boats. Rather, federal law creates a nationwide system of recordation which pleasure-boat owners and lenders may avail themselves of if they wish. The boats thereby become "vessels of the United States." The system documents state-created titles and mortgages when properly done, the effect of documentation is to confer "preferred" status on recorded mortgages. Under federal maritime law, those mortgages may then be enforced in rem against the boat (as a vessel of the United States), in preference over the claims of most subsequent claimants.
The basic idea underlying the system is provision of notice to the world of a mortgage's existence. In re Alberto, 823 F.2d 712, 720 (3rd Cir. 1985). In principle, a purchaser can search the federal registry and determine whether a preferred mortgage exists. A mortgage cannot enjoy preferred status unless it is duly recorded under this system. There is, however, no compulsion to record. Pleasure vessels can be, and often are, federally undocumented.
The security afforded to subsequent purchasers and lienors rests on two basic features of the federal system. First, the coast guard assigns an official number to each federally-documented boat. By law each boat may have only one federal number. The number "must be marked by any permanent method which cannot be obliterated or obscured, in block-type Arabic numerals not less than three (3) inches in height on some clearly visible interior structural part of the hull." 46 C.F.R. § 67.15-1. Before the number may be issued, the owner must swear in a "certificate of marking" that this regulation has been complied with. This physical security is at the heart of the system: It ensures against the creation of two or more chains of federal documentation. It also reassures subsequent purchasers and lienors that a physical inspection of the boat will reveal its documentation status.
The second feature of the system is recordation of the mortgage in the Coast Guard registry, under the official number. This recordation is also crucial to the system: It ensures that undocumented vessels have only a single chain of title, that the sole chain of title is reflected in the federal registry under a unique official number, and that a vessel may be readily located in the listing by its given number.
In summary, an official number (No. 924662) was assigned on November 19, 1987, to the vessel based on the federal documentation emanating from the builder's certificate. That number was, however, never indelibly marked on the vessel. There was thus no physical indication of an official federal registration. Meanwhile, in July 1987 Chapel obtained a New York certificate of title, as required by his Loan and Security Agreement with the bank. Somehow that title chain failed to reflect the bank's lien on the boat. The absence of a physical marking of the first official number on the boat made it possible for the second official number (No. 942142) to be issued on October 4, 1988, based on the New York title. The New York chain of title emanated from the MSO and provided purchasers no notice of the Bank's mortgage.
CLAIMANT JONES' MOTION
Claimant Jones suggests that three "breakdowns" occurred which defeated the intent and smooth working of the federal recordation system in this case: First, the bank failed to take control of the state titling process, thereby permitting Chapel to evade the federal documentation regime. Claimant suggests the bank should have demanded possession of the MSO or ensured that its lien was endorsed on the New York certificate of title. Second, the first Coast Guard official number was never affixed to the vessel, likewise allowing Chapel to evade the federal documentation process. Third, the bank failed to obtain a proper warrant of Chapel's good faith. Chapel never took such an oath, but purported to allow his attorney-in-fact (an employee of the documentation service) swear on his behalf.
Claimant initially argues that foreclosure should be denied because the bank's mortgage was never recorded against the New York chain of title as required in the Ship Mortgage Act. The vessel was initially purchased and homeported in New York. That state's Vehicle and Traffic Law §§ 2101, 2104), which applies to boats as well as cars, requires a new owner to apply for a certificate of title within 30 days of transfer of the vehicle. The bank, for its part, disclaims any knowledge or notice of Chapel's New York titling, and characterizes it as "fraudulent." Yet, claimant urges, it was more than foreseeable to the bank. State titling was not only allowed, but required, both by New York law and the terms of the March 31, 1987, Loan and Security Agreement which provided:
Borrower agrees promptly to apply for, obtain, and deliver to Creditor any certificate of title on the vessel as required under applicable state law and to have Creditor's security interest noted on any such certificate of title.
Thus both by law and by express agreement of the parties, the New York certificate of title was the operative title. By any rational definition, a "complete" chain of title, as required by the federal regulations, must include the New York certificate of title.
The New York statute does contain an exclusion for a "vessel having a valid marine document issued by the United States . . . . " § 2102. The boat in question, however, was not even issued a putative federal document until eight and a half months after the initial purchase. Thus, claimant argues, the bank allowed a live state title to remain on the loose, thereby frustrating the smooth operation of the federal documentation system. In sum, a vessel whose documentation lacks a complete chain of title, in contravention of 46 C.F.R. § 65.05-7, is not a vessel "documented under the laws of the United States."
Claimant Jones then argues that the bank's failure to take up or endorse the state certificate of title merits the equitable subordination of its interests to those of innocent purchasers who in good faith relied on that title. Claimant further suggests that, even if the court finds that the bank's mortgage is not simply a nullity for not having been properly recorded, the fact remains that the bank's failure to take custody or control of the state title constitutes a serious departure from standard good banking practices. It therefore qualifies as "inequitable conduct", requiring the bank's mortgage to be subordinated to the mortgage and ownership interests of Mr. Jones and the Sparkmans under the doctrine of equitable subordination.
The elements of equitable subordination are as follows: 1) the bank engaged in inequitable conduct; 2) the misconduct results in injury to competing claimants to the vessel; 3) subordination is not inconsistent with federal law. Wardley Int'l Bank, Inc. v. Nasipit Bay Vessel, 841 F.2d 259, 263 (9th Cir. 1988). The bank must certainly have known, as do all marine lenders, that a "loose" certificate of title can be used to resell the boat free of a mortgage. The bank's failure to take control of the certificate of title was "a serious departure" from usual practices on the part of lenders. (Affidavit of Janet K. Saxton, P 8, appended to claimant's Opposition.) It therefore constituted gross negligence, and a negligent indifference to the rights of subsequent purchasers. In claimant's view, the bank itself confirms the seriousness of this error, saying "it would not be their practice to allow him to put a title on the boat without listing them as a lienholder" and "it's not common business practice to allow someone to get a title to a boat without your lien being recorded on it." (Sledzianowski deposition, p. 67, lines 12-15; p. 75, line 2.)
In support of his equitable subordination argument, claimant relies on McCorkle v. First Penn. Banking and Trust Co., 459 F.2d 243 (4th Cir. 1972). In that case, the bank perfected a security interest in a boat under state law. The debtor later used the builder's certificate to federally document the vessel, concealing the bank's security interest. An innocent purchaser, relying on the lien-free abstract of title, bought the vessel. The district court granted summary judgment in favor of the innocent purchaser. The Court of Appeals was compelled to dismiss the action for lack of subject matter jurisdiction but left no doubt that, on the merits, summary judgment for the innocent party was proper. The court stated:
Where both parties are innocent of wrongdoing and one had it in its power to prevent the fraud while the other did not, the latter has the higher equity. (At 251, fn. 9.)