Yet Again, the Tenth Circuit Rejects a Bankruptcy Trustee’s Attempt to Avoid a Mortgage Under a “Splitting-the-Note” Theory

By: Alana Friedberg

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in Royal v. First Interstate Bank (In re Trierweiler),[1] the Tenth Circuit held that a mortgage granted in favor of the private electronic database Mortgage Electronic Registration Systems, Inc. (“MERS”), which records transfers of notes and mortgages,[2] was enforceable as to a bankruptcy trustee even though the promissory note was held by a third-party.[3]  In Trierweiler, the debtors took out a loan from and granted a mortgage to First Interstate Bank (“First Interstate”) in order to purchase real property.[4]  The mortgage identified First Interstate as the “lender,” and MERS as both the “mortgagee” and the “nominee for the lender and lender’s successors and assigns.”[5]  Sometime thereafter, First Interstate assigned the note to Fannie Mae,[6] but remained as the servicer for the loan.[7]  The debtors subsequently defaulted on the loan and filed for bankruptcy under chapter 7 of the Bankruptcy Code.[8]  The chapter 7 trustee then sought to avoid the mortgage, using his “strong arm” powers under section 544(a).[9]  In particular, the chapter 7 trustee claimed that MERS “was powerless to foreclose on the property” because it did not hold the note and instead was merely the mortgagee.[10]  The trustee also claimed that while Fannie Mae held the note, it “had no ability to enforce the mortgage because it was not listed as the mortgagee in the land records . . . .”[11]  Therefore, the trustee asserted that this “combination rendered the mortgage unenforceable and void as to [him].”[12]  The bankruptcy court, however, rejected the trustee’s arguments and ruled that the mortgage was a properly recorded and enforceable security interest that could not be avoided in bankruptcy.[13]  On appeal, the Bankruptcy Appellate Panel of the Tenth Circuit[14] and the United States Court of Appeals for the Tenth Circuit both affirmed.[15]

            Courts have universally rejected borrowers’ and bankruptcy trustees’ arguments that a mortgage granted to MERS is void under the “splitting-the-note” theory.  For example, in Martins v. BAC Home Loans Servicing, L.P.,[16] the Fifth Circuit held that Texas law permits MERS to foreclose on behalf of a lender, even without holding or owning the note.[17]  Similarly, in Trierweiler, the Tenth Circuit held that the trustee could not avoid the mortgage because: (1) it was properly recorded under Wyoming law, and thus “the [t]rustee had constructive notice of a properly recorded and enforceable mortgage lien on the [d]ebtors’ real property”[18] and (2) the parties included language in the mortgage stating “that MERS would act as mortgagee solely in a representative capacity for the lender and any of its ‘successors and assigns.’”[19]  Consistent with previous decisions that examined the issue under other state laws,[20] the Trierweiler court adopted the rule that under Wyoming law, a mortgage can designate a third party, such as MERS, as the legal holder of a mortgage in its representative capacity for the lender and its successors that retain the beneficial interest in the debt.[21]

            The Trierweiler decision is of particular importance because MERS “hold[s] title to roughly half of all the home mortgages in the nation — an astonishing 60 million.”[22]  It is not surprising that courts would reject the “splitting-the-note” argument made by various litigants because, as courts have emphasized, “there is no such thing as a ‘free house.’”[23]  If a court were to adopt the rule that a mortgagee cannot designate a third party as having the right to enforce a mortgage or deed of trust on behalf of the beneficial holder of the debt, it would likely lead to a substantial increase in litigation seeking to invalidate the mortgage or deed of trust because, as noted above, MERS holds title to so many mortgages.  Effectively, such a rule, if adopted, could result in millions of home loans becoming unsecured loans,[24] which in turn could threaten the lender’s recovery if the borrower defaults.  Yet since the courts have consistently rejected this argument, borrowers and bankruptcy trustees should be aware that it is extremely unlikely that they will be able to invalidate the mortgage against a borrower’s home on the basis that the mortgage designates a third party, such as MERS, as mortgagee even though the mortgagee does not hold the note.