Yesterday, the Massachusetts Supreme Judicial Court issued its decision in Bevilacqua v US Bank, a case that involved a defective mortgage foreclosure. Contrary to what is implied by the Boston Globe’s headline – Mass ruling on foreclosure deals leaves buyers in limbo – Bevilacqua does not radically change things, it only clarified a few points.

Here are the facts: In 2005, Pablo Rodriguez granted a mortgage on his home in Haverhill to Mortgage Electronic Registration System, Inc (hereafter MERS) as nominee of Finance America LLC. On June 29, 2006, US Bank executed a foreclosure deed on the property in which it purchased the property at the foreclosure auction it conducted (which is what usually happens in a foreclosure). On July 21, 2006, MERS assigned the mortgage that had already been foreclosed to US Bank. On October 9, 2006, US Bank sold the property to Francis Bevilacqua. Because of uncertainty about the strength of his ownership of the property, Bevilacqua filed suit in the Land Court to clarify his title to the property. The Land Court ruled that Bevilacqua did not own the property and he appealed.

To understand what’s going on here, some background is required. What we commonly call a mortgage really consists of two transactions. The first is the promissory note which is a contract by which the borrower agrees to repay the lender the amount of money loaned with interest according to certain terms. In the second transaction, the borrower conveys to the lender an interest in the borrower’s real estate. That conveyance is the mortgage which is actually a type of deed. The interest conveyed to the lender is the legal title to the property although the borrower retains what’s called “the equity of redemption” which means when the money owed is repaid in full, the lender’s interest in the property is automatically extinguished. But if the borrower fails to repay the loan, the lender may “foreclose” or cut off the borrower’s right to redeem the property. That’s what happens at a foreclosure auction.

In modern real estate finance, the entity that originally loans the money to the borrower almost never retains ownership of the promissory note (the right to be repaid the money). Instead, the original lender sells that right to be repaid to other financial institutions or investors of many types. A promissory note will often bounce through multiple owners until it is paid off. Under normal circumstances, each time the promissory note is so transferred, the holder of that note must also “assign” the accompanying mortgage to the new holder of the note. That “assignment” is done through a document recorded at the registry of deeds called an Assignment of Mortgage. During the boom of the late 1980s and early 1990s, however, the home finance industry found that promissory notes were assigned so rapidly that it was almost impossible to keep up with the many mortgage assignments that resulted.

To remedy this assignment problem, many of the nation’s largest lenders banded together to create Mortgage Electronic Registration Systems, Inc which works much like a trust that holds the actual mortgages for the benefit of the lenders who continue to own and transfer promissory notes as before, only without the need to produce and record assignments. Because the mortgages all stay with MERS, there is no need to create a trail of mortgage assignments. A problem arises when the borrower fails to pay. While MERS would be legally entitled to conduct the foreclosure, it is not structured to do so. When a foreclosure is necessary, therefore, MERS assigns the mortgage to the financial entity that happens to hold the promissory note at that time so that entity can go ahead and conduct the foreclosure itself.

In this case, the mortgage that had been signed by Mr. Rodriguez was held by MERS but the promissory note apparently was held by US Bank at the time Rodriguez stopped paying. US Bank would be the entity to conduct the foreclosure. But, before it could commence the foreclosure and certainly before it could conduct the foreclosure auction and then sign the foreclosure deed, US Bank had to be the owner of the mortgage. Otherwise it would have no ownership interest in the property and therefore nothing to foreclose. Because the assignment of the mortgage from MERS to US Bank came after US Bank had already foreclosed, its foreclosure was defective and title did not pass to it pursuant to the foreclosure deed it executed. This much of this case simply confirms the SJC’s ruling earlier this year in US Bank v Ibanez that an entity conducting a foreclosure must already have the mortgage assigned to it before the foreclosure sale occurs.

The new issue addressed in this case is the ownership status of someone like Bevilacqua who is the third party purchaser of a previously foreclosed home. In almost every foreclosure, the high bid at the foreclosure auction is made by the lender that is conducting the foreclosure. Once the foreclosure deed is recorded, that lender becomes the owner of the property. Because the new owner wants to be a lender and not a property owner, it puts the property up for sale not as a foreclosure but as a normal arms-length sale to a third party (Mr Bevilacqua in this case). Ibanez had not directly answered the question of the rights of such a third party buyer who purchased from a lender that had conducted a defective foreclosure. Bevilacqua quite clearly says that if the foreclosing lender did not obtain valid title through the foreclosure sale, no one who purchases from that lender could obtain valid title either. Those are the buyers who, according to the Globe headline, are left in limbo. That’s true, but I believe after Ibanez most people had already concluded that was the case. At least now there’s a bit more legal clarity.