to "eligible notes": "The note . . . shall be valid and enforceable against the borrower or borrowers . . . and shall be complete and regular on its face." 24 C.F.R. § 201.2.
The initial determination to be made is whether Guardian Federal is obliged to reduce the indebtedness evidenced by the notes to a valid judgment before submitting its claim. If so, its claim clearly is not in compliance. The statute and regulations, however, establish no such obligation. The regulations' reference to the mandatory assignment of "any security held or judgment taken" suggests that a claimant may proceed to judgment but need not do so. Moreover, in a case decided under a similar version of the regulations, the court noted in passing that the bank had assigned the note itself, not a judgment, to the United States. Citizens National Trust and Savings Bank v. United States, 270 F.2d 128, 129-30 (9th Cir. 1959). The implication is that, at least at one point, the United States accepted assignments of notes only. Nothing indicates the practice now is otherwise. Similarly, the fact that the bank has instituted proceedings against the Mabens should not, of itself, bar the bank's claim, though the Government might not be required to accept assignment of the judgments once they had been set aside.
The remaining question is whether the Government is required to accept assignment of the notes and reimburse the bank. The Government's argument that it need not do so is premised wholly on the regulation defining "eligible notes" and providing that a note must be "valid and enforceable . . . and . . . complete and regular on its face." 24 C.F.R. § 201.2(a). Moreover, the only respect in which the two notes in question are alleged not to comply with this regulation stems from the cancellation stamp across the face of each. Even if the cancellation mark were an irregularity within the meaning of the regulation, we conclude that it does not render the note ineligible under the regulation because we construe the regulation to apply, not at the point at which a bank submits its claim, but at the point at which the loan itself is being arranged. The determination of eligibility patently must be made before the loan funds change hands. Other regulations provide that "[if], after the loan is made, an insured [bank] who acted in good faith discovers any material misstatements or misuse of the proceeds of the loan by the borrower, dealer or others, the eligibility of the note for insurance will not be affected." 24 C.F.R. § 201.5(b). An initial determination of a note's eligibility is made when it is executed; the two notes here apparently were complete and regular when executed. While certain subsequent events or subsequently discovered facts will affect a note's eligibility, e.g., United States v. First National City Bank of New York, 353 F.2d 308, 310 (2d Cir. 1965); Citizens National Trust & Savings Bank, supra at 133, the cancellation stamp on the notes, standing alone, does not render them unqualified for insurance absent a determination that the notes are not valid and enforceable against their makers. The federal law merchant rule appears to be that unintentional, fraudulently induced, or mistaken cancellation of a note is inoperative. State Street Trust Co. v. Muskogee Electric Traction Co., 204 F.2d 920, 922-23 (10th Cir. 1953); Miller v. Usry, 160 F. Supp. 368, 370 (W.D. La. 1955); see Uniform Negotiable Instruments Law § 123.
The record here indicates that the default judgments taken, and the concomitant cancellations, were premised on the mistaken assumption that the judgments were valid. It is our view that the cancellations became inoperative and of no force and effect the moment the judgments into which they were "merged" were set aside. The notes are still "eligible notes" as that term is defined in the regulations. 24 C.F.R. § 201.2(a).
After claim for reimbursement for loss is made, " the note or any security held or judgment taken must be assigned in its entirety . . ." 24 C.F.R. § 201.11(b) (Emphasis supplied) Plaintiff has attempted to make such assignment. We further hold that defendant must accept the assignment of the notes and reimburse plaintiff for the loss it has unquestionably suffered.
A decision in favor of the Government in this case might not only contravene the regulations, but also not advance this litigation in the least. Guardian Federal presumably would resume its efforts to obtain valid service on the Mabens. If it failed to obtain service, which appears not unlikely in view of the passage of 2 1/2 years, or even if matters proceeded to a valid judgment and the bank found itself unable to collect, the bank could again claim reimbursement for the loss. In view of the purposes of the National Housing Act, which are to promote construction and improvement of private housing, in part by protecting banks against losses attributable to absconding or impecunious borrowers, the bank's failure to obtain valid service or to collect on a valid judgment would entitle it to reimbursement. Citizens National Trust & Savings Bank, supra at 133. Our determination that the Government must now assume the risks of failure of service or collection does no more than impose upon it the proper duties of an insurer and is fully consistent with the public policy underlying the passage of the legislation. Though the Government must reimburse Guardian Federal on the notes, it need not absorb any fees incurred by Guardian Federal in the course of its abortive actions on the notes. Plaintiff's submissions attribute $100 of the $5,879 claim to "uncollected court costs." Accordingly, plaintiff's motion for summary judgment for $5,779 is granted, and defendant's motion on that issue is denied.
John H. Pratt United States District Judge