1 Reported in 147 P.2d 912. This action was instituted by L.M. and Lizzie Jones, who sought recovery upon a promissory note for four hundred dollars, signed July 5, 1935, by the defendant Neil Currie, plaintiffs also asking for the foreclosure of a mortgage, executed by Mr. Currie to secure the note, covering a tract of real estate in King county. L.W. Curtiss and wife were named as parties defendant, they being at that time the owners of the real estate covered by the mortgage. The action was tried to the court, and resulted in a judgment dismissing the action with prejudice, from which plaintiffs have appealed.
We shall refer to the various parties in the following manner: L.M. Jones and wife, the owners and holders of the note sued upon and the second mortgage securing it, as appellants; and L.W. Curtiss and wife, successors in interest of Neil Currie to the real estate covered by the second mortgage, as respondents.
The following situation is disclosed by the record in the case at bar: For some time prior to July 1, 1935, Neil Currie, *Page 472 a single man, was the owner of a rectangular tract of land 330 feet by 110 feet in size, located in the southeast quarter of the northwest quarter of section 27, township 24, north range 4 east, King county, Washington, the property being subject to a mortgage in the principal sum of eight hundred dollars and some accrued interest, in favor of appellants.
Mr. Currie procured a Home Owners' Loan Corporation loan upon this property, upon what showing we do not know. The appellants, June 26, 1935, in connection with Mr. Currie's loan referred to above, signed and placed with a title insurance company escrow instructions, and together therewith the mortgage above referred to and the note securing the same, a satisfaction of this mortgage, and certain other documents with which we are not concerned. By these documents, appellants authorized the escrow holder to deliver the file to the HOLC upon receipt for appellants' account of HOLC bonds and a small amount of cash, aggregating $565.86. On or about August 12th following, appellants signed and delivered a receipt in the following form:
"RECEIVED of Home Owners' Loan Corporation the following:
Authorization No. 1635002 for delivery of Home
Owners' Loan Corporation Bonds, par value ........... $ 550.00
Accrued interest from August, 1935, to August
12, 1935, date of closing above loan ................ .45
Check No. 119903 .................................... 15.41
________
Amount accepted in full settlement of the claim
of the undersigned against the home property of above
named applicant ..................................... $565.86"
(Italics ours.)
August 14th, the satisfaction of mortgage which appellants had placed in escrow was filed for record, and October 7, 1935, there was filed for record a mortgage dated July 5, 1935, from Neil Currie to appellants, covering the property referred to above, which secured a note for four hundred dollars, payable to the order of appellant L.M. *Page 473
Jones in monthly instalments of not less than five dollars each, and bearing interest at the rate of five per cent per annum. The note contained an acceleration clause. November 9, 1938, Currie, for an express consideration of twenty-five dollars, quitclaimed the property to respondents. Apparently up to some time in June, 1935, Currie had made no payments on the principal of the note, and it was about that time application was made by Currie to the HOLC for a loan to be secured by a first mortgage on the property.
January 13, 1942, appellants filed their complaint, asking for foreclosure of the four-hundred-dollar mortgage. Neither Currie nor any person representing him appeared in the action. Respondents filed their answer, denying that Currie had executed the note and mortgage sued upon, further alleging that the same, if executed, was without consideration, and asking that the action be dismissed.
The trial court held that appellants' eight-hundred-dollar note referred to above was, under the facts and the law, paid by the delivery to appellants of HOLC bonds in the sum of five hundred fifty dollars, together with cash in the sum of $15.86; that the note sued upon in this action, representing the unpaid balance due from Currie to appellants upon the eight-hundred-dollar note, was without consideration; and that this action, based upon that note, should be dismissed.
The evidence is brief, only three witnesses having testified — appellant L.M. Jones, respondent L.W. Curtiss, and a representative of the title insurance company. No agent or representative of the HOLC testified, and no witness testified concerning the proceedings leading up to the HOLC loan. A considerable portion of the statement of facts is taken up by testimony and discussion between the court and counsel, concerning matters not relevant to this appeal. The representative of the title trust company testified only to facts concerning the carrying out of the escrow, in so far as appellants were concerned. The witness was not interrogated concerning any preliminary negotiations *Page 474 between Currie and the HOLC, and the amount at which that corporation appraised the property, as preliminary to making the loan to Currie, nowhere appears in the record.
The HOLC was established by act of Congress passed June 13, 1933, chapter 64, § 1, 48 Stat. 128, found in 12 U.S.C.A., § 1461et seq. In § 1463 of the last-given citation, the creation of the HOLC was authorized, the section providing that it should be an instrumentality of the United States and should be under the direction of, and operated by, the Federal Home Loan Bank Board "under such bylaws, rules and regulations as it may prescribe for the accomplishment of the purposes and intent of this section." The corporation was created, and rules and regulations were adopted. Thereafter for several years the board continued to make loans as authorized by the statute, including the loan here in question.
Reference to the rules of the HOLC discloses the following:
"The corporation may take up second mortgages or other inferior liens, provided the same is done along with the first mortgage and the total is within the Act. The corporation has no means of preventing the home owner from undertaking to pay any indebtedness he may owe over and above that refunded by the corporation and has no means of preventing his giving a second mortgage or other security for any such indebtedness. However, state managers are directed, as a matter of policy in dealing with home owners, to decline to conclude a refunding of a portion of the indebtedness against the home where the home owner is proposing to give a second mortgage for any excess indebtedness he may owe unless such second mortgage financing is so arranged that the home owner will have a reasonable probability of being able to carry his first mortgage to the corporation and the second mortgage indebtedness." (The foregoing was adopted September 8, 1933.)
"In the case of bond exchange loans, if the home owner owes more than 80 percent of the value of his premises he may remain indebted for that portion that the corporation cannot refund, provided the corporation secures a first lien, and he may secure the excess indebtedness with a second lien. However, such refunding will not be carried through unless such excess indebtedness is placed on a payment *Page 475 basis so that the home owner will have a reasonable opportunity to pay the same and meet his obligations to this corporation. The corporation will not proceed to refund indebtedness for mortgagees who insist upon more in face value of bonds or who insist upon any other consideration (such as second mortgage, cash or other consideration) than the net amount owing to such mortgagee, together with accrued interest to date of exchange. The corporation will not participate in any refunding where, by any means, the indebtedness of the home owner is increased or the home owner is being called upon to pay more than his debt with interest." (The foregoing was adopted November 3, 1933.)
"(5) The corporation will refund indebtedness in eligible cases where the total amount it refunds is less than the total indebtedness and permit the mortgagor to remain indebted to the mortgagee for the remainder of his honest debt and permit the mortgagor to secure such excess indebtedness by a second mortgage or otherwise, but such refunding will not be consummated unless such excess indebtedness is placed on such terms that the mortgagor will have a reasonable opportunity to pay the same, together with his obligation to the corporation." (The foregoing was adopted November 4, 1933.)
"(1) If the home owners income is so reduced that he is unable to meet full amortization payments from the beginning on his obligation to the corporation, the second mortgage shall not require any principal payments prior to June 13, 1936, and payments thereafter shall be on a schedule which the home owner may reasonably be able to meet.
"(2) In all cases where the home owner is able to meet his full amortization payments to the corporation from the beginning and is able to make additional payments from the beginning on the second mortgage, then the second mortgage may be amortized from the beginning, provided the payments thereon are not in excess of what the home owner may be reasonably able to pay and at the same time keep his obligation to the corporation, making full amortization payments." (The foregoing was adopted January 9, 1934.)
"(2) Second Mortgages — Where the full amount of the indebtedness against the property cannot be refunded by the corporation, the mortgagee or other lien holder will be permitted to take a second mortgage or second deed of trust *Page 476 if the amount of such second mortgage or deed of trust does not exceed the difference between the corporation's appraisal and the amount of the corporation's first mortgage. In no case shall the second trust or second mortgage to such other mortgagee or lien holder be in terms which would cause the mortgagor's payments to the corporation to be a hardship, or deprive the mortgagor of reasonable opportunity to pay such second mortgage or second trust." (The foregoing was adopted October 10, 1934.)
[1] As was explained in Home Owners' Loan Corp. v. Rawson,196 Wash. 548, 83 P.2d 765, also in many of the cases in which questions similar to the ones now before us were considered, and from the foregoing rules which we have quoted, it appears that the HOLC was created pursuant to the act of Congress to make loans to home owners who had become indebted and had encumbrances on their homes and were in danger of losing them because of their inability, owing to economic stress, to pay such indebtedness.
Two classes of loans were authorized. One of them was a refunding, or refinancing, loan for the purpose of paying the indebtedness of the borrower, particularly any previous loan that had been made upon the property and was secured by a mortgage. The other type of loan was known as a reconditioning loan and was made to enable the home owner to enlarge or improve his property. The social objective to be obtained was to save the home for the home owner, enlarge or improve the same, and enable him to repay the loan in instalments over a long period of time, according to his ability so to do.
It was not the policy of the HOLC to make loans as investments so as to profit by the interest earned, nor did it desire to acquire property by foreclosure of mortgages and make a profit by resales. If it appeared that the amount it could properly loan a particular home owner would not pay enough of his indebtedness so that he could repay the loan and his other debts, the loan would not be made unless he could secure a composition with his creditors and secure from them a full and complete release and discharge of their *Page 477 claims upon their receiving out of the loan an agreed sum of money or its equivalent in bonds. In this way, the home owner would get a new start and have only the HOLC loan, secured by a mortgage, against his home. In some cases, if it appeared that the home owner had the apparent ability to repay his other debts, the HOLC would make the loan and not require the other creditors to release and discharge the unpaid balance of their claims and permit the giving of a second mortgage on the property to secure the unpaid indebtedness. All of this was a matter of self-determination for the HOLC, and a secret agreement between the home owner and any creditor for a secondary lien on the home owner's property was not contemplated.
In this case, the HOLC required Currie to secure a full satisfaction of the debt he owed to appellants and to get a release of the mortgage securing it.
[2] It has been contended that it must be assumed that the HOLC knew that appellants were going to receive a second mortgage on the property, as it would be presumed that the parties did not intend to do an unlawful act; and, if it were otherwise, the burden of proof was upon the respondents, in order to defeat the second mortgage, to show that the HOLC did not in fact know of the arrangement between Currie and appellants whereby such mortgage was to be or had been given. It seems to us that this is not a correct approach to the question.
When appellants introduced their note and second mortgage in evidence, with proof that the note was unpaid, they made a primafacie case. Then when the respondents introduced the receipt in evidence showing on its face that appellants had accepted $565.86 in bonds and money in full settlement of the original eight-hundred-dollar debt, it was established that the note in suit and the mortgage securing it were of no force and effect in that the original debt had been fully paid and extinguished. If appellants had claimed that the receipt did not have this effect, then the burden of going forward and showing a state of facts from which a legal conclusion would follow that such was the case would *Page 478 have been shifted to them. This could have been done under the rule recognized in McVicar v. Peters, 12 Wash. 2d 92,120 P.2d 485, by showing that, when the loan was closed, the HOLC had knowledge of an agreement between the parties for the continued existence of the unpaid balance of the original debt and its security by a second mortgage. We think the respondents had the right to stand on the receipt until its legal effect, as appears from its face, was overthrown by the appellants. The record shows they made no attempt to do so.
The question of the validity of notes secured by second mortgages in cases like this one has been before many courts, and the great weight of authority is to the effect that they are invalid and cannot be enforced. Some of the leading cases areMcAllister v. Drapeau, 14 Cal. 2d 102, 92 P.2d 911, 125 A.L.R. 800 and note III, p. 810; Anderson v. Nelson,110 Colo. 374, 134 P.2d 1053; Smith v. Redwine, 168 S.W.2d (Tenn.App.) 185; Lavery v. Rizza, 126 Conn. 132, 9 A.2d 819; Meekv. Wilson, 283 Mich. 679, 278 N.W. 731; Murphy v. Omaha Loan Bldg. Ass'n, 141 Neb. 230, 3 N.W.2d 403. Other cases are cited in 5 John Marshall Law Quarterly, p. 373; Notes, 110 A.L.R. 250, and 121 A.L.R. 119; McVicar v. Peters, 12 Wash. 2d 92,120 P.2d 485, supra. Many other cases might be cited here, but we deem it unnecessary as they are included in the above-cited authorities.
The only cases we have found to the contrary are from the intermediate courts and the state of Arkansas, but they are so greatly in the minority that they should not be followed if preponderant judicial thought over a long period of time is to be any guide to us in deciding a case of first impression.
In their treatment of the question involved here, the courts view the validity of a secret collateral agreement between the borrower and a creditor, situated as the appellant was, to receive a second mortgage on the same property securing any part of the original debt, from different standpoints: *Page 479
(1) It was against public policy in that it violated the spirit of the act relating to the HOLC, which was considered to be for the relief of a home owner in financial distress, and a second mortgage adds a burden upon him which would diminish his ability to repay the HOLC loan. (2) It operated as a fraud upon the HOLC, as it thus would not have had an opportunity to elect whether it would make the loan if it were the intention to keep intact any part of the original debt and secure it by a second mortgage. (3) The execution and delivery of a written consent to take a lesser sum than the original debt out of the proceeds of the loan in full settlement thereof would, when received, result in an accord and satisfaction, and any note or second mortgage evidencing or securing any part of the original debt would be without consideration.
Whichever line of reasoning is adopted, the result is the same, and, from the great weight of authority on the subject, the following is the rule and the exception thereto to be applied:
[3] Where a secured creditor agrees wholly to relinquish and release his claim against a debtor in consideration of receiving a specified sum from an HOLC loan to the debtor, he cannot, as a part of the same transaction, make a secret arrangement with his debtor to keep the indebtedness intact in whole or in part and stand by and permit the loan to be closed, become a beneficiary, and later seek to realize upon his claim. But if he does make such an arrangement with his debtor with the full knowledge of the HOLC, and it closes the loan, then the creditor, not having perpetrated any constructive fraud and there having been no accord and satisfaction, can maintain an action to collect the indebtedness still owing him.
The reasons upon which the exception to the rule are based are that, if the HOLC knows when it closes a loan that the borrower and his creditor desire to continue the unpaid balance of the indebtedness in force and secure it by a second mortgage on the property, it then has the opportunity to determine whether its policy in making the *Page 480 loan can be carried out and if the borrower will probably be able to meet both obligations, and it can then act accordingly. If it then makes a loan, there is no question of public policy involved and no constructive fraud perpetrated. There would be no accord and satisfaction between the borrower and creditor because they intend otherwise, and the balance of the original debt would not be extinguished, but would remain in force.
The factual situation here presents substantially the converse of that found in McVicar v. Peters, supra, and we think the principles of law referred to in that case are applicable here.
There the creditor, situated as is appellant here, did not receive any HOLC bonds in satisfaction of the debt owing to him. He did not agree to relinquish the indebtedness. The arrangement whereby the indebtedness would be kept intact notwithstanding the HOLC loan and that the creditor would ultimately receive the balance owing to him, was known to the agents of the HOLC when the loan was made and closed; and it was held by this court that, under the facts as shown by the record, such an arrangement was not invalid.
But here the situation is entirely different. The appellants received a substantial part of the indebtedness owing to them. It is a proper inference to draw that, inasmuch as they had received nothing on the debt, they, appellants, were willing to encourage the making of the HOLC loan so that as much as possible of the debt could be liquidated out of its proceeds; and, on the other hand, the HOLC, in conformity with its general policy in making a loan, desired to have all of the secured indebtedness against the property fully liquidated, to the end that the borrower would be better able to repay such loan as it came due; and, therefore, it was the intention of all parties that, when the appellants received the HOLC bonds and cash, in the aggregate of $565.86, the original debt would be entirely liquidated.
The McVicar v. Peters case, supra, is persuasive because, *Page 481 in order to reach the conclusion that we did, we had first to recognize and sanction the rules announced by the courts in the cases therein cited before we could apply to the facts of that case the exception to the rule.
The judgment is affirmed.
MILLARD, BLAKE, ROBINSON, and MALLERY, JJ., concur.