State Can Charge MERS Higher Recording Fees

The state can charge MERS higher recording fees than other mortgagees according to the Connecticut Supreme Court decision in MERSCORP Holdings, Inc. v. Malloy, to be officially released on February 23, 2016.

In this Connecticut Appeal, MERS attacked the constitutionality of amendments to Connecticut’s recording statutes which require mortgage nominees to pay higher recording fees than other mortgagees. More specifically, mortgage nominees must pay about three times more to record a mortgage, assignment of mortgage or release of mortgage.

In the trial court, MERS claimed that that the statutes as amended “violate the equal protection, due process, and takings provisions of the federal and state constitutions, the federal dormant commerce clause, and the federal prohibition against bills of attainder. The plaintiffs further alleged that enforcement of the statutes violates 42 U.S.C. § 1983.”

The trial court granted the state’s motion for summary judgment on all counts and entered judgment accordingly. MERS appealed. The Supreme Court affirmed.

Genesis of the Amendments Charging MERS Higher Recording Fees

The secondary mortgage market created MERS, or Mortgage Electronic Registration Systems, Inc., to address a costly administrative headache. Generally, a mortgagee records its mortgage to tell the world that it has an interest in the property. When a mortgage loan is sold, the new mortgagee wants to record a mortgage assignment to tell the world that the old mortgagee is out and the new mortgagee is in. When the loan is paid off, the borrower wants the mortgagee to record a release of mortgage to tell the world there is no more mortgage interest in the property. There’s  municipality a recording fee every time anything is recorded.

When mortgage securitizations started gaining popularity in the 1980s, mortgage loans began to change hands frequently and in large quantities. That meant the loan buyers wanted to record an assignment for every loan purchased, which in turn meant a number of things: (i) seller had to sign, with necessary formality to be recorded, an assignment for each loan sold; (ii) buyer had to get the assignment to the proper recording office for each loan purchased; and (iii) someone had to pay the recording fee to record each assignment. When dealing with hundreds or thousands of loans at at time, these things were a pain in the neck administratively, not to mention expensive in both time and money.

Enter MERS. If you’re a member, as most secondary mortgage market participants are, you can record your mortgage in the name of MERS as the nominee for you and your successors and assigns. If you sell the loan to another member, you tell MERS, who keeps track of which member owns which loan. As long as the loan stays with a MERS member, there is no need to record an assignment. In short, MERS is the record mortgagee for every mortgage of every one of its members.

The problem for the state is that it was missing out on recording fees for all those loan transfers between MERS members. So, the legislature raised recording charges for a nominee of a mortgagee to record a mortgage, a mortgage assignment and release of mortgage. In doing so, the legislature defined “nominee of a mortgagee.” MERS is the only entity that meets the definition.

MERS’ Main Arguments on Appeal

MERS claimed that the statutes as amended violated (i) the equal protection clauses of the state and federal constitutions; and (ii) the dormant commerce clause of the federal constitution.

No Equal Protection Violation

The Supreme Court rejected plaintiff’s equal protection arguments. It noted that the parties agreed that the legislature imposed higher fees on MERS “simply to raise additional revenues, either to compensate for fees allegedly lost as a result of the MERS business model or, more generally, to help balance the state’s budget.” Since raising revenue is a quintessential legitimate governmental purpose, the analysis shifted to the question of whether “the legislature had a rational basis for imposing higher recording fees on nominees such as MERS than on other mortgagees.”

The court perceived at least two rational bases for the legislature charging MERS more. First, the legislature reasonably could have  concluded that MERS was in a better position than smaller mortgagees to bear the financial burden of increased fees. Second, the legislature reasonably could  have raised the recording charges for MERS to compensate for the decreased number of recordings MERS engenders.

MERS had four counter-arguments, all of which the court rejected. First, MERS argued that “there is no evidence in the record to support the contention that assignments are recorded less frequently for MERS loans than for other mortgagees’ loans.” The court noted that “under the rational basis test, our review is not limited to theories that the state has documented at trial or that have been subject to judicial fact-finding. Rather, courts may consider—and it is the plaintiffs who must debunk— any rationale that might plausibly have motivated the legislature.” In any event, “it cannot be seriously suggested that the MERS model might not result in fewer recordings in the public land records, with concomitant cost savings to MERS and its users.” The evidence showed that fewer recordings and member cost-savings were paramount considerations for the MERS model.

Second, MERS argued that “there is no legal requirement that assignments be recorded in the public land records[.]” I assume this to mean that, since recording isn’t mandatory, it’s unfair to charge MERS more than others for the same benefit. The court called this argument a “red herring.” MERS’ own literature shows that MERS considered recording a necessity.  As a practical matter, recording is necessary “if the holder is to perfect its security interest and to avoid potentially costly gaps in the chain of title.”

Third, MERS argued that “even if town clerks do perform fewer recording duties with respect to MERS loans than non-MERS loans, there is no reason to compensate town clerks for lost recording revenues because they already save the costs associated with not having to record assignments of MERS loans, or, put differently, clerks are not entitled to payment for services that they do not perform[.]” The court gave three reasons for rejecting this argument: (i) Recording fees cover not only the marginal cost of physically recording a document but also things like the clerk’s salaries, facilities and technological requirements; (ii) “The principal service provided [by the clerk], and the principal value to the recording party” is not the act of recording but the perpetual maintenance of a record of the transaction; and (iii) In addition to compensating the clerk for lost revenue, higher recording charges force MERS to pay for a portion of the benefit its members receive through the MERS system.

Lastly, MERS argued that “even if town clerks have lost recording fees under the MERS system, there is no rational relationship between those losses and the fees imposed under [the amendments].” This argument stems from the fact that the town clerks don’t retain the entirety of the recording charge. The court noted that “the legislature reasonably could have concluded that only a handful of Connecticut towns still hew to the traditional model under which financially independent clerks’ offices retain the recording fees they collect, and that, in most cases, such fees are now paid into a town’s general revenues…. Accordingly, a falloff in recording fees will adversely impact municipal budgets and potentially result in a heightened need for local community support by the state.”

No Dormant Commerce Clause Violation

The court noted that the federal constitution’s commerce clause gives Congress the power to regulate inter-state commerce. “[T]he United States Supreme Court has] consistently held this language to contain a further, negative command, known as the dormant [c]ommerce [c]lause, prohibiting certain state [regulation] even when Congress has failed to legislate on the subject…. [T]he dormant [c]ommerce [c]lause precludes [s]tates from discriminat[ing] between transactions on the basis of some interstate element. . . . This means, among other things, that a [s]tate may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the [s]tate. . . . Nor may a [s]tate impose a tax [that] discriminates against inter- state commerce either by providing a direct commercial advantage to local business, or by subjecting interstate commerce to the burden of multiple taxation.”

Even though recording is a purely local activity, MERS has a national membership that participates in a national secondary mortgage market. The court found this sufficient to implicate the dormant commerce clause.

Saving the court from having to decipher a “quagmire” of United States Supreme Court precedent as to the standard to apply, the parties agreed that “their dispute boils down to the question of whether two central criteria … are satisfied. First, a state user fee or tax is presumed to violate the dormant commerce clause if it facially discriminates against interstate commerce…. Second, a fee or tax that is facially neutral nevertheless may offend the dormant commerce clause if it has the practical effect of imposing a burden on interstate commerce that is disproportionate to the legitimate benefits.”

The court concluded that there was no facial discrimination for four reasons: (i) There is no indication that charging MERS higher fees “reflected an invidious discrimination against out-of-state interests, or an effort to favor Connecticut-based financial companies”; (ii) “[T]he legislature’s apparent intent was not to impose higher recording fees on residential mortgage transactions with a national character but, rather, merely to indicate that the higher fees are directed at MERS and any other mortgage nominees that may develop virtual recording systems to facilitate transactions in the secondary mortgage market”; (iii) “[T]he United States Supreme Court has explained that ‘a fundamental element of dormant [c]ommerce [c]lause jurisprudence [is] the principle that any notion of discrimination assumes a comparison of substantially similar entities” and MERS is not substantially similar to any other entity; and (iv) “[E]ven if we believed that the statutes in question discriminated against interstate commerce, we would conclude, for reasons discussed [earlier] in … this opinion, that there is no constitutional violation because such discrimination advances a legitimate local purpose.”

The court also concluded that the statutes placed no undue burden on MERS. Without the increased charges, MERS gets a benefit but doesn’t have to pay for it like other mortgagees. More specifically, MERS members get the protections afforded by recorded mortgage but don’t pay to transfer those protections when the mortgage loan is transferred on the secondary mortgage market because they don’t have to record anything. Non-MERS mortgagees have to pay to record an assignment to continue that protection when they sell, or buy, a mortgage loan on that market.

Next, the court noted that “[t]he United States Supreme Court also has suggested that, in gauging the burdens imposed on interstate commerce, a reviewing court should consider whether, if every state were to adopt the challenged policy, the result would be to ‘place interstate commerce at a disadvantage as compared with commerce intrastate.'” In this regard, the court concluded, as follows: