Servicing Agents Forewarned: Whether Servicing Agents are Real Parities in Interest in the Bankruptcy Forum Richard Solow,

J.D. Candidate 2011

Cite as: Servicing Agents Forewarned: Whether Servicing Agents are Real Parities in Interest in the Bankruptcy Forum, 2 ST. JOHNS BANKR. RESEARCH LIBR. NO. 25 (2010).

Introduction Under the Federal Rules of Bankruptcy Procedure, in order to move the bankruptcy court to act in some way, a movant must be a real party in interest.1 Whether or not a particular party has such standing is often a hotly contested question. This issue arises often when creditors, who commonly file motions to assert rights based on promissory notes, seek relief in bankruptcy court. Generally, promissory notes are held by lenders and embody the personal obligations of a borrower, such as those secured by mortgages. In the context of mortgages, lenders often employ servicing agents to manage mortgages for the note-holder. There is now an ongoing debate whether servicing agents possess standing to assert any rights in the bankruptcy forum. Arguably, because a servicing agent would be familiar with whether a note from a borrower who has declared bankruptcy is in default, it would be the most appropriate party to bring motions in bankruptcy court to protect the interests of a note-holder. Recently, in In Re Jacobson,2 the United States Bankruptcy Court for the Western

1 See FED. R. BANKR. P. 7017. 2 402 B.R. 359 (Bankr. W.D. Wash. 2009).

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District of Washington found that merely being a servicing agent does not necessarily confer real party in interest status without meeting further state standing requirements.3 Consequently, these agents must now prove that it not only has some ability to act for the note-holder, but also some beneficial interest in the note.4 If that holding becomes a general rule, it will become very difficult for servicing agents to ever meet standing requirements in the bankruptcy forum. Part I of this memorandum discusses a background of servicing agents and important related statutory provisions. Part II analyzes the legal controversy regarding servicing agent standing in detail, including a discussion of In Re Jacobson and a look at cases both agreeing and disagreeing with that holding. Finally, Part III discusses how the holding of In Re Jacobson and similar cases affect not only bankruptcy practice, but also the lending scheme as a whole.

I. How Servicing Agents and Issues of Standing Come Together in a Controversy A. The Role of Servicing Agents In order to fully appreciate the controversy surrounding servicing agents and standing, one must first understand these entities. A servicing agent is an entity that monitors and collects payments for the note-holder.5 When a mortgage is created, a promissory note secured by the mortgage is signed, embodying the personal obligation of the mortgagor (or borrower) to the lender (or mortgagee).6 Servicing agents monitor both the property encumbered by the mortgage and personal obligations contained in the note. Therefore, if a default on any obligation occurs, the servicing agent would be the most knowledgeable to assert rights in court. Even though a servicing agent is technically the mortgagee of record, it rarely has any
3 Id. at 370. 4 See id. (noting many states require beneficial interest for standing). 5 See V-funding, http://v-funding.com/index.php?option=com_content&view=article&id=48&Itemid=56 (last visited Feb. 17, 2010). 6 Black's Law Dictionary 492 (3d ed. 2006).

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beneficial interest in a note. Definitions of a beneficial interest vary between courts but typically require having some direct interest in a promissory note.7 For example, an ability to keep proceeds of a foreclosure sale, pursued by a note obligation, is a direct interest.8 Considering it is the note-holder that is generally the beneficial owner, it is very difficult for servicing agents to prove a beneficial interest. B. Servicing Agents in State and Federal Courts In its capacity as mortgagee of record for the lender, servicing agents have often asserted state foreclosure rights in its own name. In Bucci v. Lehman Brothers Bank,9 the court held that a servicing agent had a contractual right of foreclosure because of its status as a mortgage servicer.10 Therefore, the servicing agent in Bucci was not required to show any other standing requirements besides its status conferred upon by the note-holder. In other cases, courts have questioned the need for a beneficial interest to seek foreclosures.11 For example, in Mers v. Azize, the court held that a servicing agent could assert state foreclosure rights regardless of having any beneficial interest.12 Thus, we see a willingness in state courts to allow servicing agents rights. Whereas state courts are often willing to allow servicing agents rights, federal courts must first decide whether these entities are real parties in interest, which is required by the Federal Rules of Civil Procedure for standing.13 The bankruptcy procedural rules mirror the

7 See, e.g., In re Sheridan, 2009 Bankr. LEXIS 552 (Bankr. D. Ida. 2009) (defining beneficial interest as pecuniary interest in keeping proceeds enforced by note obligation); In re Wilhelm, 407 B.R. 392, 398 (Bankr. D. Ida. 2009) (defining beneficiary as having interest in notes or entitlement to enforce notes); Jacobson, 402 B.R. at 367 (defining beneficial interest as holding note or proof of acting on behalf of note-holder). 8 See generally In re Sheridan, 2009 Bankr. LEXIS 552 (Bankr. D. Ida. 2009). 9 C.A. No. PC 09-3888 (R.I. Super. Ct. 2009). 10 See id. at 7. 11 See generally MERS v. Azize, 965 So.2d 151 (2d Dist. Ct. App. 2007). 12 See id. at 15354. 13 FED. R. CIV. P. 17.

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federal rules in this regard.14 A real party in interest has been defined as, . . . the one who, under applicable substantive law, has the legal right which is sought to be enforced or is the party entitled to bring suit.15 Congress specifically left the term real party in interest undefined in both the federal and bankruptcy procedural rules, allowing courts to interpret the phrase based on facts presented to them.16 It is not clear from the procedural rules themselves whether a beneficial interest is needed to become a real party in interest. There are many rights in bankruptcy courts that servicing agents try to assert. Frequently, the right being asserted by a servicing agent is a Motion to Lift the Automatic Stay. Under 11 U.S.C. 362, a debtor is immediately entitled to an automatic stay the moment he files for bankruptcy.17 This stops all on-going debt collection activities, even if the creditor is entitled to them under state law.18 In order to resume these activities, a creditor must file a motion under 11 U.S.C. 362(d) to lift the automatic stay.19 If the motion is granted, state foreclosure actions, which are prohibited from commencing with the stay in effect, can once again commence even though the debtor is in bankruptcy. Furthermore, if the debtor fails to challenge the lift stay motion, under 11 U.S.C. 362(e)(2), the stay will be lifted automatically sixty days after the motion is appropriately filed.20 Of course, if a creditor lacks standing to file such a motion, he is not entitled to lift the stay. Therefore, it is very important to figure out whether servicing agents have any entitlement to this relief. C. The MERS System In many cases, the servicing agent on a particular mortgage will be the Mortgage
14 15 16 17 18 19 20 See FED. R. BANKR. P. 7017. See Roslyn Savings Bank v. Comcoach Corp. (In Re Comcoach Corp.), 698 F.2d 571, 573 (2d Cir. 1983). See In re ODell, 305 F.3d 1297, 1302 (11th Cir. 2002). 11 U.S.C. 362(a) (2006). See id. 11 U.S.C. 362(d) (2006). 11 U.S.C. 362(e)(2) (2006).

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Electronic Registration System (MERS), a computerized system that tracks significant information related to a particular mortgage. In fact, more than half of all home loans in the United States are registered under MERS.21 The concept of MERS is simple but important. Generally, MERS becomes the mortgagee of record. It also becomes the nominee for the beneficial owner, meaning MERS has the authority to act on behalf of that party.22 Typically, the party holding the beneficial interest is the lender. It is the task of MERS to track a particular mortgage for the beneficial owner by not only monitoring any duties common to a servicing agent, but also ownership interests.23 Therefore, when notes are sold by one lender to another, MERS will track that transfer.24 If one party in the sale is a member of MERS, then MERS will automatically remain the mortgagee of record, continuing to act as nominee for the new beneficial owner.25

II. Whether to Allow Servicing Agent Standing in Bankruptcy Court A. Courts Holding Servicing Agents are Not Real Parties in Interest 1. Analysis of In Re Jacobson In denying a servicing agent standing, the In Re Jacobson court held that these entities are not real parties in interest merely because of its ability to monitor and manage notes for the holder.26 In this case, UBS AG (UBS) was a servicing agent for ACT Properties, LLC (ACT) regarding a loan given to Jacobson (Debtor).27 Later, the debtor defaulted on the

21 See Christopher L. Peterson, Predatory Structured Finance, 28 CARDOZO L. REV. 2185, 2211 (2007). 22 See Austin Hall, Property, 25 GA. ST. U. L. REV 265, 268 (2008) (noting MERS was formed on secondary market by participants). 23 See id. 24 See Phyllis K. Slesinger & Daniel McLaughlin, Negotiation Bit By Bits: Introducing the Symposium on Negotiability in an Electronic Environment, 31 IDAHO L. REV. 805, 807 (1995). 25 See id. 26 Jacobson, 402 B.R. at 370. 27 See id. at 36263.

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obligation and a foreclosure on the debtor's property was scheduled.28 The debtor subsequently filed for bankruptcy, triggering the automatic stay under 11 U.S.C. 362.29 UBS, acting as servicing agent, filed a Motion to Lift the Automatic Stay under 11 U.S.C. 362(d)(1) for lack of adequate protection.30 The motion included a statement by a so called bankruptcy specialist, who is supposed to be an expert in the field, that mirrored UBS's assertions about the note's status.31 According to that statement, the current holder of the note was Wells Fargo Document Custody (Wells Fargo), who provided custodial services for lenders such as safekeeping mechanisms.32 There was no assertion as to whether UBS could act in court on behalf of either ACT or Wells Fargo except the statement that UBS was a servicing agent. In response to the lift stay motion, the debtor filed a Motion to Dismiss on grounds that UBS lacked standing.33 The court ultimately granted the debtor's motion. The court in In Re Jacobson analyzed both key terms and state law in its holding. First, the court determined who can assert bankruptcy rights under the Federal Rules of Bankruptcy Procedure.34 To that end, the court stated, [t]he real party in interest in relief from stay is whoever is entitled to enforce the obligation sought to be enforced.35 The court, relying on In Re Hwang,36 held that a servicing agent is merely a nominal party not entitled to relief unless there was proof of a direct interest in a case.37 The Hwang court made it clear that a servicing agent is not, per se, a real party in interest.38 Therefore, UBS could not be granted standing

28 29 30 31 32 33 34 35 36 37 38

See id. at 362. See id. See id. See id. See id. at 363. See id. (arguing servicing agent standing did not exist in this case). See id. at 365. See id. 396 B.R. 757 (Bankr. C.D. Cal. 2008). See Jacobson, 402 B.R. at 365. Hwang, 396 B.R. at 767.

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merely because of its servicing agent status. Considering the Jacobson court did not automatically allow UBS to assert bankruptcy rights, the court looked to prudential standing requirements. The court reiterated that to have standing in federal court, a party must have both constitutional and prudential standing.39 Putting aside the constitutional issue, the court focused on state prudential requirements. In Washington State, where this case took place, a party must be a beneficiary of an obligation to have standing in court.40 To be a beneficiary in Washington in this context, a party must either hold the note or show authority to act on behalf of a note-holder.41 It was clear from UBS's own motion that they did not hold the note because it stated that Wells Fargo was the holder. Furthermore, nothing in UBS's motion asserted that it had the authority to act on behalf of Wells Fargo.42 The court determined that UBS failed to meet the beneficiary standard required under Washington law and thus was not a real party in interest.43 2. Cases Adopting and Narrowing the In Re Jacobson Holding The holding in In Re Jacobson has been taken up by many bankruptcy courts recently, some of which have entirely adopted its holding, while others have narrowed its central principles.44 For example, in In Re Wilhelm, a bankruptcy court in Idaho stated that MERS was not a real party in interest because it lacked proper prudential standing.45 The court in that case went so far as to say that real party in interest status falls within the prudential standing

39 40 41 42 43 44

See Jacobson, 402 B.R. at 367. See id. See id. See id. at 36263. See id. at 369. See, e.g., In re Wilhelm, 407 B.R. 392 (Bankr. D. Ida. 2009); In re Fitch, 2009 Bankr. LEXIS 1375 (Bankr. N.D. Ohio 2009); In re Mitchell, 2009 Bankr. LEXIS 876 (Bankr. D. Nev. 2009); In re Sheridan, 2009 Bankr. LEXIS 552 (Bankr. D. Ida. 2009). 45 Wilhelm, 407 B.R. at 405.

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doctrine.46 The court stated, . . . as a prudential matter, a plaintiff must assert his own legal interests as the real party in interest.47 By holding that prudential and real party in interest standing are so commingled, the court inferred that a party cannot meet one burden without the other. Considering many prudential rules require a beneficial interest, servicing agents will almost never be able to attain real party interest standing with this holding. This connection between the two concepts exemplifies some bankruptcy courts' unwillingness to allow servicing agents rights. Some courts have not only adopted the Jacobson holding, but also narrowed key terms in that decision.48 For example, the court in In Re Sheridan held that only a party holding a pecuniary interest in a case has a beneficial interest.49 Therefore, only a party entitled to actual payment from the debtor can assert rights in the bankruptcy forum.50 Considering servicing agents can only collect for note-holders and not keep the proceeds, the Sheridan definition of beneficial interest prohibits these entities from ever asserting rights in bankruptcy court. Even though many courts have adopted the Jacobson holding and narrowed its key terms, some remain open to the possibility of serving agent standing, even when imposing near impossible standards.51 For example, a district court in Nevada recently agreed with bankruptcy courts in eighteen cases that MERS was not a real party in interest.52 Unlike the servicing agent in Jacobson, MERS in MERS v. Atkerson presented some evidence that it was a beneficiary of the note.53 The deed of trust in that case specifically said that MERS was a beneficiary for the

46 47 48 49 50 51 52 53

See id. at 398. See id. See Sheridan, 2009 Bankr. LEXIS 552. Id. at *8. Black's Law Dictionary 529 (3d ed. 2006). See generally MERS v. Atkerson, No. 2:09-CV-00673 (D. Nev. 2009). See id. at 45. Id.

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original lender.54 Even with an express provision stating that MERS was the holder of a beneficial interest, the court held that that was not sufficient evidence to assert real party in interest standing because there was no actual proof.55 The court did not elaborate on what proof is necessary but made clear that merely saying the words beneficial interest is not sufficient. However, the Atkerson court did not wholly reject the possibility that MERS could attain standing in some circumstances. The court stated, [t]he Court makes no finding that MERS would not be able to establish itself as a real party in interest had it identified the holder of the note or provided sufficient evidence of the source of its authority.56 However, it is not easy to envision a situation where a servicing agent can sufficiently prove a beneficial interest. B. Courts Holding Servicing Agents are Real Parties in Interest While many courts have reached a result similar to Jacobson, others have found that servicing agents are real parties in interest because of its general obligations.57 For example, in In Re Huggins, the court held that MERS was a real party in interest to file a lift stay motion because of MERS' obligation as a nominee for the note-holder.58 MERS in this case cited Black's Law Dictionary to support its claim, which defines nominee as a person designated to act in the place of another.59 The court accepted that argument, stating that MERS is a party in interest because of its obligation to act for the beneficial holder of the note.60 Therefore, servicing agents under this standard do not have to show any beneficial interest. Some bankruptcy courts justify servicing agent standing by looking at its interests in

54 55 56 57 58 59 60

See id. See id. See id. at 5. See In re Huggins, 357 B.R. 180, 183 (Bankr. Mass. 2006). Id. at 185. Black's Law Dictionary 486 (3d ed. 2006). Huggins, 357 B.R. at 185.

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performing general obligations. For example, in In re Woodberry,61 the bankruptcy court held that a mortgage servicer is a real party in interest because it had a pecuniary interest in collecting payments from the mortgagor.62 This holding should be contrasted with In Re Sheridan, where that court believed a servicing agent can only have a pecuniary interest if it was ultimately able to keep proceeds forced by note obligations. When contrasting these two decisions, there is a clear difference in what type of interest is sufficient for servicing agents to become real parties in interest. One final approach that bankruptcy courts pursue when allowing a servicing agent standing is classifying it as a creditor rather then a creditor's authorized agent. In In re CondeDedonato,63 the court started its analysis by citing the Federal Rules of Bankruptcy Procedure which states that a claimant seeking relief in court must be a creditor or a creditor's authorized agent.64 To become a creditor, a party must have a claim against the debtor.65 A creditor has a right to assert its claim against a debtor in the bankruptcy forum.66 The court held that a mortgage servicer was clearly a creditor because collecting money from a debtor for the noteholder was a proper claim.67 Therefore, the servicing agent in Conde-Dedonato had authority to assert any rights in bankruptcy court against the debtor pursuant to its duties as a servicer.68 Much like the court in Woodberry, it was irrelevant in Conde-Dedonato that servicing agents do not own any money that was ultimately collected on behalf of a note-holder.

III. The Implications and Trends of Imposing Harsh Standing Criteria

61 383 B.R. 373 (Bankr. D.S.C. 2008). 62 383 B.R. at 379. 63 391 B.R. 247 (Bankr. E.D.N.Y 2008). 64 391 B.R. at 247. 65 See id. 66 See id. 67 See id. 68 See id.

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A. How Jacobson Impacts the Bankruptcy Practitioner Even though there have been courts in the past that have permitted servicing agent standing in the bankruptcy forum, the recent trend follows the Jacobson holding.69 While courts remain open to the idea of servicing agent standing, one would be hard pressed to find an example where one of these agents actually proved it had a beneficial interest in a note since Jacobson. The most pertinent question for the bankruptcy practitioner is whether a servicing agent can ever have a beneficial interest. Keeping in mind the realities of how federal courts are trending on this issue, the bankruptcy practitioner must be mindful of the evidence presented by a servicing agent asserting rights in court.70 Unless there is a clear beneficial interest, the likelihood that an agent will be able to successfully assert any rights in bankruptcy is small under the Jacobson rule. Therefore, standing objections should always be asserted against servicing agents. Considering the prevalence of MERS in our modern day lending system, these objections should become common. B. Whether Jacobson is Appropriate for Modern Day Lending When looking at cases analyzing serving agent standing, the holdings permitting rights seem more appropriate for our modern day lending system. If the Jacobson holding becomes a sweeping law, many lenders, who now have their promissory notes being monitored by servicing agents, will lose the ability to assert rights after a bankruptcy case has commenced. Having the lenders themselves assert rights in court is not logical because of their lack of familiarity with a

69 See generally In re Wilhelm, 407 B.R. 392 (Bankr. D. Ida. 2009); In re Fitch, 2009 Bankr. LEXIS 1375 (Bankr. N.D. Ohio 2009); In re Mitchell, 2009 Bankr. LEXIS 876 (Bankr. D. Nev. 2009); In re Sheridan, 2009 Bankr. LEXIS 552 (Bankr. D. Ida. 2009). 70 See generally In re Jacobson, 402 B.R. 359 (Bankr. W.D. Wash. 2009) (noting evidence must show clear beneficial interest); MERS v. Atkerson, No. 2:09-CV-00673 (D. Nev. 2009) (using the term beneficial interest is not enough evidence to show such interest).

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note's progression. The most logical rule is to allow those closest to the note assert bankruptcy rights and that is the servicing agent.

Conclusion Jacobson provides an important look into how federal courts currently view servicing agent standing. State courts allow these entities to assert its rights of foreclosure; but, federal courts do not allow servicing agents to file motions. Most importantly for the bankruptcy practitioner is the inability of these agents to file lift stay motions under 11 U.S.C. 362. Considering most households in the United States have MERS as a servicing agent for their mortgages, this entity should frequently be a presence in federal court. In these times of financial uncertainty, it is unquestionable that bankruptcies are on the rise and MERS should be a frequent participant in bankruptcy proceedings.71 If the Jacobson court holding continues to dominate the bankruptcy scene, practitioners must always be mindful of state prudential rules. If the state rules require a beneficial interest, it is likely that the bankruptcy court will force the servicing agent to meet this near impossible standard. The message to practitioners is simple: file a Motion to Dismiss when you see servicing agents in bankruptcy court. Whether the Jacobson holding is proper for our current lending system is a matter for debate in the years to come.

71 See Sara Murray & Conor Dougherty, Personal Bankruptcy Filings Rise Fast, WALL ST. J., Jan. 7, 2010, http://articles.moneycentral.msn.com/Banking/BankruptcyGuide/personal-bankruptcy-filings-rise-fast.aspx (reporting downturn has caused bankruptcy filings to rise).