Levitin on Why Formalities Matter in Real Estate Law & Securitization

The Real Assault on the Legal System

posted by Adam Levitin

Nick Timiraos has a great piece in the WSJ about the state of play on foreclosure defense litigation. It quotes Larry Platt, a bank-industry lawyer at K&L Gates (which lost Ibanez). It’s worth pausing for a second to consider what Platt said.  Although Platt

concedes that banks may have been sloppy… [he claims that]… “the real assault on the legal system” are efforts by judges and local officials to strip lenders of their rightful ownership and make foreclosures impossible.

Platt’s view, it seems, is that everyone understood the mortgage deal and that the paperwork doesn’t really matter. That’s a very problematic view for any attorney to take, much less one with a background in real estate, secured lending, and securitization. (A less charitable interpretation of Platt’s comments is that the proper outcomes has nothing to do with law.  Instead, it’s paperwork and intent be damned, we’re the banks so we should win by right.)

 

One of the things any first year law student learns is that real estate is different. Different contract remedies apply, there are different formalities required by law for real estate contracts to be effective (the lineage of this principle goes back to the 1677 Statute of Frauds) as between the parties to the contract, and a separate recording system to make realty contracts good against third parties. While the law has dispensed with formalities in many other areas, that just isn’t the case with real estate, not least because of the recognition (ala De Soto) that clear title to real property is so fundamental to economic activity.

Anyone with a background in secured lending also knows that paperwork matters. Misspell the name of the debtor so that it doesn’t show up in a UCC search, and you’re unperfected. Check the box for a termination, rather than a continuation of a security interest (ala BoA with Heller Ehrman), and you’re unperfected sol. Dotting “i”s and crossing “t”s matters.

To raise the “it’s just paperwork” argument in the context of securitization, however, is unreal. Securitization is all about legal fictions and paperwork. Why on earth would anyone every bother with the complex legal structures of securitization (typically involving two shell entities) other than to take advantage of legal fictions?

As I’ve noted in other venues, securitization is the legal apotheosis of form over substance, and the basis on which this is legally tolerated is the punctilious observance of formalities. Failure to do so can result in a securitization failing to be bankruptcy remote or to lose its off-balance sheet accounting status or lose its pass-thru tax status, any of which are disasterous. Securitization deals were so heavily lawyered precisely because the paperwork matters. They aren’t like a sale of a used sofa over Craigslist.

The “it’s just paperwork” argument quickly proves too much. Is the borrower’s signature on the loan “just paperwork”? How about a co-signor’s? If it’s just paperwork, why bother to have the borrower or co-signor sign, especially as it can create federal Equal Credit Opportunity Act issues when a spouse is involved.

This is not to say that a lender whose paperwork is fubar is sol.  The lender can always petition the court for an equitable mortgage. But I sure wouldn’t want to be in that position, especially if there was anything fishy about the circumstances of the loan (unclean hands and all that).

Bottom line is that to claim that the courts following legal rules that have been firmly established for centuries is the “real assault on the legal system” is simply preposterous. The only thing it is an assault on is the sense of seigneurial right exuded by parts of the financial sector. (The kid gloves approach thus far of DOJ and the SEC vis-a-vis the financial services sector in terms of the financial crisis only enhances this sense of entitlement. Compare the Manhattan DA’s treatment of Dominique Strauss-Kahn with the federal non-treatment of the individuals responsible for the financial crsis. The French are apparently shocked that a member of their ruling elite would be subjected to a common criminal prosecution. Apparently when it comes to the US financial system, the same rules apply–charges simply aren’t brought against the seigneurial elite.) The gall of those homeowners to challenge the system. It’s a regular Jacquerie.

But maybe a white knight will ride to the aide of the banks. There’s a plan B in the works to “clarify” the state of law. I’m not sure it will help a whit with backdated assignments, etc., but the bank lawyers seem to think that it will make life easier for them. More on this in a future blog.

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