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EXHIBIT W: LETTER OPINION, DATED SEPTEMBER 1, 1997 FROM COVINGTON & ~URLlNG, IDENTIFIED BY R.K, ARNOLD DURING HIS DEPOSITION [727 754] , .. .M

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COVINGTON & aU~LING

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.SeptelJlber 1, 1997

PRIVILEGED
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AND CONFIDENTIAL
TQ MR. ARNOLD

MEMORANDUM

SUJ2plemental M&RS Legal Issues J This memorandum sets forth our analysis of the legal. issues which. you asked us to consider relating to MERS being named as the original mortgagee)!


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Our analysis is based upon our understanding that MERS will be named as
the original mortgagee upon the closing of a loan thai the originating lender intends to register in the MERS System.. The mortgage will be recorded in the appropriate land

records with MERS named as the mortgagee of record. the originating lender will be the payee on the note and the note will be held by the originating lender or a subsequent endorsee of the note. typically

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a loan

serv.i.cerfor a secondary mortgage market investor.
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In its capacity as mortgagee of record; MER.S will act on behalf of the holder of the
promissory note secured by the mortgage. which would be the originating lender or a subsequent holder. ____ designating_~RS By _ .. __ •
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as,_ the origlMl • mortgagee __ ,,_ record, the " of •• , .• _. -. '. • ~ • _-H'.
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holder(s) will avoid recording assignments of the mort@e. beneficial

MERS will not have a

interest in the loans nor will :MERS service 'the loans or hold the promissory

JJ For purposes of this memorandum, the term "mortgage" used to refer to a mortgage, deed.of 'trust or other security :instnu:nent and the term "mortgagee 11 is used to refer to a mortgagee under a mortgage or a beneficiary under a deed of trust or other security instrument

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.note evidencing the debt Rather, MERS will take instructions from tbe noteholder or from the loan servicer.2!
. Wjili respect to foreclosures, MERS contemplates that the b.older of the

note or loan servicer, as agent far the holdet~ will institute a foreclosure action or, if the "mortgage" is in the form. of a deed of trust, direct the trustee to do so. If necessary to
comply with law or custom

m !he applicable jurisdiction.

an employee of the lender or or will be

loan service! will act under power of a:ttomey from :MERS as mortgagee,

appointed as an officer of MERS to direct foreclo~es

on behalf of MERS as mortgagee.

There will be no substantive change in the relationsbip between the note holder and loan

servicer, Moreover, other than minor operational procedures, there will be no change in
the responsibili1ies of the loan servicer, who will. by contract with MERS, continue to
have the same obligations and liabilities with respect to a mortgage as it would .have in

the absence of the MERS System.

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You have asked us to consider several state law issues occasioned proposal that

by the

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MER.s

serve as the original mortgagee of record; these ~ues

are addressed

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hmncdlaiely be-low. You also have asked us to consider certain related issues of federal
law. w.bich are addressed in the final section of this memorandum.

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the note is serviced by a loan servicer other than the payee,

MERS will act as agent for the payee under the promissory note, and to the extent :MERS may' also act on its behalf and at its direction.

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-4Connecticut and Pennsylvania in support of its holding. Recorded mortgages with a
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nominee

as the mortgagee

likewise have been upheld in Washington State in Anderson

Buick Company v. Cook, 7 Wash. 2d 632, 110 P.2d 857.862 (1941) and in Louisiana
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NationalA,cceptance Company of .Ameriaa v. WalZace 194 So.2d 194~ 199. cert. denied. 196 So. 2d 533. 534 (1967). See generally 59 C.J.S. Mortgages §. 80 at 116 (mortgages are valid even if the mortgagees of record are nominees or straw persons). Even where no mortgagee is named. if from reading the mortgage as a whole one can discern that the mo-rtga!leis tied

m 'With the note

secured thereby. acourt

will uphold the validity of the mortgage. See Richey v. Sinclair, 47 N.B. 364 (Ill. 1897)

(reference in mortgage to note payable to the order of William P. Turner which was
executed

at the same time as 1be mortgage cured any defect that the mortgage was mvalid

because no grantee was noted therein). We are not aware of any case that holds that a

loan is unsecured or that a mortgage is unenforceable because the mortgagee is acting as
a nominee for the actual noteholder.

Likewise, in states where a deed of trust is customarily used to secure a
debt,
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it is generally accepted that the entity holding or owning the note can keep the fact and Raymond J. Werner. Modern Mortgage
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of its ownership secret. See Rebert ~vitol

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Law and Practice. § 3.03(a)(1) (1981); see, e.g; Fried

Marbw-ger, 186 S. W.2d 584,

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586 (Mo. 1945) (use of straw party to hold legal title did not invalidate deed of1rust). Moreover, under the Uniform Commercial Code, there is no requirement
that the secured party identified in the security instrument be a principal rather than an

agent See Industrial Packaging Products Co. v. Fort Pitt Packaging International, Inc;

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399 Pa 643, 161 A.2d 19. 21 (1960); see also In reo Fried FumftureCorp., 92 (E.D. N.Y. 1968).

293 F. Supp.

Accordingly; there is no reason Ylby. under a mortgage, the entity holding
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the n9E?.~,!;~!..~J1?e

fact

.of j~..9..Wm-ggp-_coITfi!ien:!j..;l. each In

case, the

promissory note governs the terms and obligations of ilie loan, and the semuity instrument, when recorded, merely provides notice to the.___ _that a -._.w'" has been world lien .•.. ....._ ...___---.~-_. _w__ placed '?D. the debtor's property
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as security for the note.
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The public has no significant
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interest in learning the true identity of the holder of the note. In faet, as one court aptly
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noted, the rationale for upholding the validity of mortgages. where the mortgagee is acting as nominee or agent, lies at the heart of We purpose of the recording system.. That is, the recording system is to provide notice of security :interests to all persons, not necessarily notice of the identity of secured parties. See In re Cushman Bakery, 526 F.2d at 30 (quoting the Pennsylvania court in Industrial Packaging Products).

Funhermore, the nature of a mortgage .instrument - an instrument given to secure indebtedness (not necessarily a note), suggests that the payee on the note mid the mortgagee of record

need not be the same entity.

Although most commercial debts are

evidenced by a promissory note, they. need Dot be. For example, a debt may be evidenced by a guarantee and secured by an indemnity deed of trust, or it may be evidenCed by no written instrument See: e.g., Bangerter v. Poulton, 663 P.2d lOO~101 debt and amount

cut. 1983) (while signed promissory note is one means of evidencing

thereof, lack of executed promissory note is not fatal to validity of trust deed or mortgage); Lee v. Fletcher, 46 Mi.nn. 49, 53, 48 N.W. 456. 457 (1891) (mortgage is valid

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Connecticut and Pennsylvania in support of its holding. Recorded mortgages with

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nominee

as the mortgagee

likewise have been upheld in Washington State in Anderson

Buick Compr:my v. Cook; 7 Wash. 2d 632, 110 P.2d 857,862 (1941) and in Louisiana:m National Acceptance Company of America v. Wallace, 194 So.2d 194~ 199, cett. denied.
196 So.2d 533,534 (1967).

See genermlY 59 C.J.S. Mortgage£ §.80

at 116 (nmrtgages

are valid even if the mortgagees of record are nominees or straw persons).

Even where no mortgagee is named, if from reading the mortgage as a
whole one can discern that the mortgage is tied:in with the note secured thereby. a-court will uphold the validity of the mortgage.

See Richey v. Sinclair. 47 N.E. 364 (Ill. 1897)

(reference in mortgage to note payable to the order of William P. Turner which was
executed at the same time as the mortgage cured any defect that the mortgage

was invalid

because no grantee was noted therein). We are not aware of any case that holds that a

loan is unsecured or tbat a mortgage is unenforceable because the mortgagee is acting as
a nominee for the actual noteboJder. Likewise. in Slates where a deed of trust is customarily used to secure a

debt, it is generally accepted that the entity holding or owning the note can keep the fact
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of its ownership secret. See Robert Kravitol and Raymond J. Werner, Modem Mortgage LIIW and Practice. § 3.03(a)(1) (1981); see, e.g., Fried v, Marburger, 186 S.W.2d 584,

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586 (Mo. 1945) (use of straw party to hold legal title did not invalidate deed of trust).

Moreover, under the Uniform Commercial Code. there is no requirement
that the secured party identified in the security instrument be a principal rather than an
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agent. See Industrial Packaging Products Co.

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Fort Pitt Packaging International, Inc.,

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& BURLING

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, . 399 Pa, 643. 161 A.2d 19. 21 (1960); see also In re Fried Furniture ,Corp.; 293 F. Supp.

92 (E.D. N.Y. 1968). Accordingly; there is
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reason whl~ unde~~mortgage. !he -~~~TE.!!!2?~_ In each case. the

tpe.g:9~~~!..!s~J1le

fact ,~~~ ..~W~~l?_confi~,!Y..

promissory note governs the tetmsanrlobligations
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of the loan. and the security

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instrument. when recorded, merely provides notice to the world that a .lien has_-been _. ~--'-. ..... .....
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placed on the debtor's property
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as security for the note.
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The public has no significant
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interest in learning the true .._.._note. . . _----_ .. identity- of the holder of the_ .. - In fact, as one court aptly _-noted, the rati.ona1efor upholding the validity of mortgages. where the mortgagee is acting as nominee or agent, lies at the heart of the purpose of the recording
system..

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is. the recording system is to provide notice of security interests to all persons. not
necessarily notice of 1he identity of secured parties. See In re Cushman Bakery, 526 F.2d at 30 (quoting the Pennsylvania court in Industrial Packaging Products). Pnrtnermore, the nature of a mortgage .instrument - an instrument given to

secure indebtedness (not nece.ssarily a note), suggests that the payee mortgagee of record

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the note arid the

need DOt be the same entity.

Although most commercial debts are

evidenced by a promissory note. 1hey need not be. For example, a debt may be evidenced by a guarantee and secured by an indemnity deed of trust, or it may be evidenCed by no written :instrument. See; e.g; Bangerter v. Poulton; 663 P.2d 100, 101

cut. 1983) (while signed promissory

note is one means of evidencing debt and amount

thereof: lack of executed promissory note is not fatal to validity of trust deed or
mortgage); Lee v. Fletcher, 46 Mi.n.n.. 49, 53, 48 N.W. 456, 457 (l891) (mortgage is valid

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~6if given to secure a debt. and the debt may be valid even without a note or bond); see

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also Govane Bldg. Co. of Baitimore City. inc. v. Sun Mortgage Co., 144 A. 486, 156 Md
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401 (1929). A debt evidenced by a note exists independent of the note; the note is

merely evidence of the debt, 54A Am, Jut. 2d Mortgages 61· (1996); see also Bologna Brothers v. Morrissr:y, 154 So. 2d 455, 458 (La. 1963) (creditor may recover for
Indebtedness although note is invalid). Thus, it is appropriate to view the mortgage as

the security for the underlying debt rather than for the note evidencing the debt See New England Savings Bankv. Bedford Realty Corp., 23& Conn. 745.680 A.2d 301 (1996) (mortgage secures Indebtedness itself, not the written evidence of it); see also In re

Perrysburg Marketplace Co; 208 RR. 14&, 159 (N.D. Ohio 1997). The mortgage is intended to secure the indebtedness for the benefit of the actual creditor. 59 CJ.S.
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Mortgages § 81 (1997); see Govane, '144 A. at 487; First National Bank of Bridgeport v.
NatiDnal Grain Corp., 131 A. 404, 406 (Conn. 1925). It therefore follows that, in light

of the note's purpose as providing evidence of a debt rather than being the debt itself, a mortgage should not be rendered invalid merely because the payee on the note and tbe mortgagee of reeord are not the same entity. Cj National Acceptance. 194 So. 2d at 198 (mortgage was upheld as valid. notwithstanding never delivered to the mortgagee);
tbat note was made payable to bearer and was upheld as

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Govane, 144 A. at 4&6--487 (mortgage

valid and the debt was held due even though the debt was not evidenced by a note). In sum, we believe that general principles of common law would permit

MERS to be named as the original mortgagee of record, as nominee for the holder of the
Dote

secured 'thereby .

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(b)


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Risks of Challenge to Mortgage Where MERE Acts as Original Mortgagee

\Vhi1e the borrower or a third party might try to challenge the validity of a morlgage

m which

MERS is named as the original mortgagee, as nominee for the

noteholder, we believe that a successful challenge ,Is unlikely. First, the .risk that the mortgagor could successfully claim that its loan is
unsecured is minimal, given the f~ that the mortgagor will have executed a mortgage

at

the closing of its loan which mr:pressly identifies N1ER.S as mortgagee on behalf of the note holder. Such a mortgagor would be estopped to' deny the validity of 1he mortgage.
'V.

See, e.g., Henry
deny validity til

First indiana Bank, 200 BR 59, 63 (1996) (mortgagor estopped to
Y.

mortgage he executed); Commonwealth. Land TItle Insurance Camparry
(1994) (mortgagor estopped to deny

Mattera. 208 AD.2d 490,616 N.Y.S. 2d 798,800
validity of mortgage consolidation,

extension and modification

agreement he executed);

see generally AIb~rs 'P. Nelson, 2f8 Kan, 575, 809 P.2d 1194. 1196 (l991) (It is a wellestablished rule of law that a failure to read the

written contract will estop the contracUng
see also

party from voiding the contract oa the ground of ignorance of its contents);

Arnold v. DMR Financial Beniees, Inc., 532 N.W.2d $52, 854 (1995). . .

Second, the only third parties that might challenge the validity of the

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mortgage would be bona fide purchasers who purchased. the property secured by the

mortgage w ithout knowledge oftb.e MERS mortgage or junior lienholders.
since. the mortgage would be recorded and indexed against both the property

However.
and

MERS.

third parties would be on constructive if not actual notice of its existence.

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& BURI..ING

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- g• In light of the foregoing, the position of the beneficial owner arguably is

stronger with. MERS as original mortgagee than it would be if 11ERS or any other entity became the mortgagee by assignment, If MERS takes the m.ortgage by assignment, the
borrower would have closed its loan without knowledge that MERS would become the

mortgagee of record, and the leader's estoppel position arguably would not be as strO:ng. Moreover, a subsequent assignment of the mortgage would create additional opportunity for mishaps - such as a failure to record an instrument or an incorrect indexing of the instrument, In cases where there has been a cba11e:ngeto the validity of a mortgage
held in the name of an entity that is not the payee under- the note. courts have concluded that the mortgage may constitute a valid secnrlty interest in favor of the actual creditor,

provided the creditor can establish that it was the intended beneficiary and that the named mortgagee, although not identified as Such. was azDng merely as its agent Boruclwff v. '. Ayvosian. 79 N.E;·2d 892, 897 (Mass. 1948); Gavane, 144 A. at 487 (fact that mortgage
debt third

was due to the mortgagee as agent of

tbe real creditor did not render

it invalid as to

persons, where such agent was duly authorized to take "themortgage in its own
One case held that the noteholder must establish that all persons interested as

name).

mongagees and mortgagors bad agreed prior-to or at the time of the advancement .funds that the note should be secured by the mortgage.

of

Boney

'V.

Williams, 38 A. 189

(N.J. J 897). Under the MERS System. 1YlERSwill be named in the original mortgage as

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the mortgagee, as nominee for the noteholder, thus comporting with tbis line of cases.

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COVINGTON & BURLING

As in any circumstance involving an agent or nominee, there is. of course,

some possibility that some action might occur that is against: the principal's interest _ here} that MERS could release or foreclose a mortgage erroneously or wrDngfully~ However, these risks are no different if MERS is the original mortgagee of record than if
MERS or any ollier entity took the mortgage byassignment, These risks are also evident

where a deed of trust rather than a mortgage is used as a security device; a trustee might wrongfully foreclose or release

the deed

of trust These risks have not troubled lenders to

date, and it would seem that lenders should be equally untroubled by a system in which

MERS is the. original mortgagee.
(c) Analogies

There are a number of situations with whlcb. we are familiar where the

mortgagee and payee on the Dote are not the same person. For example, some cammerciallending institutions structure participation loans in such a manner that the
lead bank is named the mortgagee,

acting individually and as agent for other lenders who
Each lender participating The loan

may from time to time become parties to the loan agreement

in the loan may hold a promissory note that reflects its interest therein.

participation agreement among lenders (to which the borrower would not typically be a
.party) reflects the agreement among the participating lenders regarding funding, voting
decisions and the like. The remedies section in the mortgage pennits the lead bank both

to foreclose and to release the lien on behalf of all the lenders. We know of no cases
where the borrower successfully challenged the validity of such a mortgage as security for

any of the notes held by the participating lenders.

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- 10Also. in "title theory" jurisdictions it is technically possible for the mortgagee to transfer the real estate but to keel' the obligation. Second National Bank v.

Dyer. 121 Conn. 263, 184 A. 386 (1936). This could happen if; for example, the
mortgagee dies and the land, including the mortgage, descends to the heirs of the mortgagee, while the promissory note passes to the personal representative pf the es1ate. Demarest»: WynJccop, 3 Johns. Ch. 129, 8 Am. Dec. 467 (N.Y. 1817). In such a case,
theholder of the note can compel a foreclosure of the mortgage. Grant S. Nelson and Dale A

Whitman. Real Estate Finance Law,

§ 5.27 (3d

ed,

West Publishing, 1994). We

are aware of no cases in which. a court held that such a mortgage could not be foreclosed due to the lack of identity between mortgagee and noteholder.

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Question 2: To maxinlize the likelihood that the response to Question 1 w:iUbe favorable: (a)' what wording should be used in the 10m documents to identify MERS as nominee for the beneficial owner(s) and to reflect the interrelationship of the note and the mortgage, and do the existing form documents need to be modified t~ accomplish tim; and (b) what 'Wording should be used in the

MERS Member Agreement and Rules to reflect
the eentraetual anangements pnrsnant to which MERS serves as nominee for the beneficial owner(s), and do the eJisting MERE Agreement and Rules need to be modified to accomplish this. Response: To maximize the likelihood that a court would uphold the"

validity of a mortgage in the MERS System where MERS is the original mortgagee of

record, certain modifications to the existing Fannie Mael.Freddie Mac uniform mortgage loan documents should be made, as more fully outlined below. On the other hand, for

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COVINGTON Co BURLING

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~ 11 the reasons set forth below, we do not believe that ihe language used in the MERS Member Agreement and Rules needs to be modified. (a) Loan Documents

We believe that there are three changes that should be made to the standard

Fannie MaelFreddie Mac uniform mortgage loan instrumen'@l.
First. to reflect the interrelationship of the note and mortgage. and ensure these

two loan documents are tied together properly. the named mortgagee in the recitals of the
mortgage

and the named beneficiary in the deed of trust should be identified as follows:

".MERS, solely as nominee for Lender (as hereafter defined). as beneficiary. and its

succesSors and

assigns."

Second, throughout fhe mortgage and deed of trust instrUment there are provisions for.the "Lender's" administration of tbe loan. The originating lender rather than:MERS

should be defined as the "Lender" so ~ Ioan administration
process.~

it is clear that MERS is not involved in the
the recitals in the mortgage and deed of trust

Accordingly,

should read as follows:

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¥ While we considered wbetherany changes to the Fannie Mae/Freddie Mac uniform note instrument were necessary to reflect the interrelationship between the note and mortgage, in light of the general cross reference in Paragraph 10 of the note to the Security Instrument, we concluded that no changes were necessary or appropriate. ~ Moreover, in Arizona, there is a statute that provides that failure to disclose the beneficiary by name could result in the borrower claiming the mortgage is void. See Ariz. Rev. Stat Ann. § 33-404(c) (1996). This risk is eliminated, we believe; by identifying the original note holder as the Lender :in. the mortgage.

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BURLING


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"[INSERT NAJv.ffiOF ORlGINAWG
and existing under the laws of __

LENDER} ("Lender") is organized
~ and its address is "

Third, so that MERS authority to foreclose and release the security instrument incontrovertible,

is

a sentence should be added to 1he end of paragraph 21 of the mortgage

and deed of trust as follows;

3.

"The Borrower understands and agrees that MERS holds only legal title to
the property; but if necessary .to comply with law or custom" MEM,

as

nominee or agent for the Lender, bas the right to foreclose or release this

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(b)

Security Instrument,"

Membership Documents For the following reasons, we do not believe that the MERS Member

Agreement and Rules dated May 1997. need to be modified to reflect the contractual ammgements pursuant to which MERS shall serve as origiDal mortgagee,
)

as nominee for

the notebolder. The first sentences of Paragraph 3(a) of the Member Agreement and of

Section 5{a) of Rule 2 of the Membership Rules (the "Rules") explicitly provide that the member shall promptly cause 1vffiRS to appear on the pUbfic record as the mortgagee.

The Member Agreement further provides that MERS sh.a11serve as mortgagee of record
solely as a nominee, in an administrative capacity, for the beneficial owner of the

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- 13mortgage loan from time to time as shown on the MERS System.¥ See Member
Agreement at ~ 3(a).

Some have suggested that the relationship between MERS and its members be that of a ~ of an express trust rather than as an agent of a principal in order to comport with the "real party in interest rule". the rule of civil procedure adopted in nearly every jurisdiction requiring that a lawsuit be commenced in the name of the real party in interest The concern is that the rule may be futerpreted 10 permittrustees but not agents 10 iile foreclosure actions in their own name. It is our view that MERS, as nominee and
2 agent for the beneficiary, can prosecute a foreclosure action in its own name Vlithout joining the beneficiazy should it choose to do so under typical judicial doctrine or stErtutory language which provides that a party in whose name a contract has been made . for the benefit of another may sue in that person's name without joining the beneficiaty of the contract, See, e.g., Rule 17(a) of The Federal Rules of Civil Procedure which bas been widely adopted by states. Mutual Life Insurance Company of New York v. Nicholas, 12& N.Y.S. 902, 144 App. Div. 95 (1911) (the authority to foreclose a mortgage may be inferred :from.the fact that the mortgage is in the name of the agent and a person in whose name a contract is made for the benefit of another may sue without joining the beneficiary). However, joinder of the beneficiary should not present a problem as joinder would be required cunently in the absence of the MERE System. If the beneficiary is not already a party to the foreclosure, a m.otion could be filed to join or substitute parties. Moreover, the fact that the beneficiary may be involved in executing affidavits of indebtedness and the like may cure a court's concern about the necessity of joining the beneficiary as a party.

The disadvantages of describing :MERS as a trnstee include that a trust mstrument would be required and that MERS would have a different role than heretofore contemplated. An agent acts on behalf of and at the direction of its principal 'With the principal hav:ing some degree of control over the agent's actions. A trustee acts for itself in its own name exercising independent judgment for the benefit of the trust and its beneficiaries. As MERS is to act on -behalf of its members at their direction without discretionary power. not for itself; an agency rather than a trust relationship would be preferable. ' See MER.S Member Agreement at ~ 3(a) and 4.
Others have suggested that·:MERS not be an agent of the beneficial owner, so 1hat MERS could not bind such party. However, MERE needs the limited power to take actions that will bind the beneficial owner in certain matters pertaining to administration of the mortgage. such as assignments, releases and foreclosure, as well as matters pertaining to notices and registration respecting various interests in the mortgage as specifically outlined in the Member Agreement and Rules. In any event, the foregoing issues are not affected by considerations peculiar to naming MERS as original mortgagee.

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- 14Moreover, the Member Agreement and Rules provide that at all times
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MERS shall comply with the instructions of the beneficial owner or the instructions of any designee of such owner as shown on the lv.IERS System. See Member Agreement at
~ 4 and Rule 2, Section 6. Once the MERS System reflects that the loan has been sold to

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another member, MERS will act on behalf of and take instructions from the purchasing

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member. Rule 2. Section 4(a) provides tbat if the beneficial ownership of the mortgage

loan registered on the MERS System is transferred to a non-member,

.sucl! non-member

beneficial owner may choose either to have the loan (i) de-registered from the MERS

\

• ,

System. or:(ii) continue' to be registered on the MERS System, provided that the servicer of the loan is a member. If both Thebeneficial owner of the loan and the servicer are not
,

members. the loan must be de-registered. In the event that the beneficial owner is not a
member, and chooses to have the loan registered on the MERS System by the loan

I

servicer/member, Rule 2, Section 4{b} provides that at all times ldERS will comply with.
I

instructions given by the loan serviceemember on behalf of the non-member beneficial owner. However, the loan servicer/member must indemnify MERS for any and all

i
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liability MERS incurs as a result of its compliance with. the instructions given by such loan servi.cer/member. See Rule 2 at.§ 4 (b).
These provisions make it clear that at all times MERE acts on behalf of the


beneficial owner of the loan as shown on the :MERS System and. to the extent such

beneficial owner is not a member of MERS, MERS will take instructions from the loan servicer on behalf of the non-member beneficial owner. Accordingly. we do not believe

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that any modification to the Member Agreement andlor Rules is necessary to reflect the contractual arrangements pursuant to which lv.IERSserves as nominee for the noteholder.
Questiob 3: WID tbe designation of .MERB as tbe original mortgagee make it necessary or prudent for MERS to obtain state licenses or qualify to do business any states.

m

Response:

The designation of MERS as the original mortgagee does

not appear to require that MERS obtain any state mortgage lender, mortgage; broker or supervised loan. licenses. AlthoUgh every state requires foreign corporations transacting
business m the state to qualify to do so, MERS will only be required to qualify in
I '

Vnginia where MERE maintains its corporate offices and possibly in three other states
whose laws may be sufficiently broad to require registration
by :MER.s_g

Accompanying

this memorandum as' Apperulix. 1 is a detailed state-by-state review of these licensing and

qualification issues prepared by the law firm. of Negroni & Wmston. PLLC.
Question 4: Is there any legal impediment to MERS, as nominee for the noteholder, sen'ing as the original mortgagee of record and 1'oreelosinga loan in its namey and what will be the respective roles of MERS, 'the notenolder and loan servicer in this process. Response: We are aware of no legal impediment to MERS, as nominee
.!:' i

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for the noteholder, serving as the original mortgagee of record and foreclosing a loan in
its own name. However. in a few jUrisdiCtions the investor typically forecloses in its own

mtme.z.r In a few other jurisdictions either the note must be endorsed to MERS. as the foreclosing party, or lvrERS must assign the mortgage to the noteholder. Nonetheless, we

§!

Massachusetts, New Jersey and New York.
In these jurisdictions, the investor would be the proper party to foreclose even in

Y

the absence of the MERS System,

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COVINGTON

do not foresee that the MERS System will cause any significant changes to current foreclosure practices in any state. There are two basic methods for foreclosing a residential mortgage loan: (1) judicial foreclosure and (2) non-judicial foreclosure. preferred methud of foreclosure depending

In each state there is generally a

upon the type of debt instrument used and the
by the

I
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state's statutory provisions.

Customarily. judicial foreclosures are commenced

filing of a complaint in the local

Court for the county in which the property is located.
as the

Nonnally. the mortgagee's
plaintiff.

attorneys file the suit identifying the mortgagee

Typical requirements

include serving all interested parties with the complaint;

filing copies of the note and mortgage with the court; entry of a judgment

of foreclosure; of

the conduct of a sale by a court officer or the sheriff upon notice; court confirmation
the sale and execution of a deed to the property to the highest bidder. Non-judicial

foreclosures are conducted in 'accordance with. state statutory provisions provisioas contained in the security instrument

and/or the

In each case, the person autho!ized by

statute or the power of sale provisions contained in the security instrument sells the property at a public sale subject to compliance with certain pre- and post-sale advertising and notice requirements, Accompanying this memorandum as Appendix 2 is a detailed state-by-state

review of the foreclosure process in each state, describing the respective roles. of MERS as the original mortgagee of record, the noteholder and the 10331 servicer.N To prepare

,

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~ As you know, the summaries reflected in Appendix 2 reflect the results of our research and analysis but do not constitute an opinion on the laws of any state. 'While we
(continued ...)

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. Appendix 2 we (i) reviewed each state's laws as they relate to foreclosure, consulting Dennis A. Jankowski's 14th edition of The National Mortgage Servicer's Reference Directory witb. respect thereto, and (ii) contacted foreclosure counsel in each
state

to

review and confirm the accuracy of our analysis of the foreclosure process in that state, . as well as to describe both the contemplated roles of MERS as the original mortgagee of record, the noteholder and the loan servicer In foreclosing a loan registered in the MER.S . . System,. and 1he foreclosure procedures used by Fannie Mae and Freddie Mac. In general. we found that where foreclosure is non-judicial and a deed of
.trust is used to secure the debt, :MERS would appoint

any desired substitute trustee and

direct the

trustee to foreclose under a

power of sale provision in the deed of trust or state

statute. If a mortgage has been used and the mortgage is foreclosed under its power of sale provisions, MERS generally would execute the deed upon confirmation of the sale. For judicial foreclosures, MERS would need to direct the foreclosing attorney and be 1he
named plaintiff. MERS

may hav~ to assign the mortgage to the notehalder prior 10 the

foreclosure sale (and, in a judicial foreclosure, to file a motion to substitute parties) in orD:erto permit the noteholder to use the outstanding debt as a credit bid at the. sale. In
all the foregoing examples, where necessary, :MERS could appoint an employee of the

lender or loan seivicer
act

tIS

an

officer of MERS or give such person a power of attomey to

on behalf of MERS. in either event authorizing such person to sign. pleadings.

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believe that there is DO legal impediment to MERS. as nominee for the noteholder, serving as the original mortgagee of record and foreclosing a loan in its own name, in some states MERS may need to assign the mortgage to the notebolder or loan servicer prior to the foreclosure sale.

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-18 ~

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substitutions of trustees, etc, This would avoid most administrative
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burdens and liabilities

MERS might otherwise incur as mortgagee.

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B.

Federal Law Issues Yon asked that this memorandum also address four issues of federnllaw

relating

to

the proposal that MERS be designated as the original mortgagee

of record.

In 'Will

particular. you have asked us to consider whether the implementation present problems under the Tnrthin

of 1his proposal

Lending Act and muJer the Real Estate Settlement

Procedures Act of 1974, and whether it 'Will require any change in the advice we
previously have rendered regarding either environmental law issues or bankruptcy matters,

These four subjects are addressed below.

1.
)

Truth in Lending
As you know, the requirements

iJllposed by the Truth in Lending Act (15
Z

U.S.c. §§ 1601 et seq.) are implemented

by the Federal Reserve Board's Regulation

(12 C.F.R. part 226). Regulation Z primarily requires tbat certain. disclosures be made by creditors who extend credit to consumers.

In connection with the proposal that MERS serve as the original mortgagee

of record, there are, we believe, two issues tb.8t warrant discussion in relation to Regulation Z: (a) Is it permissible under Regulation Z for lv1ERS to serve as the original mortgagee; and (b) Will MERE become responsible for complying with the requirements of Regulation Z if NIERS serves as the original mortgagee.

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(a) Permissibility

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COVINGTON & BURLING

-19 Under Regplation Z

As noted, the provisions disclosures

of Regulation Z predominantly

relate to the
The

lbat must

be made in connection

with. consumer credit transactions.

regulation does include a limited number of provisions

addressing matters other than

disclosure (e.g.. the prohibition against unsolicited issuance of credit cards), but none of
those provisions has any bearing on the proposal that MERS serve as 'the original mortgagee.
The disclosure requirements J the proposal that transaction, imposed by Regulation Z also pose no bar to

MERS

serve as the original mortgagee.

In a residential mortgage

Regulation

Z requires disclosure of the fact that there will be a Thus, for

mortgage. but

»

only in general terms,

example, the general disclosures that must be provided
"the fact that the creditor has or will or

to the consumer must include. where appropriate,

acquire a security interest in the property purchased as part of the transaction.
property identified by item or type," with home equity revolving 12 C.F.R.

in other

§ 226.1S(m).

Similarly.

in connection

credit plans, the creditor

is required to disclose "that the '
~we1ling and that loss of the

creditor will acquire a security .interest in the consumer's dwelling may occur

in the event of default." 12 C.F.R. § 226.5b( d)(3).
for the creditor
Indeed,

However, none of these provisions makes it impermissible

to use a nominee such as MERS to hold the security interest on its behalf.

Regulation Z does not even require thatthe
Official Staff Interpretation

role of MERS as nominee be disclosed.

The

of Regulation Z makes it clear thai the matter to be disclosed "No specified

is that a security interest in the property has been or wi.ll be acquired.

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I 746 I
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- 20 terminology is required in disclosing a se(:;UIity interest .••

[T]he creditor may designate

its interest by using, for example, pledge. lien, or mortgage;" Official Staff
Interpretation,
)

12 C.F.R. part 226. Supp. I. ,. 18(m)(6).

Similarly. in relation to home

equity programs, the staff has stated that "disclosure is not required about the type of security

interest, or about the creditor" s rights 'With respect to that 'collateral,
II

In oilier

,

words, the creditor need not expand on the term security interest.
Interpretation,

Official Staff

12 C.F.R. Part 226. Supp.

I.,.6(0)(1).

,
ill:

In short, we believe it clear that Regulation Z does not in any respect make

it impermissible for MERS to serve as the original mortgagee of record.
(b) Responsibility for Compliance With Regqlation Z

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The obligations imposed

by Regulation

Z generally apply to a "creditor" In a few instances,
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who extends credit of the type covered by the regulation.

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requirements are applicable to persons other than creditors, but

of those is relevant


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to the present issue.

Regulation Z provides in relevant part 'that "Creditor means: (i) A person (A) Who regularly extends consumer credit that is subject to a finance charge or is payable by written agreement in more than 4 installments (not including a downpayment), and (B) to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract. . . . "21 .,

We believe it clear that MERE will

Dot

be a "creditor" under this

definition. Most important, MERS will not be engaged in extending credit to consumers.

2!

'12 C.F.R. § 226.2( a)(17) (footnote omitted). The definition also encompasses certain other persons in connection with credit card programs.

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In addition, MERS

win not be the party

to whom the obligation

e., the note - is

initially payable. Either of these facts is sufficient to exclude MERS :from the
Regula:tion Z definition of "creditor." In these circumstances, 'the obligations tlmt Regulation

MERS will not be responsible for complyjog with

Z imposes on creditors. Compliance with those

requirements will continue to be the responsibility 2.

of the lenders,

as it is at present.

Real Estate Settiement Procedures Act
As you know, the requirements imposed by the Real Estate Settlement

Procedures Act, "RESPA" (12 U.S.C. §§ 2601 et seq.) are implemented by the Federal Reserve Board's Regulation X (24 C.F.R part 3500). Regulation X primarily requires

;

that certain disclosures of the nature and costs of 1he settlement process be made by lenders and loan servicers in connection with federally related mortgage loans,

I.

In connection with 1he proposal that MERE serve as the original mortgagee
of record, there is, we believe, only one issue that warrants discussion in relation to Regulation

X: ,Will MERS become responsible for complying with the requirements

of

'Regulation X if MERE serves as the original mortgagee.ll!1
As noted, the provisions of Regulation X relate primarily that must be made in connection with residential real estate settlements.
to

the disclosures in

In particular,

. a federally related mortgage loan, Regulation X requires inter alia disclosure of the nature

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Nothing in RESPA affects the validity or enforceability of any mortgage or lien arising in connection with a federally related mortgage loan. 12 U.S.C. § 2615. Accordingly, RESPA does not change our conclusion that there is no legal impediment to MERS serv:ing as original mortgagee.

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I 748

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and costs of the settlement process, the fact

that servicing of a loan, will be transferred

and a good faith estimate of the settlement costs to the borrower shortly after loan
I.

application. The regulation does include a limited number of provisions addressing
}

matters other 'than disclosure (e.g., the prohibition against kitkbacks and unearned fees in ,connection with real estate settlements). but none of those provisions has any bearing
QD.

)

the proposal that MERS serve as the original mortgagee. The obligations imposed, by Regulation X generally apply to a "lender" who extends credit of the type covered by the regulation or a "servicer" who services a
mortgage loan of the type covered by the regulation.

In

8 few

instances, requirements

are

applicable to persons other than lenders or servicers, but none of those is relevant to the

, •
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present issue.

Regulation X provides in relevant part that "Lender means: the secured creditor or creditors named in the debt obligation and document creating the lien!' 24 C.F.R § 3500.2(b).l!!
II

'Servicer means: the person responsible for the servicing ofa mortgage'

loan (including the person who makes or holds a mortgage loan if such person also
services the mortgage loan)." 24

~.R.

§ 3:S00.2(b).

We believe that MERS will not be deemed a "lender" or "servicer" under

• ,

these definitions. While MERS will be the named mortgagee of record, it will serve in
that capacity solely as nominee for the lender,

ann the lender

will appear by name in both

ill The definition of lender expressly excludes mortgage brokers who close loans in their own name jn a table funding transaction but assign the loan after settlement. 24

C.F.R. § 3S00.2(b).

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COVINGTON & BURLING

the promissory

note and the security instrument.

In addition, MERS will not be the party

to whom the obligation - i.e., the note -- is initially payable or the person who receives any scheduled periodic payment from a borrower.
engaged

Most importantly. :MERS will not be

in theoriginaticn,

processing, servicing or funding of residential mortgage loans

to consumers nor will MERE attend or facilitate the settlement of mortgage loans. Any of these facts is sufficient to exclude·l\IIERS from the Regulation X definitiops of "lender"
and "servieer",

In these circumstances, MERS will not be :responsible for complying with
the obligations thai Regulation X Imposes on lenders and loan. servicers, Compliance

with those requirements will continue to be the responsibility of the lenders and loan servicers, as it is at present
3. En"rimnmentaJ Law

We have previously considered Whether the functions thar MERS bas
proposed to perform would give rise to any significant exposure to environmental law

liability -- in particular, exposure under "Superfund" or nCERCLA" (the Comprehensive Environmental Response; Compensation, and Liability Act), 42 US.C. § 9601 et seq. That legislation sets forth categories

of persons

who are potentially responsible fot:

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cleanup of contaminated sites. The categories include current and former owners and/or operators of such sites.
We previously concluded that the risk that MERS would be ~ubjected to

such liability is remote, given :MERS minimal relationship to the residential
which it

properties

for

will serve as nominee mortgage holder.

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-24 We have reviewed this conclusion :in light of the proposal that MERS serve ' as the original mortgagee of record. Our prior conclusion was based on the
that MERS

limited role

will play in relation to the properties in question; our analysis did not hinge

on whether that limited role was initiated at the time the mortgage was created, or by a subsequent assignment
)

In short, in our view. the change involved. in the original

mortgagee proposal requires no change whatever :in our prior conclusion regarding

CERCLA.

3.
)

Bankruptcy
We also have previously considered whether the implementation of the

MER.S System would create difficulties under the U.s' Bankruptcy

Code in the event of a

banknIptcy proceeding involving (a) a mortgagor of a mortgage loan registered on the
)

MERS System. or (b) the servicer of a mortgage loan registered on the MERS System., or i

,I

,

(c)

MERS itself.
We concluded that none of these circumstances would have anY' different

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or more adverse consequences under the Bankruptcy Code than would occur in the

absence of the :MERS System.
We have reviewed that conclusion in light of the proposal that MERSserve

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as the original mortgagee of record. Our prior conclusion was based on the nature of

MEltS functions, not on the question whether it is designated as mortgagee of record
initially or by subsequent assignment. Acecrdingly,

the original mortgagee

proposal

requires no change whatever

in our prior conclusion regarding bankruptcy proceedings.

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- 25SUMMARy

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Our analysis supports the following generalizations regarding the proposal that MERS be named as the original mortgagee of record under the MERS System; 1. Courts are unlikely to hold that a loan is unsecured or

that the

mortgage is unenfor~eable if:MERS is named as the original mortgagee with. the originating lender being named as the payee of the note. To maximize the enforceability
of such a mortgage. we propose that the named mortgagee in the recorded mortgage and

the named. beneficiary in the deed of trust be "MERS, solely as nominee for the Lender (as hereinafter defined), as beneficiary. and its successors and assigns".
2. The mortgage should identifY the original noteholder as the

"Lender" and clearly state that MERS as mortgagee only holds legal title to the mortgaged property as nominee for the noteholder, but also state that, if necessary to comply with law or custom. MERS. as nominee or agent for the Lender will have the right to foreclose and/or release the mortgage. 3.
need not be changed.

The language used in the MERS Member Agreement and Ru1es

4.

The designation of MERS as original mortgagee does not appear 10

require that MERS obtain any stale mortgage lender or mortgage broker licenses. MERS

will be required to qualify to transact business as a foreign corporation in Virginia and
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may be required to qualify in three other states.

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5.

There are no legal impediments to rvIERS foreclosing a loan in its

own name where MERS serves as the original mortgagee of record, as nominee for the

MER 017"

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actual noteholder. However, in a few jurisdictions the investor routinely forecloses in its
own name. In a few other jurisdictions the note must be endorsed to MERS. as the

foreclosing party or MERS must assign the mortgage to the noteholder.

Nonetheless, we

do Dot foresee that the MERS System will cause any significant changes to current foreclosure practices in any state. 6. The Truth in Lending Act and Regulation Z do not preclude MERS
Moreover. as original mortgagee, MERS will not

from ,serving as the original mortgagee.

be responsible for complying with the Troth in Lending Act and Regulation Z_ Rather, compliance with these requirements will continue to be the responsibility of the lenders, as it is at present 7.

MERS. as the original mortgagee. will not be responsible for

complyjnz with the Real Estate Settlements Procedures Act (,'RESPA") and Regulation X.

Rather, compliance with these requirements will continue to be the responsibility of the lenders and loan servicers, as ~tis at present
8.

.As original mortgagee. the risk that MERS would be subjected

to

environmental law liability is no different than. if MERS were an assignee of the

mortgage. In either case the risk is remote. 9. Whether MERS is the original mortgagee or takes the mortgage by

assignment, the :MERS System will not cause any different or more adverse consequences
under the Bankruptcy Code to the beneficial owner than would occur in the absence of the MERS System.

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CONCLUSION

Our analysis of each of the issues you have asked us to address is
consistent with the conclusion 1hat it is feasible for MERE to serve as the original mortgagee of record without undue risk. to the beneficial owner or loan servieer,
.r

Please contact us if there are :further issues on this subject that you wish us to address.

COVINGTON & BURLING

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