Royal v. First Interstate Bank, a Corporation et al

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF WYOMING
In re 	)
)
MATTHEW JAMES TRIERWEILER and 	)
SHANNON RENEE TRIERWEILER, 	)
Debtors.
RANDY L. ROYAL, TRUSTEE,
Plaintiff,
v.
FIRST INTERSTATE BANK, a
Corporation, its assigns and successors,
and MORTGAGE ELECTRONIC
REGISTRATION SYSTEMS, INC.,
its assigns and successors.
Defendants.
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
)
Case No. 	10-20499
Chapter 7
Adv. No. 	10-2035
OPINION ON COMPLAINT
On July 20, 2011, this adversary proceeding came before the court for trial on the
Complaint to A void Lien filed by Randy Royal, Trustee ("Trustee") and the Answer filed
by First Interstate Bank ("First Interstate") and Mortgage Electronic Registration
Systems, Inc. ("MERS"). The Trustee was represented by Stephen Winship and Bradley
Hunsicker. First Interstate was represented by Timothy Stubson. MERS was represented
by Robert Pratte. The court considered the testimony and other evidence, the arguments
of the parties, and applicable law and is prepared to rule.
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Jurisdiction
This court has jurisdiction over this complaint under 28 U.S.C. §§ 157 and 1334.
This is a core proceeding under § 157(b)(2)(F). Movant brings this complaint under
11 U.S.C. 	§544(a)(1) and (3). 1
Findings of Fact
The facts of the case are undisputed. On March 16, 2009, Debtors obtained
financing to purchase real estate located at 10 Eagle Ridge Trail in Dayton, Wyoming,
through First Interstate by executing a promissory note ("Note"). The Note was payable
to the order of First Interstate.
The Debtors executed a mortgage ("Mortgage") on that same day. The Mortgage
describes MERS as the "mortgagee" and First Interstate as the "Lender." The Mortgage
also includes the language: "MERS is a separate corporation that is acting solely as a
nominee for Lender ... " Thereafter, Fannie Mae purchased the loan and the Note was
endorsed in blank by Ms. Donna L. Hoover, Vice President of First Interstate and
transferred to Fannie Mae. Fannie Mae, through its custodian, Bank ofNew York, was
in possession of the Note on the date that the Debtors' bankruptcy petition was filed.
The Debtors filed for chapter 7 bankruptcy protection on May 3, 2010. The
Trustee was appointed to administer the case. First Interstate requested relief from the
automatic stay to proceed to foreclose its security interest on May 20, 2010. The request
1 Unless otherwise indicated, all future statutory references are to the Bankruptcy Code, Title 11 of the
United States Code.
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was denied by the Order entered August 23, 2010. The court found that the "Bank had
failed to meet its burden that it was a real party in interest or that it had authority to act on
behalf of the real party in interest."
Discussion
In the complaint, the Trustee seeks to avoid First Interstate's position as a
secured creditor alleging that there was a separation of the Note and Mortgage, as
of the commencement of the case, rendering the Note unsecured and subject to the
avoiding powers of the Chapter 7 bankruptcy Trustee under§ 544(a)(l) and (3).
Was the Mort~:a~:e unperfected and enforceable on the date that the Debtors
filed for bankruptcy protection?
The Trustee alleges that as MERS is defined as "mortgagee" in the
Mortgage, that designation splits the note from the mortgage, making the
mortgage unsecured. For an understanding of the issue before the court, it must
first focus on the MERS system. The Court of Appeals for the Ninth Circuit,
succinctly described MERS,
Page 3
" ... as a private electronic database, operated by MERSCORP, Inc.,
that tracks the transfer of the 'beneficial interest' in home loans, as well as
any changes in loan servicers. After a borrower takes out a home loan, the
original lender may sell all or a portion of its beneficial interest in the loan
and change loan servicers. The owner of the beneficial interest is entitled
to repayment of the loan. For simplicity, we will refer to the owner of the
beneficial interest as the 'lender.' The servicers of the loan collects
payments from the borrower, send payments to the lender, and handles
administrative aspects of the loan. Many of the companies that participate
in the mortgage industry - by originating loans, buying or investing in the
beneficial interest in loans, or servicing loans - are members of MERS and
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pay a fee to use the tracking system. 2
When a borrower takes out a home loan, the borrower executes two
documents in favor of the lender: (1) a promissory note to repay the loan,
and (2) a deed of trust, or mortgage, that transfers legal title in the property
as collateral to secure the loan in the event of default. 	State laws require
the lender to record the deed in the county in which the property is located.
Any subsequent sale or assignment of the deed must be recorded in the
county records, as well. 3 This recording process became cumbersome to
the mortgage industry, particularly as the trading ofloans increased." 4
The testimony presented at the hearing before this court, also indicated that the
MERS system was initiated due to the title problems which occurred with mortgages
from the "savings and loan days." Mr. Joseph Patry ("Patry"), counsel forMERS,
testified that in the early 1980s, fees were not collected from borrowers to get releases,
compromising the chain of title and "clouding" the title. The MERS system was
established to maintain a more accurate accounting of the loan documents.
The court in Cervantes continued its explanation of the MERS system, stating,
"It has become common for original lenders to bundle the beneficial
interest in individual loans and sell them to investors as mortgage-backed
securities, which may themselves be traded. 5 MERS was designed to avoid
the need to record multiple transfers of the deed by serving as the nominal
record holder of the deed on behalf of the original lender and any
subsequent lender. 6
2 Cervantes v. Countrywide Home Loans, Inc., 656 F.3d 1034 (9'h Cir. 2011) citing Jackson v. Morg. Elec.
Registration Sys., Inc., 770 N.W.2d 487, 490 (Minn. 2009).
3 Cervantes, supra at 5.
4 Cervantes citing Robert E. Dordan, Mortgage Electronic Registration Systems (MERS), Its Recent Legal
Battles, and the Chancefor a Peaceful Existence, 12 Loy. J. Publ. Inst. L. 177, 178 (2010).
5 Cervantes citing Mortgage Electronic Registration Systems (MERS), Its Recent Legal Battles, and the
Chance for a Peaceful Exists, supra at 180; and, Jackson, at 490.
6 Cervantes at 5, citing Jackson.
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At the origination of the loan, MERS is designated in the deed of
trust as a nominee for the lender and the lender's 'successors and assigns,'
and as the deed's 'beneficiary' which holds legal title to the security
interest conveyed. 	If the lender sells or assigns the beneficial interest in the
loan to another MERS member the change is recorded only in the MERS
database, not in the county records, because MERS continues to hold the
deed on the new lender's behalf. If the beneficial interest in the loan is sold
to a non-MERS member, the transfer of the deed from MERS to the new
lender is recorded in county records and the loan is no longer tracked in the
MERS system. 7
In the event of a default on the loan, the lender may initiate
foreclosure in its own name, or may appoint a trustee to initiate foreclosure
on the lender's behalf. However, to have the legal power to foreclose, the
trustee must have authority to act as the holder, or agent of the holder, of
both the deed and the note together.8 The deed and note must be held
together because the holder of the note is only entitled to repayment, and
does not have the right under the deed to use the property as a means to
satisfying repayment. Conversely, the holder of the deed alone does not
have the right to repayment and, thus does not have an interest in
foreclosing on the property to satisfy repayment. 	One of the main premises
is that the MERS systems impermissibly "splits" the note and deed by
facilitating the transfer of the beneficial interest in the loan among lenders
while maintaining MERS as the nominal holder of the deed."
Based upon the stipulated facts and testimony of Sharon Streitz, First Interstate
has been a MERS member since 2003. Fannie Mae is also a member. First Interstate
and the Debtors entered into the loan documents consisting of the Note and Mortgage on
March 16, 2009. The Mortgage was filed in the Sheridan County land records on March
20, 2009. The Note, executed by the Debtors, by its terms allowed First Interstate "or
anyone who takes this Note by transfer and who is entitled to receive payments under the
Note to be called the 'Note Holder."'9
Page 5
7 Cervantes at 6.
8 Cervantes, citing Landmark Nat/. Bank v. Kesler, 216 P.3d 158, 167( Kan. 2009).
9
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First Interstate endorsed the Note in blank and transferred it to Fannie Mae. The
Bank of New York Mellon Trust had possession of the loan documents, on behalf of
Fannie Mae, as the custodian of the documents. Through an agreement with Fannie
Mae, First Interstate continued to service the Note. First Interstate's duties, as servicer,
are established in the "Investor Guidelines."
The language of the Mortgage, states:
"(C) "MERS" is Mortgage Electronic Registration Systems, Inc. MERS is
a separate corporation that is acting solely as a nominee for Lender and Lender's
successors and assigns. 	MERS is the mortgagee, under this Security Instrument.
MERS is organized and existing under the laws of Delaware ... "
(D) "Lender" is First Interstate Bank ... "
Additionally, the Mortgage describes in the Transfer of Rights in the Property"
section:
Page 6
"This Security Instrument secures to Lender (i) the repayment of the
Loan, and all renewals, extensions and modification of the Note, and, (ii)
the performance of the Borrower's covenants and agreements under this
Security Instrument and Note. For this purpose, Borrower does hereby
mortgage, grant and convey to MERS (solely as nominee for Lender and
Lender's successors and assigns) and to the successors and assignees of
MERS, the power of sale ... "
... Borrower understands, and agrees that MERS holds only legal title
to the interests granted by Borrower in this Security Instrument, but, if
necessary to comply with law or custom, MERS (as nominee for Lender
and Lender's successors and assigns) has the right: to exercise any or all of
those interests, including, but not limited to, the right to foreclose and sell
the Property, and, to take any action required of Lender including, but not
limited to, releasing and canceling this Security Instrument."
The Mortgage also provides for the sale of the note,
"The Note or a partial interest in the Note (together with this
Security Instrument) can be sold one or more times without prior notice to
Borrower. A sale might result in a change in the entity (known as the
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"Loan Servicer") that collects Periodic Payments due under the Note and
this Security Instrument and performs other mortgage loan serving
obligation under this Note, this Security Instrument and Applicable Law."
The court must determine MERS' role in the loan transaction. 	MERS is described
as both "mortgagee" and "nominee." The case law in Wyoming addressing nominee is
limited. The cases generally involve the Internal Revenue Service and tax issues. The
cases are not helpful to the court in defining "nominee" under the facts of this case. 10
Other courts within the Tenth Circuit have addressed the definition and authority
of a nominee in the context other than tax issues. The Kansas Court of Appeals found
that only one Kansas case discussed the meaning of nominee in detail, noting that the
meaning of the term may vary from a pure straw man or limited agent to one who has
broader authority. II 	The Kansas Court determined that whatever authority the nominee
may have comes from the delegation of that authority by the principal. "In its ordinary
meaning, a nominee represent the principal in only a 'nominal capacity' and does not
receive any property or ownership rights of the person represented. 12 There is no
express grant of any right to MERS to transfer or sell the mortgage or even assign its
rights as nominee. Nor does MERS obtain any right to the borrower's payment or even a
role in receiving payment."I 3
1
°City View Trust v. Hutton, No. 98-CV-1001-B 1998 WL 1031525, (D. Wyo. Nov. 2, 1988); and, Jessen
v. U. S. of America, Int. Rev. Ser., No. 95-CV -1 09-B, 1996 U.S. Dist. LEXIS 11192 (D. Wyo. July 29, 1996).
II Landmark National Bank v. Kesler, 192 P.3d 177, (Kan. 2008).
I2 Landmark, supra citing Thompson v. Meyers, 505 P.2d 680 (1973).
13 Landmark at 328.
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The United States District Court for the District of Utah has addressed the MERS
Issue. In cases with identical MERS provisions in deeds of trust, the court held that
"MERS (as nominee for Lender and Lender's Successors and assigns), has the right to
exercise any and all of those interests, including but not limited to, the right to foreclose
and sell the property."14 The court in Commonwealth, held that "By the clear language of
the deeds of trust, MERS has the authority to foreclose and sell the property on behalf of
both the original lender and the "lender's successors." 15
The definition of"nominee" in Blacks Law Dictionary, is "a person designated to
act in place of another, usually in a very limited way, or a party who holds bare legal title
for the benefit of others."16
The court finds that MERS' role in the loan transaction, in the case before this
court, is acting "in the place of another," i.e., that of the Lender. 	The language
throughout the Mortgage indicates MERS is acting "solely as nominee for Lender and
Lender's successors and assigns;" MERS holds "only legal title" to the interest granted
by the borrower in the security instrument; states that the loan or a partial interest in it
"can be sold one or more times without notice to the Borrower"; and, indicates that
MERS has the right to "foreclose and sell the property." 	MERS acted in a limited way,
14 Commonwealth Property Advocates, LLC v. First Horizon Home Loan, No. 2:1 0-CV -375, WL 4788209
(D.Utah November 201 0); and, Burnett v. Mortgage Electronic Registration Systems, Inc., No. 1:09-CV -69, 2009
WL 3582294 (D. Utah Oct. 27, 2009).
15 Commonwealth at 2.
16 Black's Law Dictionary, 1072 (7'h ed. 1999)
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by holding the legal title of the Lender's interest, for the benefit of Lender, for the
purpose of tracking the Lender's interest in the loan. 	Specifically, (1) MERS was acting
on behalf of First Interstate in its capacity as nominee; and, (2) the Mortgage was
recorded in the land records as required under Wyoming law. Accordingly, the court
concludes the mortgage was properly recorded.
May the Chapter 7 Trustee avoid Bank's position as a secured creditor § 544(a)(l)
and (3).
The applicable Bankruptcy Code sections state:
"(a) 	The trustee shall have, as of the commencement of the case, and without
regard to any knowledge of the trustee or of any creditor, the rights and powers of,
or may avoid any transfer of property of the debtor or any obligation incurred by
the debtor that is voidable by-
(1) a creditor that extends credit to the debtor at the time of the
commencement of the case, and that obtains, at such time and with respect to such
credit, a judicial lien on all property on which a creditor on a simple contract
could have obtained such a judicial lien, whether or not such a creditor exists; ...
and
(3) a bona fide purchaser of real property, other than fixtures, from the
debtor, against and who applicable law permits such transfer to be perfected, that
obtains the status of a bona fide purchaser and has perfected such transfer at the
time of the commencement of the case, whether or not such a purchaser exists."
The trustee has the power to "set aside transfers to third parties and to assume the
guise of a creditor with a judgment against the debtor, if state law so provides." 17
Section 544(a) is described as allowing the trustee to become the ideal creditor,
irreproachable and without notice, armed with every right and power which is conferred
by the law of the state, upon its most favored creditor who has acquired a lien by legal or
17 Zilka Energy Co. v. Leighton, 920 F.2d 1520, 1523 (lO'h Cir. 1990).
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equitable proceedings. The so-called strong-arm clause, gives the trustee whatever rights
a creditor would have at state law to effect collection as of the petition date. 18 Whether
the trustee qualifies under§ 544(a)(3) is a question of federal law. State law determines
whether the trustee's status will defeat the rights of persons against whom the trustee
asserts its power. 19
Under §544(a)(l), trustees are granted the power to avoid any transfer or
obligation that a hypothetical creditor with an unsatisfied judicial lien on the debtor's
property could avoid under relevant state non-bankruptcy law. 20
The plain language of§ 544(a)(3) grants a bankruptcy trustee all the rights and
powers of a bona fide purchaser in addition to the ability to avoid transfers made by the
bankruptcy debtor. This section provides that the trustee shall have, as of the
commencement of the case, the rights and powers of, or may avoid any transfer of
property of the debtor or any obligation incurred by the debtor that is voidable to a bona
fide purchaser. The rights and powers of a bona fide purchaser include the right to
obtain title to property free of certain unrecorded interests; the exercise of that right does
not necessarily require the avoidance of a transfer. Under §544(a)(3), a bankruptcy
trustee may be a bona fide purchaser without regard to any knowledge of the trustee, and
thus the trustee is bound only by information of which a purchaser would have
constructive notice.
18 Hill v. Gibson Dunn & Crutcher, LLP (In re MS55, Inc.,) Civil Action No. 06-cv-01233, 2008 U.S. Dist.
LEXIS 45587 (D. Colo. June 6, 2008).
19 In re Weisman, 5 F.3d 417 (9'h Cir. 1993).
20 In re Haberman, 516 F.3d 1207, 1210, (lO'h Cir. 2008).
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The Bankruptcy Court for the District of Kansas recently analyzed cases similar to
the facts in the case before this court?1 The Kansas Bankruptcy Court relied upon the
Eleventh Court of Appeals case, In re Halabi, which thoroughly discussed the issue? 2
In Halabi, the Chapter 7 trustee filed an adversary proceeding seeking a
determination of the priority and validity of a liens on the debtor's real property. The
debtors had granted a mortgage in the real property to a lender two years before the
debtor filed for bankruptcy protection. The lender had timely and properly perfected the
note and mortgage. The initial lender assigned the note and mortgage to a second
creditor, who subsequently assigned it to a third creditor. The assignments were not
recorded in the public records prior to the debtors filing their bankruptcy petition. There
was an additional assignment after the debtors filed bankruptcy. The Circuit court held
that the trustee could not prevail because,
"the assignment of the mortgage, once the original grant by the mortgagor
to the mortgagee has been perfected, does not involve a "transfer of
property of the debtor" that would activate the Trustee's strong-arm powers
and § 544. The trustee is seeking to avoid the transfer of a perfected
mortgage in which the debtor has no interest. The transaction under
scrutiny here does not involve the transfer of the debtor's real property, to
which the mortgage attaches. " 23
The Circuit Court further explained, that the trustee was challenging the secondary
sale of the mortgage by the original mortgage and its successors. But the assignment of
21 In re Kunze, Bankruptcy No. 09-41 075-7; Adversary No. 11-7029, 2011 WL 4889215 (Bankr. D.Kan.
Oct. 13, 2011) and In re Lieurance, Bankrtupcy No. 10-40838, Adversary No. 11-7035, 2011 WL 5041521 (Bankr.
D.Kan. Oct. 24, 2011).
22 In re Halabi, 184 F.3d 1335 (11th Cir. 1999).
23 K 	. . 	H l b'	unze , c1tmg 	a a z.
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the perfected mortgage did not involve the transfer of any property belonging to the
debtor or to the debtor's estate. The assignments were merely the transfer of one
mortgagee's interest to a successor mortgagee. The Circuit Court held:
That the perfected mortgage is neither actually nor potentially the
property of the debtor is confirmed by § 541 (d) which provides that
property in which the debtor holds only legal title and not an equitable
interest (such as a mortgage) becomes property of the estate only to the
extent of the debtor's interest. Section 541 (d) gives as an example a
mortgage secured by real property. See Collier on Bankruptcy (15th rev. ed)
Lawrence P. King, ed 1999) at~ 541,27 ("[Section 541(a)(1)] reiterates the
general principle that an interest that is limited in the hands of the debtor is
equally limited in the hands of the estate, and therefore, where the debtor
holds bare legal title without any equitable interest, the estate acquires bare
legal title without any equitable interest in the property."). See also Norton
Bankruptcy Law & Practice, 2d § 51:17 (1997) ("The purpose of the
section is to insure that secondary mortgage market sales as they are
currently structured are not subject to challenge by trustees in
bankruptcy ... 24
This court finds the rationale in the Kansas Bankruptcy Court persuasive and
agrees with the rationale underlying the holding by the Eleventh Circuit Court in Halabi.
The transfer of the previously perfected mortgage and note between lenders did not
involve the transfer of an interest in property of the Debtor or of the bankruptcy estate.
As this court found that First Bank's use ofMERS as the nominee did not modifY the
secured status of First Bank, the subsequent sale of the loan to Fannie Mae did not
involve a transfer of the Debtors' interest. As the Trustee's interest is that of the
Debtors' at the time the bankruptcy case was filed, the Trustee did not have any interest
to avoid.
24 Halabiat 1337.
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Lastly, the Trustee argues that the Bankruptcy Code allows a trustee to avoid a
mortgage if that mortgage could have been avoided by a hypothetical bona fide purchaser
of the property. 25 Under Wyoming law, the rights of a bona fide purchaser are that (1)
the purchaser is a purchaser in good faith, (2) for valuable consideration; (3) with no
actual, constructive or inquiry notice of any alleged or real infirmities in the title; and (4)
who would be prejudiced by the cancellation or reformation. 26
The Bankruptcy Court for the District of Kansas analyzed this issue in In re
Lieurance, 27 discussing the mortgage, the note and the debtor's interest. The law in
Kansas involving mortgages and notes is similar to that of Wyoming. As this court
discussed in Martinez, 28 a note is a negotiable instrument as it is "an unconditional
promise to pay a fixed amount of money, with or without interest or other charges
described in the promise; and if it is payable to bearer or to order at the time it is issued or
first comes into possession of a holder..." 29 The person entitled to enforce the Note is the
"holder of the instrument, or a nonholder in possession of the instrument who has the right
25 § 544(a)(3).
26 First Interstate Bank of Sheridan v. First Wyoming Bank, N.A. Sheridan, 762 P.2d 379, 382 (Wyo.
1988).; Crompton v Bruce, 669 P.2d 930, (Wyo 1983); North Am. Uranium, Inc. v. Johnston, 316 P.2d 325 (1957);
York v. James, 148 P.2d 596 (1944).
27 In re Lieurance, Bankruptcy No. 10-40838, Adversary No. 11-7035, 2011 WL 5041521, (Bankr. D.Kan,
Oct. 24, 2011 ).
28 In re Martinez, Case No. 09-21124; Slip Copy, 2011 WL 996705 (Bankr. D. Wyo. Mar. 16, 2011.)
29 Wyo. Stat § 34.1-3-104 (2009).
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of a holder..." 30 Under Wyoming law, record of the mortgage is notice of its existence. 31
Also, under Wyoming law, the mortgage follows the note. As to recording assignments of
the mortgage, the Wyoming Statute only states,
and,
"The recording of the assignment of a mortgage, shall not in itself,
be deemed notice of such assignment to the mortgagor, his heirs or personal
representatives, so as to invalidate any payments made by them or either of
them to the mortgages. 32
To entitle any party to give notice ... and to make such foreclosure, it is a
requisite:
(Iii) 	That the mortgage containing the power of sale has been duly
recorded; and if it has been assigned, that all assignments
have been recorded ... " 33
Negotiable instruments that are endorsed in blank may be freely transferred. As
the court in Horvath stated, "It is undoubtedly true that a transfer of a secured debt
carries with it the security without formal assignment or delivery." 34 Therefore, whoever
possesses an instrument endorsed in blank has full power to enforce it.
In Lieurance and Kunze, the Kansas Bankruptcy Court, like the court in Halabi,
held that the note and mortgage executed by the debtor and perfected pre-petition were
30 Wyo. Stat. § 34.1-3-301 (2009).
31 Wyo. Stat.§ 34-1-121.
32 Wyo. Stat. § 34-1-128 (2009).
33 Wyo. Stat.§ 34-4-103 (2009).
34 In re Horvath, 641 F.3d 617 (4th Circ. 2011 ).
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property of the holder of the note, not the debtor, 35 and therefore the transfers of note and
mortgage from one lender to another were not transfers of interest of debtor in property,
precluding avoidance of transfer by the trustee under the strong-arm statute. 36 The
chapter 7 estate interest in the debtor's real estate is the limited interest, at the time of the
commencement of the case which includes legal title and the right to possession, subject
to a pre-petition mortgage.
This court determined that the Mortgage in this case were properly perfected when
recorded in the Sheridan County land records. The court also agrees with the analysis of
Halibi, Kunze and Lieurance regarding§ 544. The Debtors' interest were of the holder
of bare legal title and possession. The Debtors did not have any equity in the property.
Therefore there is no interest for the Trustee to pursue under the strong-arm statute under
§ 544(a)(3).
Conclusion
The court having determined that the Mortgage was properly recorded prior to the
commencement of the Debtors filing for bankruptcy protection and that the Trustee's
interest is limited to the interest in the real property that the Debtors had at the time of
filing, finds that the Trustee is attempting to avoid the transfer of a perfected mortgage in
which the Debtors has no interest. Therefore, the Trustee's arguments fail.
35 Emphasis added.
36 In re Lieurance, Bankruptcy No. 10-40838; Adversary No. 11-7035, 2011 WL 5041521 (Bankr.D.Kan.
Oct. 24, 2011 ).
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This opinion constitutes the Court's findings of fact and conclusions of law. A
separate order shall be entered pursuant to Fed. R. Bankr. P. 9021.
DATED this _a day ofNovember, 2011.
Service to:
Page 16
Steve Winship
Brad Hunsicker
Timothy Stubson
Robert Pratte
By the Court
~?~/
< ~ 	·-::-::--HONOAABLRPETER J. MCNIFF
United ~e~ Bankruptcy Judge
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