RMBS Investors Are Missing Opportunity to Make Claims for Receipt of Foreclosure Proceeds and to Enforce Fiduciary Claims Against the Named "Trustee"

Since many foreclosures are brought in the name of a bank as trustee for an unregistered trust, on behalf of the holders of certificates, it seems logical that the judgment entered should solely be for benefit of the certificate holders, even if they are not immediately identified. While that has been the assumed result in most courts, it is not the reality.

The filing of such a claim on behalf of the holders of certificates, in my opinion, waives any contractual restrictions that would otherwise apply. And more specifically, investors who wish to claim breach of fiduciary responsibility against Bank of New York, U.S. Bank etc. may now do so because those institutions waived their right to claim there is no such relationship between investors and trustees.

Now that they have taken the opposite position in court, albeit passively, that for example, the Bank of New York Mellon is suing for foreclosure on behalf of certificate holders, there is no court that would allow them to say otherwise in a suit between Bank of New York and investors.

The investors can do that because many of the foreclosures are filed on behalf of the holders of certificates. That is as plain an admission of a representative capacity —and assumption of duties owed to certificate holders — as you can get.

And for those RMBS investors who read this blog, remember that those proceeds are not subject to reduction for “servicer advances” unless the money you received was in fact an advance from a servicer and not simply a return of your own capital from the reserve fund established when the certificates were sold.

As investors awaken to the obvious implications, the investors are now in position to dramatically increase the value of RMBS that are trading low and which have dim prospects of ever resulting in payments congruent with the original deal.

Once the fiduciary relationship is established by estoppel, then the obvious implication is that all loans are subject to a direct financial interest of investors. This would cause a paradigm shift toward investors and away from the investment banks and away from the designated companies who pose as servicers. It would enable investors to force trustees to hire servicers who would act in accordance with the interests of investors and not the interests of intermediaries who have no interest in any loan.

The net legal result is reformation of the contract between investors and the investment bank doing business as an unregistered trust. That reformation would in turn lead to greater compensation due investors not only from payment of borrowers, but also insurance and hedge proceeds on the certificates purchased by investors. The deferred write-down of RMBS assets in stable managed funds might be mitigated or eliminated completely.

The net result would be a more direct contract between investors and borrowers. And in reformation the borrowers could receive greater compensation from investment banks that drafted homeowners into a concealed securitization scheme. That could pay off investors faster than the term of the current unenforceable loan contracts.

By taking rescission off the table because it is impossible to administer, (given the number of contracts and transactions that are tied to the existence of the loans), the court could be persuaded to issue a final order of reformation. The securitization infrastructure would not only be preserved, but strengthened for the sake of investors. And the threat of increased foreclosures and further declines in the value of collateral would be offset by greater resources clawed back from the investment banks.

In order to try to protect their ill-gotten gains investment banks would threaten a credit shutdown. Any reasonable government policy would then step in to prevent the intentional act of shutting down credit markets. Such action would probably have the added of benefit of increasing competition in investment banking, by paving the way for those who are willing to play by the rules rather than invent their own rules.

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