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From Banking and Finance Law Daily, August 3, 2015

Bank, holding promissory note ‘in due course,’ immune from borrower’s incapacity defense

By Thomas G. Wolfe, J.D.

The Supreme Court of Alaska has ruled that because a bank was a valid holder of a purchased promissory note “in due course” concerning a borrower’s secured loan, the bank was immune from the borrower’s defense of his claimed “incapacity” during formation of the loan. In reaching its decision, the Alaska high court also determined “squarely” for the first time that, under Alaska law, a party’s incapacity during formation of a contract may result in a voidable—not void—obligation (Erkins v. Alaska Trustee, LLC, July 31, 2015, Stowers, C.).

Background. In October 2004, Gregory Erkins obtained from a finance company an $80,000 loan, which was secured by a deed of trust on real property that he owned. In early 2005, Erkins obtained a second loan, again secured by a deed of trust on the same property, from the company in the amount of $142,477, and he used part of the proceeds to pay off the first loan.

According to the court’s opinion, prior to obtaining the two loans, Erkins had been injured in an automobile accident and “began taking strong pain medication.” In addition, the borrower “continued working sporadically while he was taking the medication.”

In February 2005, JPMorgan Chase Bank, N.A., purchased the remaining second loan. At about the same time, the finance company assigned the deed of trust to the Bank of New York Trust Company, N.A. (Bank of NY), as the successor to JPMorgan. However, the assignment of the deed of trust to Bank of NY was not duly recorded until nearly three years later in November 2007.

Eventually, after the outstanding loan fell into delinquency, Bank of NY initiated foreclosure proceedings against the borrower. The borrower contended that he was incapacitated by his condition and the strong pain medication he was taking at the time he entered into the underlying loan contract.

Forbearance agreement. In response to the foreclosure proceedings, the borrower filed an action—alleging fraud and misrepresentation—against Bank of NY and other parties in Alaska state court in July 2008. A few months later, Bank of NY offered the borrower a “proposed forbearance agreement,” which the borrower signed, indicating that Bank of NY would halt the pending foreclosure provided that the borrower met certain conditions.

Procedural context. Bank of NY, in its first request for summary judgment against the borrower, had argued that the borrower had waived his claims against the bank through a clause in the forbearance agreement.

After an appeal of that issue ran its course, on remand, Bank of NY instead argued—in its second request for summary judgment—that since the bank was a “holder in due course” under Article 3 (Negotiable Instruments) of the Alaska Uniform Commercial Code (UCC), it was immune from any incapacity defense that the borrower might have. The state trial court agreed, granting summary judgment to Bank of NY, and the borrower appealed that decision to the Supreme Court of Alaska.

Alaska law. Under the Alaska UCC (§45.03.302), a “holder in due course” is one “who takes an instrument in good faith, for value, without notice that the instrument is overdue, and without notice that any party has a defense to the payment of the instrument.”

Further, under Alaska law, a holder in due course is “insulated from an incapacity defense only if the incapacity makes the contract voidable.” In contrast, if incapacity is a condition that automatically voids the contract, then the holder in due course is not insulated from an incapacity defense.

Court’s decision. Notably, the Alaska Supreme Court commented, “We have never squarely considered whether incapacity renders a contract void or merely voidable, and no provision of the Alaska Statutes is on point.” Ultimately, the court held that “a party’s incapacity during formation of a contract may result in a voidable—not void—obligation.” In the court’s view, “a rule that obligations arising during one party’s incapacity may be voidable by the incapacitated party will best account for the varying levels of incapacity that courts encounter.”

In reviewing the factual record before it, the court determined that the Bank of NY took the promissory note before the note had gone into default. The court rejected the borrower’s argument that the November 2007 recordation of the assignment of the deed of trust to Bank of NY should be operative; the court asserted that “the date of the deed of trust’s recordation has no bearing on the date that the note was assigned.”

Consequently, in concluding that the Bank of NY was a valid “holder in due course” under Alaska law and was immune to the incapacity defense invoked by the borrower, the state trial court had not erred in granting summary judgment to the bank.

The case is No. S-15297.

Attorneys: Nelson G. Page (Burr, Pease & Kurtz) for Alaska Trustee, LLC, Bank of New York Trust Company, N.A., and JPMorgan Chase Bank, N.A.

Companies: Alaska Trustee, LLC; Bank of New York Trust Company, N.A.; JPMorgan Chase Bank, N.A.

MainStory: TopStory AlaskaNews Loans Mortgages StateBankingLaws

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