What is the effect on a foreclosure when a promissory note and deed of trust are split?

Foreclosure1

In re Montierth (Nev. Supreme Ct. – July 30, 2015)

The United States Bankruptcy Court for the District of Nevada certified two questions of law to the Nevada Supreme Court concerning the legal effect on a foreclosure when the promissory note and the deed of trust are split at the time of foreclosure. The bankruptcy court asked what occurs when the promissory note and the deed of trust remain split at the time of the foreclosure and whether recordation of an assignment of a deed of trust is a purely ministerial act that would not violate the automatic stay.

In June 2005, the Montierths signed a promissory note in favor of 1st National Lending Services for $170,400. The note provided that the lender may transfer the note. The note was subsequently transferred to Deutsche Bank.

The note was secured by a deed of trust on the Montierths’ property in Logandale, Nevada. The beneficiary of the deed of trust was Mortgage Electronic Registration Systems, Inc. (MERS), solely as nominee for lender and lender’s successors and assigns. Additionally, the deed of trust provided:

MERS holds only legal title to the interests granted by Borrower in this Security Instrument; but, if necessary. . . , 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 Montierths’ last payment on the note was made in June 2009. Deutsche Bank recorded a notice of default and initiated foreclosure. The Montierths opted into Nevada’s Foreclosure Mediation Program (FMP), but the first two mediation attempts were unsuccessful. The Montierths petitioned for judicial review of the attempted mediation, and the district court found that Deutsche Bank failed to participate in the mediation in good faith.

Deutsche Bank then filed another notice of default, and the Montierths again elected to mediate. Less than two weeks before the scheduled mediation, the Montierths filed for bankruptcy. At the time the Montierths filed for bankruptcy, the note and the deed of trust were separate—Deutsche Bank held the note and MERS was the beneficiary of the deed of trust.

After the Montierths filed for bankruptcy, MERS assigned its interest in the deed of trust to Deutsche Bank on November 25, 2011, but the assignment was not recorded until December 23, 2011. Prior to the recordation of the assignment, Deutsche Bank filed a proof of claim in the Montierths’ bankruptcy, claiming that it was a secured creditor.

On September 5, 2012, Deutsche Bank filed a motion for relief from the automatic bankruptcy stay so that it could foreclose on the Montierths’ property. The Montierths objected to Deutsche Bank’s standing to bring the motion. The Montierths also objected to Deutsche Bank’s proof of claim insofar as it alleged secured creditor status. Both objections were premised on the argument that Deutsche Bank was not a secured creditor because it did not have a unified note and deed of trust when the bankruptcy petition was filed and the automatic stay precluded the reunification of the instruments.

Before reaching a decision on Deutsche Bank’s motion and the Montierths’ claim objection, the bankruptcy court issued an order certifying the following questions of law to the Nevada Supreme Court:

What occurs when the promissory note and the deed of trust remain split at the time of foreclosure? What is the legal effect of the recordation of an assignment of a beneficial interest in a deed of trust?

The Montierths argued that Nevada is a “Restatement state” and, pursuant to the Restatement Third of Property, the note is unsecured until it is reunited with the deed of trust. Relying on the Restatement, the Montierths argued that when the right of enforcement of the note and the mortgage are split, the note becomes, as a practical matter, unsecured.

Deutsche Bank argued that the splitting of the note and the deed of trust did not alter the status of or void either instrument. Deutsche Bank further argued that catastrophic results would occur if the Nevada Supreme Court accepted the Montierths’ argument that a note split from its deed of trust is unsecured upon the filing of bankruptcy because hundreds of thousands of home loans are secured by deeds of trust held by MERS, and, upon bankruptcy, if lenders were unsecured, they would receive a fraction of the debt owed and be unable to foreclose.

In Edelstein v. Bank of New York Mellon, 128 Nev., Adv. Op. 48, 286 P.3d 249 (2012), the Nevada Supreme Court stated that separation of the note and security deed creates a question of what entity would have authority to foreclose, but does not render either instrument void. After being split, the documents, and their respective interests, survive even if held by different parties. Further, if an agency relationship exists between those two parties such that the note holder, as principal, can require its agent, MERS, to assign the mortgage to it, then the note remains secured.

The Edelstein court discussed that both the promissory note and the deed must be held together to foreclose; the general practical effect of severance is to make it impossible to foreclose the mortgage. Because it was not pertinent to the court’s analysis in Edelstein, the court did not include the exceptions provided in the Restatement. The Restatement specifies that foreclosure is not impossible if there is either a principal-agent relationship between the note holder and the mortgage holder, or the mortgage holder otherwise has authority to foreclose in the note holder’s behalf. In this case, the Nevada Supreme Court agreed with the Restatement’s reasoning.

The Court explained that here, the deed of trust was first recorded in favor of MERS in June 2005, when the mortgage was first created. The deed of trust in this case designated MERS as nominee, or agent, for the note holder and the note holder could compel an assignment of the deed of trust. Because the security interest attached and was perfected before bankruptcy, and separation of the note from the deed of trust did not alter the interests of the parties in this instance, the Court concluded that Deutsche Bank was a secured creditor when the Montierths filed for bankruptcy. Accordingly, the Court rejected the notion that separating the note and the deed of trust between a principal and an agent renders either instrument void, or that the deed becomes unenforceable even though the named beneficiary is acting as agent for the note holder.

The Court clarified that reunification of the note and the deed of trust is not required to foreclose because of an existing principal-agent relationship between MERS and Deutsche Bank. The Restatement (Third) of Property permits the beneficiary of the deed of trust, or mortgagee, to enforce the mortgage on behalf of the note holder if the mortgagee has authority to foreclose from the note holder. A mortgage may be enforced only by, or in behalf of, a person who is entitled to enforce the obligation the mortgage secures. Thus, in this case, MERS would be authorized to foreclose on behalf of Deutsche Bank at Deutsche Bank’s direction because MERS is its agent, and reunification of the instruments would not be required.

Recordation of an assignment

The Montierths argued that under NRS 106.210, an assignment would be required from MERS to Deutsche Bank to proceed with the foreclosure. Deutsche Bank maintained that no assignment was required from an agent to its principal, but even if an assignment was necessary, it was not required until the trustee exercised its power of sale pursuant to NRS 106.210.

The Court explained that based on these conflicting arguments, the bankruptcy court’s second certified question would require the Court to determine whether the recordation of an assignment was a ministerial act such that it fell within an exception to the automatic stay mandated by bankruptcy law. This was a question of federal law and outside of the purview of the Court’s authority to answer questions from the certifying court if there are involved in any proceeding before the certifying court questions of law of this state. The Court may reframe the certified questions presented to it, and thus, the Court reframed the bankruptcy court’s second question to narrow its focus: “Is the state law effect of the recordation of an assignment of a beneficial interest in a deed of trust by an agent of the note holder a ministerial act under Nevada law?” The Court concluded that an agent’s recordation at the direction of its principal is a ministerial act under Nevada’s characterization of ministerial acts. And to the extent that the definition of “ministerial act” used by the federal court in In re Pettit, 217 F.3d 1072 (9th Cir. 2000), is determined by state law, the Court concluded that MERS’ recordation of its assignment to Deutsche Bank was a ministerial act.

The Montierths argued that the assignment of the deed of trust from MERS to Deutsche Bank was not a “ministerial act” because it gave the benefited party the right to enforce the note. In addition, they argued that recordation of the assignment was not a ministerial act because recording the assignment was a discretionary act that can occur whenever MERS decided.

The Court noted that the United States Court of Appeals for the Ninth Circuit adopted the “ministerial act” exception to the automatic stay in bankruptcy procedures in Pettit. A ministerial act exception applies to automatic occurrences that entail no deliberation, discretion, or judicial involvement. Ministerial acts are essentially clerical in nature.

Nevada has also clarified the distinction between ministerial acts and discretionary acts:

In Pittman v. Lower Court Counseling, 110 Nev. 359, 871 P.2d 953 (1994), the Nevada Supreme Court made a distinction between ministerial acts and discretionary acts:

We have defined a discretionary act as that “which require[s] the exercise of personal deliberation, decision and judgment.” A ministerial act is an act performed by an individual in a prescribed legal manner in accordance with the law, without regard to, or the exercise of, the judgment of the individual.

The Court explained that while it has primarily recognized ministerial acts based on statutory requirements, it now recognizes a similar contractual obligation to recording an assignment based on a principal-agent relationship. Here, the deed of trust that the Montierths executed provided that:

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. . . .

The Court explained that MERS had but one choice in Deutsche Bank’s demand for assignment in order to comply with NRS 106.210: performance in accordance with the contract terms. MERS has nothing to consider, and only after Deutsche Bank’s prompting and direction did MERS fulfill its agency role and perform according to the agreement.

The Court concluded that MERS’ recordation of its assignment to Deutsche Bank was a ministerial act. MERS was operating as the agent of Deutsche Bank, and both the assignment and the recordation involved obedience to instructions from Deutsche Bank. Thus, MERS could not exercise discretion in assigning its interest to Deutsche Bank and recording that assignment.

Accordingly, the Court answered the bankruptcy court’s first question by concluding that Deutsche Bank’s interest was secured at the time of the filing of bankruptcy. Reunification of the note and the deed of trust was not necessary to foreclose because the beneficiary was an agent for the principal note holder. The Court modified and answered the bankruptcy court’s second question by concluding that in Nevada, the recordation of an assignment from a beneficiary of a deed of trust is a ministerial act, because the agent is fulfilling a contractual obligation and has no discretion to disobey.

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