The U.S. Court of Appeals for the First Circuit recently held that a failure to file a probate claim does not extinguish a mortgage lien under Rhode Island law.  In so ruling, the Court held that "the piper must be paid."

A copy of the opinion is available at:  Link to Opinion

The plaintiffs, a brother and sister, inherited their mother's house.  During her lifetime, the mother had taken out a reverse mortgage secured by the house.  The mortgage securing the loan contained an acceleration clause and power of sale and became due and payable upon the mother's death.

The mother died intestate. Her son and daughter commenced a probate proceeding in Rhode Island state court. Notice was given to creditors, including the mortgagee, but the mortgagee did not file a claim in the probate proceeding. The probate case was administered and closed, with the court granting the decedent's interest in the property to the plaintiffs.

In late 2010, the plaintiffs received a notice of foreclosure, which was published pursuant to Rhode Island law. A foreclosure proceeding followed and the mortgagee recorded the foreclosure deed granting the Property to it in November of 2011.

The plaintiffs filed suit in federal district court, invoking diversity jurisdiction, challenging the validity of the mortgage assignments and the foreclosure. After the close of discovery, the mortgagee moved for summary judgment, which the trial court granted.  This appeal followed.

On appeal, the heirs argued that a) "the district court erred in determining that he lacked standing to contest the mortgage assignments;  and b) the mortgagee's "failure to file a claim in the probate proceedings pretermitted its right to foreclose on the Property."

The Court began by noting that in a diversity case, the it looks to federal law on procedural issues, and to state law for "rules of decision" on substantive issues.

The First Circuit then discussed the "idiosyncratic nature of reverse mortgages" explaining that "[a] reverse mortgage is a loan or line of credit available to a person over the age of 62 who has equity in real estate, typically the person's home. The loan provides the borrower with cash (usually in the form of a single lump-sum payment) and is secured by the borrower's equity in the real estate. There are no monthly payments; instead, the loan is due and payable in full when the borrower dies, sells the home, or no longer uses the home as her principal residence."

The typical reverse mortgage also is unique in that the loan is "non-recourse," meaning the borrower is not personally liable and the lender looks only to the mortgaged property for repayment.

Turning to appellant's standing argument, the Court explained that "[s]tanding is a threshold question in every case" and that "[a] plaintiff suing in federal court normally must shoulder the burden of establishing standing."

The First Circuit further explained that "Rhode Island is a title-theory state, in which 'a mortgagee not only obtains a lien upon the real estate by virtue of the grant of the mortgage deed but also obtains legal title to the property subject to defeasance upon payment of the debt.'"

In addition, the Court's own precedent established that "a mortgagor has standing to challenge the assignment of a mortgage on her home to the extent that such a challenge is necessary to contest a foreclosing entity's status qua mortgagee. … This means that a mortgagor (or a party standing in the mortgagor's shoes) only has standing to challenge an invalid, ineffective, or otherwise void mortgage." However, the Court noted, "a mortgagor does not have standing to challenge shortcomings in a mortgage assignment that renders it merely voidable at the election of one party but otherwise effective to pass legal title."

Referencing that the Rhode Island Supreme Court "has embraced this void/voidable distinction with respect to real estate mortgages", the First Circuit turned to the question of "whether the challenged mortgage assignment are void or voidable."

The First Circuit reasoned that under Rhode Island law, "a valid mortgage or any of its assignments must be signed, acknowledged by notarization, delivered, and recorded. … It is not necessary that the mortgage and the note that is secures be held by the same entity."

In the case at bar, there were two assignments, both of which complied with the aforementioned formalities. The parties treated them as valid.  Accordingly, the Court rejected the heirs' argument that the assignors lacked the required authority to execute the assignment because "the summary judgment record contains no evidence sufficient to create a genuine issue of material fact in this regard. Unsupported allegations are not enough."

Accordingly, the First Circuit ruled that "[o]n this record, the assignments are not void but, at worst, merely voidable. It follows that the district court did not err in concluding that the appellant lacked standing to challenge them."

Turning to the heirs' argument that the mortgagee lost its right to foreclose by not filing a claim in the probate proceeding, the Court first found that the heirs had standing to challenge the validity of the mortgage itself because under Rhode Island law, "the appellant, who has a personal stake in the outcome, has the right to ensure that the foreclosure conforms with the law."

"Because the Rhode Island Supreme Court has not addressed whether probate extinguishes a real estate mortgage," the First Circuit characterized its job as figuring out "how that court would likely rule if faced with the issue."

The Court began its analysis "by tracing how the common law historically has characterized foreclosure." Foreclosure is an equitable remedy in which "[t]he land is the real defendant." Although technically a quasi in rem proceeding, a foreclosure "is in the nature of such a proceeding and is not intended ordinarily to act in personam." However, "[a]bsent a statute to the contrary, a mortgagee can both sue the parties to the mortgage at common laws and pursue foreclosure. … If a deficiency results from a foreclosure sale, an action on the mortgage note normally will lie to recover that deficiency."

The First Circuit found "much the same dichotomy between the encumbered property and the underlying debt in the venerable structures of maritime law" which has "long recognized the feasibility of separating the mortgage res from the associated debt."

It also found a "compelling analogy … in the realm of bankruptcy law" where "a creditor may recover the deficiency on a mortgage loan through 'an action against the debtor in rem,' notwithstanding the debtor's discharge in bankruptcy."

The First Circuit pointed out that the Rhode Island Supreme Court frequently consulted "the Restatements to bring clarity to state law," finding it noteworthy that "this splitting of in rem and in person liability is consonant with the [Restatement (Third) of Property's] declaration that 'a mortgage is enforceable whether or not any person is personally liable for that performance."

The First Circuit also found "[t]his dichotomy is also consistent with section 3-814 of the Uniform Probate Code, which authorizes payment of a mortgage even if a claim has not been filed in the decedent's estate. And finally, no less an authority than the United States Supreme Court has noted that the lender's 'right to foreclose on the mortgage can be viewed as a 'right to an equitable remedy' for the debtor's default on the underlying obligation."

A survey of "the case law elsewhere" confirmed the Court's "intuition that the Rhode Island Supreme Court, if faced with the question, would hold that the right to foreclose should be treated as separate and distinct from the right to collect the underlying debt. The upshot is that though the failure to file a claim in probate proceedings may extinguish personal liability on the note secured by the real estate mortgage, that failure does not extinguish the mortgage itself. Consequently, such a failure does not interfere with the mortgagee's right to foreclose."

The First Circuit rejected the heirs' final argument that "the failure to submit a claim to the probate court within the statutorily prescribed period … bars [the mortgagee] from later foreclosing against the Property to satisfy the underlying debt" because "the statute of limitations applicable to foreclosures in Rhode Island is the general 20-year statute of limitations" and the "limitations period associated with the probate claim-filing statute … does not apply."

The Court affirmed the district court's summary judgment, holding that "the appellant lacks standing to challenge the interstitial mortgage assignments; and though he does have standing to challenge the effectiveness of the mortgage itself on a different ground, that challenge is fruitless."  Accordingly, despite its failure to file a probate claim, the mortgagee "retained the right to enforce its reverse mortgage through foreclosure."