Ohio Practical Business Lawyer & Attorney : Teri Rasmussen : Lane Alton & Horst Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

Unless I’ve somehow agreed to get up at the crack of dawn to play golf, Sunday morning is a lazy relaxing time for me - definitely a law free zone.  I gradually become aware that I’m awake.  The cats and I have a little “quality” time while I lie in bed watching the CBS Sunday Morning television news magazine.  Eventually I rouse myself to get showered and go downstairs to read the newspaper while watching one of the Sunday morning news talk shows. 

THE HOOK.  After the politicians have had their debates, an infomercial typically comes on next which I sometimes leave on whilst I'm preparing lunch.  This week, it’s “JOHN BECK'S FREE & CLEAR REAL ESTATE SYSYTEM" which promises me that I can profitably invest in all manner of real estate by spending only a few hundred dollars at government “tax sales”.  I’ve seen part of this infomercial on other Sunday mornings, but this time I became intrigued and went on a mission, in part because a client had recently been asking me some questions about real estate investments.

For only $39.95, the infomercial promised to send me a kit explaining how I too could make wads of money  -- just like the folks giving testimonials  -- by taking advantage of government tax foreclosure sales most people don't even know exist.  According to the infomercial, by using the special "Free & Clear Real Estate System",  I will be able to buy tax foreclosure properties for "pennies on the dollar" and own them "free and clear" with no monthly payments.  The infomercial also tells me that all I have to do to get these properties is pay the back taxes owed on them and assures me there are many properties in my area I could get.  Numerous examples were shown of houses bought for only a few hundred dollars, but  worth far more.  And of course there's a money-back guarantee!!! 

TAKING A CLOSER LOOK.  Having long been an adherent of the “if it sounds too good to be true, it probably is” school of thought, I found it difficult to believe this “system” actually worked, but was nevertheless curious.  As an attorney with substantial experience in real estate and foreclosure law, it also just didn’t square with what I thought I knew about Ohio law in this area.  But I’m always willing to learn new things….

So I decided to investigate.  Google and the internet are a wonderful tool!!  It wasn’t long before I found a website called Infomercialscams.com with page after page of complaints about this very program.  Among the least of the issues with the “Free & Clear Real Estate System” was that the $39.95 apparently wasn’t a one-time fee as the program certainly implied, but instead was a recurring monthly charge.  There was also heart-wrenching story after story of people induced to part with thousands of dollars to "upgrade" to more intensive training and/or who vainly tried to cancel the entire transaction.  Well, if I had been inclined to shell out some money just to check it out, I certainly wasn’t going to do it anymore.  

But I was still confused about how this would work even in theory.  The idea is that because county governments need the tax money to provide necessary services to citizens, they have the power to sell property on which taxes have not been paid.  OK, so far so good – that’s all true and some Ohio counties do indeed have annual tax lien sales.  That, however, is where reality stops.    

A quick look at the Ohio Revised Code (See ORC 5721.30 through 5721.43) and a little more internet research.  I soon determined that while I suppose it’s possible (though I think unlikely) this “buy at tax sales” plan might work in other states, it CERTAINLY DOESN’T WORK IN OHIO!!!

OFFER NOT VALID IN OHIO. Here’s why:

1.  No Such Sales.  Perhaps the most important reason it won’t work here is that Ohio simply doesn’t do a retail “over-the-counter” business in tax lien sales.  Since 1997, only counties with more than 200,000 in population are even permitted to have tax lien sales AND all of them sell tax liens once annually solely to an institutional investor as a single lot costing more than a million dollars.

2.  The Long Wait.  Even if you could participate in a tax lien sale in Ohio, it isn’t the carefree and direct road to quick profits portrayed on the infomercial.  While it is true that if property taxes remain unpaid, the county will eventually offer a tax lien certificate for sale with respect to a particular parcel, that is only the beginning of a rather long journey towards making any money. 

The tax lien certificate does in fact carry an 18% interest rate plus penalties that are dangled before the uninitiated as the safe, secure, and amazingly large return on investment.  What is not disclosed is that having once purchased the tax lien certificate, probably at a discount (i.e. with an interest rate less than 18%), you CANNOT do anything with it for TWELVE MONTHS. 

What you hope happens is that the delinquent taxpayer somehow has an upturn in his financial fortunes and suddenly becomes able to pay off the taxes, plus interest and penalties – in the unlikely event this happens, then yes, you will make money.  However, you are not permitted to contact the delinquent taxpayer during this period and must just wait and see.  In at least some counties, payment plans are offered to those delinquent taxpayers wishing to redeeem their property, thus further delaying your ability to profit on the investment.   In addition, during this period, you may also find yourself dealing with zoning and nuisance issues associated with the property. 

3.  Working Through Foreclosure of the Lien.  If the property is not “redeemed” during this year following your purchase of the tax lien certificate, then you have the “opportunity” to foreclose on your tax lien certificate and finally get possession of the property.  However, you must do so within three years.  In addition,  Ohio is a “judicial” foreclosure state which means that you can’t just schedule a sale of the property and be done with it.  No, a foreclosure action requiring a court filing fee of probably at least $200, has to be filed in the local Court of Common Pleas and wind its way through the courts.  For a fee, generally around $3,500, you can use the services of the County Prosecutor to get this done; it’s also possible for you to engage the services of a lawyer in private practice although I rather doubt there would be any savings with this approach.  By this time you should be adding up the time and expense and wondering why anyone would want to do this.  But there's more......

4.  Minimum Bids Required.  So, assume that you finally get through the foreclosure litigation in a timely manner, perhaps in only a few months. Now what?  Can you still get real estate at a fraction of its true fair market value?  Nope.  Under Ohio law, property sold at foreclosure sale must be appraised (more court costs) and offered for a MINIMUM BID of TWO-THIRDS of its VALUE.  If no one is willing to pay the minimum bid, then the property will be reappraised and offered at a somewhat lower price, but probably not enough less to make it worthwhile.

5.  Dealing with Lenders "Bidding It In".  Maybe you think buying property at two-thirds of its value still sounds like a good deal, especially if you can immediately “flip” it.  Unfortunately, the likelihood of getting the property for that little is not particularly good in practice.  Usually, there will be at least one mortgage on the property as well as possibly some judgment liens.  The bank or financial institution holding the mortgage will not infrequently “bid it in”, meaning that until it bids more than is owed on the mortgage, the lender is essentially playing with “house” money and will not have to come out of pocket to take title to the property.  If the property IS worth having, chances are the lender will have figured that out and bid accordingly.

6.  If You Don't Believe Me...  For the "official" version of what I've just explained, visit the explanations of tax lien sales provided by the Franklin County Treasurer, Hamilton County Treasurer, Cuyahoga County Treasurer, and Lucas County Treasurer.

Look Before You Leap.  Every state is different so the strategy might be more viable elsewhere, but there are bound to be some important procedures you should be sure you’re aware of that must be followed before you can realize any profits.  Some of those may be similar to what I've pointed out above.  In particular, at a minimum, I would suggest determining if the state is a “judicial” foreclosure state like Ohio.  If it is, then it will probably take longer and cost more to get to the point where you can sell or take possession of the property.  Make sure you really understand ALL the steps that need to be taken for you to get from putting money out to supposedly getting more money back.        

My point in going into some detail here is that it’s important to understand fully the process by which you are supposed to get rich before investing even a little hard-earned cash into the deal.  Whether it's this "system" or some other way to invest in real estate, or some other "plan" to make lost of money quickly with almost no risk and little effort, it really is BUYER BEWARE out there.  If there really was a foolproof method of turning real estate into cash, many more people would be financially independent.

Soo.. now you know how I spent part of my Sunday… Scary, huh?

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Whether you're a lender making a loan secured by a mortgage on real estate, a prospective buyer, or an unpaid tradesman making improvements to real estate, understanding Ohio mechanics' lien law is very important.  Guernsey Bank v. Milano Sports Enterprises, LLC, 2008-Ohio 2420 (May 20, 2008), a decision recently handed down by the Franklin County Tenth Appellate District Ohio Court of Appeals, while not really that interesting as far as making new law, underscores this importance and should be seen as a warning of what could happen if proper procedures are not followed.  Francisco Luttecke of Bricker & Eckler LLP provides a useful and complete summary of the facts and holding of this case in an e-alert to whose mailing list I seem to have been added (not that I'm complaining).

Facts of Guernsey Bank Case.  At the most basic level, the Guernsey Bank case illustrates some of the problems that can arise in more complicated transactions.  The defendant Milano Sports Enterprises, LLC ("Milano Sports") had entered into a purchase contract to buy an indoor tennis facility that it intended to convert into an ice rink.  Because Milano Sports wanted to get started on renovations immediately rather than waiting to close on the purchase, it entered into a lease agreement with the seller.  About two months later, the purchase was consumated and financed by a loan from Guernsey Bank secured by a mortgage on the subject real estate. 

Meanwhile, in the intervening two months, an electrical contractor and other tradesmen performed some of the work necessary for the conversion, but were not paid.  After the purchase transaction went through and the Guernsey Bank mortgage had been recorded, the electrical contractor and other unpaid contractors filed mechanic's lien affidavits.  It should also not come as too much of a surprise that a few months after this, Guernsey Bank started foreclosure proceedings regarding the real estate. 

Eventually the property was sold at foreclosure sale for $525,000, leaving Guernsey Bank with a deficiency of approximately $75,000.  A priority fight broke out over who was entitled to the foreclosure sale proceeds with Guernsey Bank challenging the priority and validity of the mechanics' liens.  Ultimately, Guernsey Bank received only about $137,000 of the foreclosure sale proceeds because the Court found the mechanics' lien holders had priority.  Thus Guernsey Bank wound up with a deficiency of more than $475,000 instead of only $75,000. 

What to Know About Mechanics' Liens.  Which brings us to the lessons to be learned from this rather ordinary case:

1. Mechanics' liens CAN trump and have priority over previously recorded mortgages in certain circumstances.  If no notice of commencement is filed, the relative priority of a mortgage and a mechanics' lien depends upon when the first of the labor or material was performed or furnished.  If the mortgage is recorded prior to any labor, work or furnishing, then the mortgage lien will have priority.  Ohio Rev. Code §§1311.13(A); 5301.23.  If, however, the labor, work or furnishing begin before the mortgage is filed for record, then the mechanics' lien will have priority over the entire mortgage for the entire amount of the mechanics' lienholder's claim even if (A) some of the goods or services were provided after the mortgage was recorded or (B) the lien affidavit perfecting the mechanics' lien is filed after the mortgage is recorded.  Ohio Rev. Code §§1311.13(A); 5301.23.
2. Determining when the first of the labor or materials were performed or furnished means establishing the date the "first visible" work or material being performed or furnished.  Ohio Rev. Code §1311.13(A)(1).  This test was set forth in the case of Huntington National Bank v. Treasurer of Franklin County, 13 Ohio App.3d 408, 469 N.E.2d 535 (10^th App. Dist. 1983) as

    whether the work performed had produced visible results which were sufficient to make it reasonably apparent to a person examining the site that the construction, excavation, or improvement had actually commenced.... In order for the work to be deemed the commencement of construction, it must form a part of the work necessary for the construction and be of a nature that can afterward be considered a component part of the structure.

   See also Schalmo Builders, Inc. v. Malz, 90 Ohio App.3d 321, 629 N.E.2d 52 (1993).
3. Make sure you get a title insurance policy and don't just rely on a title insurance commitment.  One of the things Guernsey Bank did right was buy a title insurance policy pursuant to which the title company promised to indemnify Guernsey Bank against any loss or damage incurred because of the "[l]ack of priority of the lien of the insured mortgage over any statutory lien for services, labor or material [ ] arising from an improvement or work related to the land which is contracted for or commenced prior to the Date of Policy * * *."  As a result, at least Guernsey Bank didn't have to pay the mechanics' lienholders out of its own pocket.
4. If you are the lender and/or purchaser in a real estate transaction, make sure you get an affidavit from the seller about off-record matters such as whether any labor or materials have been supplied to the property, just in case the title policy is not as generous as the one here.   
5. If you're going to rely on the construction mortgage exception (set forth in Ohio Rev. Code 1311.14) to the special priority given mechanics' liens, make sure you have more evidentiary support than a settlement statement (which the Court ruled was inadmissible in Guernsey Bank).
6. When preparing and filing a mechanics' lien, take care to follow the form of affidavit set forth by statute.  Ohio Rev. Code 1311.06.  Guernsey Bank challenged the validity of one mechanics' lien because it incorrectly stated the amount due.  While in this case, the Court upheld the validity of the mechanics' lien,  the law in this area is often very strictly interpreted.  Crock Constr. Co. v. Stanley Miller Constr. Co., 66 Ohio St. 3d 588, 613 N.E.2d 1027 (1993).  Pursuant to Ohio Rev. Code §1311.06 - which helpfully contains an acceptable form -- the lien affidavit must contain the following information: 
   • Amount due over and above all legal set offs
   • Description of the property sufficient to identify the premises with reasonable certainty, i.e as though for purposes of conveyance or by inclusion of the legal description contained in the deed conveying title to the owner (Ohio Rev. Code §§1311.06(D); 1311.04(B)
   • Name and address of the person to or for whom labor or work was performed or material furnished
   • Name of the owner, part owner, or lessee
   • Name and address of lien claimant
   • First and last days that the lien claimant performed any labor or work or furnished any material to the improvement giving rise to the lien
7. Another thing to remember is that an Affidavit of Lien must be filed with the county recorder for the county in which the property is located within seventy-five (75) days of the last day work was performed or furnished.  Ohio Rev. Code §1311.06(B)(3).  In addition, to perfect a mechanics' lien, it is also necessary to serve the lien affidavit in accordance with the provisions of Ohio Rev. Code §§1311.07 and 1311.19 upon the owner of the subject property within thirty (30) days after it has been recorded by the appropriate county recorder; if service cannot be accomplished, then the lien affidavit must be conspicuously posted at the subject property within ten (10) days after the thirty (30) day service period.  Even if the contracting party has actual knowledge of the lien, it must still be served (or posted) to be valid.  Brown v. Pearson, 1995 Ohio App. LEXIS 2788 (2^nd App. Dist).

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A while back, I promised to try to explain how this whole securitization thing works, especially in the context of the subprime mortgage melt-down and the various problems being experienced by the current Wall Street lenders-assignees in accomplishing foreclosure. So here goes.....

Let's start with how the whole thing is structured. Securitization creates subparts in what was initially a simple transaction. While its most well known application is with respect to residential mortgages, equipment leases and virtually any kind of cash flow producing asset can be securitized. In many respects, securitization is simply an extremely sophisticated means of "factoring" a receivable and is just a very advanced form of asset-based lending. The Cleveland Complaint filed in the Cleveland "public nuisance" suit against a number of Wall Street lenders (which I've covered in this previous post) contains a good diagram of the process and does a fairly good job of succinctly describing it as follows:

Mortgage-backed securities essentially are bonds secured by real estate loans. They comprise a collection of mortgages that lenders sell to the issuer of the securities. The issuer uses the sums received from the borrowers in repaying their loans to fund disbursements made to investors.

Using a few more words, but still doing an excellent job of contrasting the securitization process of today with the way it used to be, a recent issue of the Federal Reserve Bank of Chicago's Chicago Fed Letter explains:

Thirty years ago, if you got a mortgage from a bank, it was very likely that the bank would keep the loan on its balance sheet until the loan was repaid. That is no longer true. Today, the party you deal with in order to get the loan (the originator) is highly likely to sell the loan to a third party. The third party can be Ginnae Mae, a government agency; Fannie Mae or Freddie Mac, which are government-sponsored entities (GSEs); or a private sector financial institution. The third party often then packages your mortgage with others and sells the payment rights to investors. This can continue for additional steps. In effect, the eventual buyers of the mortgage - the parties that provide the funding - can be many steps removed from the originator of the mortgage.

 

The process by which most mortgage loans are sold to investors is referred to as securitization.... The MBS origination process typically begins when the issuer purchases a collection of mortgage loans from the originators. As payments are made on the mortgages, they are passed through the trust to bondholders.

The initial steps in securitization are fairly easy to follow. Everyone understands Level 1 - Borrower (often, but not necessarily a residential homeowner) borrows money from Hometown Bank to purchase real estate and gives Hometown Bank a mortgage to secure repayment. So far, so good.

Initial Assignment. Level 1½ might be an ordinary assignment of the promissory note and mortgage from Hometown Bank to a larger financial institution we can call National Bank. This might even be repeated more than once. If it is, this will add to the complexity of the entire transaction and increase the likelihood of a missing or incomplete assignment being involved.

The problem the lenders face in the much publicized recent foreclosure dismissals is that getting the appropriate assignment after the fact, if a discrepancy has occurred, is not a simple matter. In some cases, either Hometown Bank or National Bank, or any of the other financial institutions along the pre-securitization assignment route, may now have merged into other banks or financial institutions without clear assignments of the notes and mortgages having been made. In part, this could simply be a function of reliance upon basic corporate law that a necessary consequence of the merger of two corporations is that the surviving corporation automatically becomes the owner of the assets of the other corporation - which in the case of a bank would include all outstanding loans and all of the notes, mortgages, and other loan documents evidencing the outstanding obligations of borrowers. No specific assignment of individual assets (including notes and mortgages) is necessary. There is also the possibility of basic human error of incorrect assignments having been made along the way.

These are "fixable" problems, although potentially costly and time-consuming to remedy at this point; had these matters been addressed at the time of the original transaction, the cost would have been much less. However, what seems to have been overlooked by many jumping on the bandwagon for a beatdown of the greedy subprime lenders is that these sorts of issues can and do occur totally apart from whether a mortgage has become part of a securitization vehicle.

Why Securitization Is Attractive. Level 2 is where the basic securitization vehicle is created. For National Bank (or even for Hometown Bank if no further assignment is made), the underlying assigned promissory note and mortgage is primarily an income-producing asset. The real property connected to the mortgage is only secondarily important as a means of guaranteeing that the loan will be repaid, i.e. the value of the asset is protected. Before securitization became popular in the 1990's, Hometown Bank made a profit through the spread between (A) the interest rate on its cost of funds from money it obtained through deposits from other bank customers, or otherwise and (B) the interest rate charged to Borrower. Hometown Bank might decide to accept a discounted return by assigning the note and mortgage to National Bank and receiving an immediate lump sum payment in return. National Bank made money by buying the promissory note and mortgage for less than their full amount and being willing to wait for Borrower to pay the full face amount over time.

Securitization provides a new way to unlock the income producing potential of the mortgage and promissory note and to leverage the associated cash flow. This can result in greater returns to the owners of that financial institution or simply give National Bank more funds so it can make more loans to other borrowers.

Nature of Securitization. At Level 2, a new "bankruptcy remote" "special purpose entity", known colloquially as an SPE, is created, often as a "trust" entity in which the originator National Bank holds the sole beneficial interest. This is where things become a bit more complicated. The concept is that the SPE will have no other purpose than as a holding vehicle for the notes and mortgage which are assigned to it. In addition, because the SPE is a separate entity from National Bank, any insolvency or financial difficulties experienced by National Bank will not affect the SPE or cause any of the SPE's assets to be distributed to creditors of National Bank. Consequently, any investment vehicle connected with the SPE becomes more attractive to investors.

The SPE "buys" the underlying promissory note and mortgage and there is an "absolute" assignment of promissory notes and related mortgages from the "originator" Hometown Bank or National Bank to the SPE. To fund this "purchase", the SPE (to which mortgages and promissory notes have been assigned) issues securities usually referred to as mortgage-backed securities, or MBSs, representing the right to receive the cash flow from the SPE's entire portfolio of mortgages and promissory notes.

The agreements assigning the mortgages and promissory notes to the SPE, as well as the Servicing Agreements which cover loan administration after the assignment, are extremely long and complicated and contain numerous provisions. For example, one of the keys to securitization is that the "originator" -- National Bank in our example -- needs to be able to remove the underlying promissory note and mortgage from its balance sheet. For this to occur, lawyers for National Bank will be asked to give "true sale" opinions of counsel to the effect that in fact actual ownership of the promissory note and mortgage has been conveyed to the SPE from National Bank. However, as a practical matter, National Bank may be forced to repurchase notes and mortgages assigned to the SPE if too many of them prove uncollectible.

Securitization Achieved. Level 3 is the point at which the connection between the cash flow tied to the mortgage and promissory note really becomes attenuated. This is where the securitization part actually happens. Just as the assets of an ordinary company might include accounts receivable, an SPE's assets are (theoretically) the underlying promissory notes and mortgages and the obligations of Borrower evidenced by these debt instruments. MSBs are issued by the SPE based on the value of these promissory notes and mortgages which in a perfect world would be based on the face amount still owing; when investors purchase MSBs, it is not unlike buying shares of stock in an ordinary company.

In reality, the MBSs are given a rating by an underwriter based upon the perceived likelihood of the collectibility of the underlying promissory notes and mortgages. They are then offered in the public market to investors, primarily sophisticated "institutional" investors; the better the "rating", the more attractive the MSBs are to "institutional" investors, including those seeking a "conservative" investment such as state pension plans.

An already complex set of relationships is further complicated by the fact that, typically, at Level 4, the SPE delegates the actual oversight over the mortgages and promissory notes, and the cash flow they produce, to a servicing agent. The servicing agent then may take action, including initiating collection activities and foreclosure, in its own name or in the name of others along the chain. Frequently, originator National Bank continues to act as the servicing agent and receives a fee from the SPE for performing these tasks.

Investor Cash Flow. As Borrower repays his or her loan, the cash flow generated - minus any servicing fee paid to National Bank or other servicing agent - flows through the SPE to the investors who purchased the MSBs. Sometimes, there will be various classes of investors, sometimes referred to as "tranches", so that certain investors will be paid sooner than others or receive a greater return on their investment.

And that, essentially is what securitizationis all about. For those wanting still more detail (including a very nice summary of the advantages and disadvantages to the various parties in the transaction other than the Borrower) or technical information, about securitization, I recommend visiting Wikipedia's entry on the subject.

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Today, Ohio Attorney General Marc Dann -- along with the Attorney Generals of ten other states as part of a group calling itself the State Foreclosure Prevention Working Group -- issued a report on the "foreclosure crisis" and the perceived shortcomings in the response of "subprime mortage loan servicers". The report is titled Analysis of Subprime Mortgage Servicing Performance -Data Report No. 1, thus implying that additional "reports" will be forthcoming. Click here to read the press release issued by the Office of Ohio Attorney General Marc Dann about the report. (Click here to learn about the other foreclosure prevention assistance resources the Office of Attorney General Marc Dann has assembled.) As things have been going on this topic, this is one of the more sedate and traditional governmental responses to arise.

I've previously posted on the initial set of foreclosure dismissals by federal judges in Cleveland and Dayton which, at least in the Cleveland cases, might have had as much to do with federal judges wanting to send a message to lenders to stop bothering federal courts with ordinary foreclosure cases that belonged in regular state court. And in another previous post, I rounded up pertinent pleadings from those cases. Then, as things began to take a truly novel turn with the Cleveland "public nuisance" lawsuit against the Wall Street securitization lenders and the Baltimore "predatory lending" case, I posted again to the effect that while I wasn't convinced any of attacks on pending foreclosures had much basis in legal rationality, I recognized that things were about to get a whole lot more interesting.

I had thought this would be the end of it for a while and had every intention of quietly returning to my usual array of topics more immediately related to the legal concerns and issues facing businesses. I had no idea. As events in what the swirling maelstorm generally becoming known as the subprime problem/foreclosure mess continue to unfold every day and every week, I find myself inextricably drawn to discovering each new revelation. And I'm rapidly coming to the conclusion that this is only the beginning of a very long, very tortuous, odyssey in the annuals of foreclosure law. Because part of the purpose behind this blog is to help business people make sense of legal concepts intruding into their lives, I've chosen to revisit this topic once again.

Ohio AG Efforts to Halt Foreclosures. Thanks to the Wall Street Journal Law Blog for reporting on another intriguing chapter in the whole bizarre Ohio foreclosure scene. Earlier this week, Magistrate Michael L. Bachman of the Hamilton County Common Pleas Court issued a Magistrate's Decision in Deustche Bank Nat. Trust Co. v. Barnes, Case No. Ao705631, Judge Ruehlman presiding, arguably interjecting something of a voice of reason to the debate, but also igniting its own controversy.

The 11-page decision rebuked Attorney General Marc Dann for filing a Motion to Dismiss piggybacking on prior federal decisions dismissing foreclosures in Cleveland and Dayton and even went so far as to question the Attorney General's legal ethics. (Interestingly, in contrast to other actions being undertaken by the Office of Ohio Attorney General Marc Dann, this and similar legal actions are being pursued without publicity or press release by the AG's Office.) However, to me, the more important part of the decision points out that the whole "where's the assignment piece of paper" ignores well settled law that as between the debtor and the holder of the note and mortgage, recording is not a necessary element for recovery. As Magistrate Bachman explains:

under the Uniform Commercial Code as codified in Ohio, parties to a Note, subsequent holders of the note, nonholders in possession of the note who have the rights of holders and persons not in possession of the note who are entitled to enforce the Note pursuant to other statutory requirements, may enforce the terms of the Note as to each other. parties falling within these legal categories may enforce the terms of the note even if the note is lost, stoledn, or destroyed.

 

Ohio law does not require parties to the note to record the note with the county. Rather, controlling case law states that the current holder of a note, despite having no part in the original transaction, is the real party in interest....

 

Ohio case law and statutory authority do not require the recording of a mortgage as a condition precedent to enforcement as between the parties.

Magistrate Bachman makes the additional point that requiring "plaintiffs to attach all relevant assignments at the pleading stage seems overly burdensome, given the notice pleading requirements contemplated in Civil Rule 8."

The Disconnect. Don't get me wrong - I recognize that this country is facing a crisis of substantial proportions as a result of many people having become unable to pay their home mortgages in accordance with the terms of the loans they signed for. And I'm even willing to accept that in at least some cases, unsophisticated borrowers may have been taken advantage of by unscrupulous mortgage brokers more interested in their bonus commission than explaining exactly how the "too good to be true" mortgage was really likely to unfold. Nor do I care to dispute that some governmental intervention may well be appropriate at some point.

It's just that I'm having more and more difficulty understanding how the governmental response reflected by various recent convoluted actions and events makes much sense even by itself or is really going to be very productive in the long run. For example, the Barnes case presents a rather unusual procedural situation in which the State of Ohio's Motion to Dismiss was apparently not filed until after the State of Ohio had already filed an untimely Answer, a Judgment Entry had already been entered, AND the property in question had ALREADY BEEN SOLD AT SHERIFF'S SALE and only the Entry Confirming the Sale remained to be entered. Now call me picky, but this does seem to be the proverbial situation where the horse has already left the barn.

Apparently Barnes was only one of seven foreclosure cases in which the Attorney General sought to have the case dismissed on the grounds that the lender had failed to demonstrate it was the proper owner of the note and mortgage in default. I don't know what the procedural status of the others were, but I would hope that at least some of them were not quite so far down the track. Otherwise, it's difficult for me to even seriously consider the argument being made.

The bottom line for me is yes, lenders should have to demonstrate they are the proper holder of a promissory note and mortgage involved in a foreclosure. However, once a lender has asserted that, regardless of whether an actual assignment is produced, it ought to be up to the borrower/homeowner to demonstrate that's not the case. Unless there's really any serious doubt that the foreclosing lender is the proper "holder in due course" entitled to enforce the mortgage -- and up to now I've not heard of any cases in which multiple lenders are claiming they are BOTH entitled to foreclose a particular mortgage -- borrowers should not be allowed to escape the consequences of having freely borrowed money and not paying it back.

No one disputes that real money was lent to real people who used it to buy actual homes. Whether these borrowers fully understood what they were getting into -- and regardless where one comes out on whether these people need to take some responsibility for their actions in accepting these loans -- is a separate issue. The point is that no one disputes that these borrowers do in fact have some obligation to repay these amounts, or at least a substantial portion of the funds received. Addressing the unfortunate consequences of this legal conclusion IS a valid concern, but it is one that ought to be addressed somewhere other than in the standard foreclosure case.

Others will undoubtedly note that the Barnes Magistrate's Decision has no force until it is adopted by Judge Ruehlman and that objections to it will almost certainly be filed, all of which is true. However, I find myself in agreement with Magistrate Bachman's conclusion:

The Attorney General acknowledges he directed his staff to file the seven motions to dismiss in Hamilton County in order to "raise a public policy issue". The court acknowledges courts in Ohio and throughout the nation have sometimes created new public policy based upon tenuous linkages to existing law or procedure. Certainly, the Attorney General is free to use his office to "lobby" for changes in the law and civil procedure he feels are in the public interest.

 

The Constitutions of both the United States of America and the State of Ohio guarantee the people the right to petition their respective governments for a redress of their grievances. However, the proper venue for such petitions lies in the branches of government vested with the authority to change the law or procedure at issue. In Ohio, the people and the State Assembly have the express authority to enact legislation in the State of Ohio. Similarly, the Supreme Court of Ohio is vested with the authority to "prescribe rules governing practice and procedure in all courts of the state." Comity suggests the judiciary defer its exercise of jurisdiction over these questions to those governmental institutions constitutionally vested with such authroity. If, as the Attorney General asserts, he directed his subordiantes to file these motions seeking to change the way courts adjudicate foreclosure actions in the State of Ohio, then the Attorney General should address his efforts to the General Assembly or Supreme Court of Ohio.

I haven't yet read the AG's foreclosure crisis report, but I for one would like to see more of this sort of governmental response and political proposals based on this sort of analysis and less mettling with legitimate judicial proceedings.

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OK, so I thought the dismissals of foreclosures without prejudice by three federal judges a couple of months back were not that big a deal by themselves. Click here and here for my earlier postings on the decisions by Judge Boyko, Judge O'Malley, and Judge Rose. However, the recent "public nuisance" and "predatory lending" lawsuits by the City of Cleveland and the City of Baltimore, respectively - coupled with a number of other events I'll describe below - HAS gotten my attention.

I stand by my earlier postings about the importance of those particular decisions on their own, but the march of events since then clearly indicates that foreclosures - regardless of whether they are connected to the subprime mortgage business - and mortgage lending in general are destined for the national stage. For a quick round-up on what's been happening here in Ohio click here. For those wanting the most succinct description of recent legal filings in Cleveland and Baltimore, click here for the Wall Street Journal Law Blog's posting.

As might be expected, according to the Cleveland Plain Dealer, the rulings did affect the actual number of filings in federal court in Cleveland, resulting in drastically fewer filings. Click here for the Christmas Day story in the Cleveland Plain Dealer. However, the impact has been far more widespread. Like a lit match dropped on dry wood, these rulings have ignited a veritable forest fire not easily extinguished.

Summary of Recent Events. A brief review of some recent events is in order. This is by no means complete, even with respect to Ohio, but should give an idea of the burgeoning issue.

• In early December, Hamilton County Common Pleas Judge Steven E. Martin dismissed a Wells Fargo foreclosure with facts very similar to those in the federal cases. Although the bank was ultimately able after the case had been filed to demonstrate that it was the owner of the mortgage, Judge Martin nevertheless dismissed the action. In addition, the law firm handling the foreclosure was told that it could not file any more foreclosures unless it provided proof of the client's ownership of the mortgage at the time of the initial filing. Click here for news coverage on this by Cincinnati Enquirer.

• According to several news reports (including various ones I've linked to elsewhere in this post), the Consumer Protection Section of the Office of Ohio Attorney General Marc Dann is apparently waging a stealth campaign by filing motions in Hamilton County and elsewhere challenging whether the named plaintiff is the proper "party in interest". Interestingly, while some reports state that as many as 30 such motions have been filed, there is no press release on the Attorney General's website concerning these actions.

• On the Friday before Christmas, Ohio State Bar Association President Rob Ware sent an e-mail to OSBA members seeking volunteers to help assist people facing foreclosure and according to this story in the Cincinnati Enquirer, by the day after Christmas more than 200 attorneys had volunteered.

• In Clermont County, Common Pleas Judge Robert P. Ringland has sent a letter to local law firms asking that they participate in mediation in foreclosure cases. Click here for coverage by the Cincinnati Enquirer.

• Following on the heels of the recently released University of Iowa study Misbehavior and Mistake in Bankruptcy Mortgage Claims detailing widespread "shortcuts" and other less than stellar loan collection practices in Chapter 13 bankruptcies, came a New York Times article about how Countrywide Home Loan, Inc. was forced to admit it "recreated" certain letters used as evidence in a bankruptcy proceeding. Read the Countrywide Transcipt of the Status Conference in which this came out.

Enter City of Baltimore and City of Cleveland. Then, last week came the attention-commanding lawsuits by the City of Baltimore and the City of Cleveland:

• Last Tuesday, the City of Baltimore filed a Complaint infederal district court, Case No. L 08 CV 062,against Wells Fargo Bank, NA alleging that the bank engaged in a"reverse redlining"predatory lendingpractice by charging higher fees and interest rates in Baltimore's poorest neigborhoods, resulting in foreclosure rates twice the citywide average. Click here for the press release issued by the City of Baltimore about the lawsuit. Click here for news coverage by the New York Times. Click here and here for news coverage by the Baltimore Sun-Times and here for Baltimore Sun-Times coverage of reaction.

• A couple of days later on January 10, 2008, the City of Cleveland filed a "public nuisance" action in state court against Deutsche Bank Trust Company and twenty other lenders (including Wells Fargo & Company, but not including any Ohio home grown institutions such as National City Bank, KeyBank, Fifth Third Bank or the Huntington National Bank) in a suit on the docket of Cuyahoga Common Pleas Court captioned City of Cleveland v. Deutsche Bank Trust Company, Case No. CV 08 646970, Judge Corrigan presiding, Here is a copy of the filed Cleveland Complaint and a graphic showing the named defendants and their foreclosure activity in the Cleveland area. Click here for the City of Cleveland press release on the case.
  • For news coverage from Cleveland including a video of Cleveland Law Director Robert Triozzi discussing the lawsuit, click here and here. In the "notable quote" department, Cleveland Mayor Jackson told the Cleveland Plain Dealer reporters, "To me, this is no different than organized crime or drugs."
  • For Cleveland Plain Dealer coverage of reaction to the suit, click here
  • For the Cleveland Plain Dealer's Sunday editorial praising the filing of the lawsuit click here.
  • UPDATE: On January 16, 2008, defendant Lehman Brothers Holdings, Inc. got the case removed to federal court in the U.S. District Court for the Northern District of Ohio, Case No. 08-CV-00139-DCN, Judge Donald C. Nugent presiding. As might be expected, the City of Cleveland has responded by filing a Motion to Remand.

What the Boyko, O'Malley, and Rose decisions did was legitimize lingering questions and uncork pent-up forces long looking for an angle of attack. To some extent, an old problem has simply gotten new visibility. Click here for an ABC News story on a New Hampshire man engaged in a six year "predatory lending" battle and click here for a Wall Street Journal Law Blog posting about a Cleveland man ahead of the curve who made the "not the owner" argument years ago and is now appealing on that basis to the United States Sixth Circuit. Read his arguments in Davet Motion.

So, basically there's a lot to take in at this point. For one academic perspective on whether municipalities even have standing to file actions like the City of Baltimore action, see Cleveland State University Assistant Professor Kathleen Engel's 2005 paper, "Do Cities Have Standing? Redressing the Externalites of Predatory Lending", which discusses "public nuisance" as a possible basis for city claims against predatory lenders.

What's It All Mean? Anyone who reading the papers over the last month or so can see that the politicians from the federal government on down have recognized that foreclosures have started to be a enough of a real risk for a substantial enough Americans that they need to take notice. And there will undoubtedly be various plans offering "assistance" of one kind or another to "deserving" homeowners. It's still too early to know the form these will take or whether they will really help any significant number of people.

From a legal standpoint, residential foreclosures in Ohio may become more costly for lenders (and less easy for lenders' counsel to do on a "flat rate" per case basis as is often done) in the short run. Logically, the stricter standards may also carry over into commericial foreclosures although probably with less impact since commericial mortgages are less often commoditized into securitization vehicles.

Documenting Ownership. In the end, however, the "not the real owner" argument will merely force lenders to take more care in documenting transfers of mortgage loans. While this is certainly not a bad thing from an objective standpoint - although it may add to transaction costs ( which may ultimately be passed on to consumers), especially in the beginning as lenders retool - it is also not some sort of fatal blow to the mortgage lending industry or even to securitization. In addition, not every mortgage loan has been assigned away. This theory may buy some borrowers some time (and sometimes that IS very important), but with some exceptions, it's probably not going to change the outcome for most borrowers in default.

Public Nuisance. Although the "public nuisance" theory advanced by the City of Cleveland is certainly innovative and I'd be remiss if I didn't give kudos to a superfically appealing argument, I just don't see it as a winning argument ultimately. I haven't fully digested the lengthy Complaint yet and perhaps once I do, I'll have a better understanding. It strikes me as just another reincarnation of the "lender liability" arguments in vogue when I began practicing law - "you shouldn't have lent me the money because you knew I couldn't pay it back". At some point, there has to be some assumption of responsibility by borrowers for taking the loans in the first place. From my cursory review of the City of Cleveland Complaint, it seems to contend that lenders "should have known" about all sorts of trends and economic factors more easily understood by everyone in hindsight. While "lender liability" lawsuits did get some borrowers out of some loans and did complicate lenders' lives for a while, eventually the novelty wore off. I think the same thing may happen here.

Predatory Lending. Now this one MIGHT amount to something. If lenders did mislead borrowers about the terms of their loan, then they should have to reap the consequences. Perhaps due to all my years as bank counsel, however, I'm a bit skeptical here too. The truth of the matter is that NONE of us really listen to all of the terms of the loan; we just want the house and are happy we found a bank willing to give us the money we need to make it happen. So who's job is it to police the terms offered? Again I haven't fully analyzed the allegations of the City of Baltimore Complaint either so I'm not sure how strong that case is. So I will be interested to see how this one develops, both in Baltimore and elsewhere.

Why It Matters. Aside from the obvious reasons why we should all care about this issue both personally in terms of our own ability to access mortgage loans and more generally in terms of the plight of our fellow citizen, its effect on the credit markets is likely to extend beyond residential mortgages. Business owners may find that their ability and cost to obtain credit have changed.

It's hard to know for sure how the foreclosure "crisis" will play out over the next few months in Ohio and elsewhere. In the short run, however, "business as usual" for the foreclosing lender is over for a while.

UPDATE: What Might Be Next. For an interesting peek at what might be next in Cleveland and Baltimore, click here for the recent cover story in Business Week about "Bank Day" in a Buffalo courtroom in which lenders are being held accountable for various housing code violations on properties being foreclosed upon.

This post was accidentally deleted for a time, but fortunately I had kept a copy and was able to put the original post back up once I realized the problem.

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Over the last couple of weeks, Judge Boyko and Judge O'Malley in Cleveland, as well as Judge Rose in Dayton, have dismissed numerous residential foreclosures brought by the trustees of mortgage-backed securitizations on the grounds that the financial institutions have failed to demonstrate adequately their ownership of the mortgages being foreclosed. Because of all the hype these federal court dismissals without prejudice seem to be getting, especially in the blogosphere (visit Iamfacingforeclosure.com if you don't know what I'm talking about), I thought it would be helpful to post some basic source documents in one place so that everyone could see what this is all about.

1. Judges' Opinions - there are three so far that I know about:

• Judge Boyko's decision, handed down October 31, 2007, dismissed 14 cases and has the most colorful language and juicy footnotes - click JudgeBoykoOrder to read.

• Judge O'Malley's decision, handed down November 14, 2007, dismissed 32 cases and is the most matter-of-fact decision - click Judge O'Malley Order to read.

• Judge Rose's decision, handed down November 15, 2007, dismissed 20 cases and chooses to focus on a perception that mortgage lenders are generally scofflaws by referencing a study by University of Iowa Associate Professor Katherine Porter (more about this below) - click JudgeRoseOrder to read.

2. Misbehavior and Mistake in Bankruptcy Mortgage Claims, a recently released study by University of Iowa Associate Professor Katherine Porter of 1700 Chapter 13 bankruptcy cases filed in April 2006 across 24 states which was quoted by Judge Rose as follows:

("[H]ome mortgage lenders often disobey the law and overreach in calculating the mortgage obligations of consumers.... Many of the overcharges and unreliable calculations... raise the spector of poor recordkeeping, failure to comply with consumer protection laws, and massive, consistent overcharging.")

I have not yet read this study with any thoroughness so I can't comment on it other than to say its conclusion certainly is that mortgage lenders have been permitted to be rather lax in providing appropriate documentation in at least consumer bankruptcy proceedings. From the limited vantage point of my own legal practice, I will say that I disagree with the conclusion as a sweeping generalization.

3. The Affidavits - Just so everyone understands what these Judges were looking at, I thought I would post examples from each Judge of an Affidavit being put forth. In most state courts in Ohio, no such affidavit is needed at the inception of the case. Yes, they are fairly conclusory.

• Affidavit in Boyko Case
• Affidavit in O'Malley Case
• Affidavit in Rose Case

4. The Complaints - again so we are all starting from the same information, here are examples of the Complaints that were filed in these cases, together with a notation of the named plaintiff and the named mortgagee in the document in each case:

• Complaint in Boyko case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset-Backed Pass-Through Certificates, Series 2006-W4 under the Pooling and Servicing Agreement dated April 1, 2006, assignee of Argent Mortgage Company, LLC. Mortgagee is Argent Mortgage Company, LLC
• Complaint in O'Malley case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset Backed Pass-Through Certificates, Series 2005-W5 under the Pooling and Servicing Agreement dated as of November 1, 2005 Without Recourse. Mortgagee is Argent Mortgage Company, LLC
• Complaint in Rose case - Plaintiff is Citibank, N.A., as trustee for First Franklin Mortgage Loan Trust, Mortgage Loan Asset-backed Certificates, Series 2005-FF12 c/o Home Loan Services, Inc. Mortgagee is First Franklin, a division on Nat. City Bank of In.

Rather than explaining the chain of title or alleging that the named plaintiff is an assignee of the original mortgagee, the Complaints simply allege that the named plaintiff is the "holder" of the mortgage, or perhaps the "owner and holder" of the mortgage. Had either the Complaint, or the Affidavit, in these cases added an extra sentence or two explaining the assignment, it would not have been nearly as easy a decision for the courts to dismiss these cases.

5. Securitization - What's it All About? - And finally for those who really are trying to understand the underlying factual and legal context in which these dismissals occurred, I offer the following links to resources explaining how securitization works. At some point soon, I hope to post on this as well [UPDATE-click here for post on this] , but for now visit either:

Chicago Federal Reserve November 2007 newsletter

Wikipedia's Securitization posting

In Ohio, foreclosures are most often brought in state, rather than federal, court. One reason these cases may have been filed in federal court was for the convenience of being able to assign a number of cases to a single attorney who would not have to travel from county to county. It will be interesting to see if Ohio state court judges (who are elected) follow the lead of the federal courts or this becomes a friendlier forum for financial institutions.

I continue to think that the most likely outcome in the long run will simply be more detailed form Complaints explaining the securitization process and alleging the plaintiff is an assignee. New securitizations may also involve a few more pieces of paper as individual assignments are executed for the notes and mortgages, or more likely there will simply be a schedule attached to a blanket assignment.

What is not going to happen is that securitization ceases to be a viable financing tool. Instead, those involved in these transactions will merely adapt. There may be some delays, or additional costs, in the short run, but ultimately securitization will continue.

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The Cleveland foreclosure cases recently dismissed by Judge Boyko and Judge O'Malley have been incorrectly heralded by some as a severe blow to lenders wishing to foreclose on delinquent loans. At most, the decisions are merely a warning to a certain class of lenders involved in "securitization" transactions that they will need to pay more attention to certain details in those transactions, particularly if they wish to avail themselves of the federal courts in Northern Ohio.

It may have started with this post from I am Facing Foreclosure.com, but it was the New York Times story by Gretchen Morgensen which increased the level of interest in the dismissals of more than thirty foreclosure cases by two federal judges in Cleveland, Ohio. This then produced a bevy of activity in the blogosphere as others rushed in to express how exciting this was for borrowers. Click here and here for a sample of the reaction.

Now that Judge Rose, another federal judge in Dayton, Ohio has dismissed fourteen other similar cases and this has now also been reported by Gretchen Morgensen in the New York Times, some pundits will undoubtedly become even more effusive about this "victory" for homeowners facing foreclosure. For a copy of Judge Rose's Order, click JudgeRoseOrder.

However, those believing that these federal trial court dismissals without prejudice have somehow signaled disaster for lenders everywhere and a debt holiday for borrowers are sadly mistaken. To be sure, there have been some responsible bloggers who have tried to stem the tide against premature celebration. For example Calculated Risk has made at least two reasoned and exceptionally well explained posts about what this is all really about. Click here and here to read these - and if you read nothing else about these cases, read this! In addition, John Waller of the Indiana Commercial Foreclosure Blog has rather succinctly summed up what these cases mean in reality for lenders:

The moral of the story is that the institution filing the foreclosure suit, if pressed by the Court or the defendant borrower, must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint. As demonstrated by the Ohio ruling, with respect to mortgage security pools this seemingly simple requirement may be burdensome or perhaps even impossible under certain structuring.

Corrective action probably can be taken during the proceedings in most cases to ensure that the named plaintiff actually holds the mortgage and owns the note. For example, depending upon the circumstances, the pleadings can be amended to name the proper party or, on the other hand, assignments can be executed to place the note/mortgage into the hands of the plaintiff. Lenders/investors and their counsel should be advised of the Ohio ruling and prepare themselves accordingly.

At the outset, it is important to understand how limited the dismissal ruling really is. All of the cases were dismissed "without prejudice" which means that once the deficiencies noted by the Judges are corrected (which they probably can be), the lenders can, and almost certainly will, refile the foreclosure successfully. In addition, unlike most foreclosures that are typically filed in state court, these dismissals occurred in cases filed in federal courts and there is no way to know whether state courts would require the same proof of the ownership of notes and mortgages. Finally, these were decisions made by trial courts which leaves other trial courts free to make other decisions.

So why were the cases dismissed? Simply put, the lenders failed to take sufficient care in establishing the chain of ownership through the various assignments of the mortgage and promissory note from one financial institution to another. The nature of the "securitization" process as applied to the mortgages in question certainly contributed to this shortcoming by making it more cumbersome to obtain all of the proper assignments throught the chain of title.

However, as explained in the Calculated Risk postings, with some expenditure of time and money, the problem can be remedied in these cases and relatively minor changes in procedures can totally eliminate the issue. Moreover, in those cases where the promissory note and mortgage have only been assigned once or twice and are not part of a mortgage-backed securitization, the problem of demostrating ownership is unlikely to arise anyway.

Thus, while these developments certainly underscore the importance of attention to detail, they in no way indicate any collapse of the securitization market or an insurmouintable problem for lenders. For another bank attorney's similar conclusion focusing on the practical realities of the situation, read Kevin Funnell's "Tale of Two Judges" posting on his Bank Lawyer's Blog.

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