>Daily Development for   Tuesday, August 19, 2008
>by: Patrick A. Randolph, Jr.
>Elmer F. Pierson Professor of Law
>UMKC School of Law
>Of Counsel: Husch Blackwell Sanders
>Kansas City, Missouri
>dirt@umkc.edu
>
>MORTGAGES; FUTURE ADVANCES; DRAGNET CLAUSE: An advance that otherwise would be beyond the scope of the dragnet clause in a senior mortgage will not be permitted to prime a junior mortgagee even if the senior mortgage contains broad terms permitting modification of the senior lien. 

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>Nature’s Sunchine Products, Inc. v. Watson, 174 P.3d 647 (Ut. App. 2007)   
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>Watson borrowed $75,000 from First Security Bank, apparently agreeing to a “home equity line of credit” mortgage on certain property.  The court states that the security was “valuable property” and, since it described the loan as a “home equity line of credit,” we must assume that he lived there. 

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>The mortgage contained a both a dragnet clause and a modification clause.  The language becomes relevant, so we’ll set both clauses forth here. 

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>First, the dragnet clause: 
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>“FOR THE PURPOSE OF SECURING (1) payment of all obligations now or hereafter arising pursuant to or otherwise related or connected to that certain "First Security Home Equity Line Agreement, Note, and Disclosure Statement" of even date herewith executed by the Trustor (the "Agreement"), which Agreement evidences a revolving credit line in the maximum principal sum of SEVENTY FIVE THOUSAND AND 00/100 Dollars ($75,000.00) together with interest, costs, and expenses, as therein provided, payable to the order of Beneficiary at the times, and in the manner and with interest as therein set forth, together with any extensions, renewals, modifications, and future advances thereof or thereunder; (2) the performance of each agreement of Trustor herein contained; (3) the payment of all sums expended or advanced by Beneficiary under or pursuant to the terms of this Trust Deed and/or the Agreement, together with interest thereon as provided therein.”

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>The modification clause, contained in paragraph 10, provides in part as follows:
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>At any time, and from time to time upon written request of Beneficiary, ... Trustee may ... grant any extension or modifications of the terms of the Agreement[.]”

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>Seven years later, Watson borrowed $775,000 from NSP, secured by a trust deed on the same property. 
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>Four years later, First Security Bank assigned its first mortgage interest to Waters.  We’re not told what the balance of the mortgage was at that time, but presumably it did not exceed the $75,000 cap in the line of credit. 

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>Five years after that, Watson was in default on the note to NSP and NSP was preparing to foreclose.  Waters assigned the senior mortgage debt to MoneyCode, which purported to “modify” the mortgage pursuant to the modification language set forth above to turn it from a $75,000 mortgage into a $1,320,000 mortgage.  This was done on the very day that Waters assigned to MoneyCode.  The very next day, NSP completed its trustee’s sale.  A few weeks after that Watson signed a deed in lieu of foreclosure to MoneyCode and MoneyCode leased the property back to Watson, who remained in possession.

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>Guess what?  NSP didn’t think all this was quite kosher.  Claiming ownership under its own trust deed, it brought a summary possession action against Watson.  MoneyCode responded by declaring a default on the $1,320,000 note, apparently setting up to foreclose away NSP.  NSP brought a lawsuit challenging, basically the priority of MoneyCode to the $1,320,000 claim.  NSP admitted that the $75,000 originally contemplated principle had priority over its mortgage, but disputed whether the parties had the right to “modify” the mortgage to effectuate what was essentially a massive future advance.

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>The court noted that  a provision permitting modifications does permit a senior lender to modify its loan, even to the detriment of a junior lender. Restatement of Mortgages Section 7.3(c) And of course the junior lender had constructive notice of the provision permitting modifications.   But that massive change of almost $1.3 million in principle amount was not a modification within the contemplation of the original mortgage, it was a “future advance.”   Of course, the future advance clause in the prime mortgage had a specific dollar limit, and otherwise consistent with the purposes of the original line of credit agreement.  The court read this future advances clause as an implicit limitation on the right of the parties to modify the mortgage pursuant to the modification clause.  It concluded that any other reading would be unfair to junior lenders, as they would be misled by the future advance clause into believing that only increases in principle pursuant to that clause would

be permitted.
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>Comment 1: The editor has drafted an article on this subject that he published as PLI course materials.  It can be found on the DIRT website: www.umkc.edu/dirt  His conclusions are similar to those reached by Nelson and Whitman with respect to the modification right.  Modifications that may be injurious to the security of juniors are permitted (by agreement of the mortgagor and mortgagee) but likely not future advances unless they are otherwise permitted by law or the agreement.  The editor is not necessarily in line with the Restatement on future advances, as it attempts to engraft what is essentially a statutory approach into the common law, but acknowledges that the current common law “optional/obligatory” test is problematic as well.  That debate about future advances is beyond the scope of this discussion.

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>Comment 2: Unfortunately, to the editor, the appeals court’s is all over the place with respect to its reasoning.  For instance, it notes that the instant mortgagee is two places removed from the original mortgagee, and suggests that this makes a difference with regard to the validity of the modification.  Of course, it might well make a difference if we were talking about a future advance.  There certainly is an argument that one shouldn’t traffic in future advance rights. But is it appropriate to permit junior lenders to limit the right of subsequent transferees of the mortgage to effectuate modifications other than advances if the mortgagor so agrees?  The editor would not so limit a modifications clause.

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>Comment 3: The court also goes on and on about how various modifications might be injurious to juniors, citing cases decrying such occurrences.  But the authority deals almost exclusively with situations in which the modification was not contemplated by the prime mortgage.  The court seems to agree with the Restatement (and the editor) that (other than future advances) the parties can draft an enforceable modifications clause valid against juniors.  So the discussion about injury to juniors in the case, which takes up a good deal of the discussion, is superfluous.

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>Also see:  Cottingham v. The Citizens Bank, CV-01-14, 2003 Westlaw 133246 (Alabama 1/17/03) (A mortgage that provides that it secures a certain note, "and all renewals, extensions and modifications," shall not be construed as a note securing future advances, and consequently, when the loan balance is paid down to zero, the mortgage is deemed cancelled.)

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