Ellis v. Popular Bank

1

ALLYSON ELLIS and CURTIS ELLIS, Plaintiffs, v. POPULAR BANK f/k/a BANCO POPULAR, and UNITED STATES SMALL BUSINESS ADMINISTRATION Defendants.

No. 2:24-cv-02042-EFM-ADM

United States District Court, D. Kansas

June 28, 2024

MEMORANDUM AND ORDER

ERIC F. MELGREN CHIEF UNITED STATES DISTRICT JUDGE

Before the Court are two Motions to Dismiss. First, Defendant United States Small Business Administration (the “SBA”) seeks dismissal of Count I of Plaintiffs' Complaint as well as the payment of $228,000, held by the Court, to itself (Doc. 24). Similarly, Defendant Popular Bank (the “Bank”) seeks dismissal of Plaintiffs' Counts I-V, which are claims against it for slander of title, fraud violation of K.S.A. § 58-2309a, and punitive damages.^[1] For the reasons stated below, the Court denies the SBA's Motion and grants in part and denies in part the Bank's Motion.

I. Factual and Procedural Background^[2]

In 2008, Plaintiffs owned and operated a business called Ellis Medical Supply, Inc. (“Ellis Medical”). On February 28, 2008, Ellis Medical borrowed $1,588,000.00 from the Bank. Ellis Medical issued the Bank a promissory note (the “Note”) for the loan along with a mortgage (the “Mortgage”) on their house, which secured the Note in the amount of $228,000. The Note was issued on an SBA form. Concerning the SBA, the Mortgage states:

If the United States is seeking to enforce this document then under SBA regulations:

a) When SBA is the holder of the Note, this document and all documents evidencing or securing this Loan will be construed in accordance with federal law.

b) Lender or SBA may use local or state procedures for purposes such as filing papers, recording documents, giving notice, foreclosing liens, and other purposes. By using these procedures, SBA does not waive any federal immunity from local or state control, penalty, tax or liability. No Borrower or Guarantor may claim or assert against SBA any local or state law to deny any obligation of Borrower, or defeat any claims of SBA with respect to this Loan.

In 2011, Plaintiffs declared bankruptcy. In either 2011 or 2012, Ellis Medical defaulted on the Note. Shortly thereafter, Ellis Medical wound up, becoming administratively dissolved in 2012. During the wind-up process, the Bank accelerated the Note and Mortgage, repossessing and selling Ellis Medical's assets to cover the value of the Note. However, Plaintiffs allege the Bank never applied the proceeds from those sales towards the Note.

Sometime in 2022, Plaintiffs began the process of selling their house. On August 2, 2022, the Bank informed Security First Title, Plaintiffs' title company, that it held a valid mortgage on Plaintiffs' house. On October 23, 2022, Plaintiffs entered into a contract to sell their house for $940,000. On October 27, 2022, the Bank once again informed Security First Title that it held an enforceable mortgage on the property. Plaintiffs allege that the Bank knew at this time that it could not enforce the Mortgage because it did not hold the Note and the statute of limitations had passed. Although Plaintiffs do not state it directly nor specify why, it appears that the sale fell through. Further, they allege that the Bank knew that informing Security First Title of the Mortgage would cause the sale contract to fail. Based on the Bank's representations, Plaintiffs chose not to enforce the buyer's performance under the sales contract.

On July 21, 2023, Plaintiffs contacted the Bank and demanded that the Bank release the Mortgage because they claimed it was barred by the statute of limitations. At that time, Plaintiffs stated the Mortgage had prevented one sale of the house already, presumably referencing the contract entered into on October 23, 2022. The Bank responded by claiming it had assigned the Note to the SBA in December 2013.^[3] It also said that it had reached out to the SBA for direction for how to respond to Plaintiffs' demand and refused to release the Mortgage.

On November 8, 2023, Plaintiffs demanded that the Bank produce the original copy of the Note. The Bank has not yet produced the original copy. As alleged by Plaintiffs, neither the Bank nor the SBA currently holds the original Note, and the SBA has never held the Note.

On December 12, 2023, Plaintiffs once again entered into a contract to sell the house, this time for $885,000. Despite the Bank's refusal to release the Mortgage, Plaintiffs sold their home on or about February 23, 2024, for $885,000.

On January 19, 2024, Plaintiffs filed suit in Kansas state district court against Defendants, seeking release of the Mortgage as well as damages from the Bank based on claims for slander of title, fraud, and K.S.A. 58-2309a. As alleged by Plaintiffs, the Bank only transferred the Mortgage to the SBA after Plaintiffs initiated this suit.

On February 2, 2024, the SBA removed the lawsuit to federal court under 28 U.S.C. § 1444. Shortly after, Plaintiffs moved for a preliminary injunction. Before the Court could rule on the Motion, the parties agreed that Plaintiffs would pay $228,000 into the Court, after which the SBA would release the Mortgage. The Court adopted the parties' agreement, ordered it to happen, and declared Plaintiffs' motion for an injunction to be moot. Plaintiffs deposited the $228,000 with the Court on February 23, 2024. However, the SBA did not release the Mortgage until April 17, 2024.

On March 27, 2024, both Defendants filed their respective Motions. These matters are now fully briefed and ripe for ruling.

II. Legal Standard

Under Rule 12(b)(6), a defendant may move for dismissal of any claim for which the plaintiff has failed to state a claim upon which relief can be granted.^[4] Upon such motion, the court must decide “whether the complaint contains ‘enough facts to state a claim to relief that is plausible on its face.'”^[5] A claim is facially plausible if the plaintiff pleads facts sufficient for the court to reasonably infer that the defendant is liable for the alleged misconduct.^[6] The plausibility standard reflects the requirement in Rule 8 that pleadings provide defendants with fair notice of the nature of claims as well the grounds on which each claim rests.^[7] Under Rule 12(b)(6), the court must accept as true all factual allegations in the complaint, but need not afford such a presumption to legal conclusions.^[8] Viewing the complaint in this manner, the court must decide whether the plaintiff's allegations give rise to more than speculative possibilities.^[9] If the allegations in the complaint are “so general that they encompass a wide swath of conduct, much of it innocent, then the plaintiffs ‘have not nudged their claims across the line from conceivable to plausible.'”^[10]

III. Analysis

At the core of the parties' dispute is whether Defendants have a valid Mortgage and Note against Plaintiffs' property. A substantial portion of the parties' dispute involves competing factual allegations. For example, Defendants claim that Bank transferred the Mortgage to the SBA in 2012 or 2013, a factual allegation absent from the Complaint. Instead, Plaintiffs allege that the Bank destroyed or transferred the Note at some unspecified time and that the SBA has never possessed the original Note. At this stage in the case, the Court will look solely to Plaintiffs' allegations. Therefore, the Court will only address Defendants' legal arguments-not their factual ones.

A. Count I

In Count I, Plaintiffs seek the release of the $228,00 they paid into this Court by claiming the Mortgage now held by the SBA is not enforceable. Although Count I names the Bank as a Defendant, the parties agree that the Bank has no interest in the funds now held by the Court, and thus this Count exists solely between Plaintiffs and the SBA. For its part, the SBA moves to dismiss Count I and simultaneously requests that the Court essentially enter judgment in the SBA's favor by paying the $228,000 to it.

This case presents a unique scenario on multiple levels. First, most cases dealing with enforceability of mortgages and notes occur in either foreclosure proceedings or bankruptcy court. This is neither. Second, despite the Court's review of Kansas caselaw, it cannot find an analogous case where plaintiffs allege that the mortgage and note have split, with the note's whereabouts unknown.^[11]

Generally, “a holder of a promissory note has standing to enforce the terms of the indebtedness, including the right to foreclose on a mortgage that secures it.”^[12] Both Kansas caselaw and statutes strive to keep the mortgage and note together “based on the intent of the parties.”^[13] Nevertheless, it is possible to split the note from the mortgage by transferring the note alone. However, this rarely occurs and is an exception to the rule.^[14]

If that happens, “a person or entity possessing only the mortgage would never experience the cognizable injury, i.e., the default necessary to foreclose the mortgage.”^[15] Similarly, “[t]he practical effect of splitting the deed of trust from the promissory note is to make it impossible for the holder of the note to foreclose, unless the holder of the deed of trust is the agent of the holder of the note.”^[16]

Thus, “possession of the mortgage alone without demonstrating enforcement rights in the note is insufficient to establish standing in a mortgage foreclosure proceeding.”^[17] But, and importantly for this case, the mortgage itself continues to exists, “[r]egardless of whether a split occurred.”^[18] However, that mortgage would be unenforceable by the noteholder, unless the holder of the mortgage acted as an agent for the noteholder.^[19]

For the purposes of this Order, the Court accepts Plaintiffs' allegations that the Bank held only the Mortgage and not the Note. Thus,...