In October 2005, CAS, LLC, a Rhode Island limited liability company (“Debtor”) owning and operating real property in Middletown, Rhode Island, executed a promissory note (the “Note”) evidencing a $500,000 loan from Sovereign Bank (the “Original Creditor”). Debtor executed a mortgage on the Middletown property to secure payment and performance of the loan (the “Mortgage”). In September 2012, the Original Creditor assigned its right, title and interest in the Note and Mortgage to Northeast LP IV, LLC (“Creditor”).
The Note had a ten-year term and provided for interest at a rate per annum of 6.77% for the first five years. After those first five years, the Original Creditor could, “in its sole discretion,” change the interest rate to the five-year marginal cost of funds index plus 2.25% per annum. The Original Creditor did not implement that change at the end of the first five years, i.e. October 2010, and elected to continue charging interest at the rate of 6.77%. In April 2011, however, the Original Creditor changed the interest rate to a lower rate of 4.957%. Debtor eventually fell into receivership and Creditor filed a proof of claim as owner and holder of the Note and Mortgage. Debtor challenged Creditor’s proof of claim, arguing that the Original Creditor’s charging of 6.77% interest from October 2010 to April 2011 amounted to common law fraud and breach of contract. Debtor further argued that Creditor was not a holder in due course since Creditor had notice of Debtor’s defenses at the time of the Note transfer.
The court analyzed Debtor’s alleged contractual defenses by first establishing that, “In Rhode Island, our Supreme Court adhere[s] to the rule of interpretation that when considering whether a contract is clear and unambiguous, the document must be viewed in its entirety and its language be given its plain, ordinary and usual meaning. . . . When determining if a contract is ambiguous, the Court should refrain from engaging in mental gymnastics or from stretching the imagination to read ambiguity into [a contract] where none is present.” (Internal quotations omitted). With this backdrop, the court looked to the terms of the Note and identified the following controlling language to be unambiguous: “At the end of the 5th loan year, [the Original Creditor] shall, in its sole discretion, have the right to change the interest rate . . .” Specifically, the court held, “No reasonable interpretation of the terms of this Note leads this Court to believe that if [the Original Creditor] was going to change the interest rate, it was restricted . . . to do so exactly at the end of the fifth year.” The court further added, “If [the Original Creditor] was required to change the interest rate exactly upon the conclusion of the five-year fixed interest rate term, such conditional language would have been included as part of the Note . . .” As such, Debtor could not raise breach of contract and common law fraud as defenses to enforcement.
Finally, the court struck Debtor’s argument that Creditor was not a holder in due course. The court noted that recognition as a holder in due course under Rhode Island law requires, among other factors, that the holder take the instrument “without notice that any party has a defense or claim in recoupment.” However, because the Original Creditor’s actions were permissible under the Note and Debtor’s defenses were thus without merit, Creditor could not have taken possession with notice that any party had a defense to enforcement. Therefore, Creditor took possession of the Note and Mortgage as a holder in due course. For these reasons, the court granted the Creditor’s motion to approve its proof of claim.