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American Fletcher Mortgage Co. v. Cousins Mortgage and Equity Investments

decided: June 20, 1980.


Appeal from the United States District Court for the Southern District of Indiana, Indianapolis Division. No. IP 75-339-C -- William E. Steckler, Judge .

Before Cummings, Circuit Judge, Wisdom, Senior Circuit Judge,*fn* and Cudahy, Circuit Judge.

Author: Cudahy

Plaintiff, American Fletcher Mortgage Company, Inc. (the "Mortgage Company"), a mortgage brokerage concern, brought this action against Cousins Mortgage and Equity Investments ("Cousins") seeking a declaratory judgment that the Mortgage Company had complied with the terms of the parties' participation agreement (as amended). Cousins counterclaimed for damages resulting from the Mortgage Company's alleged breach of the participation agreement and the fiduciary duty it owed to Cousins.

Through the participation agreement, dated June 12, 1973, between the Mortgage Company and Cousins, Cousins participated to the extent of $2,100,000 in a non-recourse loan of $4,200,000 made by the Mortgage Company to Norbeck Development Associates ("Norbeck"), a Virginia limited partnership. Norbeck engaged in the development of the Water Oaks project, a condominium project near Virginia Beach, Virginia. Eighty percent of the remaining $2,100,000 of the mortgage money was allocated to American Fletcher Mortgage Investors ("AFMI") (for which the Mortgage Company acted as advisor) and 20% was allocated to a sister corporation, American Fletcher National Bank & Trust Company ("AFNB"). Norbeck mortgaged the property in question to the Mortgage Company to secure the $4,200,000 loan.*fn1

After a series of events generally paralleling the onset of severe economic problems for the Water Oaks development, the Mortgage Company released its mortgage on the land which secured its loan for "Phase I" of the Water Oaks project and brought this action for a declaratory judgment. The district court found that the actions of the Mortgage Company were authorized and valid and not in breach of its contractual obligations and that the Mortgage Company had acted in good faith at all times. Cousins' counterclaim was dismissed.

Cousins argues on appeal that the Mortgage Company violated the amended participation agreement in several ways: (1) by releasing the mortgage on Phase I even though the developer Norbeck, was in default on the loan which the mortgage secured and (2) by paying Cousins the release fee out of the proceeds of a second loan rather than out of the proceeds of sales of condominiums as they were sold. Cousins has not argued on appeal that the Mortgage Company breached its fiduciary duty. We agree with the district court's finding that the release did not violate the amended contract because Cousins waived any objection to the source of payment of the release fee, the timing of the payment and Norbeck's default and, therefore, we affirm the judgment of the district court.

1. Facts

For purposes of this analysis, we generally accept the findings of fact of the district court, with certain modifications which will be made clear.

The Mortgage Company has been in the mortgage brokerage business for several years. Its principal business has been to arrange and administer financing for the development and construction of relatively substantial real estate projects. The Mortgage Company does not itself normally provide funds for real estate developers but acquires such funds from large institutional lenders. A lender which contributes to the funds made available to the developer through the Mortgage Company is commonly referred to as a "participant." Each participant enters into a contract with the Mortgage Company (known as a participation agreement) which provides that the latter shall administer the loan, make disbursements, receive payments of principal and interest and so on all on the participant's behalf.

Cousins is an institution which engages in the business of investing in real estate, and in 1973 Cousins was qualified as a real estate investment trust. Both the Mortgage Company and Cousins are sophisticated and experienced in real estate financing.

A. The Land Acquisition and Development Loan

In late 1972, Norbeck contacted the Mortgage Company to arrange financing for a condominium project, "Water Oaks," to be constructed near Virginia Beach, Virginia. The plans for the project called for the acquisition of approximately 43 acres on Chesapeake Bay, the development of that land and the ultimate construction of 350 condominium units. The units were to be divided into three phases: Phase I involved 52 garden and townhouse condominiums located along the beach, and Phases II and III each involved 2 high-rise "towers" with a total of 149 condominium units each.

In January 1973, the Mortgage Company agreed to arrange initial financing for Norbeck so it could acquire the land for the project, begin developing the site and begin marketing and sales efforts to "pre-sell" the condominium units. This initial loan provided a sum of 4.2 million dollars for land acquisition and development and was known as the "LA&D" loan.

Later in that same month, the Mortgage Company offered Cousins a 50% participation in the 4.2 million dollar LA&D loan. The Mortgage Company's offering to Cousins was on the same terms as the offering it made to its own affiliate, AFMI, for a share of the same loan. The written participation agreement, dated June 12, 1973, between the Mortgage Company and Cousins recited that Norbeck would not be personally liable for the loan and that Norbeck would pay interest on the outstanding principal of 51/2% over AFNB's fluctuating prime rate. The participation agreement also provided that the Mortgage Company would have a right of first refusal to arrange the construction loans for the condominiums and, with respect to any future loans for subsequent construction of the condominium units, the various investors would receive a share of the profits from unit sales in addition to interest and other fees. In the June 12, 1973, participation agreement Cousins accepted a 50% participation in the LA&D loan subject to certain terms and conditions it requested, including the condition that Cousins be offered the right to participate with the Mortgage Company in a later construction loan for improvements on the property in question.

The documents presented to Cousins, upon which its approval of a 50% participation was based, indicated that the principal of the LA&D loan was to be paid down "at a rate of not less than $15,000 per unit." This meant that, until the 4.2 million dollar LA&D loan was completely retired, for each condominium unit constructed and sold, Norbeck would pay at least $15,000 to the Mortgage Company to reduce the principal of the LA&D loan. This mode of loan retirement would have resulted in the LA&D loan's being retired at the time that the first 280 units of the project had been built. In other words, 80% of the units would have borne the cost of the entire $4,200,000 LA&D loan, which had been provided for a 350-unit project.

Although Norbeck was obligated to repay the loan at a rate of at least $15,000 per unit constructed, no price for the release of the mortgage encumbering the property was set. Thus when the LA&D loan closed on February 20, 1973, the release of the mortgage was a matter for future negotiation between the Mortgage Company and Norbeck.

Similarly, the participation agreement between the Mortgage Company and Cousins did not establish the conditions under which the Mortgage Company could release the mortgage. Thus, paragraph 8 of the agreement states that the Mortgage Company may not release the collateral securing the LA&D loan (or take certain other actions) without Cousins' "prior written consent," but it does not set a release price. Paragraph 5 of the Agreement provides for the Mortgage Company to perform a number of routine loan administration functions, including acceptance of payments of the note from Norbeck and execution of satisfaction of mortgage documents, without first obtaining Cousins' consent.*fn2

B. The Construction Loan

In the fall of 1973, plans for construction at Water Oaks of the first 52 condominium units (Phase I) were near completion. These 52 units would occupy approximately 20% of the project's 43 acres and construction was financed by a second loan arranged by the Mortgage Company known as the construction loan. Pursuant to the terms of the construction loan agreement the Mortgage Company advanced $2,900,000 to Norbeck for construction and related purposes, including $780,000 budgeted to retire part of the LA&D loan. The $780,000 would provide a pay-down of $15,000 per unit for the 52 units of Phase I.

In its October 4, 1973, letter of commitment for the construction loan, the Mortgage Company agreed to make the 2.9 million dollar loan to Norbeck at an interest rate of 5% over AFNB's fluctuating prime rate. This commitment letter specifically provided for principal retirement payments on the LA&D loan and a release price of $15,000 per unit on the LA&D loan. Norbeck executed the commitment letter on October 16, 1973, and agreed to the $15,000 release fee. Thus, as between the Mortgage Company and Norbeck, the Mortgage Company was obligated to release the mortgage securing the LA&D loan on payment of the $15,000 per unit fee if Norbeck were not in default at the time of payment. However, Cousins and the Mortgage Company had not yet agreed to a release price.

At about this same time, an officer of the Mortgage Company communicated with an officer at Cousins offering Cousins a 50% share of the 2.9 million dollar construction loan. The offering papers presented to Cousins disclosed that $15,000 per unit, or $780,000, would be paid out of the construction loan to reduce the outstanding principal balance of the LA&D loan. The construction loan participation offering also stated in the first paragraph on the first page: "(T)he security consists of approximately 10 acres located in Virginia Beach, Virginia, on which 52 condominium units are to be constructed." The original LA&D loan documents contemplated that release fees would be paid from the amount obtained at closing of individual unit sales rather than from construction loan proceeds, as the construction loan package indicated. But customarily, as Cousins knew, LA&D loans were repaid with construction loan proceeds. To the extent that a participant in the LA&D loan decided to become a participant, pro rata, in the construction loan, the amount of the release fee would be relatively immaterial since the security would merely be shifted from the support of the LA&D loan to the support of the construction loan.

In October 1973 the Mortgage Company also offered portions of the Phase I construction loan to AFMI and to AFNB in shares of 40% and 10%, respectively, but AMFI declined to participate. In January 1974 Cousins informed the Mortgage Company that it would not participate in the Phase I construction loan for reasons unrelated to the status of the LA&D loan. By refusing to participate in the construction loans, Cousins avoided putting more money into the project. In addition, Cousins received its 50% share of the $780,000 release fee for the LA&D mortgage on the Phase I land.

Since Cousins and AFMI were not participating, the construction loan participants would not be the same as the LA&D loan participants. In fact, AFNB (an affiliate of the Mortgage Company) ...

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