Bank of the Federated States of Micronesia v Pacific Foods and Services Inc [2001] FMSC 69; 10 FSM Intrm. 327 (Pon. 2001) (18 July 2001)

FEDERATED STATES OF MICRONESIA
SUPREME COURT TRIAL DIVISION
Cite as Bank of Federated States of Micronesia v Pacific Foods & Servs Inc,[2001] FMSC 69; 10 FSM Intrm 327 (Pon 2001)

BANK OF THE FEDERATED STATES OF MICRONESIA
Plaintiff,

And

FEDERATED STATES OF MICRONESIA DEVELOPMENT BANK
Plaintiff in Intervention,

vs.

PACIFIC FOODS & SERVICES, INC., a corporation, PERDUS EHSA, an individual, TIMAKIO EHSA, an individual, and ELLEN MAE T. EHSA, an individual
Defendants and Defendants in Intervention.

CIVIL ACTION NO. 2000-005

ORDER

Richard H. Benson
Associate Justice

Decided: July 18, 2001

APPEARANCES:

For the Plaintiff:
Stephen V. Finnen, Esq.
Law Offices of Saimon & Associates
P.O. Box 1450
Kolonia, Pohnpei FM 96941

For the Plaintiff in Intervention:
James Woodruff, Esq.
P.O. Box M
Kolonia, Pohnpei FM 96941

For the Defendants:
Joseph S. Phillip, Esq.
P.O. Box 464
Kolonia, Pohnpei FM 96941

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HEADNOTES

Civil Procedure - Dismissal; Civil Procedure - Summary Judgment and Judgment on the Pleadings
A motion to dismiss will be denied when the parties' later stipulation to entry of partial judgment made moot any contention that the defendants' subsequent payments entitled them to a dismissal of the bank's claim to foreclose and sell the vessels, and when the pleadings and the mortgage terms on their face entitle the bank to such a remedy if its factual allegations are taken as true, as they must be on a motion to dismiss or for judgment on the pleadings. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 331 (Pon. 2001).

Admiralty - Ships
The statutory scheme sets up a system for the registration of FSM vessels, the recordation of ownership interests in those vessels, the priority of liens and claims against those vessels, and the methods of enforcing those claims. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Admiralty - Ships; Admiralty - Ships - Mortgages
The Secretary of the Department of Transportation and Communications, appoints a Registrar, who keeps a Register of FSM vessels and the instruments that must be deposited with the Registrar. A transfer of any interest, including a mortgage, in a registered vessel is not valid with respect to that vessel against any person other than the grantor or mortgagor until the instrument evidencing such transaction is recorded in the Register. The Registrar is required to record the particulars in such instruments as soon as they are received, including the amount and date of maturity of any mortgage. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Admiralty - Ships; Admiralty - Ships - Mortgages
Once an FSM ship is registered, the Registrar must issue a Certificate of Registry for it, and once a mortgage has been properly recorded with the Registrar, the Registrar must endorse on the Certificate of Registry the mortgagor's and mortgagee's names, the mortgage's amount and date of maturity, and the time and date the mortgage was recorded. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Admiralty - Ships - Mortgages
An earlier recorded mortgage has priority over one recorded later according to the time and date on which each mortgage was recorded in the Register and not according to the date of each mortgage itself. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Admiralty - Ships - Mortgages
The question of mortgage priority is important because if a ship has to be sold either as forfeiture or to satisfy its or its owner's debts, the mortgagees will be paid from the proceeds according to their priority. A mortgagee with a higher priority will thus be paid in full before a subsequent mortgagee with a lower priority is paid one cent. The priority of the mortgages should be immediately apparent because they will all be recorded on the same Certificate of Registry. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Admiralty - Ships - Mortgages
No principle of law prohibits a lender from securing with a mortgage a sum less than the full amount of what it has lent. It merely does so at its own risk. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 332 (Pon. 2001).

Civil Procedure - Pleadings; Torts - Fraud
Any proposed amended complaint seeking to add a civil fraud charge against a defendant must state the circumstances constituting fraud with particularity. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 333 (Pon. 2001).

Admiralty - Ships - Mortgages
To permit a registered ship mortgage to hold priority for an additional $100,000 over its registered amount would destroy the statutory scheme created by Congress and one of the goals of the ship registry system - that all ownership interests be recorded on the ship's Certificate of Registry, and would also hinder another purpose and goal - enhancing the ability of ship owners to obtain needed financing. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 333-34 (Pon. 2001).

Statutes - Construction
FSM Code provisions must be construed with a view to effect their object. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 334 (Pon. 2001).

Admiralty - Ships - Mortgages
A mortgagee cannot assert that its registered mortgage has priority over a subsequent mortgagee for a principal amount greater than the principal amount registered. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 334 (Pon. 2001).

Admiralty - Ships - Mortgages
When there is more than one registered mortgagee of the same vessel, a subsequent mortgagee cannot apply to sell the vessel without the concurrence of every prior mortgagee, except under an order of the Supreme Court. Bank of the FSM v. Pacific Foods & Servs., Inc., [2001] FMSC 69; 10 FSM Intrm. 327, 334 (Pon. 2001).

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COURT'S OPINION

RICHARD H. BENSON, Associate Justice:

This comes before the court on the Bank of the FSM's Motion for Summary Judgment and its Motion to Force Sale of Vessel Lady Mae, both filed May 28, 2001, and on the defendants' Motion to Dismiss, filed December 6, 2000. The Bank of the FSM opposed the defendants' motion to dismiss on December 12, 2000. The FSM Development Bank opposed the summary judgment motion and filed its own Counter Motion for Summary Judgment on June 8, 2001, which the Bank of the FSM opposed on June 18, 2001. The FSM Development Bank filed its reply on June 27, 2001. At a status conference on June 5, 2001, the Bank of the FSM announced that it elected not to proceed on its Motion to Force Sale of Vessel Lady Mae until the summary judgment motions had been decided.

I. Background

The business relationship between defendant Pacific Foods & Services, Inc. ("Pacific Foods") and the Bank of the FSM began with the bank's extension of a line of credit agreement on September 30, 1997. At various times in 1998 and 1999, Pacific Foods executed a number of short-term (including renewals) promissory notes or commercial notes for varying amounts at various interest rates, usually 11.5%, and with various due dates. The most recent were dated on July 30, 1999.

During November, 1999, Pacific Foods negotiated with the FSM Development Bank for financing. The original sum agreed upon was $337,184.38. It was later changed to $437,184.38, and on November 29, 1999, Pacific Foods executed a loan agreement for that amount (with Perdus Ehsa, Timakio Ehsa, and Ellen Mae T. Ehsa signing for Pacific Foods). A ship mortgage for $337,184.38 was apparently executed on the vessel Lady Mae at about that time (although it is not among the numerous documents in the file). This $337,184.38 mortgage was registered with the FSM Department of Transportation and Communications ("the Department") on December 6, 1999 (at 1425 hours), at which time the Department endorsed the Lady Mae's Certificate of Registry (Registration number VR0047) showing that Pacific Foods had mortgaged the Lady Mae for $337,184.38 with a maturity date of November 10, 2009.

On December 9, 1999, Pacific Foods & Services, Inc., acting through its President, Perdus Ehsa, executed three preferred ship mortgages with the Bank of the FSM on the vessel Lady Mae and the vessel Lady Pearl III for the amounts of $172,000 ("effective the 16th day of July, 1998"); $19,000 ("effective the 30th day of July, 1999"); $99,629.05 ("effective the 30th day of July, 1999"). Each mortgage contained a provision in which, among other things, the mortgagor (Pacific Foods) warranted that it owned the vessel and that the vessel was "free and clear of all liens and encumbrances arising under or through the Mortgagor other than ___________" with the space for the mention of any previous liens and encumbrances left blank. The Bank of the FSM filed these ship mortgages with the Department the next day, December 10, 1999 (at 1100 hours). The Department, rather than endorsing these mortgages on a Certificate of Registry containing the endorsement of the Development Bank's previously-filed mortgage, as it is required to do by law, 19 F.S.M.C. 318(2), endorsed these three mortgages - $172,000 (maturity date August 14, 2001); $19,000 (maturity date October 28, 1999 [sic]); and $99,629.05 (maturity date October 28, 1999 [sic]) - on a separate Certificate of Registry (same Registration number VR0047).

Sometime in early 2000, the FSM Development Bank, reviewing its files, noticed that the ship mortgage it held on the Lady Mae was for $100,000 less than the loan it secured. It then submitted, on February 3, 2000 (at 1414 hours), to the Department a "correction ship mortgage" for $437,184.38, also dated November 29, 1999, which it sought to be effective as of December 6, 1999 when it filed its original ship mortgage. The Department refused to issue a new Certificate of Registry showing a $437,184.38 mortgage filed by the FSM Development Bank on December 6, 1999, but did file the mortgage in its records and stamped it "Received" and endorsed it "Entered in the Register" with the February 3rd date and time.

On February 14, 2000, the Bank of the FSM, its loans being in default and having somehow learned that the Development Bank claimed an interest in the Lady Mae, filed suit against Pacific Foods & Services, Inc., Perdus Ehsa, Timakio Ehsa, and Ellen Mae T. Ehsa, and served a copy of the complaint on the FSM Development Bank. The Bank of the FSM sought judgment for the amounts due on its loans and the seizure and forced sale of the Lady Mae and the Lady Pearl III to satisfy those debts. The Development Bank moved for leave to intervene. Leave was granted on March 31, 2000, and the Development Bank filed its Complaint in Intervention on April 13, 2000.

On November 27, 2000, the Development Bank filed a summary judgment motion seeking an adjudication that its ship mortgage for the Lady Mae had priority over the Bank of the FSM's because of its earlier filing date. At the end of the hearing on December 12, 2000, that motion was denied because there was then a material fact at issue - whether the Development Bank's $337,184.38 loan and mortgage had been paid off and whether a new loan and mortgage had been executed for $437,184.38 thus making the mortgages the Bank of the FSM recorded on December 10, 1999, the first filed undischarged mortgages.

On February 2, 2001, all parties filed their stipulation to, and on February 22, 2001, the court approved and entered a partial judgment in favor of the Bank of the FSM jointly and severally against defendants Pacific Foods & Services, Inc., a corporation, Perdus Ehsa, an individual, Timakio Ehsa, an individual, and Ellen Mae T. Ehsa, an individual. (Certain typographical or clerical errors in the partial judgment were corrected and the partial judgment made final because there was no just cause for delay, FSM Civ. R. 54(b), by order entered nunc pro tunc July 12, 2001.)

II. Defendants' Motion to Dismiss

The defendants (who are also defendants in intervention) filed a motion to dismiss on December 6, 2000. They sought to dismiss the Bank of the FSM's and the FSM Development Bank's right to foreclose on their ship mortgages and seize and sell the Lady Mae. The basis for the motion is that the defendants had been making, and the banks accepting, some payments since the suit was filed.

The FSM Development Bank's complaint, however, does not ask for foreclosure; it only asks that if there is a foreclosure and sale of the Lady Mae that the FSM Development Bank's mortgage be granted priority and that the proceeds, after being applied to expenses of sale, be first applied to its mortgage. The Bank of the FSM opposed on the grounds that the payments that were made fell far short of what would have been due if the regularly scheduled payments had been made so that the loans would still have been in default and that because the loans are in default the pleadings clearly establish that the Bank of the FSM has stated a claim for which the relief of mortgage foreclosure and sale may be granted.

The parties' February 2nd stipulation to entry of partial judgment makes moot any contention that the defendants' subsequent payments entitled them to a dismissal of the Bank of the FSM's claim to foreclose and to sell the Lady Mae and the Lady Pearl III. Furthermore, the pleadings and the mortgage terms on their face entitle the Bank of the FSM to such a remedy if its factual allegations are taken as true, as they must be on a motion to dismiss or for judgment on the pleadings. Accordingly, the defendants' motion to dismiss is denied.

III. Mortgage Priorities

A. The Banks' Positions

Each bank thus has at least one ship mortgage on the vessel Lady Mae, and each bank claims it has priority over the other bank as a matter of law. The FSM Development Bank claims its mortgage has priority, pursuant to 19 F.S.M.C. 326(7), because it was filed first. The Bank of the FSM concedes that the Development Bank's mortgage was filed first but asserts that it is invalid because it was filed for the wrong amount and with the wrong maturity date, and because it appears that the loan was rewritten because the Development Bank records as of May 21, 2001 show $451,360.99 as the principal balance on the mortgage and, with further interest, $469,153.10 due.

The FSM Development Bank notes that the five-month difference in the maturity date between the mortgage as written and as recorded is because, since the actual mortgage was for $100,000 more than the recorded mortgage, it would take an extra five months to pay off. The Development Bank contends that under the "renewal mortgage rule," not only does its mortgage have priority for the $337,184.38, as recorded, but also for the additional $100,000 in the actual final mortgage (which it tried to register as a "correction ship mortgage"). The Development Bank also rejects the Bank of the FSM's argument that the mortgage was rewritten because the current principal amount owed on it is now larger than $437,184.38. It states that the $475,858.34 due on the mortgage as of June 5, 2001 is not evidence that the mortgage has been rewritten because, since no payments have yet been made on the mortgage, and since it is within the mortgage's grace period, under the mortgage's terms the unpaid interest was added to the principal.

B. Analysis

The statutory scheme sets up a system for the registration of FSM vessels, the recordation of ownership interests in those vessels, the priority of liens and claims against those vessels, and the methods of enforcing those claims. 19 F.S.M.C. 301 et seq. The statute provides for a Registrar, appointed by the Secretary of the Department of Transportation and Communications, who will keep a Register of FSM vessels and the instruments that must be deposited with the Registrar. 19 F.S.M.C. 309(1). A transfer of any interest, including a mortgage, in a registered vessel is not valid with respect to that vessel against any person other than the grantor or mortgagor "until the instrument evidencing such transaction is recorded in the Register." Id. § 310(1). The Registrar is required to record the particulars in such instruments "as soon as they are received," id. § 310(2), including "the t annt and date of maturity of any mortgage," id. § 310(3)(e). Once a ship is registered, the Registrar must issue a Certificate of Registry for it. Id. § 318(1). Once tgage has been been properlorded with the Registrar, the Registrar must endorse on the Certificate of Registry the more mortgagor's and mortgagee's names, the mge's amount and date of maturity, and the time and date thee the mortgage was recorded. Id. § 324. By statute, an ea reco recorded mortgage has priority over one recorded later.

Where there is more than one mortgage recorded in the ter in respect of the same vessel, the mortgages shall, notwithstanding any expressed, impl implied, or constructive notice, be entitled in priority one over the other according to the time and date on which each mortgage was recorded in the Register and not according to the date of each mortgage itself.

Id. § 326(7). The quesof priorityority is important because if a ship has to be sold either as forfeiture or to satisfy its or its owner's debts, the mortgagees will be paid from theeeds according to their priority. Id. §§C 3, 330(2). A mortgagee with with a higher priority will thus be paid in full before a subsequent mortgagee with a lower priority is paid one cent. Thus the lower the mortgage priority the more y it becomes that the mortgmortgage will not be paid in full or perhaps not at all.

As stated above, the priority of the mortgages should be immediately apparent because they will all be recorded on the same Certificate of Registry. If the Department had not performed so poorly in issuing a separate Certificate of Registry listing just the Bank of the FSM's mortgages, that bank would have realized when it went to register its mortgages that they did not have first priority because the Development Bank had registered its mortgage first, and perhaps then taken some other course of action to protect its interests. Protection of creditors (or of someone contemplating the purchase of the ship) is a purpose of the ship registration system.

The Bank of the FSM acknowledges that the Development Bank's mortgage was first filed but contends that defects, specifically that Pacific Foods actual indebtedness to the Development Bank was for $100.000 more than the recorded mortgage, in its filing make it invalid. There is no principle of law that prohibits a lender from securing with a mortgage a sum less than the full amount of what it has lent. It merely does so at its own risk. The Development Bank's $337,184.38 mortgage was properly registered, and it was registered first. The FSM Development Bank's $337,184.38 mortgage is therefore entitled to the first priority as a matter of law. 19 F.S.M.C. 326(7).

The Bank of the FSM also asserts that the equities of the situation favor it because of what it terms the debtors' fraud in executing mortgages on the vessel Lady Mae while claiming that there were no other liens or encumbrances on the vessel. If the Bank of the FSM wishes to pursue a civil fraud charge against any defendant, it may, if it is so advised, move to amend its complaint. Any proposed amended complaint must comply with Civil Procedure Rule 9(b) and state the circumstances constituting fraud with particularity. See Medabalmi v. Island Imports Co., [2001] FMSC 53; 10 FSM Intrm. 32, 35 (Chk. 2001).

The Development Bank cites cases where minor discrepancies concerning the amount and the maturity date between a mortgage as executed and as recorded did not cause that mortgage to lose its priority. The Development Bank also contends that the "renewal mortgage rule" allows a mortgagee with a first preferred mortgage to rewrite or renew its first mortgage and still retain its priority over subsequent mortgagees because those mortgagees were on notice of the prior mortgage and therefore knew it might be renewed, and the debt and the security were the same. Under this "rule," renewing a mortgage would not extinguish its priority and subordinate it to subsequent mortgages. The Development Bank contends that the court should apply this "rule" and hold that the Development Bank has first priority not only for the $337,184.38 it registered on December 6, 1999, but also for the full $437,184.38, which it tried to register on February 3, 2000 as a "correction ship mortgage." This cannot be so. With one exception, all of the United States cases that the Development Bank cites for the validity of the "renewal mortgage rule" involved mortgages that were renewed or rewritten for principal amounts either equal or less than the original mortgage amount. In the exception, Prudential Insurance Co. of America v. S.S. American Lancer, 686 F. Supp. 469 (S.D.N.Y. 1988), aff'd[1989] USCA2 272; , 870 F.2d 867 (2d Cir. 1989), a typographical error caused the first preferred ship mortgage to be recorded for $92,885 instead of $92,885,000. However, in S.S. American Lancer, the second mortgage holder at all times, including before and during its loan negotiations, knew of the true amount of the first mortgage and in its own second mortgage specifically subordinated its mortgage to the Prudential Insurance Co.'s first mortgage. Both mortgages were part of a joint refinancing arrangement in which both lenders participated together. It was not until after the shipowner had been in bankruptcy for over a year that the typographical error was noticed. The court refused to let the second mortgagee to receive a $92 million windfall for what the second mortgagee knew was a clerical error and when it knew all along that the first mortgage was for $92,885,000, and had extended its credit based on that knowledge and in the terms of its own mortgage subordinated its mortgage to the $92,885,000 first mortgage. That is not this case. Not only was the Bank of the FSM unaware of the Development Bank's prior mortgage, or its amount, before it executed its mortgages, but also, because of the Department's failure to properly endorse and issue the Lady Mae's Certificate of Registry, was not aware of it until sometime later. (The Bank of the FSM could have been more diligent in searching the records and the Lady Mae's file at the Department to determine on December 9, 1999, before it executed the mortgages, whether any prior mortgages were filed there, but considering the Department's failure to properly handle issuance of the Certificate of Registry even that might not have been fruitful and revealed the other mortgage's existence. The Department, however, quite properly refused to register the $437,184.38 "correction ship mortgage" with a December 6, 1999 date.)

In this case, the Development Bank asks that it be given priority for an additional $100,000. To do so would destroy the statutory scheme created by Congress. It would mean that anyone contemplating issuing a second mortgage on a vessel could never be sure of the extent of the registered first mortgage's priority - whether it was actually greater than the recorded amount (and how much greater) and whether it was so large as to make any second mortgage worthless from the start. For example, if a vessel worth about $400,000 had a recorded first mortgage for $150,000, the vessel owner might easily obtain more financing, but, if the court followed the interpretation the Development Bank urges it to, a second lender, contemplating lending $100,000 on the vessel's security could never be sure that the first priority was only for $150,000 and not for some higher sum, such as $350,000 that would make its loan insecure. Such a result would destroy one of the goals of the ship registry system - that all ownership interests be recorded on the ship's Certificate of Registry. It would also hinder another purpose and goal - enhancing the ability of ship owners to obtain needed financing. Code provisions must be construed with a view to effect their object. 1 F.S.M.C. 211. Thus, without deciding if the FSM statutory scheme for ship registration would ever allow the application of the "renewal mortgage rule," the statute prohibits its application in the manner the Development Bank wants it to be applied in this case. A mortgagee cannot assert that its registered mortgage has priority over a subsequent mortgagee for a principal amount greater than the principal amount registered.

The Development Bank therefore has first priority only for its $337,184.38 mortgage registered December 6, 1999. The Bank of the FSM has second priority for its three mortgages registered December 10, 1999. The Development Bank may, if it so chooses, register Pacific Foods's additional $100,000 indebtedness to it, but such registration shall not cause that indebtedness to take priority over the Bank of the FSM mortgages registered December 10, 1999.

C. Foreclosure and Forced Sale of the Lady Mae

The Bank of the FSM also has pending a motion to foreclose on the vessel Lady Mae. Its registered mortgages do not hold first priority. It is a subsequent mortgagee. "Where more than one person is registered as mortgagee of the same vessel, a subsequent mortgagee shall not make an application to sell the vessel without the concurrence of every prior mortgagee, except under an order of the Supreme Court." 19 F.S.M.C. 327(8). The prior mortgagee, the Development Bank, does not concur. The Bank of the FSM's Motion to Force Sale of Vessel Lady Mae is accordingly denied. By this order, however, the Bank of the FSM is permitted to renew its motion to sell the vessel, if it is so advised.

IV. Conclusion

The defendants' motion to dismiss the Bank of the FSM's right to foreclose on its ship mortgages is denied. There being no just cause for delay, let judgment be entered that the FSM Development Bank's $337,184.38 mortgage on the vessel Lady Mae, registered December 6, 1999, has first priority and that the Bank of the FSM's three mortgages on the vessel Lady Mae, for $172,000, $19,000, and $99,629.05, all registered December 10, 1999, hold second priority. By law, 19 F.S.M.C. 318(2), the Registrar must issue a Certificate of Registry listing all of these mortgages in their proper priority.