Tuesday, September 30, 2014

Thank you Neil Garfield! The Devil is in the Details — The Mortgage Cannot Be Enforced, Even If the Note Can Be Enforced

New post on Livinglies's Weblog

The Devil is in the Details — The Mortgage Cannot Be Enforced, Even If the Note Can Be Enforced

by Neil Garfield
Cashmere v Department of Revenue
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Editor's Introduction: The REAL truth behind securitization of so-called mortgage loans comes out in tax litigation. There a competent Judge who is familiar with the terms of art used in the world of finance makes judgements based upon real evidence and real comprehension of how each part affects another in the "securitization fail" (Adam Levitin) that took us by surprise. In the beginning (2007) I was saying the loans were securitized and the banks were saying there was no securitization and there was no trust.
Within a short period of time (2008) I deduced that there securitization had failed and that no Trust was getting the money from investors who thought they were buying mortgage backed securities and therefore the Trust could never be a holder in due course. I deduced this from the complete absence of claims that they were holders in due course. Whether they initiated foreclosure as servicer, trustee or trust there was no claim of holder in due course. This was peculiar because all the elements of a holder in due course appeared to be present because that is what was required in the securitization documents --- at least in the Pooling and Servicing Agreement and prospectus.
If the foreclosing party was a holder in due course they would merely have to show what the securitization required --- a purchase in good faith of the loan documents for value without knowledge of any of borrower's defenses.  This would bar virtually any defense by the borrower and allow them to get a judgment on the note and a foreclosure based upon the auxiliary contract for collateral --- the mortgage. But they didn't allege that for reasons that I have described in recent articles --- they could not, as part of their prima facie case, prove that any party in their "chain" had funded or paid any money for the loan.
After analyzing this case, consider the possibility that there is no party in existence who has the power to foreclose. The Trust beneficiaries clearly don't have that right. The Trust doesn't either because they didn't pay anything for it. The Trustee doesn't have that right because it can only assert the rights of the Trust and Trust beneficiaries. The servicer doesn't have that right because it derives its authority from the Pooling and Servicing Agreement which does not apply because the loan never made it into the Trust. The originator doesn't have the right both because they never loaned the money and now disclaim any interest in the mortgage.
Then consider the fact that it is ONLY the investors who have their money at risk but that they failed to get any documentation securing their "involuntary loans." They might have actions to recover money from the borrower, but those actions are far from secured, and certainly subject to numerous defenses. The investors are barred from enforcing either the note or the mortgage by the terms of the instruments, the terms of the PSA and the rule of law. They are left with an unsecured common law right of action to get what they can from a claim for unjust enrichment or some other type of claim that actually reflects the true facts of the original transaction in which the borrower did receive a loan, but not from anyone represented at the loan closing.
Now we have the Cashmere case. The only assumption that the Court seems to get wrong is that the investors were trust beneficiaries because the court was assuming that the Trust received the proceeds of sale of the bonds. This does not appear to be the case. But the case also explains why the investors wanted to take the position that they were trust beneficiaries in order to get the tax treatment they thought they were getting. So here we have the victims and perpetrators of the fraud taking the same side because of potentially catastrophic results in tax treatment --- potentially treating principal payments as ordinary income. That would reduce the return on investment below zero. They lost.
I have changed fonts to emphasize certain portion of the following excerpts from the Case decision:
"Cashmere's investments merely gave Cashmere the right to receive specific cash flows generated by the assets of the trust at specific times. But if the REMIC trustee failed to pay Cashmere according to the terms of the investment, Cashmere had no right to sell the mortgage loans or the residential property or any other asset of the trust to satisfy this obligation. Cf. Dep't of Revenue v. Sec. Pac. Bank of Wash. Nat'/ Ass'n, 109 Wn. App. 795, 808, 38 P.3d 354 (2002) (deduction allowed because mortgage companies transferred ownership of loans to taxpayer who could sell the oans in event of default). Cashmere's only recourse would be to sue the trustee for performance of the obligation or attempt to replace the trustee. The trustee's successor would then take legal title to the underlying securities or other assets of the related trust. At no time could Cashmere take control of trust assets and reduce them to cash to satisfy a debt obligation. Thus, we hold that under the plain language of the statute, Cashmere's investments in REMICs are not primarily secured by mortgages or deeds of trust.
"Cashmere argues that the investments are secure because the trustee is obligated to protect the investors' interests and the trustee has the right to foreclose. But, this is not always the case. The underlying mortgages back all of the tranches, and a trustee must balance competing interests between investors of different tranches. Thus, a default in one tranche does not automatically give the holders of that tranche a right to force foreclosure. We hold that if the terms of the trust do not give beneficiaries an investment secured by trust assets, the trustee's fiduciary obligations do not transform the investment into a secured investment.
"In a 1990 determination, DOR explained why interest earned from investments in REMICs does not qualify for the mortgage tax deduction. see Wash. Dep't of Revenue, Determination No. 90-288, 10 Wash. Tax Dec. 314 (1990). A savings and loan association sought a refund of B&O taxes assessed on interest earned from investments in REMICs. The taxpayer argued that because interest received from investments in pass-through securities is deductible, interest received on REMICs
should be too. DOR rejected the deduction, explaining that with pass-through securities, the issuer holds the mortgages in trust for the investor. In the event of individual default, the issuer, as trustee, will foreclose on the property to satisfy the terms of the loan. In other words, the right to foreclose is directly related to homeowner defaults-in the event of default, the trustee can foreclose and the proceeds from foreclosure flow to investors who have a beneficial ownership interest in the underlying mortgage. Thus, investments in pass-through securities are "primarily secured by" first mortgages.
"By contrast, with REMICs, a trustee's default may or may not coincide with an individual homeowner default. So, there may be no right of foreclosure in the event a trustee fails to make a payment. And if a trustee can and does foreclose, proceeds from the sale do not necessarily go to the investors. Foreclosure does not affect the trustee's obligations vis-a-vis the investor. Indeed, the Washington Mutual REMIC here contains a commonly used form of guaranty: "For any month, if the master servicer receives a payment on a mortgage loan that is less than the full scheduled payment or if no payment is received at all, the master servicer will advance its own funds to cover the shortfall." "The master servicer will not be required to make advances if it determines that those advances will not be recoverable" in the future. At foreclosure or liquidation, any proceeds will go "first to the servicer to pay back any advances it might have made in the past." Similarly, agency REMICs, like the Fannie Mae REMIC Trust 2000-38, guarantee payments even if mortgage borrowers default, regardless of whether the issuer expects to recover those payments. Moreover, the assets held in a REMIC trust are often MBSs, not mortgages.
"So, if the trustee defaults, the investors may require the trustee to sell the MBS, but the investor cannot compel foreclosure of individual properties. DOR also noted that it has consistently allowed the owners of a qualifying mortgage to claim the deduction in RCW 82.04.4292. But the taxpayer who invests in REMICs does not have any ownership interest in the MBSs placed in trust as collateral, much less any ownership interest in the mortgage themselves. By contrast, a pass-through security represents a beneficial ownership of a fractional undivided interest in a pool of first lien residential mortgage loans. Thus, DOR concluded that while investments in pass-through securities qualify for the tax deduction, investments in REMICs do not. We should defer to DOR's interpretation because it comports with the plain meaning of the statute.
"Moreover, this case is factually distinct. Borrowers making the payments that eventually end up in Cashmere's REMIC investments do not pay Cashmere, nor do they borrow money from Cashmere. The borrowers do not owe Cashmere for use of borrowed money, and they do not have any existing contracts with Cashmere. Unlike HomeStreet, Cashmere did not have an ongoing and enforceable relationship with borrowers and security for payments did not rest directly on borrowers' promises to repay the loans. Indeed, REMIC investors are far removed from the underlying mortgages. Interest received from investments in REMICs is often repackaged several times and no longer resembles payments that homeowners are making on their mortgages.
"We affirm the Court of Appeals and hold that Cashmere's REMIC investments are not "primarily secured by" first mortgages or deeds of trust on nontransient residential real properties. Cashmere has not shown that REMICs are secured-only that the underlying loans are primarily secured by first mortgages or deeds of trust. Although these investments gave Cashmere the right to receive specific cash flows generated by first mortgage loans, the borrowers on the original loans had no obligation to pay Cashmere. Relatedly, Cashmere has no direct or indirect legal recourse to the underlying mortgages as security for the investment. The mere fact that the trustee may be able to foreclose on behalf of trust beneficiaries does not mean the investment is "primarily secured" by first mortgages or deeds of trust.
Editor's Note: The one thing that makes this case even more problematic is that it does not appear that the Trust ever paid for the acquisition or origination of loans. THAT implies that the Trust didn't have the money to do so. Because the business of the trust was the acquisition or origination of loans. If the Trust didn't have the money, THAT implies the Trust didn't receive the proceeds of sale from their issuance of MBS. And THAT implies that the investors are not Trust beneficiaries in any substantive sense because even though the bonds were issued in the name of the securities broker as street name nominee (non objecting status) for the benefit of the investors, the bonds were issued in a transaction that was never completed.
Thus the investors become simply involuntary direct lenders through a conduit system to which they never agreed. The broker dealer controls all aspects of the actual money transfers and claims the amounts left over as fees or profits from proprietary trading. And THAT means that there is no valid mortgage because the Trust got an assignment without consideration, the Trustee has no interest in the mortgage and the investors who WERE the original source of funds were never given the protection they thought they were getting when they advanced the money. So the "lenders" (investors) knew nothing about the loan closing and neither did the borrower. The mortgage is not enforceable by the named "originator" because they were not the lender and they did not close as representative of the lenders.
There is no party who can enforce an unenforceable contract, which is what the mortgage is here. And the note is similarly defective --- although if the note gets into the hands of a party who DID PAY value in good faith without knowledge of the borrower's defenses and DID GET DELIVERY and ACCEPT DELIVERY of the loans then the note would be enforceable even if the mortgage is not. The borrower's remedy would be to sue the people who put him into those loans, not the holder who is suing on the note because the legislature adopted the UCC and Article 3 says the risk of loss falls on the borrower even if there were defenses to the loan. The lack of consideration might be problematic but the likelihood is that the legislative imperative would be followed --- allowing the holder in due course to collect from the borrower even in the absence of a loan by the so-called "originator."
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