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Trustees Probably Won't be on Hook for a Put-Back Apocalypse

The American Bankers Association has put out a statement intended to “clarify” the legal limitations on the duties of trustees in mortgage-backed securities deals.

Mortgage
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Mortgage

"Importantly, the trustee typically has no duty under the transaction documents to make investigations on its own for the purpose of detecting defaults, fraud or other breaches," the ABA says in a statement reported by HousingWire.

The statement was probably issued in reaction to a recent story in the magazine American Banker discussing how trustees have come under scrutiny as the foreclosure crisis reveals problems with the securitization process.

The main role of a trustee in mortgage securitization deals is to keep the mortgage file—containing the mortgage, the original notes, and any assignments. The biggest mortgage securitization trustees are Bank of New York, Deutsche Bank, Wells Fargo, and US Bank.

It now appears that in many—perhaps nearly all—of the mortgage securitization deals that occurred from 2005-2007, many of the documents that were supposed to be contained in the mortgage file were never transferred to the trustee. Failing to take possession of the mortgage and note may be interpreted by some courts as a failure to protect a security interest in the home, which could prevent a successful foreclosure. It may also raise a deeper issue of who is the actual owner of the mortgage and therefore is entitled to demand and accept mortgage payments or bring foreclosure actions.

Technically, the ABA is correct when it says that trustees are not obligated to investigate for fraud or defaults. Most pooling and servicing agreements—the contracts which govern securitizations—exempt the trustee from almost any duty to check the authenticity of documents, the legitimacy of the conveyance of the mortgage, or pretty much anything else that seems like it involves work.

There is one exception to this, however. Almost all the pooling and servicing agreements require the trustee to inspect the mortgage file to verify that the required documents are there. Within a specified period—typically around 90 days but sometimes stretching out to 270 days—they are supposed to issue a report to that usually goes to both the deal’s “servicer” and the seller of the mortgages. That report lists the defects in the mortgage file and instructs the seller to either supply the missing documents or buy back the loans. The seller gets another 90 days or so to get together the paperwork.

If reports about mortgage files almost never being properly transferred are true, it seems as if trustees have utterly failed at one of the few positive obligations they had—to inspect the mortgage file to make sure the documents were there. If this materially impairs the ownership of the mortgages or the ability to foreclose in the case of defaults, trustees could find themselves liable for investor losses.

This doesn’t mean, however, that Bank of New York Mellon , Deutsche Bank , Wells Fargo, and US Bank are going to wind up on the hook for very much. The pooling and servicing agreement do not require the trustees to buy back the mortgages. They do not lay out penalties for non-compliance with the duty to inspect the mortgage files.

In order to recover against a trustee, investors will have to sue. In these lawsuits, they will be required to show that the breach of contract by the trustees caused actual damages. Proving damages will be difficult because the investors arguably only suffer losses from the trustee’s breach if a court declares that the mortgage trust never took ownership of the mortgage, or that an incomplete mortgage file permanently nullifies standing to bring a foreclosure action or permanently undermines the security interest in the home.

Which is to say, the lawsuits against trustees will have to wait for a slew of successes—which are far from guaranteed—by homeowners fighting foreclosure actions in “show me the note” cases.

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Bank of New York Mellon

Deutsche Bank

Wells Fargo

US Bank

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