Pricing exceptions are widespread in mortgage — and so are the regulatory risks

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Connecticut Supreme Court upholds new fee on lending industry

Will other states follow suit?

States long imposed fees to record documents in land records.

The Mortgage Electronic Registration Systems loan registry system, created in the mid-1990s, meant lenders no longer needed to record security interest assignments in county land records each time they transferred a promissory note. 

As a result, many counties sued MERS to force MERS members to record future security interest assignments and recover fees they claimed were “lost” because MERS members stopped recording assignments. MERS won the large majority of these cases.

[Note: Read HousingWire's extensive chronicle of MERS proceedings, 600+ pieces of content, by clicking here.]

Connecticut tried a different tack to recover these alleged “lost” fees:  it amended the state’s land records statute to impose higher fees on mortgages for loans registered with MERS.  MERS filed suit to challenge the constitutionality of the statue, but in a February 2016 decision captioned MERSCORP Holdings, Inc. v. Malloy, the Connecticut Supreme Court upheld the trial court’s ruling and the validity of the higher fees. 

[This blog discusses the decision and its possible impact in other states. The opinions are the author's alone.]

The MERS System

A borrower in a residential loan transaction typically executes a promissory note agreeing to repay the loan, and a mortgage (or deed of trust), granting a security interest in real property to secure repayment. Lenders typically record mortgages in local land records to protect the lender’s lien priority in the property, which provides public notice to third parties that the lien exists. 

Before the MERS System, lenders often created and recorded an assignment of mortgage in the land records each time they transferred their interest in a promissory note, providing public notice of the transfer of interest.  Counties charge statutorily-specified fees to record mortgages and assignments.

As lenders began securitizing loans in the 1980s and 1990s, they started selling loans to investors at a much greater volume, and needed to record assignments at the same pace. But County clerks could not keep up with the flow of paper, often losing assignments and significantly delaying recording.

The MERS System addressed these problems.  It is a national electronic registry of residential loans, which lenders can join for a fee.  A lender that is a member of the MERS System agrees with the borrower in the mortgage or deed of trust document that MERS will serve as a mortgagee of record, on behalf of, or as the nominee for, the lender and any of the lender’s successors and assigns (the latter of whom must also be members of MERS). 

With MERS serving as a “placeholder” mortgagee for the lender and its successor and assigns in the land records, lenders and investors can transfer promissory notes from one entity to another without needing to record a corresponding mortgage assignment in county land records, or paying associated recording fees.

Counties sue MERS, claiming that they were wrongfully deprived of recording fees

As local budgets faced pressures from the recent economic downtown, counties across the country filed a series of lawsuits arguing that state land records statutes required lenders to create and record mortgage assignments where notes were transferred, and seeking millions of dollars in recording fees that they otherwise would have earned had lenders recorded mortgage assignments after the creation of MERS.  

The lending industry won virtually all the lawsuits. Courts have generally rejected the counties’ lawsuits because (1) recording statutes are permissive rather than mandatory, and do not impose a duty to record mortgage assignments; and (2) counties have no right of action to enforce alleged violations of land records statutes.      

If you can’t sue, pass legislation:  Connecticut creates a new fee structure.

Connecticut adopted a different approach.  It amended its recording statute — Conn. Gen. Stat. § 7-34a — in 2013, to require a “nominee of a mortgagee” to pay an additional tier of fees when recording any document in the state’s land records.  MERS is the only entity that falls within the definition of “nominee of a mortgage” under the amended statute. 

The 2013 amendment created a two-tier recording fee structure.  It retained the pre-amendment recording fees, which are generally applicable to MERS mortgagees and non-MERS mortgagees alike:  $53 for the first page of each filed document, $5 for each subsequent page, and an additional $2 per assignment of mortgage from the third assignment on. 

The 2013 amendment then imposed a second tier of fees that only “nominees of mortgagees” must pay in addition to the first tier fees:  $126 for the first page of a mortgage assignment or release, and $5 for each additional page thereafter; and $116 for the first page of any other document.  

MERS filed suit against the State of Connecticut in July 2013, arguing that the two-tiered statute violated MERS’s equal protection rights, deprived MERS of substantive due process, and represented an unlawful taking.  The Connecticut Superior Court upheld the statute on May 19, 2014, and MERS appealed to the Connecticut Supreme Court.    

The Connecticut Supreme Court rejects MERS’s constitutional challenge

MERS only appealed the trial court’s rulings under the equal protection clause and the dormant commerce clause.  The Connecticut Supreme Court rejected MERS’s arguments on both of those grounds.

The Equal Protection Clause

MERS argued that the amendment violated the equal protection clauses of the federal and Connecticut constitutions because it singled out MERS to pay higher recording fees than other persons or entities.  The Connecticut Supreme Court rejected this argument, finding that the statute must be afforded only a rational basis review—the most lenient standard under which a statute can pass constitutional muster. 

Therefore, to prevail, MERS had to demonstrate that the purpose of the statute was not legitimate or that the statute was not rationally related to accomplish its stated purpose.  Further, because MERS challenged what the court classified as a “taxation scheme,” the court concluded that the statute should be afforded the greatest possible deference because “inequalities [that] result from a singling out of one particular class for taxation or exemption, infringe no constitutional limitation.” 

Because the challenged statute was a taxation scheme, MERS had to show “by the most explicit demonstration that a classification is a hostile and oppressive discrimination against particular persons and classes.”  The Court found that the purpose of the statute—raising revenue—unquestionably served a legitimate purpose. 

It also found that the Connecticut legislature could have concluded that imposing higher recording fees on MERS was a rational way to accomplish this purpose because (1) the higher recording fees imposed on MERS were necessary to make up for the recording fees that the state “lost” as a result of the MERS System; and (2) MERS was able to shoulder the burden of increased fees better than other mortgagees because of its size. 

In so finding, the Court was careful to emphasize that it would not judge the merits of the legislature’s rationale for imposing higher fees; the Court only needed to determine that the legislature had some reason to impose higher fees on MERS, even if the reason was “based on rational speculation unsupported by evidence or empirical data.” 

MERS made several arguments in support of its equal protection argument.  First, MERS argued that because there was no evidence that lenders and investors recorded MERS loan assignments any less frequently than non-MERS loans, the county clerks could not show that they suffered any diminution in revenue as a result of MERS loans.  The Court rejected this argument, pointing to an amicus brief touting the benefits of the MERS System as savings it members $200 million by eliminating the need to record mortgage assignments, and stating that whether county clerks will lose revenue “remains an open question.”  The Court therefore had “no difficulty concluding” that the Connecticut legislature might have found that the cost savings offered by the MERS® System could have resulted in “lost revenue” to county clerks, thus justifying charging higher recording fees to MERS. 

Next, MERS asserted that county clerks could not show that they suffered any “lost revenue” because there was no statutory requirement mandating that MERS record mortgage assignments.  The Court called this argument a “red herring,” reasoning that, even if the statute did not require lenders and investors to record mortgage assignments, recording assignments was still a practical necessity to preserve chain of title.  The Court stated that the legislature might have concluded that, but for the existence of the MERS System, many more mortgage assignments would have been recorded—along with the attendant fees—as a matter of necessity.   

The Dormant Commerce Clause

The Connecticut Supreme Court also rejected MERS’s dormant commerce clause argument. 

To demonstrate that the statute violated the dormant commerce clause, MERS contended that the Connecticut recording fee statute was facially discriminatory because it singled out MERS to pay increased fees that no one else was required to pay.  In rejecting this argument, the Court noted that the true purpose of the dormant commerce clause was to prevent states from engaging in economic protectionism by enacting laws to discriminate against out-of-state market participants to the benefit of in-state market participants. 

In MERS’s case, the Court found that the Connecticut legislature could not discriminate against MERS as an out-of-state market participant because there are no in-state market participants similar to MERS that the legislature could favor.   In fact, the Court found that the fee would have the opposite effect in practice:  because MERS would pass on the initial fee increases to Connecticut borrowers, it would be Connecticut residents—and not MERS—that would bear the brunt of the increased fees. 

MERS next asserted that the fee imposed an undue burden on interstate commerce because Connecticut received an additional $5 million from MERS per year as a result of the increased fees.  In rejecting this argument, the Court noted that the party challenging a tax or user fee bears the heavy burden to demonstrate that the burden on interstate commerce clearly outweigh the benefits of the statute.

The Court found that MERS could not meet this burden because the recording fee was essentially a way to balance the benefit that the MERS System conveyed to its members.  In contrast to non-MERS members—who would typically need to record mortgage assignments two or three times over the course of a mortgage loan—the MERS System eliminated the need for its members to execute any mortgage assignment, no matter how many times the promissory note is transferred. 

Thus, MERS members are able to take advantage of the benefits provided by county clerks without having to pay the recording fees that would typically be charged for multiple mortgage assignments.  Finally, the Court noted that MERS could not show an undue burden on interstate commerce because it did not show that it was adversely impacted by the increased fee—MERS could not show that its business suffered in any way as a result of higher recording fees. 

The aftermath:  What to expect in the wake of Malloy

On June 22, 2016, MERS filed a petition for a writ of certiorari seeking Supreme Court review of the Connecticut Supreme Court’s decision.  Even if the Supreme Court does not review the decision, the impact of Malloy in other states remains unclear. 

Texas (Tex. Prop. Code Ann. § 51.0001(1)) and Minnesota (Minn. Stat. § 507.413(a)(1)), for example, previously passed statutes that expressly approved of the use of the MERS System.  Other states may decide not to pass legislation like Connecticut’s that could adversely impact the public, concerned that lenders might pass on increased costs to borrowers. 

Even if some state did decide to pass a similar statute, different courts could decide things differently than the Connecticut Supreme Court did.  For example, a court could conclude that a similar statutory scheme violates the equal protection clause because there is no connection between MERS’s operations and the alleged loss of revenue by a state. 

Because recording documents in land records is purely voluntary, it is hard for states to attribute any diminution in filing—and thus filing fees—to the existence of the MERS System.  Since there is no evidence that county clerks have actually lost any revenue, the state’s rationale for increasing fees on MERS filings is dubious.  And even if the MERS System did result in a decreased number of filings, clerks did not actually “lose” anything because they never recorded any document in the first place. 

Additionally, Connecticut’s rationale for increasing fees on MERS filings was that county clerks lost fees because MERS purportedly records fewer mortgage assignments over the life of the loan.  Yet the statute hikes recording fees on a host of different kinds of documents (not just assignments) and allocates a majority of the fee increase to the state’s and the municipality’s general revenue fund—neither of which received any portion of recording fees under Connecticut’s pre-amendment fee structure.  Thus, the fee increases imposed by the statute are arguably not rationally related to the purpose of compensating county clerks for their purported lost revenues.

Courts may also differ from Malloy on the basis of the dormant commerce clause.  A court could conclude that a two-tiered fee structure targeted at MERS is facially discriminatory not because the statute favors a specific in-state company, but because interstate commerce itself is being discriminated against by the fee structure.  Or, a court could find that such a fee structure unduly burdens interstate commerce because the higher fees placed MERS at a competitive disadvantage vis-a-vis local market participants, even if MERS ultimately passes the cost of the fee increase on to consumers. 

Time will tell whether other states choose to model their recording fee statutes after Connecticut’s.  If a state chooses to do so, MERS has strong arguments to challenge the constitutionality of such a statute, and the high court of another state could easily strike the statute down for one or more of the reasons rejected by the Malloy court.   

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