For those of us who follow the largely self-inflicted trials and tribulations of the US residential securitization business, the recent White Paper from the American Securitization Forum (Transfer and Assignment of Residential Mortgage Loans in the Secondary Mortgage Market) is an interesting review of a couple of current legal issues associated with U.S. residential mortgage conveyancing that relate directly to the integrity of US securitization structures and foreclosure actions. These mortgage conveyancing practices are being raised daily in US residential foreclosure actions, and certain recent US Court decisions have raised some fundamental questions of concern to the securitization industry. One of these issues (the use of title nominees) is relevant to Canadian mortgage lending and securitization structures, so a short summary here is in order.
The ASF paper is authored by 13 large US law firms that have been major players in the US securitization market for many years. It defends the assignment and conveyancing practices historically used in US securitizations, as well as the legal standing of Mortgage Electronic Registration Systems (MERS) which holds registered title to many residential mortgages as nominee on behalf of the unregistered owners of the related promissory notes. Issues relating to the legal standing of MERS (as the registered holder of the security but not the documentary holder of the promissory notes) and the mortgage conveyancing practices relating to MERS and the promissory notes have been successfully used in several US court decisions to defend foreclosure actions. If upheld by appellate courts, these decisions could have potentially severe consequences for most US mortgage securitizations. However, after going through a very methodical and thorough analysis of the traditional legal principles governing the assignment of "mortgage notes" under the Uniform Commercial Code (UCC), the paper concludes that transfers of mortgage loans in US residential securitizations should be legally effective to convey both the mortgage notes and the mortgages in the secondary mortgage market, even where a third party agent/nominee, such as MERS, is the registered mortgage holder. Securitization investors and other participants would expect this result and will breathe a sign of relief. We will now watch and wait to see if the US appellate courts agree.
From a Canadian perspective, there are a couple of important similarities and differences with respect to our securitization and mortgage origination practices. Canadian residential mortgage documentation differs from US residential mortgages in one important respect - Canadian mortgage loans generally do not use separate promissory notes because the typical form of residential mortgage contains both the borrower's promise to pay (the loan receivable) and the grant of the mortgage security. It is common in Canadian residential securitizations for both the loan receivable and the mortgage instrument to be conveyed together, generally by an assignment or transfer of the mortgage which makes no distinction between the loan receivable and the mortgage security. Because the registered holder of a Canadian registered mortgage is usually the documentary holder of the loan receivable as well, any legal challenge to Canadian mortgage conveyancing and securitization practices would not likely be based on the same issues being raised in these US foreclosure cases.
However, Canadian securitizations (both residential and commercial) frequently use and rely on a nominee (i.e. a title or collateral agent) to hold registered and documentary title to the mortgages (and loan receivables) on behalf of the investors in the securitization (but not through MERS). Some of the US foreclosure cases have raised separate legal questions concerning the legal standing and effectiveness of MERS as a title “nominee”. In Canada, the use of a title nominee or collateral agent to hold mortgage security on behalf of the “real” loan owners is a common lending practice and the legal principles (primarily agency law) governing this practice are well-established. While Canadian loan originators, securitizers and their legal counsel should monitor these US MERS foreclosure cases to the extent that they consider the legal effectiveness of the title nominee structure, there is no reason at this time to re-consider the use of this structure in Canadian deals.