Opinion ID: 1301364
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Heading: The Fraudulent Mortgages Insuring Agreement

Text: While the bond broadly excludes loan-related losses, the FMIA provides coverage for  Loss resulting directly from the Insured's having, in good faith . . . accepted or received or acted upon the faith of any real property mortgages . . . or like instruments . . . which prove to have been defective by reason of the signature thereon of any person having been obtained through trick, artifice, fraud or false pretenses. . . . In this case, OSB contends that the borrowers were fraudulently induced to sign the notes and mortgages by representations that the loan proceeds would be used to satisfy their existing mortgage loans. The broad exclusion clearly applies to losses resulting from fraudulently induced notes, but OSB argues that its losses are nonetheless covered by the FMIA because the borrowers' signatures on the mortgages were obtained through trick, artifice, fraud, or false pretenses, as those words are broadly construed in the law of fraud. Like the district court, we disagree. The critical flaw in OSB's contention is its lack of focus on the word defective. Under the FMIA, a loss is covered only if the bank relied on a mortgage that proves to be defective by reason of the signature thereon . . . having been obtained through trick, artifice, fraud, or false pretenses. Commercial law has long distinguished between common law fraud in the inducement, and fraud as to the nature and terms of the contract [being] signed. M & M Sees. Co, v. Dirnberger, 190 Minn. 57, 250 N.W. 801, 802 (Minn.1933). The former is a defense against any party with knowledge of the fraud, but only the latter type of fraud, often referred to as fraud in the factum, [4] is a defense against a holder in due course of a negotiable instrument. Id. at 803. This distinction is now codified in the Uniform Commercial Code, which provides that a holder in due course is subject only to real defenses that include (iii) fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or its essential terms. Minn.Stat. Ann. §§ 336.3-305(a)(l), (b) (emphasis added). [5] Recognizing that the FMIA is a narrow exception to the bond's exclusion of loan losses, we conclude that a mortgage defective by reason of the signature thereon is one that fails to provide the promised security interest in real property because the mortgagor was tricked or defrauded as to the nature of the document being signed. A hidden defect of this kind, one that bars recovery by a holder in due course under commercial law and strips a mortgage of its essential nature, is the rare type of fraud one would expect an exception to the broad exclusion to encompass. The few prior cases interpreting the FMIA are consistent with this conclusion. In deciding a different issue in Jefferson Bank v. Progressive Casualty Insurance Co., 965 F.2d 1274, 1280 (3d Cir.1992), Judge Becker explained: The Rider thus would cover bank losses resulting when the seller of real property fraudulently induces the mortgagor to . . . sign a mortgage by promising that the mortgage will never be enforced, by misrepresenting to the mortgagor that the mortgage covers a different piece of property, or by telling the mortgagor that the document being signed was a contract to purchase rather than a mortgage. In deciding an issue much like the one before us, a New Jersey state court quoted the above portion of Judge Becker's opinion in holding that the FMIA did not provide coverage. There is a distinction, the court explained, between a fraudulent scheme and a fraudulently induced signature. A mortgage may have been induced by fraudulent acts, but the signature may be valid. . . . There is no evidence [in this case] that any mortgagor . . . did not realize he was signing a mortgage. North Jersey Sav. & Loan Ass'n v. Fid. & Deposit Co. of Md., 283 N.J.Super. 56, 660 A.2d 1287, 1300 (N.J.Super. Ct. Law Div.1993). Likewise, in this case the borrowers admitted knowing they were signing mortgages that would encumber their property. Thus, the mortgages were not defective. Indeed, OSB failed to prove that the borrowers' mortgages were unenforceable due to Niblock's fraud in the inducement, only that the borrowers refused to pay their mortgage notes. In these circumstances, the district court correctly concluded that OSB's loan losses were not covered by the FMIA.