The Massachusetts Supreme Judicial Court ruled late last week in Eaton vs Fannie Mae that in order to foreclose, a lender must possess both the mortgage and the note, largely upholding the ruling of a lower court on that point.

But the justices also said their ruling should apply only to foreclosures conducted from now on, and not to past foreclosures, and that it would be possible for an agent of the note-holder to still foreclose without actually physically possessing the note themselves.

"The meaning of the term ‘mortgagee’ as used in the statutes is not free from ambiguity, but we now construe the term to refer to the person or entity then holding the mortgage and also either holding the mortgage note or acting on behalf of the note holder," the justices wrote. Essentially, they determined it is not sufficient for a foreclosing entity to prove merely that it has been assigned the mortgage – it also must prove it was owed money for the loan, or is acting on behalf of the party owed the money.

"We think it’s a victory for homeowners. Obviously we’re disappointed that people who have already lost their homes won’t be able to benefit from the decision, but we were pleased to see that the SJC clarified that the these very basic documents are needed to foreclose," said Stan Levine, a Harvard Law student who represented Eaton on behalf of the Harvard Legal Aid Bureau.

The ruling had the potential to throw a monkey wrench into foreclosure processing even as banks were beginning to accelerate a foreclosure system long stalled by robo-signing settlement negotiations between major lenders and states’ attorneys general. But, lenders’ attorneys told Banker & Tradesman, the fact the ruling only applies to future cases, coupled with the clear roadmap provided for servicers to prove they are acting for note-holders, ought to make the ruling a huge relief for lenders.

"The majority of what the court has done, especially applying the ruling prospectively and not retroactively, is a positive from the perspective of the real estate bar," said Christopher Pitt, president of the Real Estate Bar Association (REBA).

Sigh Of Relief

"This decision could not have come out better for lenders," said real estate litigation specialist Jason Manekas, a partner at law firm Bernkopf Goodman. "It’s a big sigh of relief."

Massachusetts law requires only that the mortgage be recorded, not the note. A huge proportion of lenders use the services of the Mortgage Electronic Registration System (MERS) to accomplish this, enabling them to freely transfer notes among themselves electronically. Often, it is difficult to locate the original physical note signed by the homeowner at the closing. Many were fearful that the ruling would require a foreclosing entity to prove it physically had the note in its possession at the time of foreclosure, a task likely impossible for thousands of prior foreclosures, and potentially quite difficult for any going forward.

The case resolved a possible ambiguity related to MERS, said Pitt, making clear that it would be possible for MERS to act as an agent in a foreclosure – though the judges refrained from ruling that it automatically ought to be considered an agent.

But the judges ruled instead that the entity enacting the foreclosure does not have to have physical possession of the note itself, but can be an agent of the note-holder.

"We have focused principally on the statutes governing mortgage foreclosure by sale and have concluded that where a mortgagee acts with the authority and on behalf of the note holder, the mortgagee may comply with these statutory requirements without physically possessing or actually holding the mortgage note," the judges wrote. In a footnote, the justices indicate that a simple attorney’s affidavit swearing that the lender is acting on behalf of the note holder could accomplish this.

Ripple Effects

Less clear is the exact standard by which the servicer should identify the note. 

"In the court’s suggestion, an affidavit saying you comply with the statute could be sufficient. Whether that’s going to be sufficient for buyer’s attorney and title insurers, I think remains to be seen," Pitt cautioned. "The court has left that up to the interpretation of practitioners." Placing too great a burden of proof on attorneys and servicers could cause problems with certifying clear title, he pointed out.

Manekas said he believed that referring to the standard pooling and servicing contracts used by lenders and servicers to set terms between them would be sufficient, however, since servicing agreements list those loans being serviced and spell out servicers’ rights to act on behalf of the owner of the underlying debt.

In the Eaton case itself, the judges vacated the initial injunction, allowing it to continue in the lower courts. The judges said it was not enough for the homeowner merely to suspect that the foreclosing entity didn’t have the note in order to halt an eviction. They did say, however, that the homeowner in that case should have the opportunity to prove that their foreclosing entity did not have such authorization.

In the end, the ruling may prove more of a ripple than the splash it might have been, said Ed Bloom, partner at Sherin and Lodgen. The question of whether a lender has to physically possess the note in order to foreclosure has vexed courts nationwide, and lenders and attorneys feared tremendous disruption if the court had ruled that physical possession was required.

"The Supreme Court of Arizona just recently addressed the issue [and] said, ‘no you don’t have to hold the note,’" Bloom told Banker & Tradesman. "If the SJC had said, ‘yes, you do, and it’s retroactive,’ I think it would have created quite a stir around the country."