In re Mortg. Store

• Decision Date: 08 April 2014
• Docket Number: No. 10–03454.,10–03454.
• Citation: 509 B.R. 292
• Court: U.S. Bankruptcy Court — District of Hawaii
• Parties: In re THE MORTGAGE STORE, Debtor.

509 B.R. 292

In re THE MORTGAGE STORE, Debtor.

No. 10–03454.

United States Bankruptcy Court, D. Hawai‘i.

Signed April 8, 2014.

Ryther L. Barbin, Wailuku, HI, for Debtor.

Cades Schutte, LLP, Kahului, HI, Dane S. Field, Honolulu, HI, Alika L. Piper, Nicole D. Stucki, Klevansky Piper, LLP, Honolulu, HI, for Dane S. Field, Trustee.

MEMORANDUM OF DECISION ON HSBC BANK'S MOTION FOR DISBURSEMENT OF PROCEEDS

ROBERT J. FARIS, Bankruptcy Judge.

HSBC ¹ claims a first mortgage, and the bankruptcy trustee of The Mortgage Store (“TMS”) claims a second mortgage on property formerly owned by Mr. and Mrs. Abatie. The TMS trustee sold the property and is holding a portion of the proceeds pending resolution of his objections to HSBC's claims. HSBC seeks disbursement of all the remaining proceeds. For the following reasons, I will grant HSBC's motion in large part but will allow a reduced amount of attorneys' fees to HSBC.

Facts

In 2003, IndyMac Bank, F.S.B. (“IndyMac”), agreed to make a construction loan to Lawrence and Kathy Abatie in the amount of $524,000. The Abaties signed a promissory note and a mortgage that encumbered the Abaties' property in Lahaina.² The mortgage secures “the repayment of the Loan [including ‘the debt evidenced by the Note’], and all renewals, extensions, and modifications of the Note.” ³

The note provided an initial interest rate of six percent per annum, subject to annual change based on an index. The interest rate could not exceed twelve percent and would never change by more than two percentage points at any one time. The note further provided for adjustable monthly payments of principal and interest based on a thirty-year amortization period.

The note gives HSBC “the right to be paid back by [the obligor] for all of its costs and expenses in enforcing this Note to the extent not prohibited by applicable law. Those expenses include, for example, reasonable attorneys' fees.” ⁴ The mortgage provides that “Lender may charge Borrower fees for services performed in connection with Borrower's default, for the purpose of protecting Lender's interest in the Property and rights under this Security Instrument, including, but not limited to, attorneys' fees.... Lender may not charge fees that are expressly prohibited by ... Applicable Law.” ⁵ Section 22 of the mortgage also provides that, if the borrower defaults, “Lender shall be entitled to collect all expenses incurred in pursuing the remedies provided in this Section 22, including, but not limited to, reasonable attorneys' fees....”

In 2006, The Mortgage Store lent the Abaties $220,000, secured by a second mortgage on the Lahaina property.⁶

In 2007, IndyMac and the Abaties entered into a Modification Agreement. ⁷ The modification agreement says that it “MODIFIES THAT NOTE [i.e., the Abaties' 2003 note] TO CHANGE THE INTEREST RATE AND MONTHLY PAYMENT.” ⁸ IndyMac and the Abaties agreed that the principal balance was $524,000. The interest rate calculation was changed in many respects. Among other things, the maximum interest rate was reduced from twelve percent to 9.95 percent. The payment schedule was also revised to permit “negative amortization”; subject to various complicated limitations, the Abaties could pay less than the monthly accrual of interest, and the unpaid interest would be added to the principal amount of the loan. The mortgage was not amended and no new mortgage was recorded.

At some point, through a series of intermediate transfers, HSBC succeeded to the interest of IndyMac in the Abaties' loan. HSBC has possession of the original promissory note, which is endorsed in blank.

Mrs. Abatie filed a chapter 13 bankruptcy case in 2008 that was dismissed in 2009. She filed another chapter 13 case in 2009 that was dismissed in 2010.

In 2010, TMS filed this chapter 7 case.

In 2011, Mrs. Abatie filed her third bankruptcy case, this time under chapter 7. Both HSBC and the TMS trustee obtained relief from the stay to foreclose their respective mortgages. The TMS trustee commenced a judicial foreclosure proceeding. HSBC could have sought foreclosure of its mortgage in that proceeding but inexplicably did not. The TMS trustee obtained a decree of foreclosure and was the successful bidder at the foreclosure sale. Thus, the TMS trustee became the owner of the property, subject to the HSBC mortgage.

In 2013, I authorized the TMS trustee to sell the property for $840,000, to pay the costs of sale, to pay HSBC the then undisputed part of the HSBC debt ($524,000), and to retain the remaining proceeds until the HSBC debt could be determined.

The parties exchanged information about HSBC's claim. Both parties are dissatisfied with the other's performance in this process. The TMS trustee complains that HSBC produced documents and information too slowly, and HSBC complains that the TMS trustee took too long to review the information that HSBC produced.

In December 2013, HSBC filed the motion that is before me now. The TMS trustee objects to the motion on numerous grounds and argues, not only that HSBC should receive none of the additional sale proceeds, but that it should also refund the $524,000 it received at closing.

Discussion

1. HSBC's Right to Enforce the Note and Mortgage

The TMS trustee argues that HSBC has not established that it is entitled to enforce the loan and mortgage. I disagree.

The TMS trustee acknowledges that the promissory note is a negotiable instrument and that it was endorsed in blank. HSBC has established that its counsel has possession of it. Thus, HSBC is a person entitled to enforce the note.⁹

The TMS trustee argues that the recorded assignment of the mortgage does not also transfer the note. This is correct but irrelevant. Under Hawaii law (and the law of most other states), the collateral follows the obligation. ¹⁰ A transfer of a promissory note automatically transfers any security for that note.¹¹ HSBC is therefore also entitled to the benefit of the mortgage without a separate assignment of the mortgage.

The TMS trustee argues that “[t]he assignment of a security interest, without a concomitant assignment of the underlying obligation, severs the security from the obligation it secured.” ¹² The premise of this argument—that the mortgage was transferred but the note was not—is false. The note was transferred to HSBC (by endorsement in blank and delivery of the original instrument). Therefore, there was no such separate transfer of the mortgage. Even if the premise were true, the conclusion would not follow. Assuming that HSBC acquired the mortgage but not the note, the claim would not necessarily become unsecured. Because the obligation and the collateral are inseparable, one cannot assign a mortgage without also transferring the note. An attempt to transfer the mortgage apart from the note does not, however, invalidate the mortgage. Rather, such an assignment is ineffective.¹³

2. Effect of the 2007 Modification Agreement

The trustee's argues that “[t]he 2007 Modification Agreement was essentially a new note,” and that the 2003 mortgage does not secure the “new note” or any additional principal or other charges arising from that modification. I disagree.

There is only one obligation of the Abaties to HSBC and its predecessors. HSBC's predecessor lent money to the Abaties and the Abaties promised to pay it back. The modification agreement changed the interest rate and repayment terms of that existing debt. This change did not create a new obligation or destroy the existing security for that obligation.

The 2003 mortgage secures the debt under the note as modified by the 2007 modification agreement. The mortgage says that it secures modifications of the original note. TMS had constructive notice of this provision of the recorded mortgage when it made its second mortgage loan. The lender was not required to record a new mortgage or an amendment to the existing mortgage due to the modification agreement.

The trustee argues that the 2007 amendment cannot be enforced against him because the negative amortization feature of the modification materially jeopardized his second lien position. He cites only one court decision in support of his argument, Remodeling & Const. Corp. v. Melker.¹⁴ The Melker decision is a trial court decision based on New York law that cites no authority and contains almost no analysis. A later decision of the same court, citing substantial authority, holds that “[t]he consent of a second mortgage is not required in order to validate a modification of the terms of a first mortgage” and limits the rule of Melker to modifications that “render the junior lien practically valueless.” ¹⁵

Neither the trustee nor HSBC cites any Hawaii law on point. I predict that a Hawaii court would hold that, in the absence of an agreement between the senior and junior lienholder, the junior lienholder cannot challenge a change of the interest rate or payment schedule for the debt secured by the senior mortgage, where the first mortgage expressly states that it secures “modifications” of the original note. This is consistent with the Restatement (Third) of Property.¹⁶ A lender that makes a loan secured by a junior mortgage should not be allowed to force the senior lender to protect the junior lender's interests, particularly where the first mortgage puts the junior lender on notice that the first mortgage secures modifications of the debt. Junior lenders desiring such protection should negotiate for it with the senior lender. (Even assuming that a Hawaii court would follow the New York rule, the modifications in this case—effectively an increase in the interest rate—did not render TMS' second mortgage lien practically valueless.)

The TMS trustee argues that Hawaii law disfavors negative amortization. I disagree. Nothing in Hawaii law precludes “negative amortization,” “interest on interest,” or the capitalization of accrued but unpaid interest. Prior to 1986, Hawaii law forbade compound interest in most circumstances.¹⁷...