# FILED
September 24, 1998 Cecil W. Crowson Appellate Cou rt Clerk 

### IN THE COURT OF APPEALS OF TENN ESSEE

AT NASHVILLE

METRIC PARTN ERS GROWTH ) SUITE INVESTORS, L.P., ) ) Plaintiff/Appellee, ) ) VS. ) ) NASHVILLE LODG ING COMPANY; ) Appeal No. 2300 ELM HILL PIKE, INC., ) 01-A-01-9712-CH-00723 ) Defendant/Appellant, ) Davidson Chancery ) No. 96-1405-III and ) ) ORLANDO RESIDENCE, LTD. ; and ) LA SALLE NATIONAL BANK as ) trustee under t hat certain poo ling ) and servicing agr

eement dated ) July 11, 1995, for the holders of the ) WHP Commercial Mortgage Pass ) Through Certificates, Seri es 1995C1, ) and ROBERT M. HOLLAND, JR ., ) Trustee, ) ) Defendants/Appellants. )
APPEALED FROM THE CHAN CERY COUR T OF DAVIDSO N COUNTY AT NASHVILLE, TENNESSEE THE HONORABLE ROBERT S. BRA NDT, CHANCELLOR

ALAN T. FISTER STEWART, ESTES & DONNELL 424 Church Street Nashville, Tennessee 37219- 2392 MIKE BUCKLEY CROSBY, HEAFEY, RO ACH & MAY 1999 Harrison Street Oakland, California 94604-2084 Attorneys for Plaintiff/Appellee SAMUEL L. FELKER JOSEPH F. WELBORN, III BASS, BERRY & SIMS 2700 First American Center Nashville, Tennessee 37238- 2700 Attorneys for Defendant/Appellant EUGENE N. BULSO, JR.- 2 -

BOULT, CUMMINGS, CONNERS & BERRY 414 Union Street Nashville, Tennessee 37219-8062 Attorney for Defendant/Appellee Or lando Residence, Ltd. KENNETH M. BRYANT TRABUE, STUR DIVANT & DEWITT 522 Union Street Nashville, Tennessee 37219- 1738 HUNTER T. CARTER ARENT, FOX, KINTNER, PLOTKIN & KAHN 10 50 Co nn ec ti cu t A ve nu e, N. W. Washington, D.C. 20036-5339 Attorneys for Defendants/Appellees LaSalle National Bank and Robert M. Holland

AFFIRMED AND REMAN DED

BEN H. CANTRELL, JUDGE
CONCUR: TODD, P.J., M.S. CAIN, J.- 3 - 

## O P I N I O N

The owner of a hotel s ubject to a firs t mortgage sold the building and its
co ntents to the plaintiff and took a second mort gage to secure the purchas e p rice

. The plaintiff also operated the hotel unde r a ground lease with the owner. When the
owner failed to pay the first mortgage, the plaintiff sought a decl aratory judgment that the owner

was in default, that the plai ntiff could pay the first mortgage directly to the mortgagee, and that the plaintiff was disc harged from its obligati on to the owner. The
owner resisted the declaration on the ground that it had cert ain defenses against the first mortgagee. TheChancery Court of Davidson County g ranted summary judgment to the plaintiff. We affirm.

I.

In 1983 National Lodging Company (NLC) borrowed the mon ey t o finance the construction of a Marri ott Hotel in Nashvil le. NLC signed a note and deed of trust giving the lende r a firs t mortgage on the property . The original lender w ent into rece ivership and the note became the property of the Resolutio n Trus t Corpo ration. The note passed through two other hands before it was finally transferred to LaSalle National Bank, and it is referred to throughout the record as “the LaSalle note.”

In 1989 NLC sold the hotel improvements to the plaintiff , Metric Partners Growth Suite Investors, L.P., and entered into a long term ground lease with Metric. Metric executed a note to NLC secured by a deed of trust on the hotel improvements. Thus, Metric mad e monthl y payments to NLC and NLC made t he paym ents on the first mortgage.- 4 - As a part of

the 1989 transaction, Metric, NLC, and the or iginal lender entered into a threeparty agreement. The agr eement provided that in the ev ent NLC defaulted on the payment s on the first mo rtgage (1) the lender would notify M etric of the default and Metric could cure th e default within ten days after receiving the notice, and (2) Metric could then assume NLC’s obligations under the firs t mortgage and be discharged from any further obligations to NLC on the second mortgage.

In Ja nu ary of 1996 (for reasons we will discuss in a later part of this opinion) NLC failed tomake its payment to LaSalle, and filed a bankruptcy petition in the United State Bankruptcy Court for the Eastern Distr ict of Wisconsin. On April 5, 1996 LaSalle notified Metric of the d efault. On April 15, 1996 Metric cured the default bymaking the required pay ment directly to LaSalle. At the same time Metric noti fied NLC that Metric was ex ercising its rig hts to pay LaSalle direc tly under the three party agreement, and that NLC should void the second mortgag e. When NLC refused to honor that arrangement and threatened to foreclose on the second mortgage, Metric filed this action seeking declarat ory and injunctive relief. NLC’s defense rested on the following assertions: (1) that i t had a defense against LaSalle’s collection of the note; (2) that it had a bad faith and unclean hands defense against M etric; (3) that it w as not in default on the LaSalle note; and ( 4) that the three party ag reement did not afford Metric relief from the second mor tgage.

II. The Recoupment Defen se

NLC asserts that it was not in default on theLaSalle note because it had
a $1,700.00 judgment against the Resolution Trust corporat io n (RT C), one of the holde rs in LaSa lle’s chain of title. The obl igation arose when the RTC became the receiver for the original lender and repudiated a refinancing ag reement NLC had with the original lender. N LC recovered the judgment against RTC as c ompensation for- 5 -

t he breach. Since LaSalle’s status as a holder in due course is disputed, we wil l assume that this defense, if it ex ists, may be asserted ag ainst LaSalle.

The recoupment question was litigated in the case that established NLC’s claim against the RTC. NLC askedfor a declarati on that it had a r ight to set-off
or recoupment against the purchas er of the note from the RTC. The D.C. Circuit held that the Financial Institutio ns Reform, Recovery and Enforcement Act (FIRREA) allowed the RTC to sell the asse

ts of a failed thri ft free and clear of any encumbrances arising from a borrower’s counterc laims; and that the purchaser o f the NLC note did not assume the claim against the RTC. Therefore, NLC could “recov er these amounts only fro m the RTC in its primary claim for damages.” Nashville Lodging Co. v. Resolution T rust Corp. , 59 F.3d 236 at 247 (D.C. Cir. 1995).

We recognize, however, that NLC’s position in this case rests on a disti nction between a defense to the note and a cl aim against the assignee of the note. The D.C. Circuit acknowledged that such a distinction might be made, but the court refused to address it because NLC had not raised it in that case. See 59 F.3d at 247. Thus the precise questi on raised here was not dec ide d b y the court in the litigation between N LC and RTC.

Other cou rts have allowed a recoupment defense to a note when an assignee has sued to collect the note. See FLSIC v. Mackie , 962 F.2d 1144 (5th Cir. 1992); DiVall Insured Incom e v. Boatmen’s Fi

rst Nat’l Bank

, 69 F. 3d 1398 (8th Cir. 1 995). A recoupment defense , however, even ag ainst a non holder in due course , must arise out of the same transactio n that gave rise to the instrument. See Tenn. Code Ann. § 47-3-305(a)(3); Howard v. Abernathy , 751 S.W.2d 432 ( Tenn. App. 1988). NLC concede

s that the cl aim a gainst th e RTC arose out of the refinancing agreement, a contract separate from the note. Therefore, w e are sa tisfied that the recoupmentdefense was not available to NLC, regardless of whether RTC ha d the power to strip defenses from the assets it sells.- 6 - III. NLC’S Default and N otice

We have dealt with NLC’s arg ument that it was not in default because of the recoupment defense. Withoutthat defense, NLC must concede that it was in default for not making the January and Feb r uary payments in 1996. It also must concede that LaSalle gave notic e of the default by letter on April 5, 1996. Therefore, the two conditions pre ce dent to Metric’s action in curing the default are met. The “other” defaults alluded to by the chancellor, of which NLC alleges it had no notice, are now beside the point.

IV. The Three Party Agreement

NLC makes a similar argument w ith respect to Metric’ s rights under the three party agreement, i.e., t hat because NLC was not i n default, Metric could not
assumethe NLC note and be free of the second mortgage. Our d iscussion in Parts II and III of this opinion disposes of this argument as well.

V. The Bad Faith and Un clean Hands Defenses

NLC traces its ill fortune t o a n alleged breach of a 1993 settlement agreemententered into by NLC, Metric, and others in the California Superior C ourt at San Francisco. To settle some l itigation unrelated to the Nashville property, Metric agreed to purcha se the Nas hvi lle p roperty “as is, including but not limited to title issues.”The settlement fell through, how ever, when Metric discovered that NLC’s title
was clouded by

two actions filed in Nashville to set aside fraudulent convey ances by NLC and by some lien claims that had been filed against the property. NLC sued- 7 -

Metric in chancery court in Nashville for b reach of t he settlement agreement and obtained a judgment of liability . The damages have apparently not been ascertained.

NLC’s difficul tie s intensified in 1995 when Or lando Residence, Ltd. obtained a judgment against NLC for a fraudulentconveyance. Metri c was one of the defendants in that litigationand one of the claimed fraudulent conv eyances was the sale of the hotel to Metric in 1989. After obtaining the judgment, Orlando served a notice of garnishment on Metric i n December of 1995. On January 2, 1996 NLC filed its petition in bankruptcy.Metric filed an interpl eader in the bankrupt cy c ourt and tendered to the court its January 1996 payments und er the ground lease and the second mortgage. The interpleader alleged that Metri c wou ld continue to make its payments to the court until further orders.

This court reversed the jud gment in favor of Orlando on December 18, 1996, and the cause was remanded for a retrial on all iss ues. On remand the trial court held that Orlando was, neve rtheless, a bona fide purchaser of the property at
a prior foreclosure sale. The net result is that Orl and o is now the owner of the property previously owned by NLC.

On February 13, 1996 the bankr uptcy court dismissed N LC’s petition because it wasfiled in bad faith. As we have indicated, LaSalle declared a default in April of 1996 and Metric cl aimed its rights under the three party agreement.

NLC’s bad faith and clean hands defenses are pr imarily based on Metric’s failure to abide by the settlement agreement in the California litigation . The rule NLC relies on has been stated in many Tennessee cases. It can be found in its distilled form in Gibson’s Suits in Chancery §18: This maxim d eclares

that a pl aintiff

who has been guilty

of unconscientious

conduct or bad faith , o r has committed any wrong, in reference to a particular transaction , cannot have the aid of a Court of Equity in enforcing any alleged rightsgrowing out of such transaction. In the orig in of the- 8 - jurisprudence, the th eory was adopted that a C ourt of Equity interposed only to e nf orce the requirements of good conscience and good reason as t o matters not equitablydeterminable in the Law Courts. This interposition being deemed a matter of grace, it would not be exerc is ed in favor of a person whose conduct in the matter complained of

had been unconscientious, or in bad faith, or who had violated an y of those principles

of Equity and righteous dealing, w hich the Co urt had been constituted to enforce. Although used chiefly in cases see king e quitable relief, the bad faith/clean hands defense has been held to apply to legal claims, Continental Bankers Life Ins. Co. v. Simmons , 561 S.W.2d 460 (Tenn. App. 1977). But the unconscientious conduct must arise out of the particular transaction which is the subject of the litigation. Hogue v. Kroger Co. , 373 S.W.2d 714 (Te nn. 1964).

The California l itigatio n does have a connection to the Nashville property since Metric was to purc hase the prope rty as part of that agreement. But the legal rightsand liabilities involved in that litigation were entirely separate from the financing of the Nashville property or the 1989 three party ag reement.

NLC argues that Metric’s failure to purchase th e Nashville property forced NLC into default. That may or may not be true, but that claim is the subject of
a separate action for which NLC is seeking a judgment for damages. We assume that its damages claim will include its losses res ulting from its default on the LaSalle note.

For all ofthese reasons, we affirm the cha ncellor’s decision to disallow the good faith/clean hands defense.

Finally, there are no facts in this record from which an inference could be drawn that Metric acted in any way except in accordance wit h its best business j udgment. That does not mean that it is free of a claim that it violated N LC’s legal rights. But it does mean that there is n o proof that would meet the burden NLC has to meet.The judgment of the court below is affirmed and the cause is remanded

to the Chancery Court of Dav ids on County

for any further proceedings that may become necessary. Tax the costs on appeal to the appellant.

____________________________ BEN H. CANTRELL, JUDGE

CONCUR:

_______________________________ HENRY F. TODD, PRESI DING JUDGE MIDDLE SECTION

_______________________________ WILLIAM B. CAIN, JUDGE