Opinion ID: 197343
Heading Depth: 2
Heading Rank: 4

Heading: Impairment of Collateral

Text: 26 Lastly, Gens challenges the bankruptcy court ruling dismissing her impairment of collateral defense without first affording her an evidentiary hearing. She claimed that a prior holder of the Gens Note--presumably U.S. Funding--used $36,000 of the loan proceeds to pay off the preexisting second mortgage on the Barnstable Property, but failed to obtain and record the mortgage discharge. Thus, the mortgage securing the Gens Note remained third in priority, rather than climbing to second priority. 27 Pursuant to Mass. Gen. Laws. Ann. ch. 106, § 3-606(1)(b), [t]he holder discharges any party to the [negotiable] instrument to the extent that without such party's consent the holder ... unjustifiably impairs any collateral for the instrument given by or on behalf of the party or any person against whom he has a right of recourse. An impairment of collateral may result if the conduct of the holder of a collateralized negotiable instrument unjustifiably diminishes the physical value of the collateral, releases the collateral to the principal obligor before the loan is repaid, or fails to perfect its security interest in the collateral. See Rose v. Homsey, 347 Mass. 259, 197 N.E.2d 603, 605-06 (1964); see also Hawaii Broad. Co. v. Hawaii Radio, Inc., 82 Hawai'i 106, 919 P.2d 1018, 1029 (Ct.App.1996); White v. Household Fin. Corp., 158 Ind.App. 394, 302 N.E.2d 828, 835 (1973). Nevertheless, in most jurisdictions a party asserting an impairment of collateral defense must prove she signed the negotiable instrument (viz., promissory note) merely as an accommodation party for the principal debtor, rather than as a borrower. See James A. White & Robert S. Summers, Uniform Commercial Code §§ 13-16 (3d ed.1988). 10 28 An accommodation maker is one who signs the [negotiable] instrument in any capacity for the purpose of lending [her] name to another party to it, Mass. Gen. Laws. Ann. ch. 106, § 3-415(1). Frequently, accommodation parties sign debt instruments to enable the principal obligor to obtain a loan which would not have been granted absent the accommodation. Although an accommodation party is liable to the lender under the debt instrument, her liability is that of a surety only. Id. cmt. 1. Thus, the accommodation maker reasonably expects that if called upon for payment following the principal obligor's default, she will be subrogated to the lender's rights against the principal obligor, including the right of recourse against any collateral securing the underlying debt instrument. See id. cmt. 5; see also FDIC v. Blue Rock Shopping Ctr., Inc., 766 F.2d 744, 749 (3d Cir.1985); accord Restatement of Security §§ 104, 141 (1941). Therefore, to the extent the holder of the debt instrument unjustifiably devalues or releases the collateral, or fails to perfect its rights in the collateral against third parties, the right of recourse may be diminished, thereby entitling the accommodation maker to a commensurate discharge from liability under the debt instrument. See Blue Rock Shopping Ctr., 766 F.2d at 751. 29 The bankruptcy court considered Gens' second signature conclusive evidence that she had signed the Gens Note in her individual capacity, that is, as a principal coborrower rather than an accommodation maker. It also concluded that the purport of Gens' second signature on the Gens Note was not rendered ambiguous, either by the anterior designation of the Trust as the sole Borrower or the failure to designate a Co-borrower. 30 Citing considerable case authority, Gens maintains that all accommodation makers necessarily sign promissory notes either in their individual or representative capacities. Consequently, she argues, these designations cannot conclusively resolve a signatory's accommodation status. 11 Since the Gens Note must therefore be considered facially ambiguous, Gens argues that a hearing should have been conducted to consider parol evidence that the parties to the Gens Note (viz., U.S. Funding, the Trust, and Gens) all understood that Gen's second signature was intended only as an accommodation endorsement. See, e.g., Mass. Gen. Laws. Ann. ch. 106, § 3-415(3) (expressly allowing parol evidence of accommodation status except as to holders-in-due-course); United Beef Co. v. Childs, 306 Mass. 187, 27 N.E.2d 962, 964 (1940) (same); see also Butler v. NationsBank, 58 F.3d 1022, 1027 (4th Cir.1995) (outlining multi-factored, intent-based purpose and proceeds tests for determining accommodation status); First Dakota Nat'l Bank v. Maxon, 534 N.W.2d 37, 41-42 (S.D.1995) (same). 12 31 Even were we to assume arguendo that Gens was entitled to an evidentiary hearing to determine whether she signed the Gens Note as an accommodation maker, she failed to set forth allegations which would establish the second essential element in her affirmative defense--a cognizable impairment of the collateral. See RTC v. Feldman, 3 F.3d 5, 9 (1st Cir.1993) (appellate court may affirm on any ground supported by record), cert. denied, 510 U.S. 1163, 114 S.Ct. 1187, 127 L.Ed.2d 537 (1994). As her section 3-606 defense is founded exclusively on the claim that her subrogation rights were frustrated, supra, Gens was required to do more than prove that U.S. Funding or another holder failed to obtain and record a mortgage discharge. 13 32 Section 3-606 plainly requires evidence that the holder's dereliction actually resulted in a loss to the accommodation party. See Mass. Gen. Laws. Ann. ch. 106, § 3606 (The holder discharges any party to the instrument to the extent ... the holder ... unjustifiably impairs [the] collateral....). 14 Gens alleged no facts which would demonstrate any actual diminution of her subrogation rights. See FDIC v. Blanton, 918 F.2d 524, 530 (5th Cir.1990) (burden of proof is on party alleging discharge). 33 First, she did not allege that any creditor obtained a superior right of recourse against the Barnstable Property due to the fact that the preexisting second mortgage was never discharged of record. In addition, the auction sale of the Barnstable Property conducted pursuant to the first-mortgage foreclosure resulted in no surplus for application to any junior lien, including the second mortgage. Accordingly, the record can support no finding that any junior lien was impaired. Consequently, Gens' liability would not have been affected even if she had been able to establish that she signed the Gens Note as an accommodation maker. See, e.g., Rempa v. LaPorte Prod. Credit Ass'n, 444 N.E.2d 308, 313 (Ind.Ct.App.1983) (Thus, where the party asserting the impairment establishes that the creditor did not perfect its lien but fails to establish the extent to which that failure resulted in loss, the party has failed to establish its affirmative defense of pro tanto release.). 15 III