You need to ask the right questions

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by Neil Garfield

In thinking about how to present the issues in cases where the loans are part of a securitization process, whether successful or unsuccessful, I realized that one of the things that I failed to do was bring the attention of the court to the the cornerstone of the transaction --- the loan closing, rather than the the actual chronological first step which is the selling forward of empty mortgage bonds to investors. I realized that if I was sitting on the bench and the matter before me was the foreclosure of a mortgage that was facially correct and recorded in the county records, any argument that starts with securitization is going to seem like side-stepping the real issues. So I am working on going outside the chronological order of reality and starting with the middle point, which is the loan contract and loan closing.

Every contract must have an offer, acceptance and consideration. Every first year law student knows that. In the case of mortgage loans, the loan contract consists of

OFFER: I OFFER TO LOAN YOU MONEY PROVIDED YOU REPAY ME ON THE TERMS SET FORTH ON THE NOTE.

ACCEPTANCE: YOU ACCEPT THE OFFER AND SIGN THE NOTE AND MORTGAGE

CONSIDERATION: I GIVE YOU THE MONEY

The problem is that the above scenario is not the usual scenario with 96% of all mortgages between 2001-2009. If I don't give you the money, there is no contract and even though you signed the note, I have no right to record the mortgage because I never loaned you the money. You were fooled by the fact that money appeared at the closing table just as I said. But the money wasn't my money and I didn't lend it to you. But you signed the note and mortgage to me. What I have just done is probably fraudulent and certainly a table funded loan in violation of the Federal Truth in Lending Act. When the Judge says "did you sign the note?", he is only asking half the required questions. The other half should be asked of the forecloser "did the payee on the note make the loan?" The answer in most cases is no, and in all cases as to the assignment of the loan, no value was paid by the assignee for the transfer to the assignee. The loan should either have been originated with the name of the actual source of funds on the note and mortgage or the assignment should have been recorded in the name of the trust when the loan was acquired. But then the wholesale rejection of common underwriting standards would have been exposed and most of the loans would never have been made.

The reason why Judges and lawyers are missing the mark in many cases is that the loan contract is not the one they are thinking about. In the great majority of loan contracts the actual source of funds is NOT the party who is named as Payee or mortgagee. The actual party who made the loan is either the group of Trust beneficiaries or the actual REMIC trust where the trust was funded. The loan contract is implied by law and undocumented. And the terms are not necessarily what was stated in the note and mortgage. The lenders agreed to a loan with different terms than the terms set forth in the note and mortgage.

The contract for loan that everyone has their eye on is written but never completed. The originator offers a loan provided that the borrower agrees to the terms presented and executes the loan closing papers. In plain language the originator is saying "I agree to loan you money provided you agree to the terms of repayment and you execute the loan closing documents." You agree and execute the loan closing documents but then the originator who made the offer does not make the loan. The result by any interpretation is that there is no enforceable contract. In fact, there is an implied duty to return the documents to the borrower marked canceled.

The originator has no documentation showing that it was acting as agent for the trust beneficiaries or the trust. Even if such documentation existed, it would have required that the originator act as agent for the Trust or the trust beneficiaries without disclosure to the borrower. Such a provision requiring non disclosure would violate Federal law (TILA) and would therefore be void.

But the money appears at the closing table anyway, unknown to the borrower, from the trust beneficiaries who thought their money would first be used to fund the REMIC trust where they would get certain tax benefits. The receipt of the money by the borrower creates an obligation to repay implied by law --- the assumption being that it wasn't a gift.

Thus when the Judge asks "Did you sign the note and mortgage" he or she is only asking half of the essential questions. The other half should be directed to the foreclosing party "did you make the loan"?

The forecloser would then be forced to explain why they should collect on a debt that was created outside of their cloud of parties and entities. This is why they don't allege they are the holder in due course because THAT would require them to prove they have the note and mortgage "for value" and that they didn't have actual knowledge of the borrowers claims and defenses. The borrower would only need to deny such an allegation thus forcing the burden of proof onto the forecloser --- a burden that no forecloser these days can meet unless it is a local bank loan.

Instead of alleging that the Forecloser is a holder in due course, they carefully allege that they are the holder with implied rights to enforce because the documents appear to be valid on their face. But a holder is subject to the defenses available in any breach of contract action including non-performance --- I.e. The denial that the originator ever made the loan. Then they stonewall discovery on questions about the wire transfer receipt that would reveal who made the loan. At trial the borrower should have objections and motions in limine after properly seeking to enforce discovery and getting no results except more objections.

If the homeowner raises the issue of payment of the loan from the originator they are properly challenging the existence of a valid contract, which was never formed because of the failure of performance by the originator. Most loans during the mortgage meltdown period fit this scenario.

The end result should be that the debt cannot be enforced by the foreclosing party because no entity in their "securitization" cloud ever performed the essential act required by the loan contract --- performing the act of delivering money as a loan to the homeowner. Hence no debt was created between THOSE parties.

Non stop servicer advances are payments to the creditors --- the trust beneficiaries (investors) --- of the trust whether or not the borrower is paying the required payments under the note.

This could also  be grounds for challenging the default saying that there was no default from the creditor's perspective because they continued to receive their expected payments. Or it could be grounds for saying they waived the default or that the default was cured while they were accepting the servicer advances. The creditor is only allowed to be paid once on your loan.

Assuming the court accepts that argument, you have established that there are not one, but two loan contracts --- the one that the lender saw, and the one that the borrower saw. That would mean there was by definition no meeting of the minds, which is a basic term used in contract law. If the money from investors actually funded the trust, then they could argue that there was nothing wrong with the two contracts because the borrower's loan contract was with the trust. But our retort would be that if the borrower's contract was with the trust, why were they not on the note?

These are Razor thin distinctions that must be carefully argued or presented by an expert. The goal would be to discredit the initial loan transaction such that the loan was not secured because the real contract was an implied contract at law rather than the written one you signed. If the written one is void, then the debt exists, but it is not secured by a mortgage, hence there could be no foreclosure.

Collection could only be by the trust in a judicial case brought against you that could be discharged in bankruptcy. I don't know how the homestead exemptions work in California bankruptcy court, so we would need to be careful about how this would be used. In any event, amounts received from insurance contracts and the like would be deducted along with offset for appraisal fraud --- but realize that appraisal fraud can only go so far. You must prove what the real value of the home was (not presume or guess at it) at the time of the  loan transaction, which could be the modification or refi which would be when the real value had already plummeted while the loan amount was higher. The difference between the appraised value and the real value could be the an element of consequential damages, and if you can prove malevolent intent you could ask for punitive damages.

While I have been writing about these things for years it is only now that some judges are beginning to loosen up to listen to the realities of securitization --- that it was a fraudulent scheme to deprive investors of their money and the promised secured enforceable loans. The investors all sued saying the loans were NOT enforceable even though they had supposedly been transferred into the trust. These are the lawsuits that the banks are settling every week or every other week for hundreds of millions or billions of dollars. The largest so far is Chase who just paid $13 Billion to settle claims of fraud, misrepresentation, and mismanagement of funds.