Delaware Court Rejects "Veil Piercing" Claims Against MERS Shareholders: Dismisses Shareholders From Lawsuit
By: Irene C. Freidel, Gregory N. Blase
A federal court in Delaware recently held that shareholders of Mortgage Electronic Registration Systems, Inc. (“MERS”) – some of the country’s largest mortgage lenders – could not be held liable for the alleged activities of MERS. Trevino et al. v. Merscorp., Inc., et al., No. 1:07-cv-00568-JJF (D. Del.). MERS was created in 1996 by the real estate finance industry to eliminate the need to prepare and record assignments when trading residential and commercial mortgage loans. MERS’s chief business purpose is to simplify and streamline the manner in which mortgage ownership and servicing rights are originated, sold and tracked. Recently, in light of its visibility in connection with mortgage defaults and foreclosures, MERS and its shareholders have come under attack by plaintiffs’ class action lawyers. The court’s decision resulted in the dismissal from the putative class action of MERS shareholders Citigroup, Inc., Countrywide Financial Corp., Fannie Mae, Freddie Mac, GMAC-RFC Holding Company, LLC, HSBC Finance Corporation, JPMorgan Chase & Co., Washington Mutual Bank, and Wells Fargo & Company (the “shareholder defendants”).
In their complaint, plaintiffs alleged that MERS overcharged them and a class of similarly situated individuals for costs arising out of proceedings to enforce mortgage instruments, including foreclosures. Plaintiffs asserted that MERS’s alleged actions constituted breach of contract, unjust enrichment, and breach of the duty of good faith and fair dealing.
Plaintiffs sought to hold the shareholder defendants liable for the alleged actions of MERS through the theory of “piercing the corporate veil.” Specifically, plaintiffs contended that because of its alleged “diminutive size and meager asset base,” MERS is undercapitalized and would be unable to pay on any judgment that plaintiffs and the putative class may eventually obtain. Plaintiffs contended that these facts stated the basis for their request to pierce MERS’s corporate veil and to hold the shareholder defendants liable for MERS’s alleged wrongdoing.
The shareholder defendants moved to dismiss the complaint arguing, among other things, that there was no allegation that MERS was set up for the purpose of committing fraud or some other injustice to borrowers, that MERS was established for a legitimate business purpose, and that its shareholders – all competitors in the marketplace – could not be considered a “single functioning entity” for veil-piercing purposes. The court agreed, finding in part, that plaintiffs had failed to allege an overall element of injustice. The court noted that the plaintiffs’ only substantive factual allegation in support of their claim against the shareholders was that MERS was undercapitalized. But the court held that a shortage of capital is not a per se reason to pierce the veil. This is particularly the case where there is no allegation that the alleged undercapitalization was undertaken to defraud a corporation’s creditors. The court noted plaintiffs’ acknowledgment that MERS was established for a legitimate business reason, i.e., to “create a secondary mortgage market, internally administer the buying and selling of mortgages, and to simplify the administration of home mortgages.”
Finally, the court found that plaintiffs had failed to allege any unfairness sufficient to ignore MERS’s corporate form. Specifically, while plaintiffs alleged that MERS was created to facilitate its shareholders’ business interests and to limit their liability, neither of these factors shows unfairness, unless the attempt to limit liability was undertaken in order to avoid responsibility for a specific tort or class of torts.The Trevino decision is significant because it spared MERS’s shareholders from potential exposure to consumer class actions on the now rejected theory of indirect liability. MERS is integral to the successful functioning of the secondary mortgage market. Plaintiffs’ discredited legal theory, if not rejected by the court, could have exposed MERS shareholders to liability for the actions of third party investors and servicers, causing further stress to the already embattled mortgage market.
