Friday, April 29, 2011

FYI: US Sup Ct Says FAA Preempts State Law Rule Allowing Invalidation of Class Action Waivers

As widely reported in the news, the Supreme Court of the United States
recently held that the Federal Arbitration Act (FAA) preempted a state
court rule that class action waivers in consumer arbitration agreements
may be invalidated as unconscionable.

A copy of the opinion is available at

Respondents-consumers ("Respondents") entered into a contract for cell
phones and service with AT& T. That contract provided for arbitration of
all disputes between the parties, and disallowed class arbitration. After
a dispute arose between the parties, Respondents filed a complaint in
federal court in California. AT&T moved to compel arbitration.
Respondents opposed the motion on the grounds that the arbitration
agreement was unconscionable.

The district court denied AT&T's motion, and the Ninth Circuit affirmed,
finding the provision denying class arbitration unconscionable under state
law. Both courts based their decision on the rule laid out in Discover
Bank v. Superior Court, 36 Cal. 4th 148, 113 P. 3d 1100 (2005) (the
"Discover Bank rule"). The Ninth Circuit further held that the Discover
Bank rule was not preempted by the FAA. The Supreme Court granted

As you may recall, the FAA provides that agreements to arbitrate are
"valid, irrevocable, and enforceable, save upon such grounds as exist at
law or in equity for the revocation of any contract." See 9 U.S.C. §2.
The Discover Bank rule provides that class waivers in consumer arbitration
agreements are unconscionable where the agreement is in an adhesion
clause, the amount of damages are likely to be small, and the party with
inferior bargaining power alleges a deliberate scheme to defraud. The
Court's decision turned on whether the Discover Bank rule was preempted by
the FAA's provision that agreements to arbitrate are generally valid, or
consistent with the FAA's provision that such agreements may be invalided
upon legal or equitable grounds to revoke contracts.

In holding that the Discover Bank rule was preempted by the FAA, the
United States Supreme Court began by examining the FAA, noting that it
reflects a "liberal policy favoring arbitration" and was intended to allow
for "efficient, streamlined procedures" to resolve disputes. The Court
then laid out several flaws with class-wide arbitration, describing it as
slower, costlier and more complicated than bilateral arbitration. The
Court also raised a concern that if the Discover Bank rule were allowed to
stand, then agreements to arbitrate might be invalidated on grounds that
would effectively eliminate arbitration clauses from contracts (for
example, on the grounds that such an agreement did not allow for
judicially monitored discovery).
Further, the Court noted that the informal procedures of arbitration are
"poorly suited to the higher stakes of class litigation." In particular,
the Court expressed doubt that defendants in arbitration matters would
consent to class-wide arbitration, due to the risk of error, lack of
judicial review, and the size of potential losses. Although the Court
noted that defendants are often willing to accept those risks in bilateral
arbitrations with smaller stakes, the Court stated that "[w]e find it hard
to believe that defendants would bet the company with no effective means
of review."

Because "[r]equiring the availability of classwide arbitration interferes
with fundamental attributes of arbitration and thus creates a scheme
inconsistent with the FAA," the Court held that the Discover Bank rule is
preempted by the FAA.

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874

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Monday, April 25, 2011

FYI: Mich App Says MERS Not Allowed to Foreclose by Advertisement Under Mich Law

A Michigan Court of Appeals recently held that Mortgage Electronic Registration Systems ("MERS"), the mortgagee under the security instrument for a home mortgage loan, but not the holder of the note evidencing the debt for that loan, could not exercise its contractual right to foreclose by advertisement pursuant to the applicable Michigan law, MCL 600.3204(d)(1).   A copy of the opinion is attached.

Defendant-borrower ("Borrower") obtained a home mortgage loan which included a security instrument that provided for rights of foreclosure by the designated mortgagee, MERS.  However, MERS was not the owner of the debt and did not hold or service the subject loan.  After the Borrower defaulted on his loan, MERS began non-judicial foreclosure by advertisement, purchased the property and then quit-claimed the property to successor lender ("Plaintiff").  When Plaintiff began an eviction action, Borrower challenged the foreclosure, arguing that MERS did not have authority to foreclose by advertisement because it did not qualify as a mortgagee permitted to do so under MCL 600.3204(d)(1). The lower court rejected Borrower's arguments and Borrower appealed.

As you may recall, Michigan law allows a party to foreclose a mortgage by advertisement if, among other things, that party owns an interest in the indebtedness secured by the mortgage.  See MCL 600.3204(d)(1).  The Court first held that where, as here, the "indebtedness is solely based upon the note," a party "must have a legal share, title, or right in the note" in order for that "party to own an interest in the indebtedness" under MCL 600.3204(d)(1).  Further, an "interest in the mortgage" is insufficient because "the note and the mortgage are two different legal transactions providing two different sets of rights, even though they are typically employed together."

The Court next held that "MERS did not have the authority to foreclose by advertisement on Borrower's property."  The Court reasoned that "it was the Plaintiff that lent the Borrower money pursuant to the terms of the note," and not MERS as mortgagee, which "only held an interest in the property as security for the note, not an interest in the note itself."  "Moreover, the mortgage specifically clarified that, although MERS was the mortgagee, MERS held 'only legal title to the interest granted' by Borrower in the mortgage."  "Consequently, the interest in the mortgage represented, at most, an interest in Borrower's property. MERS was not referred to in any way in the note and only Plaintiff held the note."

The Court also rejected various arguments set forth by the plaintiff mortgage loan investor.  First, the Court denied that "MERS was a contractual owner of an interest in the note based on the agreement between MERS and the lenders" because "MERS had no right to possess the debt, or the money paid on it."  In addition, "the fact that the originating lender gave MERS authority to take 'any action required of the Lender' did not transform MERS into an owner of an interest in the note."  The "contract language expressly limits the interests MERS owns to those granted in the mortgage instrument and limits MERS' right to take action to those actions related to the mortgage instrument." 

The Court also rejected the plaintiff mortgage loan investor's argument "that MERS had the authority to foreclose by advertisement as the agent or nominee for the originating lender, who held the note and an equitable interest in the mortgage."  The Court reasoned that the "statute explicitly requires that, in order to foreclose by advertisement, the foreclosing party must possess an interest in the indebtedness," and "simply does not permit foreclosure in the name of an agent or a nominee."

The plaintiff mortgage loan investor also argued that the Michigan legislature did not create three distinct categories of entity which could foreclose by advertisement, but rather envisioned a continuum of entities: those that actually own the loan, those that service the loan, and some ill-defined category which might be called "everything in between." However, the Court found no language in the statute providing for a "continuum," no analysis from the plaintiff mortgage loan investor of what the "continuum" constitutes, and therefore found no merit in that position.

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois  60602
Direct:  (312) 551-9320 
Fax:  (312) 284-4751
Mobile:  (312) 493-0874

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