, therefore, the defendant may be held to have acted as vendor of a part of the mortgage, or as agent for the guardian in the purchasing of the mortgage interest, or even as merely aiding or abetting in the use of these funds, known by him to be unlawful, it has become liable to the plaintiff for the injuries sustained. The judgment should therefore be reversed, and judgment directed for the plaintiff as demanded in the complaint. Findings and judgment to be settle upon notice.”

    The principles described in National Surety evolved into New York’s rule that imposes constructive knowledge of the terms of the trust if the parties to the transaction have actual or constructive knowledge that the property is held by a trust. New York made a policy decision long ago that it did not want to litigate the issue of actual knowledge by a transferee of property from a trust. A bright line rule was established at common law [and then codified] that states a transferee with knowledge that property is in a trust has constructive knowledge of the terms of the trust. See In the Matter of Pepi, 268 A.D. 2d 477 (2nd Dept. 2000). New York courts limited their review to interpreting trust construction to determine the nature of the trustee’s authority.
    New York law states that an ultra vires transfer of assets to or by a trustee on behalf of a trust is void rather than voidable. If the transfer were voidable then the damaged party would have to bring an action against the malfeasant parties to have the transfer declared void. In New York the transaction is void ab initio, just like it never happened. The trustee’s defense would have to be that it had no knowledge of the terms of the trust. This would of course be an absurd proposition and would be stricken. The trustee has actual knowledge of the terms of its own trust.
    The person or entity that has authority to make lawful transfers of the note and mortgage within the RMBS varies depending on what stage of the transaction the transfer was made. The transfer to the trustee must be lawful pursuant to a document or writing that does not create a presumption that the transfer violates state law or other controlling trust document. This is not a form over substance argument. In RMBS transactions, a violation of state law or of the PSA would open the trust to liability from creditors and the loss of tax free pass through status to the asset[s] that were transferred in violation of the trust document.
    In particular, the entity that presumably needs standing to enforce the mortgage needs to prove as a threshold matter that they have the lawful authority to do so. Since there have been numerous transfers of the note and mortgage the downstream holder of the note and mortgage must rely on the proper and lawful transfer of those documents throughout the chain of possession and title respectively.
    YOU CANNOT GIVE WHAT YOU DO NOT HAVE.
    Devolution in title due to securitization failure has consequences before and after transfer of title. Prior to a transfer of title, devolution is relevant to the identity of the entity that has the authority to affect the satisfaction, modification or consolidation of the mortgage. After transfer of title, devolution is an issue because the entity that satisfied or foreclosed the mortgage had no authority to do so, and the person who took title, either took subject to an unsatisfied lien or subject to a defective foreclosure.
    The entities that had the authority to foreclose did not foreclose. The wrong party foreclosed and either holds title or has transferred title to an unsuspecting transferee who believes that it is a bona fide purchaser, whereas in reality, that person is anything but. Transferees of foreclosure deeds have taken title from an entity that had no interest in the property to transfer. Nemo dat quod non habet. You cannot give what you do not have. Nemo dat trumps bona fide purchaser every time. This is why we purchase fee policies when we buy real estate.
    TITLE INSURANCE IS NOT MARKETABLE TITLE
    However, finding a title insurance company that will insure your fee interest in real estate is not the same as receiving marketable title. Insurable title is not marketable title. Marketable title is title that is free from reasonable doubt or any sort of threat of litigation. In the case of real estate that is encumbered by a mortgage that was placed into an MBS the source of the satisfaction of the lien may be in question.
    In Voorheesville Rod & Gun Club Inc., v. E.W. Tompkins Co,. 82 N.Y. 2d 564 (NY Ct. App. 1993) The Court of Appeals defined marketable title as follows:
    We have said that a “purchaser ought not to be compelled to take property, the possession or title of which he may be obliged to defend by litigation. He should have a title that will enable him to hold his land free from probable claim by another, and one which, if he wishes to sell, would be reasonably free from any doubt which would interfere with its market value” As can be seen from these definitions, marketability of title is concerned with impairments on title to a property, i.e., the right to unencumbered ownership and possession . . ..

    The RMBS transaction and REMIC failure creates uncertainty concerning the legal effect of any action taken by the trustee or its agents concerning rights in that property. This uncertainty applies specifically to the authority of the trustee or its agents to satisfy a mortgage that the trust does not own.
    A break in the chain of title to the mortgage results in the fee owner being unable to transfer title to any person free and clear of encumbrances. If the satisfaction of mortgage is made without the authority of the person entitled to enforce the note and without the authority of the last lawful mortgagee of record, the note is not discharged and the lien continues to exist.
    DEVOLUTION IN TITLE TO THE MORTGAGE
    Devolution in title would occur if any party other than the last mortgagee of record executes the satisfaction of mortgage. Devolution is simply a break in the chain of rights in real estate. The only party that can affect an interest in real estate is the party [or that party’s lawful agent] that has an interest in the real estate. Every state defines “interest in real estate” by statute or by common law interpreting statutory construction.
    The issues in MBS transactions concern the chain of authority derived from the original mortgagee of record. We will begin with the assumption that the original mortgage and note were prima facie valid. The only party that has the right to assign or transfer those rights in the mortgage begins with the original mortgagee. Likewise, the only entity that has the right to exercise rights under the mortgage, such as the right to satisfy the lien or foreclose on the lien/deed of trust is the entity that is the last mortgagee of record or its successor and or assign.
    Seen in this context, there is no difference in the rules for any entity that claims an interest in real property. The authority to affect an interest in real property can only be vested in the entity that is designated on the instrument that created that particular interest. This same principle applies to deeds, mortgages, agrarian, riparian, leases, air, subterranean, easement, license, restrictive covenant and every other stick in the “bundle” of rights associated with ownership of rights in real property. The reason we maintain a public property record is to give the world constructive notice of the identity of the entities that hold rights in real property and the time those rights were created and transferred.
    REAL PROPERTY TRANSFERS ARE GUIDED BY A STATUTE OF FRAUDS
    Every jurisdiction has laws that govern the creation of these rights including a statute of frauds that demand the rights are created by an instrument in writing, how the person granting those rights is given the authority to do so, how or if the instrument needs to be acknowledged [notarized] and if the instrument needs to be recorded in the public land record to be valid.
    The lender seeking to enforce the loan can choose one of two remedies. The first is the right to enforce the lien “at equity”. This involves the exercise of the power of sale (non-judicial) or obtaining a judgment of foreclosure and sale and selling the property at auction (judicial). The other remedy involves the entity enforcing to disregard the lien or deed in trust altogether and choosing to seek a money judgment only. This is referred to as the remedy “at law”. The entity enforcing must choose a remedy. It cannot elect both.
    Foreclosure is the involuntary transfer of title pursuant to judgment of sale (judicial) or power of sale (non-judicial). What is actually being foreclosed is the fee owner’s right of redemption. The right of redemption can only be foreclosed by the entity that has the right/authority to enforce the contractual debt (note). The property must be titled to the successful bidder after the sale or to the plaintiff if there is no successful bidder. In New York the RPAPL requires that title passed post-sale be “sourced” via the recording of the mortgage or assignment of mortgage prior to the sale. The referee cannot pass title until the [foreclosed] mortgage is recorded.
    In New York the referee can only transfer title under authority of the judgment of sale. This is to ensure that any successive purchaser has certainty that title was derived pursuant to lawful sale by a lawful party entitled to enforce not only the underlying indebtedness but also by the party who was entitled to enforce that indebtedness to foreclose the borrower’s [fee owner] right of redemption. Similar principles apply in other jurisdictions under different statutory constructions. Nevertheless, the overriding policy considerations are the same; the chain of title to real property, [via the lien or deed of trust] is preserved and remains certain throughout the foreclosure process.
    The issue in RMBS foreclosure is that the entity foreclosing is either the trust itself or the trust’s agent designated as such by agreement. If the trust cannot or could not take lawful possession of the note due to a restriction in the trust agreement then the trust has no authority to affect any aspect of the loan’s servicing, management, right to declare a default or foreclose. This is the definition of securitization failure. The trust does not and cannot ever own the loan.
    REMIC FAILURE
    REMIC failure is a proper defense to mortgagors because REMIC failure destroys the marketability of the mortgagors’ title. Every mortgagor has a right to know who owns their loan. Successor mortgagees, mortgagees that are not the original payees on the loan, claim that mortgagors do not have standing to assert the ultra vires/REMIC failure defense. However, every mortgagor has the right to know the identity of the entity to which they should pay. Mortgagors also have the right to an explanation as to how the presumptive mortgagees obtained “title” to the mortgage or deed of trust. REMIC mortgagee’s classic argument essentially states that mortgagors have no right to know how the successor mortgagee became the successor mortgagee. This is absurd.
    The legal result of successor mortgagee’s argument is that successor transferees of title to the real property, whether through foreclosure or arm’s length contractual transfer, have no right to know if they are receiving title to real property free and clear of liens or encumbrances. If the entity that purports to satisfy the lien has no authority to do so then the mortgagor/homeowner cannot pass marketable title. Likewise, the purchaser has not taken marketable title and that title may be subject to attack by the true owner of the note.
    Transfers of loans to REMIC trusts fail due to the ultra vires act of the REMIC trustee. The commonest and most easily discovered ultra vires act as relates to an affirmative defense to the foreclosure is the trustee’s acceptance of the loan past the trust’s cutoff date. The cutoff date is usually defined in Section 1.01 of the trust’s Pooling and Servicing Agreement. The PSA is the document that creates the trust. All the contractual obligations between the trustee, the certificate holders, the depositor and the master servicer are contained in the PSA.
    A breach of any contractual obligation by the trustee with relation to any loan is an ultra vires act. An act by the trustee not specifically granted by the trust document is void as per the rule pertaining to common law trusts created under the laws of New York. This rule is in place to protect the trust and the certificate holders from acts by the trustee or its agents that are ultra vires of those powers specifically granted to the trustee. The purpose behind New York as the choice of law jurisdiction that govern these trusts is that, in New York, ultra vires acts of a trustee are treated as if they never happened. This has been the rule in New York for well over one hundred years.
    The affirmative defense that plaintiff cannot be the proper party in the action is the mirror image of the counterclaim for a declaratory judgment as to the identity of the entity that has the right to enforce the loan. A demand for trial is made in the counterclaim concerning the determination of the identity of the entity that is the person entitled to enforce the note and assert the equitable remedy of foreclosure. In this sense, the factual basis for the affirmative defense is similar to the counterclaim.
    However, the difference between the affirmative defense and the counterclaim is that the affirmative defense of “plaintiff lacks standing” is only asserted against the plaintiff. The counterclaim involves naming every party to the REMIC transaction that had an interest in the note. A determination by the court that plaintiff lacks standing is non-instructive as to the identity of the person entitled to enforce.
    To determine the identity of the proper party with authority to enforce the note, every entity that had a role in the RMBS transaction would have to be a third party defendant named in the counterclaim. In other words, defendant may owe someone money, but it is not the trust. Once the court determines it is not and cannot be the trust, the third party defendants will have to fight it out amongst each other. The end result is that foreclosures commenced in the name of an improper party will be dismissed. The mortgage lien still exists against the property in the name of some entity.
    It is clear that the REMIC is constructed as a common law trust with a “commercial” purpose. This alleged dual function has raised form versus substance arguments as to REMIC classification and treatment under New York Trust law. This issue is just being addressed by courts in New York and various other jurisdictions with widely varying results.

  3. brian d says:

    If real estate laws don’t matter, then why not have securitizations approved first. Not ruin land title records.

  4. mare says:

    Brian d thanks for posting. Where did you get all this info from on the aRemic failure and securitization fail? I have an appeals court coming up on this exact scenario and Deutsche is stating the Mortgagor does not have standing in either the PSA contract nor the Remicic thus the reason for appeals court. Thd judge had no desire to.listen and made tthe ruling .even though the discovery was incomplete even after a motion to compel

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