Daily Development for Thursday, October 26, 2006
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri

MORTGAGES; FUTURE ADVANCES; SCOPE: Dragnet clause does not incorporate into the lien of the mortgage an unrelated judgment rendered against the mortgagor by a third person when the mortgage containing the dragnet clause is assigned to the third person. 

Money Store Investment Corp. v. Summers, 849 N.E. 2d 544 (Ind. 2006)

National City Bank held several mortgages on real estate owned by Summers.  The mortgages contained “dragnet clauses,” providing that the mortgages secured “any and all other notes or obligations of the Mortgagor to the Mortgagee.”

Money Store later loaned Summers $879,000 secured by the same real estate.  These mortgages were intended to replace National City’s previous mortgages and to provide additional capital to Summers. Summers forwarded payoff statements, including daily interest, to the loan escrow, but in the end there remained an unpaid balance on one of the National City mortgages of $375.  National City also claimed that it was owed $4700 due to “overdraws” by Summers.  Consequently, although the mortgage balances were paid down substantially, did not release its mortgages.  Those dragnet clauses were still out there.

Subsequently, Phillips, a third party, obtained a judgment against summers for $206,000.  Summers went into defualt on the Money Store mortgages, and Money Store instituted a foreclosure. 

Phillips, facing wipeout in the Money Store foreclosure, obtained an assignment of the unreleased National City Bank mortgages, and claimed that the $206,000 was now covered by the dragnet clauses under those mortgages.  Phillips then filed her own foreclosure complaint, naming Money Store as a party defendant, arguing that she held a lien senior to Money Store by virtue of the dragnet clauses contained in the mortgages that she now held.  (Note again the language: “any and all other notes of obligations of the Mortgagor to the Mortgagee.”)  The trial court and the Court of Appeal held in favor of Phillips. 

The best laid plans, however . . . .  The Indiana Supreme Court sensibly held that the tradition of strict construction of dragnet clauses drove it to the conclusion that the parties couldn’t possibly have intended to create a collection device for any and all future creditors of the mortgagor.  Rather, the parties intended to limit the scope of the clause to obligations Summers incurred in the future to National City Bank.  The Phillips judgment was for a different claim that had no relationship to the National City loans, and it was not made in reliance on the security.  Thus her judgment did not fall under the coverage of the dragnet clauses. 

In another Indiana decision, Hepburn v. Tri-County Bank, 842 N.E. 2d 378 (Ind. App.  2006), the Court of Appeal ruled that a dragnet clause in a mortgage executed by a wife also covered a guaranty that she later executed for an obligation of her husband, thereby making her mortgaged property security for both of the loans.  A dissenting opinion argued that her guaranty could have, but did not, fall under the dragnet clause because the guaranty specifically declared that it was unsecured.  Also see:  Iuka Guaranty Bank v. Beard, 658 So.2d 1367 (Miss. 1995) (dicta) (The DIRT DD for 10/27/95). (Dragnet clause securing all debts to bank, present or future, owed by husband and wife, or one of them, is valid as drafted, and secures loans known only to one of the parties.)

Comment 1: There is an obvious practice lesson here - get a discharge of loans that you believe that you are refinancing. 

Comment 2:   This case was a commercial loan case.  Because many dragnet clauses bite small businessmen, as was the case here, particularly farmers, we find that the courts basically provide “consumer like” protection for borrowers who sign these things.  But for a consumer protection case involving a consumer, see  In re Wollin, 249 B.R. 555 (Bankr. D. Or. 2000) (The DIRT DD for 7/18/00) (lender may not use a dragnet clause in a personal property security agreement to add to its secured claim future advances made on a credit card; nor may it add unpaid balances on loans made prior to the secured transaction without a specific reference to the prior loans in the subsequent security agreement.) For another example of a narrow reading language dealing with these clauses, see: NAB Asset Venture III, L.P. v. Brokton Credit Union, 815 N.E. 2d 606 (Mass. App. 2004) (The DIRT DD for 3/21/05) ( First lienholder's agreement to subordinate its interest to a junior lienholder is not an agree

ment to subordinate to future advances subsequently made pursuant to a future advance clause in the junior lien.) (The editor criticized this decision.) Compare:   VATACS Group, Inc. v. Homeside Lending, Inc., 623 S.E.2d 534 (Ga.App. 2005), (a clause subordinating an identified loan “and all other interests” of subordinating party successfully subordinates all mortgages of the subordinating party in existence at time of subordination.)

Comment 3: The Supreme Court stated the Indiana test of scope of dragnet clauses has three independent standards: (1) Is the later debt of the same general kind as the original mortgage debt? (2) Does the later debt bear a  “close relationship” to the original mortgage debt? Or (3) Is there evidence that  lender “specifically relied” on the security in making the subsequent loan?

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