Royal v. First Interstate Bank (In re Trierweiler)

• Decision Date: 28 December 2012
• Docket Number: Adversary No. 10–02035.,Bankruptcy No. 10–20499.,BAP No. WY–11–111.
• Citation: 484 B.R. 783
• Parties: In re Matthew James TRIERWEILER and Shannon Renee Trierweiler, Debtors. Randy L. Royal, Trustee, Plaintiff–Appellant, v. First Interstate Bank, a Corporation, and Mortgage Electronic Registration Systems, Inc., Defendants–Appellees.
• Court: U.S. Bankruptcy Appellate Panel, Tenth Circuit

484 B.R. 783

In re Matthew James TRIERWEILER and Shannon Renee Trierweiler, Debtors.

Randy L. Royal, Trustee, Plaintiff–Appellant,

v.First Interstate Bank, a Corporation, and Mortgage Electronic Registration Systems, Inc., Defendants–Appellees.

BAP No. WY–11–111.

Bankruptcy No. 10–20499.

Adversary No. 10–02035.

United States Bankruptcy Appellate Panel of the Tenth Circuit.

Dec. 28, 2012.

Stephen Winship (Brad T. Hunsicker with him on the reply brief), of Winship & Winship, P.C., Casper, WY, for Plaintiff–Appellant.

Timothy M. Stubson of Crowley Fleck, PLLP, Casper, WY (Robert J. Pratte of Fulbright & Jaworski LLP with him on the brief), for Defendant–Appellee First Interstate Bank, a Corporation.

Brent R. Lindahl of Fulbright & Jaworski LLP, Minneapolis, MN (Robert J. Pratte and Bill Greendkye of Fulbright & Jaworski LLP, and Timothy M. Stubson of Crowley Fleck, PLLP, with him on the brief), for Defendant–Appellee Mortgage Electronic Registration Systems, Inc.

Before THURMAN, Chief Judge, BROWN, and SOMERS, Bankruptcy Judges.

SOMERS, Bankruptcy Judge.

Randy L. Royal (the “Trustee”) appeals the bankruptcy court's judgment in favor of First Interstate Bank (“FIB”) and Mortgage Electronic Registration Systems (“MERS”) (collectively “Appellees”) on his adversary complaint seeking to avoid the mortgage on the debtors' home. The Trustee attacked the mortgage based on a split-note theory due to MERS's involvement in the transaction. The bankruptcy court rejected the Trustee's position that defining MERS as the mortgagee in the mortgage split the note from the mortgage. It also held that the mortgage was properly recorded and that there was no interest for the Trustee to pursue under 11 U.S.C. § 544(a)(3).¹ We affirm.

I. Factual Background

On March 16, 2009, Matthew and Shannon Trierweiler (the “Debtors”) obtained financing for their home located in Dayton, Wyoming (the “Property”) by executing a promissory note in favor of FIB (the “Note”), and a mortgage identifying MERS as mortgagee and nominee for FIB and its successors and assigns (the “Mortgage”).² The Mortgage was recorded in the applicable county clerk's office on March 20, 2009. Thereafter, FIB sold the Note to Federal National Mortgage Association (“Fannie Mae”), endorsing the Note in blank.³ Fannie Mae possessed the Note through its document custodian, Bank of New York.⁴ Pursuant to the MERS system, because both FIB and Fannie Mae were MERS members, an assignment of the Mortgage to Fannie Mae was not recorded in the county records.⁵ MERS continued to hold the Mortgage, but now on Fannie Mae's behalf. By agreement, FIB continued to service the loan for Fannie Mae.⁶

On May 3, 2010, Debtors filed a Chapter 7 petition (the “Petition Date”). A week later, FIB filed a motion for relief from stay to foreclose on the Property (the “RFS Motion”).⁷ The bankruptcy court held a hearing on the RFS Motion on July 14, 2010, and heard testimony from FIB's collections manager.⁸ The parties stipulated that there had been a default on the loan and that there was no equity in the Property currently.⁹ The day before the RFS hearing, MERS executed an assignment of the Mortgage to FIB, but that assignment had not yet been recorded.¹⁰ FIB presented the assignment at the RFS hearing but withdrew it ¹¹ after the bankruptcy court expressed concern regarding the postpetition assignment ¹² and indicated that it would require briefing on the matter. ¹³ In August 2010, the bankruptcy court denied the RFS Motion, finding that FIB “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.” ¹⁴ The bankruptcy court noted that the Note was in Fannie Mae's possession and that neither the Note nor the Mortgage proved FIB, the loan servicer, had authority to act as an agent for Fannie Mae to foreclose on the Property.¹⁵

In December 2010, the Trustee filed an adversary complaint against FIB and MERS, seeking avoidance of the Mortgage on the Property because on the Petition Date, the Mortgagee (MERS) was not entitled to enforce the Note since it had been assigned to Fannie Mae. According to the Trustee this resulted in a separation of the Note and Mortgage ( i.e., MERS held the Mortgage, while Fannie Mae held the Note), rendering the Mortgage unenforceable and the Note unsecured.¹⁶ The parties filed cross-motions for summary judgment. On April 7, 2011, the bankruptcy court denied both motions for summary judgment, finding that there was a genuine issue as to the relationship between the lenders and MERS, which prevented the court from making an ultimate determination as a matter of law.¹⁷

On November 21, 2011, after a trial, the bankruptcy court entered judgment in FIB's and MERS' favor (the “Judgment”) and concluded that (1) MERS was acting on behalf of FIB in its capacity as nominee, (2) the Mortgage was properly recorded prior to the Petition date, (3) the Trustee could not avoid the transfer of the Note and an interest in the Mortgage to Fannie Mae since it was a transfer of a perfected mortgage in which the Debtors had no interest, and (4) the Debtors did not have any equity interest in the Property which the Trustee could pursue under the strong-arm statute.¹⁸ The bankruptcy court implicitly rejected the Trustee's “split-note” argument.

The Trustee appeals the Judgment.¹⁹ After evaluating the Trustee's brief, the Court has analyzed this appeal as presenting two primary issues: (1) whether the bankruptcy court correctly rejected the Trustee's theory that use of the MERS recording system split the Note from the Mortgage giving rise to avoidance rights under § 544; and (2) whether the law of the case doctrine mandated finding the Mortgage unenforceable.

II. Appellate Jurisdiction and Standard of Review

This Court has jurisdiction over this appeal because: the appeal was timely filed pursuant to Rule 8002(a) of the Federal Rules of Bankruptcy Procedure; the challenged order is a final order; ²⁰ and no party has elected to have the appeal heard by the district court as required by 28 U.S.C. § 158(c).

We review the bankruptcy court's determination that the Trustee may not avoid a mortgage under § 544de novo.²¹ Likewise, we review the bankruptcy court's determination as to the applicability of the law of the case doctrine on appeal de novo.²²

III. DiscussionA. The bankruptcy court correctly determined that the Trustee is not entitled to avoid the Appellees interests under § 544.

1. The Trustee's split-note theory.

The Trustee acknowledges the Debtors' execution of the Note in favor of FIB and their grant of the Mortgage to secure that obligation. He also acknowledges that the Mortgage was recorded in the Sheridan County land records and that under Wyoming law, recording the Mortgage gave the Trustee notice of its existence. Generally, proper recording would preclude avoidance of a mortgage lien under § 544. But in this case, the Trustee nevertheless seeks to avoid the Mortgage, relying upon the split-note theory to attack the efficacy of the Mortgage based upon MERS' role as Mortgagee and the transfer of the Note to Fannie Mae. In Wyoming, since a mortgage is only an incident to the debt it secures, a transfer of a note carries with it the mortgage security and operates as an equitable assignment of the mortgage, unless it is agreed otherwise.²³ For there to be bifurcation as the result of a transfer, clear evidence of intent to bifurcate is required.²⁴ And, when the note and mortgage are split, the result is “a practical loss of efficacy of the mortgage” and “the note becomes, as a practical matter, unsecured.” ²⁵ The Trustee's theory is that a split occurred between the Note and the Mortgage and he may therefore avoid the ineffective Mortgage under § 544.

2. The MERS mortgage recording system.

Examination of this theory requires an understanding of the MERS system of mortgage recording. The Nebraska Supreme Court succinctly describes the system as follows:

MERS is a private corporation that administers the MERS System, a national electronic registry that tracks the transfer of ownership interests and servicing rights in mortgage loans. Through the MERS System, MERS becomes the mortgagee of record for participating members through assignment of the members' interests to MERS. MERS is listed as the grantee in the official records maintained at county register of deeds offices. The lenders retain the promissory notes, as well as the servicing rights to the mortgages. The lenders can then sell these interests to investors without having to record the transaction in the public record. MERS is compensated for its services through fees charged to participating MERS members.²⁶

The MERS system was designed to facilitate the transfer of notes and accompanying mortgages and deeds of trust because such transfers had become cumbersome under the traditional recording procedures.²⁷ The system tracks transfers of promissory notes and changes in loan servicers.²⁸ In a mortgage loan transaction, MERS acts as the mortgagee and holder of the title to the security interest in a representative capacity as the agent (nominee) of the lender and the lender's successors and assigns.²⁹ Subsequent transfers of the note as well as assignments of servicingrights are tracked in the MERS database, but are not recorded in the public records, since notes are not recorded.³⁰ Upon transfer of a note secured by a mortgage, there is no separate assignment of the security interest and there is no change in the mortgagee, since MERS remains the mortgagee and holder of legal and record title to the mortgage on behalf of the new lender, as successor or assign of the original lender.³¹ Both FIB and Fannie Mae are members of MERS.³²

The loan transactions at issue in this case reflect this arrangement. The Mortgage states that MERS “is the mortgagee under this Security Instrument” and that it is “a separate corporation that is acting solely as nominee...