Sackadorf v. JLM Group Ltd. Partnership

Present: Carrico, C.J., Compton, Stephenson, Whiting, 1 Lacy,
Hassell, and Keenan, JJ.
LEONARD SACKADORF, ET AL.
v. Record No. 941561 OPINION BY JUSTICE BARBARA MILANO KEENAN
September 15, 1995
JLM GROUP LIMITED
PARTNERSHIP, ET AL.
FROM THE CIRCUIT COURT OF ARLINGTON COUNTY
Paul F. Sheridan, Judge
In this appeal involving the priorities of several deeds of
trust, we consider 1) whether a transaction structured as an
assignment of a note and first deed of trust was in fact a
payment and satisfaction by the deed of trust debtor that
extinguished the first lien; and 2) whether modifications to the
first deed of trust and other documents following the purported
assignment, and physical changes made to the property by the deed
of trust debtor, require that the junior lienors be advanced in
priority.
Leonard Sackadorf, Dominic Foglio, Leo Wilder, and Lodging
Consultants, Ltd. Pension Fund were the beneficiaries of two
junior deeds of trust in which Leroy E. Batchelor, Jr., was the
designated trustee (collectively, the complainants). They filed
a bill of complaint seeking a declaratory judgment that the lien
of American Security Bank, N.A. (ASB), was not entitled to retain
first priority on the property in question. The defendants
1
Justice Whiting participated in the hearing and decision of
this case prior to the effective date of his retirement on August
12, 1995.
before the trial court were JLM Group Limited Partnership (JLM
Group), which executed the deeds of trust, one of JLM Group's
partners, and ASB and its substitute trustees.
The trial court heard the evidence ore tenus and entered
judgment in favor of the defendants. Therefore, we consider the
evidence and all reasonable inferences it raises in the light
most favorable to the defendants. Quantum Dev. Co. v. Luckett,
242 Va. 159, 161, 409 S.E.2d 121, 122 (1991).
Sackadorf, Foglio, Wilder, and Rita Wilder (collectively,
the sellers) formerly held all the interests in a partnership
that owned as its sole asset two adjacent parcels of land
(collectively, the property). Parcel 1 was unimproved, and
Parcel 2 was the site of several buildings constituting a motel.
By a Partnership Interest Purchase Agreement (the Purchase
Agreement) executed in November 1984, the sellers agreed to
assign all their partnership interests to Saul H. Bernstein and
Barrett Penan. By later assignment, the sellers transferred
their interests to Bernstein, Penan, and several others, who
became the partners composing JLM Group. This assignment also
conveyed the property to JLM Group.
The Purchase Agreement provided that portions of the
purchase price would be represented by notes payable to the
sellers and to Lodging Consultants, Ltd. Pension Fund, which was
controlled by Sackadorf and Foglio. These notes were to be
secured by second and third deeds of trust on the property.
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The sellers further agreed that JLM Group could place a
first deed of trust on Parcel 1 to secure construction financing,
provided that the "improvements on Parcel 2 remain intact as a
self contained operating facility capable of providing to guests
the services which are now available." The Purchase Agreement
provided for survival of its provisions after closing of the
transaction; however, the Purchase Agreement was not recorded.
By the time of the closing of the transaction in March 1985,
JLM Group obtained financing from Dominion Federal Savings and
Loan Association (Dominion) to acquire the property, rehabilitate
the existing motel on Parcel 2, and construct an addition on
Parcel 1. Dominion agreed to make an initial disbursement of
$9,016,000 and future advances for construction, up to a total
amount of $14,500,000.
JLM Group executed two notes to Dominion in the amounts of
$8,000,000 and $6,500,000, each bearing interest at 13.25%. In
addition, JLM Group signed a note payable to Lodging Consultants,
Ltd. Pension Fund in the amount of $500,000 (the Pension Fund
Note), and a series of notes payable to the sellers individually
in amounts aggregating $750,000 (the Series Note).
JLM Group executed a first deed of trust encumbering Parcel
2 to secure the $8,000,000 note given to Dominion. An additional
deed of trust granting a first lien on Parcel 1, and a fourth
lien on Parcel 2, was recorded to secure both the $8,000,000 and
the $6,500,000 Dominion notes. Dominion's deeds of trust
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provided that they and the underlying notes may be assigned, and
that the deeds of trust may be changed, waived, discharged, or
terminated by written instrument.
The Pension Fund Note and Series Note were secured by deeds
of trust stating therein that they were second and third in
priority, respectively, on Parcel 2. These deeds of trust, which
appeared on pre-printed legal forms, did not contain any language
stating that they were subordinated conditionally and did not
incorporate or refer to the Purchase Agreement. They were
recorded immediately following Dominion's deed of trust securing
its $8,000,000 note on Parcel 2.
In early 1986, JLM Group applied to ASB to borrow
$14,500,000, with interest at 10.25%, to "refinance" the Dominion
loan. Several of the documents thereafter executed between ASB
and JLM Group stated that the purpose of the loan was to
"refinance" or "retire" the Dominion loan. However, when the
transaction closed in May 1986, Dominion executed and delivered
to ASB an "Assignment" of all its interest in its notes and deeds
of trust, endorsed the notes payable to the order of ASB, and
delivered the original notes to ASB.
Dominion delivered these documents to ASB's attorney on May
19, 1986, with a letter authorizing their transmittal to ASB upon
Dominion's receipt of approximately $11,589,786. This amount
included principal, interest, and a prepayment penalty required
by the terms of the Dominion notes.
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On May 20, 1986, the transaction closed. As shown on ASB
bank statements, ASB transferred $14,500,000 into a newly opened
ASB account titled "ASB Loan Escrow Account for JLM Group Ptnrs"
(the Escrow Account). On the same day, approximately $11,600,000
was transferred from that account to the settlement agent.
The settlement statement shows a sum denominated "Payoff to
Dominion Federal" of approximately $11,589,786, equal to the
total of the amounts demanded in Dominion's May 19 letter. The
balance of the $11,600,000 transferred from the Escrow Account
was retained by the settlement agent for legal fees and recording
costs.
The settlement statement further shows a loan origination
fee of $145,000 payable to ASB. On May 22, 1986, the Escrow
Account was debited for $145,000. Interest was credited to the
account in May 1986 and in the months following.
At the May 1986 closing, JLM Group executed a "Replacement
Promissory Note" payable to ASB in the amount of $14,500,000,
with interest at 10.25%, and a "First Amendment, Restatement and
Consolidation of Deeds of Trust, Assignment of Rents, and
Security Agreement" (the Amended Deed of Trust). The Amended
Deed of Trust recited the existence and validity of the Dominion
notes and deeds of trust, restated the priorities of Dominion's
liens on each parcel, and provided that the Amended Deed of Trust
"shall be entitled to the same lien and priority as the Original
Deed of Trust."
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The agreement between JLM Group and ASB under the documents
executed between them in 1986 varied in several respects from the
1985 agreement with Dominion. Interest on the ASB note was
10.25% as compared with 13.25%. Because of the lower rate and
different amortization, JLM Group's payments under the ASB loan
were lower than under the Dominion loan.
The ASB note, like the Dominion notes, matured in
approximately March 1990. However, the Dominion notes had
provided that the original term could be "automatically extended"
for five years upon certain conditions, including a showing that
there was no "deferred maintenance" on the property.
Further, the guaranty agreements required by each lender
differed. ASB limited the guarantors' liability to $5,500,000.
The guaranty that Dominion obtained imposed liability up to
$14,500,000, which would be reduced to $1,250,000 once the
property had achieved a specified debt service coverage ratio.
ASB's deed of trust, unlike Dominion's, provided that any
"material adverse change" to the finances of JLM Group's general
partners or its guarantors would constitute a default. ASB's
deed of trust also permitted the lender to apply insurance
proceeds to payment of its secured debt, rather than to repair of
the premises, after a loss of more than $1,000,000.
JLM Group later defaulted on the ASB loan. At the trial, an
attorney employed by the settlement agent, and the Dominion and
ASB officials who participated in the 1986 transaction, each
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testified that the parties intended and understood that the
transaction was a purchase by assignment of Dominion's interests
in its notes and deeds of trust. Dominion's official testified
further that he executed the Assignment and endorsed the original
Dominion notes, and that these notes were not canceled or marked
"paid" or "satisfied."
ASB called expert witnesses in the areas of real estate
transactions and commercial lending practices, who stated that
the 1986 transaction employed all the documentation necessary to
accomplish a purchase by assignment. The complainants presented
the testimony of John Mandler, an expert on the subject of real
estate financing. Mandler testified that language in the Amended
Deed of Trust, stating that it was "entitled to the same lien and
priority as the Original Deed of Trust," preserved the $8,000,000
first lien priority on Parcel 2, and did not purport to enlarge
ASB's senior lien on that parcel.
Dennis M. Coombe, the ASB official who supervised the 1986
transaction, testified that the Escrow Account was under the
control of ASB. He explained that ASB had found it necessary to
advance the full $14,500,000 at the 1986 closing, in order to
assure JLM Group a fixed rate of interest, because ASB was
required to purchase all the funds required for the loan at one
time.
Coombe further stated that disbursements from the Escrow
Account could be made only by an officer of ASB, and that the
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funds in the account were ASB's property. He testified that JLM
Group did not have signature authority over the account, was not
provided any checks, and did not receive account statements.
Michael Ryan, an expert witness for ASB, stated that it is
not uncommon for a bank, when it has fully advanced funds under a
construction loan, to establish an interest-bearing escrow
account in which to hold in reserve monies not yet disbursed to
the borrower. Witnesses for both parties testified that a
borrower's payment of prepayment penalties and loan origination
fees is not inconsistent with an assignment between banks.
One of the sellers, Leonard Sackadorf, testified that, when
the Purchase Agreement was executed, the motel on Parcel 2
included a free-standing registration building and sign, as well
as another building containing a banquet room, which, Sackadorf
stated, was an amenity needed to attract large groups to the
motel. However, Sackadorf testified that, within a few years
after the 1985 transaction, the registration building and sign
were demolished, and the banquet room was converted to use as a
registration area.
Although the new building which was erected on Parcel 1
included banquet facilities, no such facilities remained on
Parcel 2. Sackadorf did not state when these changes occurred.
However, other evidence suggested that the Parcel 2 alterations
took place after the 1986 transaction involving ASB.
After hearing the evidence and arguments, the trial court
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denied the complainants the relief sought. The trial court found
that, by May 19, 1986, the parties had intended an assignment of
the Dominion notes and deeds of trust to ASB, that their actions
were consistent with that intent, and that the 1986 transaction
was a valid assignment. The trial court further found that the
Escrow Account was beyond the control of JLM Group, and that the
transfer of funds from the account to Dominion did not constitute
payment of the Dominion loan by JLM Group. The trial court
stated, "There was neither intentional pay-off of the debt, nor
inadvertent pay-off of the debt by the facts and acts and/or
omissions here."
Finally, the trial court held that neither the physical
changes to the motel nor the modifications in the terms of the
senior debt prejudiced the complainants or "caused a loss of
their security position." The trial court concluded that the
case did not present "any reason in equity to subordinate ASB to
the trust position" of the complainants.
On appeal, the complainants argue first that ASB did not
acquire Dominion's senior priority through purchase by
assignment. Instead, they contend, Dominion's first lien was
extinguished in the 1986 transaction, pursuant to former Code
§ 8.3-603(1), because Dominion's notes were paid from funds owned
by JLM Group. The complainants assert that ASB's deed of trust
thus secured a "new loan" inferior to the complainants' prior
deeds of trust.
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In the alternative, the complainants contend that the trial
court erred in failing to declare the subordination of ASB's
lien. First, they assert that JLM Group, with ASB's knowledge
and approval, failed to maintain the existing motel as a "self
contained operating facility" as required by the Purchase
Agreement. Second, the complainants argue that the 1986
modifications to the terms of the original Dominion notes, deeds
of trust, and guaranty agreements substantially impaired the
complainants' ability to avail themselves of their security.
In response, ASB and its trustees (collectively, ASB) 2 argue
that the trial court correctly found that the Dominion notes were
paid from funds beyond JLM Group's control, and thus Dominion's
lien was not extinguished but was acquired by ASB through a valid
purchase by assignment.
ASB further argues that the complainants' deeds of trust did
not contain conditions of subordination prohibiting changes to
the first deed of trust. Since the modifications were not
significant, did not expose the complainants to additional
burdens, and actually benefitted the complainants, ASB contends
that the trial court correctly held that equity did not require
ASB's lien to be subordinated to the liens of the complainants.
We agree with ASB regarding both issues raised.
2
JLM Group and its partner, Bernstein, have not participated
in this appeal.
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The legal effect of the 1986 transaction depends on a
determination whether JLM Group, the sole obligor under the
Dominion notes, was payor of the funds received by Dominion. At
the time of the 1986 transaction, former Code § 8.3-603(1)
provided, in relevant part: "The liability of any party [to a
negotiable instrument] is discharged to the extent of his payment
or satisfaction to the holder." Thus, if JLM Group paid or
satisfied the Dominion notes, the liability of the sole obligor
on the notes was discharged and Dominion's first lien was
extinguished.
By contrast, if the person or entity supplying the funds is
not a party to the instrument alleged to have been paid, and is
not obligated in any way for its payment, then the question
whether the transaction "is a payment or a purchase is a question
of intention--of fact rather than of law--and is to be settled by
the evidence." Cussen v. Brandt, 97 Va. 1, 7, 32 S.E. 791, 793
(1899). See also Strauss v. Princess Anne Marine & Bulkheading
Co., 209 Va. 217, 224-26, 163 S.E.2d 198, 203-05 (1968); Union
Trust Corp. v. Fugate, 172 Va. 82, 89, 200 S.E. 624, 626-27
(1939).
Here, the trial court found that the Escrow Account, which
was the source of payment to Dominion, was beyond the control of
the obligor, JLM Group. The trial court heard the evidence ore
tenus, and we are bound by its findings of fact, unless those
findings are plainly wrong or without evidence to support them.
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Code § 8.01-680; Yamada v. McLeod, 243 Va. 426, 430, 416 S.E.2d
222, 224 (1992).
The uncontradicted evidence showed that JLM Group did not
have signature authority over the account, and that ASB's
approval was required for the transfer of funds into JLM Group's
operating account. The trial court's finding that the account
was beyond the control of JLM Group is supported by the evidence
and is not clearly wrong. Thus, payment from the account was not
payment by JLM Group, and former Code § 8.3-603(1) does not
control.
We disagree with the complainants' contention that the
evidence showed that "ownership" of the account was in JLM Group.
The evidence showed that restrictions were placed on JLM Group's
access to the account to a degree inconsistent with ownership,
and that an ASB official considered the funds to be "the bank's
money."
The trial court also found that the parties intended and
effectuated the assignment of the Dominion notes and deeds of
trust to ASB, and the evidence supports this finding. Although
some documents connected with the transaction suggested that a
"refinance" was originally planned, the transaction was
consummated by endorsement and delivery of the notes, and
execution and delivery of a written "Assignment," to ASB.
Participants in the transaction stated that they
subjectively intended an assignment, and expert witnesses opined
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that the participants' actions were effective in realizing this
intention. In addition, as several witnesses testified, although
the account was credited with interest, and the funds advanced
were used to satisfy Dominion's prepayment penalty and ASB's
origination fee, these facts were not inconsistent with ASB's
continued control of the account, and its use of the account to
fund its purchase of the Dominion notes.
The cases cited by complainants are factually
distinguishable from the present case. In those cases, payment
was made out of the funds of parties who were primarily liable on
the obligations in question. For that reason, the debts were
held to be extinguished, regardless of the parties' contrary
intention. See Green v. Foley, 856 F.2d 660, 665-66 (4th Cir.
1988), cert. denied, 490 U.S. 1031 (1989); Bank of Russell County
v. Griffith, 176 Va. 1, 8, 10 S.E.2d 481, 483 (1940); Citizens
Bank v. Lay, 80 Va. 436, 438-39 (1885). 3
In addition, the evidence presented was not only consistent
3
The complainants also cite Whitehead v. Planters Bank &
Trust Co., 180 Va. 76, 80-81, 21 S.E.2d 724, 726-27 (1942), which
involved an instrument that was discharged when the holder
assigned it for value to the principal debtors. That case lends
no support to the complainants' position, because the evidence in
this case did not show either that JLM Group gave value directly
to Dominion or that Dominion assigned its notes to JLM Group.
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with an assignment; it was inconsistent with payment. There was
no evidence that Dominion recorded a certificate of satisfaction
to release its deeds of trust, or that JLM Group demanded that it
do so. Similarly, the evidence showed that Dominion neither
canceled the notes nor returned them to JLM Group, but instead
endorsed and delivered the notes to ASB. See Schmitt v. Redd,
151 Va. 333, 339, 143 S.E. 884, 885-86 (1928). Thus, we conclude
that the trial court did not err in holding that Dominion's lien
was not extinguished by its receipt of funds derived from the
Escrow Account, and that ASB acquired a valid first lien on the
property.
The complainants next contend that their liens should be
elevated to positions of priority over ASB's lien, as a result of
prejudice to the complainants' rights through 1) physical
alterations to improvements on the parcel subject to their liens,
and 2) modifications in the substituted ASB deed of trust that
were adverse to their interests.
We agree with the principle that a senior lienor may not
modify the terms of its agreement with the borrower so as
materially to prejudice the rights or impair the security of
junior lienors, without their consent. See Shane v. Winter Hill
Fed. Sav. & Loan Ass'n, 492 N.E.2d 92, 95-96 (Mass. 1986);
Shultis v. Woodstock Land Dev. Assocs., 594 N.Y.S.2d 890, 892
(N.Y. App. Div. 1993); Citizens & S. Nat'l Bank of S.C. v. Smith,
284 S.E.2d 770, 772 (S.C. 1981). However, we hold that the
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record supports the trial court's finding that the evidence
failed to show the complainants were prejudiced by the physical
alterations to Parcel 2 and the modifications in the senior deed
of trust.
First, we will assume, without deciding, that JLM Group's
renovations to the motel on Parcel 2 violated the condition in
the Purchase Agreement, to which JLM Group agreed, that the
"improvements on Parcel 2 remain intact as a self contained
operating facility capable of providing to guests the services
which are now available." Nevertheless, neither Dominion nor ASB
agreed to take responsibility for the fulfillment of the
condition and, accordingly, in the absence of fraud or collusion,
neither lender had a duty to prevent breach of the condition.
See Tuscarora, Inc. v. B.V.A. Credit Corp., 218 Va. 849, 857-58,
241 S.E.2d 778, 782-83 (1978).
Further, the evidence failed to establish collusion or
concert of action between JLM Group and ASB. There was no
evidence showing that either Dominion or ASB received a copy of
the unrecorded Purchase Agreement. Thus, although the
complainants argue that ASB gave its approval to building plans
that provided for the alterations to the motel, we do not agree
that such approval constituted participation by ASB in actions
meant to undermine the value of the complainants' security.
The complainants also did not establish that the value of
the motel on Parcel 2, considered as a "self-contained facility,"
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had declined as a result of the renovations. No evidence showed
that the absence of the banquet room on Parcel 2 resulted in a
lower market value. Nor did the complainants quantify any
detrimental effect resulting from the loss of the separate
registration building and sign. Thus, it remained a matter of
speculation whether the value of the complainants' security had
been materially impaired.
Second, we hold that the terms of JLM Group's agreement with
ASB did not materially impair the complainants' security or
materially prejudice them by exposing them to risks they had not
assumed. We disagree with the complainants' contention that our
decision in First Funding Corp. v. Birge, 220 Va. 326, 257 S.E.2d
861 (1979), supports their contrary position.
In Birge, a trustee attempted to subordinate a seller's
deeds of trust to the lien of a single deed of trust covering
both lots, in contravention of the express terms of the seller's
subordination agreement. Id. at 333-34, 257 S.E.2d at 865-66.
We held that this attempted subordination was beyond the
authority given the trustees by the trust document, and that the
trustees had "permitted the quality of [the construction
lender's] security to be enhanced while at the same time caused
the value of [the seller's] security to be undermined." Id. at
334, 257 S.E.2d at 866; see also Business Bank v. Beavers, 247
Va. 413, 416-17, 442 S.E.2d 644, 646 (1994).
In contrast, the complainants' deeds of trust contained no
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express conditions of subordination to the $8,000,000 Dominion
deed of trust on Parcel 2. Instead, they contained unqualified
language of subordination stating that they were "second" and
"third" in priority. Further, Dominion's first deed of trust
securing its $8,000,000 advance, of which the complainants had
notice at the time their subordinated deeds of trust were
recorded, included provisions that Dominion's note and deed of
trust "may at any time be assigned, in whole or in part," by
Dominion, and that the deed of trust may be changed "by an
instrument in writing signed by the party against which
enforcement of the change . . . is sought."
In addition, the Amended Deed of Trust did not purport to
encumber Parcels 1 and 2 with a first lien in the amount of
$14,500,000. Instead, it contained language that maintained all
lien priorities as they existed under the separate Dominion deeds
of trust. Thus, the complainants' deeds of trust on Parcel 2
continued to be subordinated only to a lien on that parcel in the
amount of $8,000,000.
The complainants' security was also unaffected by the fact
that ASB advanced JLM Group the full $14,500,000, a sum greater
than the $11,500,000 needed to purchase the Dominion notes. Both
before and after the assignment, the complainants' liens were
subject only to the deed of trust securing the first $8,000,000
advanced.
The modifications to the agreement between JLM Group and ASB
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were not of such a nature or degree that they materially impaired
the security of the complainants' liens. The modification
agreement was highly advantageous to JLM Group in providing for a
lower interest rate and significantly decreased payments. Since
these changes improved JLM Group's cash flow and rendered its
default less likely, the modifications also benefitted the
complainants.
Although the Dominion notes provided for an "automatic"
five-year extension, such an extension depended upon the
fulfillment of several conditions, including a showing that there
was no "deferred maintenance" on the property. Since the
evidence failed to show that these conditions would have been
met, the complainants have failed to show that they were
prejudiced by the lack of such an extension provision in ASB's
note.
The complainants further argue that they were prejudiced
because ASB required a guaranty of only $5,500,000 of the total
debt, whereas the Dominion guaranty covered a potential
$14,500,000. The Dominion guaranty, however, provided that the
guaranty would be reduced to $1,250,000 if JLM Group achieved a
specified debt service ratio, and the complainants did not show
that the ratio had not been achieved or that the reduction had
not taken place.
The trial court recognized that some provisions of ASB's
modified agreement with JLM Group might subject the junior
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lienors to increased risk. In reserving the right to declare JLM
Group in default whenever ASB perceived a "material adverse
change" in the financial condition of a borrower or guarantor,
and in further reserving the right to apply insurance proceeds to
its debt rather than to repair of the property that secured the
junior liens, ASB protected itself but potentially disadvantaged
the complainants.
Nevertheless, the trial court properly considered these
matters in light of all the circumstances of the case, including
the complainants' unconditional subordination and their failure
to reserve control over any changes in the terms of the senior
lien. The trial court also weighed the fact that several
provisions of the modified agreement with ASB benefitted the
complainants. Thus, in reaching its conclusion that JLM's
agreement with ASB did not prejudice the junior lienors, the
court considered the evidence and weighed the equities, without
looking solely at the rights of one party and ignoring those of
the other. See Virginia Pub. Serv. Co. v. Steindler, 166 Va.
686, 698, 187 S.E. 353, 358 (1936).
For these reasons, we will affirm the judgment of the trial
court.
Affirmed.
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