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

The other day, one of my attorney friends called to see if I could "sign a cog" for him, by which he meant confess judgment for the defendants by signing an Answer to the Complaint on their behalf.  Since this function is considered merely a ministerial act in Ohio and gives rise to no actual attorney-client relationship with the unfortunate defendants, I said sure and we made a date for lunch when I'll sign the pleadings. 

I've previously posted on the enforceability of cognovit promisory notes, but I thought it might be useful to step back for a moment and explain in more detail what they really are.  Ohio is one of only a handful of states that still allow the enforcement of cognovits in commercial transactions.  To the best of my knowledge, it has been decades since any jursidiction permitted cognovit provisions to be enforced in consumer transactions.  While cognovit provisions are most commonly used in promissory notes, they can also be used in guaranties, litigation settlement agreements and even contracts involving the payment of money.   

As long as the debtor does not default, there is really no practical difference between a cognovit promissory note and any other promissory note.  However, when  things go bad, they head south much faster for the borrower who signed a cognovit note.   

Language.  Cognovit notes are simply a special kind of promissory note -- with the addition of certain statutorily required language.  That extra verbage gives creditors an unusually rapid path to judgment and collection activities in the event of a default by the borrower.  In Ohio, cognovit provisions are effective ONLY if they have the language required by Ohio Rev. Code 2323.13.  Thus, the following warning - IN EXACTLY THIS LANGUAGE - must appear "in such type size or distinctive marking that it appears more clearly and conspicuously than anything else in the document" immediately above or below (customarily it will be just above) the signature of the debtor:

WARNING

BY SIGNING THIS PAPER, YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.  IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE, AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY OTHER CAUSE.

To ensure compliance with the statute, this language is typically in a larger boldfaced typeface and often boxed.

In addition, an authorization to take a cognovit judgment must be contained somewhere in the body of the promissory note or other instrument of indebtedness,   Thus, generally near the end of the document, the following language (or something fairly similar) must appear:

WARRANT OF ATTORNEY

Each of the undersigned authorize any attorney at law to appear in any Court of Record in the State of Ohio or in any other state or territory of the United States after the above indebtedness becomes due, whether by acceleration or otherwise, to waive the issuing and service of process, and to confess judgment against any one or more of the undersigned in favor of the Bank for the amount then appearing due together with costs of suit, and thereupon to waive all errors and all rights of appeal and stays of execution.  No such judgment or judgments against less than all of the undersigned shall be a bar to a subsequent judgment or judgments against any one or more of the undersigned against whom judgment has not been obtained hereon; this being a joint and several warrant of attorney to confess judgment.

Execution.  To be valid, a cognovit promissory note must either be signed in Ohio or the borrower executing the cognovit must reside in Ohio at the time judgment is taken.  To ensure enforceability, virtually all creditors will require execution in Ohio, even if that means the borrower must make a plane trip.

Enforcement.  The primary value of cognovit provisions is that they provide a shortcut to judgment for the creditor.  If the debtor defaults, the creditor can file a complaint, as well as an answer on behalf of the delinquent debtor, and obtain judgment within minutes of filing the action rather than having to wait a month or more to obtain a default judgment.  Within minutes after that, bank account or wage garnishments or other post judgment action can be instituted against the now judgment debtor.  Thus it is entirely possible that the defaulting borrower's bank account will be cleaned out by the creditor before the debtor even knows judgment has been taken.  The only requirement is that the ORIGINAL of the note or other document with cognovit provisions must be produced and shown to the judge before judgment is entered. 

Traditionally, the job of taking cognovit judgments falls to the youngest lawyer in the office.  In urban populated areas like Columbus and Franklin County where I practice, taking a cog is really no big deal from the standpoint of difficulty.  You simply call one of your attorney friends and take them to lunch in exchange for their signature on the purported answer of the debtor and then head down to court with the pleadings and the original note.  Once there, you file the Complaint and then find your way to the "Duty Judge" who checks to make sure you have the original promissory note or other instrument with the cognovit provision, signs the judgment entry, and gives it back to you to be filed downstairs with the Clerk.  If you want to hit some bank accounts belonging to the defendant, you can then do that too, although I usually let the court runner take care of that in his next run because there's lots of copies involved and it takes too long.  The whole thing takes maybe an hour at most, but it does have to be a real lawyer who does the deed - no paralegals or laypeople allowed.

In more rural counties, taking a cog can sometimes be an adventure.  Often there is only one judge for the county and if he or she is in trial, well then you just have to wait for a break in the action.  In addition, I have strong and not so pleasant  memories of one judge in particular cross-examing me at length about whether our "Warning" was distinctive enough.  For a while, I was seriously concerned that he would refuse to sign my judgment entry and began wondering just how I was going to be able to spin this one and explain coming home without the judgment.  Fortunately for me, the judge did eventually sign the entry and my membership in the mythical American College of Cognovit Lawyers remained secure.         

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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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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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Several recent Ohio Court of Appeals decisions have confirmed that while Ohio will remain among the minority of states that recognize and enforce cognovit provisions in promissory notes (see Ohio Rev. Code section 2323.13), getting back into court on a motion for relief from judgment may be becomining easier.  Over time, Ohio courts have been gradually lowering the threshold for obtaining relief from judgment when it comes to opening up a cognovit judgment.  However, the individual  facts of the case and the specificity of the judgment debtor's factual allegations supporting the purported meritorious defense remain important. 

 When a promissory note contains a cognovit provision, also known as "confession of judgment" provisions, a creditor can obtain judgment immediately following the filing of the Complaint without any notice to the erstwhile debtor or opportunity to be heard.  All that is necessary is that the creditor file a ministerial answer on behalf of the debtor and present the court with the original of the promissory note containing the appropriate "warrant of attorney" cognovit language and "clear and conspicuous" warning.  Creditors obviously appreciate this feature as it can give them a head start on such post-judgment collection activities as bank account garnishment.

 For many years, cognovit judgment debtors were required to demonstrate they in fact did have a "meritorious defense" just as any other party seeking relief form judgment was required to prove.  In addition, many courts held the view that the mere existence of cognovit provisions in a promissory note precluded any defense other than payment.  (see, e.g. Fifth Third Bank v. Jarrell,  2005 Ohio 1260 (Franklin Cty- 10th App. Dist.). 

While no less an authority than the United States Supreme Court has upheld the constitutionality of cognovit notes and specifically as used in Ohio (D. H. Overmyer Co., Inc. v. Frick Co., 405 U.S. 174 (1972)), Ohio courts have gradually become more uncomfortable about the lack of due process inherent in the enforcement of cognovit provisions in promissory notes.  Some courts have become more willing to entertain potential defenses to cognovit judgments beyond simply payment.  In addition, the threshold for obtaining relief from judgment on a cognivit judgment has been modifed so that the judgment debtor need only show that a meritorious defense can be asserted, and need not prove that he or she would prevail upon that defense.

However, while Ohio courts are becoming somewhat more receptive to relief from cognovit judgment, it is not entirely clear what that will mean in practice.  Just last week, in Gerold v. Bush,  2007 Ohio 5885, 2007 Ohio App. LEXIS 5171, the Erie County Court of Appeals for the Sixth Appellate District upheld a trial court's grant of relief from judgment where the debtor alleged accord and satisfaction and a failure of consideration without requiring much more from the judgment debtor.  Meanwhile, a little more than a month ago, the Knox County Fifth Appellate District Court of Appeals upheld the denial of relief from a cognovit judgment in World Tire Corp. v. Webb, 2007 Ohio 5135, 2007 Ohio App. LEXIS 4517 in which the debtor alleged fraudulent inducement to execute the note because the judgment debtor failed to provide sufficient "operative facts" in its affidavit.  Other Ohio Courts of Appeal also upheld denial of relief from cognovit judgments on the grounds that insufficient "operative facts" had been alleged.

Thus from the creditor's perspective, cognovit promissory notes will remain an important tool.  From the judgment debtor's perspective, taking care to be specific about the facts giving rise to a perceived defense seems likely to be particualry important.

UPDATE: To learn more about cognovit notes in Ohio, click here for my post on the basics.

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