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Carondelet Savings & Loan Association v. Citizens Savings & Loan Association


August 3, 1979


Appeal from the United States District Court for the Eastern District of Illinois, East St. Louis Division. Nos. 73-298-E and 73-302-E -- James L. Foreman, Judge.

Author: Cummings

Before CUMMINGS, Circuit Judge, PECK, Senior Judge,*fn* and PELL, Circuit Judge.

CUMMINGS, Circuit Judge. On October 14, 1965, defendant Citizens Savings & Loan Association (Citizens) sold plaintiff Carondelet Savings & Loan Association (Carondelet) a 35% interest in a certain loan and the parties entered into a loan participation agreement which provided that Citizens was to service the loan. Citizens foreclosed on the real estate securing the loan in May 1973 and at the same time Carondelet sued Citizens for breach of fiduciary obligation and breach of contract.*fn1 Claiming that Citizens should have foreclosed sooner and should not have agreed to certain modifications of the loan, Carondelet sought damages of $431, 597.81*fn2 or, in the alternative, rescission of the purchase and the participation agreement.*fn3

After a full trial, Judge Foreman held that the plaintiff had failed to establish any breach of fiduciary obligation or breach of contract and entered judgment for the defendant. We affirm.


During the summer of 1965, Cherry Realty, Inc., a Delaware corporation doing business in Illinois, negotiated with Citizens for a loan for the construction of the Pyramids Dormitory, a student dormitory in Carbondale, Illinois. Based in part on an appraisal indicating that the building would be worth $2 million, Citizens agreed to loan $1.4 million with interest at 6 1/4 for 20 years. Carondelet agreed to purchase a 35% interest in the loand, and Bohemian Savings & Loan Association (Bohemian) agreed to purchase another 35% interest. Bohemian, like Carondelet, is a Missouri corporation, but it is not involved in this lawsuit. Citizens retained the remaining 30% interest in the loan.

On September 23, 1965, Citizens executed the agreed-upon loan to Cherry Realty, Inc. and took back a promissory note and a mortgage on the dormitory. On October 1, 1965, Cherry Realty, Inc. conveyed the property to Rawlings Dormitory Trust, an Illinois land trust. On October 14, 1965, Carondelet purchased its 35% interest in the loan and entered into a participation agreement that provided for Citizens to service the loan,*fn4 retaining a fee of 1/4 of 1% for doing so. On September 1, 1966, Rawlings Dormitory Trust merged with another Illinois land trust to form Investors Land Trust (Investors). Subsequently, on February 12, 1968, Cherry Realty, Inc. was dissolved and on February 27, 1968, the shares representing beneficial interests in the newly created Investors Land Trust were registered with the Illinois Secretary of State.

Apparently the loan presented no problems until December 10, 1969, at which time the manager of the property*fn5 requested a modification of the loan terms because of a drastic downturn in the demand for student dormitory space.*fn6 The manager asked for an advance of ten months' interest payments, to be held by Citizens and applied to monthly payments as they became due and for an extension of the loan term from 20 to 25 years. This request also applied to a number of dormitories held by Investors to which Citizens had made loans. Citizens held a 50% interest in the loans on these other dormitories, and Carondelet was not involved in them.

In response to the loan modification request, Citizens called a meeting of the loan participants. Although Bohemian apparently did not object, Carondelet objected to the advance or any modification in terms and advocated foreclosure. Citizens concluded that the loan should be modified, but because of Carondelet's resistance to making an advance, the payment schedule was instead modified effective February 27, 1970, to reduce the monthly payments of $10,233 to $8,443. The loan again became delinquent in the summer of 1971, when payments for the months of July, August and September were missed. In October 1971, Citizens loaned $120,000 to Investors in return for a second mortgage on Washington Square, a dormitory which was held by the trust. Washington Square Dormitory was then under a contract of sale to the University. The proceeds of this loan were used to bring the payments on the Pyramids Dormitory up to date and to convert some of the rooms in Pyramids into efficiency apartments.*fn7

Even more serious problems were encountered with the loan in early 1972. Carondelet objected to any further modification but did not attend meetings of the loan participants to determine a course of action. *citizens and Bohemian agreed to grant a moratorium of all payments on the loan for the 8 months from April 1, 1972, until December 1, 1972, to reduce the monthly payments further to $7,875, and to segregate the income from Pyramids from the other income of Investors.*fn8 Nevertheless, the December 1972 payment was not made and soon thereafter Citizens proceeded to foreclose.

Carondelet then brought this action, alleging, as indicated, that Citizens' granting of the modifications and refusal to foreclose earlier constituted a breach of fiduciary obligation or a breach of the loan participation agreement. Carondelet sought damages in the face amount of its participation interest on the theory that its interest had been converted by Citizens. In the alternative, it sought to rescind the purchase and the participation agreement. The district court held that there had been no breach by Citizens of either the fiduciary relationship or of the contract. We agree.

Judge Foreman acknowledged that Citizens was a dominant fiduciary, but concluded that under Illinois law the burden of proving breach of fiduciary duty shifts to the defendant only after the plaintiff has demonstrated both the defendant's dominance and that the defendant benefitted at the expense of the plaintiff. The court concluded that Carondelet had demonstrated neither that Citizens profited from its fiduciary relationship nor that Citizens had breached the duty of care to which a fiduciary is held.

On appeal, Carondelet urges that Judge Foreman erred in not shifting the burden of proof to Citizens. The cases cited in support of this argument recognize that the burden of proof shifts "wherein the dominant party is profited." Boryca v. Parry, 24 Ill.2d 320, 327 (1962). Thus the question becomes whether Judge Foreman erred in concluding that Carondelet had failed to show that Citizens benefitted from the relationship. Carondelet first suggests that the 1/4 of 1% service fee retained by Citizens constitutes such a benefit. However, such a fee, freely negotiated between commercial lenders, is not a benefit of the sort that shifts the burden of proof to the defendant. Brown v. Commercial National Bank of Peoria, 42 Ill.2d 365, 369 (1969). There was no conflict of interest between collecting this small fee and acting in the best interests of the loan participants, especially since Citizens itself retained a 30% interest in the loan.

Second, Carondelet asserts on appeal that

"[the] evidence clearly showed that Carondelet's loan participation remained unpaid while Citizens, on other loans to which Carondelet was not a participant, was being concurrently repaid. Citizens received benefit from its manipulations of the collections and servicing" (Br. 37).

No citation to the record is provided in support of this assertion. Judge Foreman found that

"[it] is clear that Citizens attempted to make this project a financial success.

Reasonable collection methods were followed by Citizens" (App. 5, 8).

Our own review of the record fails to substantiate Carondelet's claim that Citizens manipulated various loans to its own advantage.*fn9 Thus, we agree with Judge Foreman that under Illinois law Carondelet has failed to shift the burden of proof to Citizens.

We also agree that Carondelet has not demonstrated that Citizens breached its fiduciary duty by failing "to exercise the care and prudence which ordinary men would exercise under like circumstances in dealing with their own affairs" (App. 5). Judge Foreman specifically found that Citizens' collection efforts were reasonable at the time. We cannot say that he erred in this conclusion. On appeal, Carondelet urges a number of specific instances in which Citizens allegedly acted or failed to act in such an unreasonable manner as to demonstrate either a breach of fiduciary duty or a breach of any authority delegated under the contract to Citizens to modify the loan terms. These assertedly wrongful actions will be discussed below, but we are convinced that none of them, singly or in the aggregate, justifies a reversal of the district court's judgment.

No Breach Of Contract Has Been Shown

Carondelet also argues that Citizens' modificatons of the loan without its consent constituted a breach of contract. Specifically, Carondelet asserts first that Citizens had no authority under the participation agreement to do anything other than collect and disburse funds. In the alternative, Carondelet asserts that if Citizens did have some authority to modify the loan, it was limited to sound servicing practices. Certain actions assertedly departed so far from this standard as to constitute a breach of contract. Carondelet's objections to specific actions will be considered in the next section of this opinion. The focus here will be on the scope of Citizens' authority under the participation agreement.

Citizens relies on Paragraph VIII of the Loan Participation Agreement, which provides in relevant part that

"[it] is agreed that the exclusive right to decide how to service such loans and what to do and how to do it and * * * when to foreclose * * * is hereby vested in the Seller [Citizens]. The Buyer shall not be authorized to give directions to the Seller in connection with these matters."

Citizens claims that the authority to service the loan granted in Paragraph VIII encompassed all of its challenged actions -- most importantly the two modifications granted in 1970 and 1972, the permission to convert the dormitories into efficiency apartments and forebearing from foreclosure until May 1973. Carondelet, on the other hand, asserts that "servicing" includes only collecting and disbursing the loan proceeds and that Citizens was obligated to foreclose when the loan first went into default. This obligation is said to be based on Paragraph VI of the Loan Participation Agreement, which provides

"In the event of the inability of the Seller to collect any of said loans after exercising reasonable efforts to do so, Seller agrees to give prompt notice to Buyer, and to proceed to foreclose the same * * *."

Judge Foreman held that "[the] participation agreement imposed no obligation upon Citizens to immediately foreclose upon default" (App. 7). We agree. Foreclosure was required only after exercising reasonable collection efforts. Moreover, Paragraph VIII (quoted supra) specifically granted the Seller authority to determine when to foreclose.Thus Citizens clearly had the authority not to foreclose. The remaining question -- whether its forberance was reasonable in the circumstances -- will be discussed later.

With regard to whether "servicing" includes the kinds of modifications to the loan and collateral that Citizens authorized, neither party has cited a case directly on point, nor has our own research disclosed one. Carondelet relies on Board of Commissioners of Shawnee County v. Cook, 141 Kan. 677, 42 P.2d 568 (1935), but as Citizens points out, there was no participation agreement in the Cook case. Therefore it can shed no light on the proper interpretation of the agreement before us.*fn10 Citizens relies on treatises which specify that loan modification is included in the servicing function. While this may very well be so for a loan wholly owned by the association servicing it, it is not clear that this broad definition applies generally to participation interests owned by others.

However, we agree with Judge Foreman that the participation agreement in this case permitted the kinds of modifications allowed by Citizens, even over Carondelet's objections. Although inartfully drafted, the agreement as a whole clearly intended to grant a great deal of discretion to the seller servicer. While the agreement does not say in haec verba that the Seller may modify the loan term or collateral, the term "servicing" is sufficiently ambiguous as to make admissible the evidence put on by Citizens to show custom and usage in the industry. Ciizens' expert witnesses testified that in their opinion "servicing" would include the kinds of modifications at issue here, even in a participation loan. In the context of this testimony and the treatises cited by Citizens, it seems likely that if it were intended to limit the power of the servicer to modify the loan, this would have been done expressly.

The canon of contract construction that requires an agreement to be read strictly against the party that wrote it is not helpful here, since the agreement was a form contract put out by the United States Savings and Loan League. Prior to the 1970 loan modificaion, when Carondelet had voiced its objection to a further advance or to extension of the term of the loan, Citizens sought the advice of the Savings and Loan League as to whether the proposed modifications were permissible under the form agreement. The Assistant Counsel for the League responded affirmatively, noting that the "form was designed to 'vest complete decision-making power in the seller-servicer' as to servicing advances and collection * * *" (App. 60).*fn11

Moreover a practical construction of the participation agreement favors Citizens' interpretation. although an institution acting as an agent in servicing a loan wholly owned by another might not have the implicit power to modify the loan without the owner's consent, it is manifest that in the context of a participation agreement some party must have the authority to decide whether to modify or to foreclose. Here Citizens and Bohemian, holding interests aggregating 65%, wished to modify whereas Carondelet favored foreclosure.*fn12 Northing in the Participation Agreement gives Carondelet the power to insist on foreclosure in such a situation, and we are satisfied that the authority to decide what to do was vested in Citizens.

Citizens' Actions Were Not Unreasonable

Carondelet has objected to a whole series of decisions taken by Citizens, urging that they demonstrate either bad faith or such commercially unreasonable behavior as to establish a breach of the fiduciary's duty of care or a breach of the contractual obligation to service the loan "consistent with good mortgage practice" (Paragraph V of Loan Participation Agreement). Many of the actions objected to by Carondelet were found by Judge Foreman to be reasonable collection efforts and servicing of the loan consistent with good mortgage practice, since circumstances dictated that "an attempt be made to salvage the loan as a going business as opposed to immediate foreclosure" (App. 6). Judge Foreman specifically found that the reduction of payments and extension of term granted in 1970, the permission to convert part of the building to efficiency apartments, the permission to the debtor to withhold payment of escrow funds for taxes and insurance, and the granting of an eight-month moratorium on payments in 1972 all were reasonable under the circumstances.*fn13 We are convinced that the evidence supports these conclusions.

On appeal, as well as re-arguing at length the conclusions specifically reached by the district court, Carondelet emphasizes certain other instances that assertedly demonstrate Citizens' bad faith or unreasonable business judgment. Carondelet asserts, for instance, that "Citizens received benefit from its manipulation of the collections and servicing" (App. 37). As we have already indicated, the record does not disclose that such manipulation was established.*fn14 Similarly, Carondelet speculates that "[the] Pyramids project may well have been thus viewed [by Investors] as a highly leveraged tax loss, rather than a long term investment * * *" (Br. 12). The record is devoid of support for this charge.

Sufficient explanation was given for other actions by Citizens to rebut Carondelet's charges that they were unreasonable. There was, for instance, testimony that asserting control over the income stream (rents) would have been very difficult in a student dormitory situation (Tr. 60). Similarly, a $40,000 disbursement to the beneficial owners of the land trust in early 1969 out of 1968 income couldnot have been prevented because the loan was current at that time (Tr. 335). The $22,899.98 that was left in the Pyramids account at the end of 1972 and apparently never recovered was said to be necessary for operating expenses.

Only two of the objections pressed by Carondelet on appeal warrant extended consideration, and we conclude that they too were reasonable responses to the circumstances. First, Carondelet asserts that Citizens had no power to grant a moratorium of payments because under the Illinois Savings and Loan Act (Illinois Rev. Stat. ch. 32 ยง 796(a)), such a moratorium can be granted only if certain conditions are met, and can only be granted for payments of principal.*fn15 It is undisputed that the conditions set out in Section 796(a) were not met, and that the moratorium extended to payments for interest, taxes and insurance, as well as for repayment of principal. Citizens contends that the authority granted to an association in Section 796(b) "to modify, in any manner not inconsistent with the provisions of this Act, the terms of a loan as to the amount time, or method, of the payments to be made, the interest rate, and any other provision of the loan contract * * *" allows it to grant a moratorium even though the conditions of Section 796(a) are not met. Although there appears to be no Illinois authority interpreting these Sections, we think the proper construction of the statute clearly is that Section 796(b) allows savings and loan associations freely to modify loans except with respect to "extensions" as that term is used in Section 796(a). "Extensions" in that subsection clearly means deferrals of payments, or what Carondelet has called a moratorium. Such extensions are allowed only when the conditions set out in Section 796(a) are met. Moreover, it is well established that Illinois savings and loan associations have only those powers granted by law (Africani Home Purchase & Loan Association v. Carroll, 267 Ill. 380, 391 (1915); Fritze v. Equitable Building & Loan Society, 186 Ill. 183 (1900)) so that the fact that the language of Section 769(a) is permissive rather than prohibitive does not help Citizens.

The fact that a savings and loan association could not in ordinary circumstances legally grant a moratorium of the sort involved here does not mean, however, that Citizens was in breach of Illinois law, its fiduciary obligations or the contract. The Illinois Savings and Loan Act also provides associations substantial salvage powers.*fn16 Examinations of Citizens by the Illinois Savings and Loan Commissioner both prior to and after the Pyramids loan had been foreclosed did not indicate any objection to the handling of the Pyramids loan (Ex. 78, 88, 90, 91). Moreover, Judge Foreman specifically recognized that Citizens was attempting to salvage the loan. In this circumstance, we do not consider the limitations of Section 796(a) apply to deprive Citizens of the power to take the action it reasonably believed to be in the best interests of itself and the other loan participants.

Finally, Carondelet insists that Citizens exculpated various persons and assets from recourse on the loan. It has developed two separate theories of exculpation. First, it asserts that since Cherry Realty, Inc. originally signed the note, its assets would have been available to satisfy the loan. Assertedly some distributions were made to the shareholders on dissolution, and under Delaware law the corporate liability could, to the extent of such distributions, be asserted against the shareholders for up to three years after the corporation was dissolved. Since the corporation was dissolved in February 1968, theoretically Citizens could have proceeded against the shareholders if it had instituted foreclosure proceedings before February 1971. Yet during this time Citizens modified the loan in 1970 and loaned an additional $120,000 in 1971, part of which was used to make delinquent monthly payments.*fn17 Through these maneuvers, Carondelet asserts, Citizens exculpated Mr. Cherry and Mr. Goss, the sole shareholders of Cherry Realty, Inc. There is, however, no evidence in the record which would show that Citizens' actions during the years in question were other than good faith attempts to rehabilitate the loan. Moreover, there was undisputed testimony by Citizens' President, Mr. Dunck, that the note was signed by Cherry Realty, Inc. only so that the corporation could waive the privilege of redemption in the mortgage (Tr. 414, 416). He testified in addition that Carondelet was clearly infomred that the security would immediately be transferred to a land trust,*fn18 that no one would be personally liable and that the sole source of satisfaction for the debt would be the building itself (Tr. 311, 312, 383-384, 419, 424). We therefore cannot conclude that Citizens exculpated the shareholders of Cherry Realty, Inc.

Carondelet's second theory is that after Pyramids Dormitory was transferred from Rawlings Land Trust to Investors Land Trust, all of the assets of the latter trust (though not the personal assets of the beneficiaries) became available to satisfy the Pyramids debt.*fn19 The 1972 modification, however, specifically provided that no other assets of the merged trust could be reached by the lenders (Ex. 69). Carondelet's theory that but for this provision the other assets of the trust would have been reachable is based on three facts: (1) the February 1968 registration of the shares resulting from the merger of the land trusts stated that "[the] trustee of the new merged trust * * * shall assume and agree to pay all existing and outstanding obligations and debts in connection with such land * * * as are transferred to him as Trustee" (Ex. 25, p. 14); (2) the income from all of the properties held by the merged trust was commingled; and (3) a letter to Citizens from its counsel prior to consummation of the 1972 modification assumed that the other assets of the merged trust could be reached if the Pyramids loan was foreclosed. However, Mr. Dunck, President of Citizens, unequivocally testified that it was never intended that assets held by the merged trust other than the Pyramids Dormitory would be available to satisfy this particular debt. Carondelet put on no witnesses to rebut this version of the original understanding even though Mr. Tarter, who as Carondelet's then-president negotiated the purchase of the participation, was still a member of Carondelet's board and apparently available. The language quoted above from the registration statement is consistent with Mr. Dunck's position that it was intended to assure merely that the merged trust took the property subject to the mortgage. The commingling of the income from the various properties held by the trust does not demonstrate that the properties themselves were available to satisfy the Pyramids debt. It apparently was thought at first that the income from the other properties would help to meet the monthly payments on the Pyramids loan. When it was determined that the income from Pyramids might in fact be the most reliable in the trust, this income stream was required to be segregated (Ex. 69). In light of Mr. Dunck's unrefuted testimony, the fact that counsel to Citizens assumed in April 1972 that other assets of the merged trust would be available in foreclosure cannot be controlling. The specific disclaimer in the subsequent modification agreement is as consistent with an attempt to clarify this apparent misunderstanding as it is with an exculpation of otherwise available assets.

All of the testimony regarding whether there was any unauthorized exculpation was before Judge Foreman. Although he did not address the question specifically, it was implied in his conclusions that there was no exculpation. Our independent examination of the record reveals no reason to upset this or any other of the district court's conclusions.

For these reasons, the judgments appealed from are affirmed.

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