The immediate fears of the Massachusetts real estate community were averted when the Supreme Judicial Court (SJC) issued its long-awaited decision in Eaton v. Federal National Mortgage Association, its latest decision regarding foreclosure requirements. But consumer advocates will continue to challenge title to foreclosed properties unless lenders substantially improve their foreclosure procedures.

Having decided almost two years ago that a lender may not foreclose unless it actually owns the mortgage, the SJC was asked whether ownership of the underlying promissory note is also required. Promissory notes may change hands several times over the life of a loan, but are supposed to end up in the hands of the loan’s ultimate owner. Homeowners nationwide have challenged foreclosures by demanding that lenders prove their right to foreclose by producing the note. In Eaton, the SJC was asked to decide whether these challenges can succeed in Massachusetts.

Henrietta Eaton’s mortgage loan was purportedly owned by Fannie Mae and serviced by Green Tree Servicing LLC, which also owned the mortgage. When she fell behind on her payments, Green Tree foreclosed and bought the property on Fannie Mae’s behalf. Eaton convinced the Superior Court to block Fannie Mae’s subsequent attempt to evict her because Fannie Mae, and not Green Tree, was likely the note holder. The trial court held that a foreclosure sale is invalid if the lender does not own both the note and mortgage at the time of the sale. The SJC took the appeal and heard arguments in September 2011.

Since then, the real estate community has lived in fear that the SJC would uphold the lower court’s ruling. Since promissory notes are not publicly recorded with foreclosure deeds, title searches do not indicate whether a foreclosing lender is the holder of the note. If the SJC upheld the Superior Court’s ruling, there would be no clear way to prove whether past foreclosures were valid. The resulting cloud on title would make it nearly impossible to sell or finance virtually every property with a foreclosure in its history.

The SJC’s ultimate decision adopted much of the lower court’s reasoning, but limited its scope in light of the potential fallout. The court held that the foreclosing party must also own the note, or at least be an authorized agent of the note owner – such as a loan servicer. In permitting an agent to foreclose on the owner’s behalf, the SJC held that the foreclosing mortgagee need not have physical possession of the note. To prevent the much-feared disaster, the court decided that the new rule would only apply to foreclosures beginning after June 22, 2012.

Adapt And Overcome

This decision has widely been seen as a substantial victory for lenders since pending litigation challenging foreclosures based on the possession of the promissory note is likely to fail.

But the court’s conclusion that lenders do not need physical possession of the note will not prevent homeowners from demanding proof of the note’s ownership.

While the rule permits a loan servicer that is not the note holder to foreclose on behalf of the note holder, for the foreclosure to be valid, someone must still either have possession of the note or otherwise be permitted to enforce it. In order to prevent further challenges – and an ongoing cloud on the titles of foreclosed properties – recorded title of the property will need to establish the identity of the note holder and its relationship with the foreclosing servicer. A mere statement by a servicer that it is acting on behalf of the note owner may be insufficient to prove that a foreclosure is valid.

Consumer attorneys will likely argue that every foreclosure deed from now on should be accompanied by an affidavit of an officer of the note holder, stating under the penalty of perjury that (a) he or she has personally seen the original promissory note in the company’s possession, or other proof of ownership of the note, and (b) that the servicer, as foreclosing mortgagee, is authorized to act on behalf of the note holder.

Though evidence of this sort would invariably complicate the foreclosure process, and may nevertheless face allegations of “robo-signing,” lenders should expect consumers to challenge any foreclosure where the record does not prove the ownership of the note. A decision favorable to these consumers would only exacerbate foreclosure title issues in the future, so lenders may wish to adapt their procedures accordingly.

Meyer H. Potashman is an associate in the Corporate Department of Sherin and Lodgen.