Written by attorney Oliver Max Gardner III

The Rules of the Road for Securitization of Residential Mortgage Loans

The term “Mortgage Note" or “Note" refers to the promise to pay signed by the homeowner or obligor.

The term “Mortgage" refers to the real estate security instrument (mortgage or deed of trust) that must be filed with the local land registry to perfect the rights of the holder of the note and that is subject to the Statute of Frauds.

Note that Standard Fannie and Freddie Uniform Instruments cross-reference the note and the mortgage and provide that a breach of covenants in either document provides right to accelerate balance due and declare a default.

State law determines how mortgages travel—always travel by assignment due to statute of frauds. An assignment is a conveyance of a security interest in real property.

State law governs the necessity to record assignments. Some state laws have been amended to accommodate MERS, but not that many.

Failure to record an assignment is a matter of priority and perfection if a bankruptcy is filed.

Generally, in most states the mortgage is deemed to follow the note. This means that the foreclosure can proceed if the creditor has the note but no assignment of the mortgage. Still, statute of frauds can be raised as a defense.

If the foreclosure sale is void due to lack of standing, the sale is simply going to be set-aside. If voidable only, then sale is final unless the former homeowner is able to undo the sale by legal action.

If the Plaintiff does not hold the note, then no standing to sue in a judicial foreclosure state and no right to foreclosure in a non-judicial state.

Can MERS foreclose or file a motion for relief from stay in its own name? No. MERS does not hold or ever transfer mortgage notes. The role of MERS is limited to the mortgages.

A promissory note is an instrument that evidences a promise to pay a monetary obligation that does not evidence an order to pay (in other words it is not a check). See 9-102(a)(65). An “instrument" means a “negotiable" instrument under Section 3-104(b) of the UCC.

Loan notes are transferred by the rules found in Article 3 of the UCC or by a written sales agreement. Article 3 transfers occure with the transferred or its agent acquires possession of the note AND certain requirements are met. If the loan is not a negotiable instrument under Article 3 of the UCC, then the UCC does not apply. If it is negotiable insturemnet, then did the transferee become a holder or can it otherwise enforce the note.

Is the note Negotiable under 3-104 or 3-112 of the UCC? a. Unconditional order promise or order to pay;b. Payable to order or to bearer;c. Pyament on diamond or at a definitie time; and d. Not estate any other undertaking or instrucition by the person prominsing or ondering paymyemnt to do any act in addition to the payment of money.

Negotiable note payable to order must state the name of the transferee.

Negotiable note payable to a blank party is bearer paper.

Negotion means transfers of “possession" of the note. If no delivery of the note, then no negotiation of the note.

The Custodian for an RMBS Trust could be an agent to accept possession of the note by transfer of possession nad elivery.

Negotiation ALWAYS requires a change of pessison of an instrument to a person who becomes a holder. Negotiation always requires a change of possessin either directly or thorugh an agent.

If the instrument is payable to an identified person, or order paper, then it is negotiated by delivery plus the necessary indorsement.

Allonge can normally be used in most states even if there is enough room at the foot of the note for the indorsement. The Allonge must be permantelty affixed to the instruement.

If a instrument is payable to bearer, then it is neogiated by delivery of possession alone with proof of delivery.

Need a complete chain of delievery of physical possession of the note and the allonge and a complete and unbroken chain of indorsements on order paper.

Home Equity Line of Credit or HELOC is not a negotiable instrument under the UCC since it is never for a sum certain. It could never travel by the UCC.

ARMS can be negotiable insutrments since 3-112, under the 1999 amenments, allows the same since the principal amount is fixed.

A notice in an instrument to pre-pay the debt makes it a non-neogitable instrument under the UCC.

A Negative-AM loan is not enough to defeat neogitability under the UCC.

If not a negotiable insturemnet under the UCC, the instrument can only be transferred under assignment law.

A holder is a person in possession of an instrument aht is payable either to order or to an identified person and that person is in possession of the note. A holder is eitntield to enforce the insturemnt. A holder has standing to foreclose, so long as it also owns the mortgage or the mortgage follows the note by operation of law. See 1-201(b)(21) and 3-301 of the UCC.

The holder must prove up to the court in a judicial state that theya re in fact a holder under the UCC.

Assignment law means a transfer of ownership that does not occure under Article 3. Assignment or sale of an instrument is allowable for a negotiable or a non-negotiable note.

Assigment will provide standing to the holder so long as the transerfor had the right to foreclose. Plain old assignment law applies to the transfer of any instruement that is not a negotiable instrument.

The Lost, Stolen or Destoryed insurtruemnts under 3-309(b) of the UCC ONLY applies to Negotiable Instruments under the UCC.

The PSA terms trump Article 3 Rules as an otherwise agreed provision under 1-302 of the UCC and therefore the notes in a securitized trust are transferred by Assignment and not by Negotiation. And, the Assignment Rules are set and structured by the PSA and the collateral Mortgage Loan Sales Agreements related to the PSA.

The only relevance of the REMIC Tax Rules as releated to the homeowner is that the PSA is drafted in such a way as to comply with the REMIC Tax Rules. The result, of course, is that the PSA takes the transfer of the instruments totally out of the UCC and relegates the form of transfer to applicable assignment law.

The PSA imposes stricter Rules on the transfer and delivery of the notes than the UCC thus the PSA trumps the UCC Rules that otherwise apply to transfers of the notes. However, the parites cannot contract away the dueties of good faith and fair dealing and the duty of due diligence. Note, hoeweve, that the Comments to 1-302 of the UCC provide that ___________________________________

Since the homeowner is not a party of the PSA, then the homeowner is not a beneficiary of the contract. However, the right of the Trust to enforce the note is governed by the PSA and the homeowner can always raise the issue of the rights or standing of the Trust to enforce the note.

The parties to a residential mortgage secuiritzation constructed their own separate rules about a how the Trust would become the hodler of the note with the rights to enforce the note through the mortgage. These specialized rules were driven for the most part by the need to fully comply with the REMIC Tax Rules. Compliance with those Tax Rules allowed the Trust to avoid the assessment of any income taxes on the Trust itself and also allow the Trust to structure the investment bonds into different grades or tranches. To that exent, the parties elect to determine holder status for the Trust by the way of a hybrid Assignment law that incorporates some aspects of UCC neogtiaiton law. However, in order to maintain REMIC tax compliance, the hodler status of the Trust must always be based on the law of Assigments as established the contracts between the parties.

The applicable state Trust law really imposes nothing new or different on this analysis other than the imposition of tradaitional duties on the Trustees with respect to their fiduciary obligations to the investors or bondholders. In otherwords, strict compliance with the transfer and delivery rules of the PSA also comports with strict compliance with the common law imposed on Trustees under both New York and Dealware law. To that extent, these common trust rules refinforce the need to strict compliance with the PSA and other contracts related to the transfer of the notes but does not require any more than is otherwise required by these contracts.

The key player in any RMBS transaction is the Master Document Custodian for the Trust.

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