The Massachusetts Supreme Judicial Court will hear arguments next month on an important new case that could provide an Ibanez-level shakeup to the real estate world – or elicit a sigh of relief among beleaguered lenders and title insurers.

The case, Eaton vs. Fannie Mae, involves a loan originated in 2007 by Florida-based Bank United to homeowner Henrietta Eaton of Boston’s Roslindale neighborhood. Bank United failed in 2009 and has since been taken over by the FDIC and sold.

At the time of origination, the mortgage attached to the note was assigned to the Mortgage Electronic Registration System (MERS) and the note itself sold onto the secondary market.

In 2009, MERS assigned the mortgage to Green Tree Servicing, which began foreclosure proceedings and held a foreclosure auction. After the auction, Green Tree sold its servicing rights in the property to Fannie Mae, which then tried to have Eaton evicted.

Eaton moved to block the eviction, saying that Green Tree should never have been able to foreclose in the first place, since at the time of the foreclosure it didn’t possess the note – that is, the underlying debt – to which the foreclosure was attached. In subsequent proceedings, Green Tree conceded that at the time of foreclosure it had only a photocopy of the note, which was assigned “in blank” by Bank United and never amended to show who had bought it. Superior Court Judge Frances McIntyre ruled in June that the eviction proceeding should be stopped since Eaton was likely to win her case.

Fannie Mae appealed, and earlier this month the Supreme Judicial Court plucked the case out of the normal appellate process for direct review, a sign that that the SJC thinks the issues in the case are important.

‘Black-Letter Law’

The Eaton case is an example of a “show me the note” defense, a tactic widely used by foreclosure defense attorneys in many jurisdictions. Their essential argument is that an entity wishing to foreclose must be able to prove they are owed the debt for which the home serves as collateral, or are acting as the agent for that owner.

Since notes are bearer paper, they argue, the foreclosing entity must be in possession of the note in order to foreclose. Otherwise, the homeowner is placed at risk of double jeopardy – first losing their home to foreclosure by one bank, then having a different servicer come along later with the note and claim they’re owed hundreds of thousands of dollars.

“It is black-letter law that a mortgage without a debt associated [which is owned by the same party] is a ‘nullity.’ You cannot foreclose on someone that doesn’t owe you any money. This is true under both state and federal case law – going back more than 100 years,” said Jaime Ranney, a Nantucket-based lawyer who’s taken on several foreclosure defense cases. “The cases for this proposition are too numerous to cite.”

The case is a mirror image of the ground-breaking Ibanez case, in which the foreclosing entity had the note but had not been assigned the mortgage before beginning foreclosure proceedings. The SJC’s ruling on the “show me the note” defense would be one of the first from a state high court to touch on this issue, and as with the highly scrutinized Ibanez case, could prove influential elsewhere in the country.

“I think Eaton will be a very important decision,” if it confirms that the mortgagee must possess the note, said Elizabeth Renuart, a law professor at Albany Law School in New York who has studied the implications of the Ibanez decision for other state courts across the country. “[It] will have resonance outside of Massachusetts as well.”

Title Defense

Lawyers for lenders and servicers said they believe the Eaton ruling may vindicate them, arguing that splitting apart the note and the mortgage is perfectly legal in Massachusetts, and has been standard practice – both here and in other states – for many years, particularly since the expansion of MERS in the 1990s.

“The law in Massachusetts has been pretty clear that the entity foreclosing on the mortgage does not have to hold the note – the mortgage holder is foreclosing on behalf of the noteholder. In Ibanez, there’s a discussion of the fact that they can be separate entities,” said Ed Bloom, president of the Real Estate Bar Association. “It’s pretty clear that the Superior Court got the law wrong [in the original ruling].”

REBA is considering filing an amicus brief in the case.

If the lower court’s ruling in Eaton were to hold up, it would severely disrupt real estate transactions, much the same way Ibanez did, Bloom said, because of the implications for title insurance. Since public records only show who foreclosed on a property, title insurers and attorneys would have no way of knowing whether that entity possessed the note at the time of the foreclosure, and therefore whether the foreclosure was valid or if a prior property owner might have cause to claim property ownership at a future time.

“If somehow the SJC were to say that in order to foreclose they have to have the note, they have to be in the same entity, you’d create all kinds of bad title problems,” said Bloom, especially if, as was the case with Ibanez, the judges were to rule that the law covered all foreclosures, including those executed prior to the ruling.

“Many attorneys have no idea who owns the note – they assumed that whoever was foreclosing had the authority to do it. So it could have really important ramifications,” Bloom explained. “In this political atmosphere, you don’t know where the courts are going.”