In recent weeks, the Washington Supreme Court and the Oregon Court of Appeals have issued opinions limiting the ability of mortgage lenders to foreclose trust deeds without a full judicial process. A final ruling on the law in Oregon is expected sometime in 2013, as the Oregon Supreme Court has agreed to rule on the same question; until then, the Court of Appeals’ ruling is in effect. As a result of these rulings, trust deed lenders will have to go to court to foreclose most trust deeds, which slows the foreclosure process and makes it somewhat easier for homeowners to raise defenses. Some cases in Washington also may allow homeowners to make claims under that state’s powerful consumer protection law.
Trust deeds are the preferred method of financing real estate lending in Oregon, Washington, and most Western states. The borrower places the property in trust for the lender or some other beneficiary named by the lender, with a bank, title company, lawyer, or similar person or entity named as the trustee. When the borrower pays off the loan, the property is returned from the trust to the borrower.
If the borrower defaults, the beneficiary has two foreclosure options. The beneficiary may file suit (judicial foreclosure) to foreclose the loan. If the court approves the foreclosure, the property is sold and the proceeds used to pay the costs of suit and the balance of the loan. The borrower remains liable for any shortfall. Because this takes time, enables the borrower to set up potentially delaying defenses, and allows the borrower a time after the sale to buy out the buyer, this option is rarely used.
Instead, most beneficiaries choose to declare the default (nonjudicial foreclosure), set a deadline to cure it, and if not cured, to auction the property. The borrower usually needs only to catch up on the default and pay the beneficiary’s expenses to cure a default. In both Oregon and Washington, a beneficiary who chooses to use nonjudicial foreclosure is stuck with any shortfalls from the sale. Despite this risk, most lenders choose to use nonjudicial foreclosure because it is a quick process, and the borrower has to sue to stop it if they can’t come up with the money to cure.
The process is complicated by the frequency of sales of lenders’ rights. If the note for the loan is sold, the lender’s rights in the trust deed follow it. Because most trust deeds and mortgages are now repackaged into securities containing large numbers of individual loans, recording an assignment in the county records requires time and expense that the banking industry did not want to undertake. Instead, in created a private tracking system called the Mortgage Electronic Recording System (MERS). The MERS corporation is now often named as the beneficiary on trust deeds, and in many states, borrowers have challenged its right to serve as beneficiary and order nonjudicial foreclosures.
The Oregon trust deed statute requires changes in the trustee or beneficiary to be recorded in the county records in order to proceed with a nonjudicial foreclosure. The Washington stature does not include a recording requirement, but declares the beneficiary to be the holder of rights under the promissory note or the loan documents, and requires the trustee to obtain proof of this right from the beneficiary and notify the borrower of the name and address of the beneficiary.
How the Question Got to the Courts
Borrowers in both states filed suits to stop nonjudicial foreclosures initiated by MERS. The borrowers challenged MERS’s right to be named as beneficiary and start nonjudicial foreclosures. One Oregon borrower also argued that her requests for proof that transfers of the note and trust deed were properly recorded had gone unanswered.
Most suits challenging the MERS system are filed in federal court. Mortgage and trust deed law, however, is created at the state level. Unfortunately, in those states that have not ruled whether the MERS system complies with state law, some federal judges have been unwilling to predict how the state courts would rule, and in some of those states, different judges have disagreed as to their predictions. Fortunately, both Oregon and Washington have a way out of this problem: the federal court may send a question of law to the state supreme court, and that’s what the Washington Supreme Court ruled on on August 16, 2012. (The pending question in the Oregon Supreme Court got there the same way. The Oregon Court of Appeals’ ruling on July 18, 2012, came from a suit that was filed in state court and appealed through the usual channels.)
How the Courts Ruled
The Oregon case turned on whether the lender or MERS is the initial beneficiary. If the lender was the initial beneficiary, a transfer to MERS would have to be recorded.
The Oregon trust deed statute defines the beneficiary as “the person named or otherwise designated in a trust deed as the person for whose benefit a trust deed is given, or the person’s successor in interest . . . .” MERS argued that the designation of itself in the trust deed meant that it was the beneficiary. The court disagreed, ruling that if the legislature wanted to state that the named person was the beneficiary, it could have said so. Instead, the court focused on who benefits from the trust deed. Because the purpose of the trust deed is to secure a loan, the court decided the lender was the beneficiary. The lender, not MERS, therefore, was the proper party to start the nonjudicial foreclosure.
The Washington case turned on the statutory definition of “beneficiary,” which reads, “the holder of the instrument or document evidencing the obligations secured by the deed of trust, excluding persons holding the same as security for a different obligation.” The court ruled that because a trust deed cannot secure itself, the “instrument or document evidencing the obligations” had to be the promissory note or loan agreement, and bolstered this argument by reviewing the structure of other provisions of the trust deed law and the use of the word “holder” in the promissory note laws. The court also ruled that the designation of MERS as beneficiary in the agreement could not trump the statutory system.
The most obvious implications of the rulings is that nonjudicial foreclosure will not be available under the MERS system in Oregon and Washington. Instead, the current holders of notes will need to accumulate documentation of the transfers and record it.
The Washington court chose not to clearly state what it thought should happen to the trust deeds, other than to say that MERS was not entitled to enforce them. Exactly who should enforce the trust deed remains to be determined. The holder of the note probably would be able to foreclose nonjudicially if its identity could be determined, and judicial foreclosure would be available if nonjudicial foreclosure is not.
More ominously for MERS and the mortgage industry, the Washington court also stated that it could not rule out the possibility that MERS declaring itself to be the beneficiary might be deceptive, which leaves open the possibility that a borrower might be able to sue under Washington’s consumer protection law. Because one of the problems with failure to identify the real beneficiary is potential confusion as to the proper person to negotiate with, the court found that it was entirely possible a borrower could be harmed by the deceptive statement. The Washington consumer protection law allows for treble damages (not to exceed $25,000 additional damages) and attorney fees, so MERS could find itself in peril of significant liability statewide.
Oregon’s consumer protection law also may be implicated by the Oregon decision. On January 27, 2012, the Oregon Department of Justice issued temporary rules stating that a misrepresentation in an affidavit, declaration, or other sworn statement detailing a borrower’s default and a loan servicer’s right to foreclose is a violation of the consumer protection law. Based on this, a false statement by MERS that it is the beneficiary may be a violation. The potential damages under the Oregon law, however, are limited to actual damages plus attorney fees, with possible punitive damages. The Oregon courts have not generally imposed substantial punitive damage awards, so MERS probably is less likely to be exposed to significant liability in Oregon than in Washington.
Borrowers who receive a notice of nonjudicial foreclosure in Oregon or Washington should compare the notice with their loan documents to see if the names of the parties involved match. If not, they may have reason to challenge the foreclosure and should consult a lawyer. There may also be other reasons to challenge the foreclosure, and a consultation with a lawyer may be advisable.