Opinion ID: 232455
Heading Depth: 1
Heading Rank: 1

Heading: Objectors' Appeal

Text: 13 1. From Dismissal of the First Objection. The first objection is addressed to the action of the Bank on December 26, 1930, in releasing from the trust fund the Butterick Publishing Company mortgage, on which the principal then due was $887,500, and surrendering it to the debtor in return for this sum in cash. The objectors contend that since other collateral in the fund, namely, the Hillman Hotel Company, Inc., mortgage, was in default of principal for more than 60 days on the date of this transaction, the release of the Butterick mortgage while the defaulted security remained in the fund violated Article I, § 6, of the trust agreement. Pointing out that the Butterick mortgage was not due to mature until March 1, 1935, they assert that its release therefore did not fall within the third proviso of § 6 authorizing withdrawals in connection with the redemption or final payment at maturity, even though other collateral may be in default of principal for more than 60 days. The Bank, on the other hand, takes the position that its action was permitted by the redemption or final payment clause, interpreting it to mean redemption before maturity or final payment at maturity. Both the Master and the district judge agreed with the Bank's construction, and so do we. The word redemption is clearly used in the sense suggested by the Bank in the later Article II, § 6, of the agreement, the heading of which is Redemption and Discharge Before Maturity. And only with this interpretation does redemption in the phrase at issue retain any meaning, since it would otherwise be a pointless and confusing redundancy. 14 In pressing this objection on appeal — and also below, according to their assertions — the objectors do not claim the full face of the mortgage, although, as they point out, its payment did provide available cash for some of the releases challenged in the second objection. So, as they say, the ultimate result was that the trust fund lost not only the Butterick mortgage, but also all the cash received in substitution for it. The second objection therefore somewhat overlaps this, but can and will be disposed of separately below. What was actually claimed here, and allowed by the Master, was the sum of $22,187.50, a prepayment fee paid to the guarantor of the Butterick mortgagor for the privilege of early redemption, which the Bank failed to collect from the guarantor. 3 But we think the judge was correct in rejecting the Master's surcharge of this amount against the Bank. The trust agreement required remittance to the Bank only of payments of principal on fund securities; collections of interest and all other charges could be retained by the debtor or guarantor. The premium here paid to the guarantor was merely consideration for its surrender of the right to receive future interest under the mortgage; it was in effect a reduced prepayment of interest. Our view is not in conflict with the apparent position of the New York courts holding such prepayment fees not to be interest for purposes of the usury statutes. Feldman v. Kings Highway Sav. Bank, 303 N.Y. 675, 102 N.E.2d 835; Lyons v. National Sav. Bank of City of Albany, 280 App.Div. 339, 113 N.Y.S.2d 695. These cases construe such fees as consideration for a new and separate agreement terminating the indebtedness. Since, as we have held, the debtor and guarantor were free to withdraw securities from the trust fund for redemption before maturity, we can see no bar to their entering into a collateral contract to compensate them for the loss in interest income which they will sustain by virtue of such redemption. And whether the payment thus received be deemed in the nature of interest or consideration on a separate contract, it is in any event not principal on the redeemed mortgage and was thus not payable to the Bank. 15 2. From Dismissal of the Second Objection in Substantial Part. The second objection challenges the propriety of the Bank's releasing from the trust fund as excess collateral a total of $1,045,250 in cash in twelve separate payments between October 31, 1930, and August 17, 1931, as follows: 16 October 31, 1930 ...... $ 12,500.00 November 29 ........... 30,616.63 December 22 ........... 2,333.33 December 27 ........... 47,833.34 February 26, 1931 ..... 416.70 April 27 .............. 525,450.00 June 8 ................ 42,300.00 June 8 ................ 372,566.66 June 17 ............... 3,475.00 July 20 ............... 2,258.34 July 27 ............... 1,408.32 August 17 ............. 4,091.68 _________ $1,045,250.00 ------------- 17 Release of these amounts was claimed to be unauthorized by the trust agreement because collateral in the fund was in default of principal for more than 60 days. The fact that these payments were made is undisputed. And the district judge agreed with the Master that the Hillman Hotel Company, Inc., and Elmhurst-Hampton Holding Corporation mortgages were in such default during this period; the court held the former to be in default of principal for more than 60 days between October 1, 1930, and May 27, 1931, and the latter at all times here relevant after May 21, 1931. The Bank's challenge to the resulting conclusion that each of the enumerated releases was thus unauthorized will be considered below. Here, however, we are concerned with the court's holding reducing the full $1,045,250 surcharge ordered by the Master to $142,500 on the ground that there was a clear day from June 4 to June 8, 1931 — during which period collateral in the fund not in default of principal for more than 60 days equalled or exceeded the principal amount of outstanding Prudence-Bonds — thus exonerating the Bank from liability for earlier unauthorized releases. 18 This clear day doctrine was originated in connection with earlier Prudence-Bonds trust fund accountings by the Special Master, whose report in the present case describes it as follows: 19 In the other accountings in this proceeding, the doctrine of the `last clear day' came into being and was applied. If, during the administration of the trust, all mortgages and other securities in the trust fund became in good standing, that is to say, were not in default in the payment of principal, and the aggregate principal amount of the bonds outstanding did not exceed the aggregate principal amount of the trust fund, and the trust fund otherwise complied with the trust agreement, it was held that no ascertainable diminution of the trust fund resulted from prior withdrawals and substitutions of trust fund collateral, however unauthorized they may have been. 20 The broad question now presented is whether the aggregate principal amount of the trust fund between June 4 and 8 exceeded that of the outstanding Prudence-Bonds of this series. We had occasion to define what constituted such an excess under an essentially similar release clause in President and Directors of Manhattan Co. v. Kelby, 2 Cir., 147 F.2d 465, 470, certiorari denied 324 U.S. 866, 65 S.Ct. 916, 89 L.Ed. 1422. We there said: In this context, the word `excess' means the amount by which (a), (b) and (c) securities not in default, taken at their face value, plus cash and (d) and (e) securities, taken at their then market value, exceeds the principal amount of all then outstanding Corporation bonds. 21 Adopting and applying this definition, the Master found no clear day in June, 1931, or at any other relevant time. The principal amount of Fifteenth Series Prudence-Bonds outstanding on June 4 was $4,651,600. On the same day, the highest principal value of the trust fund (after deposit on that day of a $400,000 mortgage) was $5,093,900. Of this amount, however, the Elmhurst-Hampton mortgage was then in default of principal for more than 60 days; and the Master also properly found that two other mortgages, those of the Brooklyn Parking Terminal and Van Cortlandt Sporting Club, totalling $556,083.34 in principal amount, were in default for 60 days or less. Deducting all of the defaulted mortgages under the above definition of excess, the Master concluded that the nondefaulted collateral in the trust fund on June 4 had a principal value of only $4,377,816.66 — $273,783.34 less than the then amount of the outstanding bonds. 22 The judge disagreed with the Master's interpretation of the requisite excess under this trust agreement. Noting that the agreement in our earlier case did not contain the 60-day clause in the third proviso of Article I, § 6, of the present trust agreement, he held the definition of excess in that case inapplicable here. Instead, he ruled that excess for purposes of the clear-day doctrine was to be computed by taking into account all securities in the trust fund not in default for more than 60 days. By thus computing the principal amount of the fund, the judge found that it exceeded the principal of the outstanding bonds between June 4 and 8 by $282,300, and that there was therefore a clear day during this period. The surcharge which he actually allowed of $142,500 was based on the difference between this amount thus available for release and the amounts in fact released from June 8 to August 17. The question now before us is whether it was error for the judge to include securities in default for 60 days or less in his computation of the value of the trust fund. 23 We think it was. The situation seems to us to be controlled by both the ruling and the rationale of President and Directors of Manhattan Co. v. Kelby, supra, 2 Cir., 147 F.2d 465, involving the Fifth and Ninth Series Prudence-Bonds. The variance in the third proviso of the release clauses, there providing for withdrawal of the mortgage securities in default in the payment of interest, and here for withdrawal of such securities in default in the payment of principal for more than 60 days, was succinctly expressed by the Master as an allowance here to the collateral in default of an incubation period of 60 days. But he added quite properly: However, this incubation period did not change the formula for arriving at `excess'; the defaulted collateral was no less excludable from the required residue, after the withdrawal, because the default was not then 60 days old. Nevertheless, Judge Inch overruled the Master on this point to hold that under the release clause here a `defaulted' security is one `in default in the payment of principal for more than 60 days' and a default for any lesser duration appears to me to be immaterial. This, we think, was error. 24 The rationale of the Kelby case is not based upon the isolated language of the release provisos, but is an interpretation of the entire provision in its purpose and intent construed as part of an entire contract. So the reasons for the interpretation stressed by Judge Frank in his opinion are based upon clauses and provisions found elsewhere in all the respective trust agreements. In fact, the first reason, 147 F.2d at page 470, stresses a provision also found in the agreement here: Article I, § 2, provides that each bond and mortgage of type (a) delivered to the trustee as part of the trust fund must be accompanied by an affidavit of a corporation officer that it is not in default as to payment of principal or interest. His second reason is based on Article II, § 2, relating to the authentication and issuance of Corporation bonds, which provides that so long as the Corporation shall not have been in default for a period of eighteen months, it shall have the right to issue, and the Trustee must authenticate, Prudence-Bonds in any maturity, provided that there are proper securities in the trust fund to match those issued. This provision is substantially the same as the requirement of the second proviso of the release clause, Article I, § 6. It is true that the agreements there contained a condition not found here for the deposit of securities of matching maturities with those to be authenticated, 4 which served additionally to show the strictness of the requirement for good securities in the trust fund. But there is nothing here which suggests any modification in the requirement there found that the Corporation bonds could not be issued in amounts not matched by cash or (d) or (e) securities, plus the face amount of (a), (b), and (c) securities not in default. As Judge Frank says: For to construe this provision to permit bonds to be authenticated and issued against (a), (b), or (c) securities which were in default would be to impute to the Corporation and the Bank an intention which verges on dishonesty, and it is therefore an interpretation not to be adopted unless (as is not the case here) no other is possible. 25 Judge Frank continues: The Bank, however, contends that, when an installment of the principal of a mortgage is in default, the quantum of the default, for purposes of the release clause, must be limited to that installment. We cannot agree. We think that, as the Master held, the clear intention was that, for this purpose, if one installment went unpaid when due, the entire amount of the principal of that mortgage should be regarded as in default. 26 He then takes up the argument of the Trustee-Bank based on the provisions of § 4 of Article I (see quotation above) for the computing of the (a), (b), and (c) securities at their face principal amounts, irrespective of whether any thereof are overdue or in default as to principal or interest. He says, 147 F.2d at page 471: But were this true, the release clause would in all circumstances permit the substitution of mortgages in default for undefaulted mortgages or cash. Such an interpretation would lead to so unreasonable a result that it should not be adopted if avoidable. It is avoidable: (1) The reference in the release to Article I, § 4, was, we think, intended merely to say that (a), (b) and (c) securities should be taken at their face amount, and (d) and (e) securities at their market value. (2) That reference in the release clause to Article I, § 4, is preceded by a reference to securities `authorized by Section 1 of this Article,' and obviously that section called for the deposit of securities not in default. (3) That portion of the second sentence of Article I, Section 4, which states that (a), (b) and (c) securities are to be taken at their face amount regardless of whether or not they are in default is to be read in association with the first sentence, and also with the provision of Article II, Section 1 (which provides that the aggregate principal amount of the Corporation's bonds at any time outstanding shall not exceed the principal amount of the trust fund and shall not exceed $5,000,000); therefore we think that that portion of the second sentence of Article I, Section 4, was meant, first, to protect the Corporation against demands for additional collateral, if (a), (b) or (c) collateral were in default or (d) and (e) securities declined in market value; and second, to define the rights of the Corporation to make collections under Article I, § 5. 27 Judge Frank goes on to consider other details of the trust; but enough has been said here to show that the conditions of interpretation in the two cases are essentially the same. As he says, 147 F.2d at page 472, the release clause, as we have construed it, expresses the agreement's dominant purpose in the light of which its other provisions to which the Bank refers must be interpreted, that dominent purpose being that the trust fund was equally to secure all the bonds. This construction makes the entire agreement consistent and avoids an intention which verges on dishonesty. It accords to the 60-day default provision the intent to assure speedy elimination of stale defaulted securities, rather than to increase the assets subject to withdrawal. And it avoids the anomaly of the district court's view, which requires the writing into this negative restriction of an affirmative grant neither stated nor implied. The anomaly of such agreement-making appears the greater when we recall that there is no provision for a clear day in the trust itself; the principle is developed only as one of guidance to a court of equity in doing equity between the parties. As a creature of equity it is not naturally to be expanded sharply by remote implications deduced from an agreement touching other matters entirely. 28 Since this seems to us a reasonable construction of the trust along lines already established by this court we need not examine in detail other claims made by objectors to show that there occurred no clear day, but only the recurring dark and cloudy ones. We should notice, however, their contention that the releases of cash in question did directly violate the third proviso of the release clause. It is pointed out several times in the Kelby case, supra, 147 F.2d at pages 469, 470, 473, that all three conditions of the release clause must be fulfilled before the Bank was justified in making the releases. This proviso is explicit in saying that if any securities so deposited in the trust fund are in default in the payment of principal for more than 60 days the Corporation shall be permitted to withdraw only such securities    as shall be so in default. The words we have italicized seem to make the requirement beyond dispute. Since there were such securities in default — first the Hillman Hotel mortgage and then the Elmhurst-Hampton mortgage, as discussed in the first point of the Trustee's appeal below — the particular security in default alone could be eliminated at the time each of the releases in question was made. 29 The trial judge has objected to this as a barren formula determining simply the order of withdrawal; thus he says that if the Elmhurst-Hampton mortgage had been withdrawn first, then immediately thereafter the excess cash could have been taken. But this seems to overlook the purpose, namely, that the fund be made sweet by covering the defaulted bonds before other withdrawals could be made. Here, as the Master found, there was no cash excess; and the defaulted mortgage could be withdrawn only by appropriate substitution of proper securities. The proviso would then fulfill its intent in the elimination of defaulted securities in accordance with the dominant purpose of the arrangement to protect all bonds issued. For this reason, also, the cash releases were therefore improper and the Master was correct in surcharging the Bank as Trustee for them in the sum of $1,045,250, plus interest. 30 It may be noted that the Bank urges vigorously a settled construction of the trust agreement made and acted upon by the parties at the time, contrary to our conclusion and in accord with the view of the district judge. But the parties were the Trustee and the debtor corporation; overlooked entirely are the bondholders for whom the protective provisions were drawn. 31 3. From Rulings as to Interest, Expenses, and Costs. The objectors also appeal from certain rulings of the court allowing interest on the amounts surcharged at 3 per cent only and only certain of the costs, while disallowing expenses to them. The Master had found that the Trustee was not guilty of fraud or bad faith except as gross negligence may be said to be bad faith; on this basis he recommended the interest award at the reduced rate. He also recommended that the Trustee be required to pay the costs of the proceeding, together with reasonable allowances for expenses, including counsel fees. The court struck out the findings of gross negligence, and then allowed interest at 3 per cent and disallowed expenses. In his decision the judge did provide that the Bank should pay the costs of the proceeding Later when a bill of costs was presented, he struck out the item for compensation of the Special Master (together with two other items not here disputed) and divided the remaining costs by one-half, allowing a total of $1,183.12. The objectors assert that both expenses and costs should be allowed, together with interest on the surcharges at the rate of 6 per cent per annum. 32 We are not inclined to upset the joint findings of good faith made below. The Trustee does appear to us negligent, whether we apply further descriptive adjectives or no; but it was not itself receiving the money or refusing to disgorge, as in Dabney v. Levy, 2 Cir., 191 F.2d 201, certiorari denied Levy v. Dabney, 342 U.S. 887, 72 S.Ct. 177, 96 L.Ed. 665; cf. Dabney v. Chase Nat. Bank of City of New York, 2 Cir., 201 F.2d 635. The events happened back in the halcyon days of high finance before the legal responsibilities of indenture trustees had been judicially defined. Looking now at these matters by wisdom of hindsight we should not attempt to enforce penalties based on a standard unrealistically high for the era. At any rate, we do not think the conduct of the Bank such as to require the full measure of exaction or deprive the court of its discretion to allow interest at the lesser rate. President and Directors of Manhattan Co. v. Kelby, supra, 147 F.2d at page 479, note 33, and cases there cited. 33 The court's disposition of the matter of expenses and costs we find more troublesome. Such issues are normally within the discretion of the trial judge, which we are loath to disturb. Disallowance of expenses, i. e., substantially of counsel fees, may well follow the ruling on interest and rest on the finding of an absence of bad faith. But that measure of grace made all the more natural the court's first ruling that the Bank should bear the costs of the proceedings. We do not understand why the judge retreated from this position; the record vouchsafes no reason. It may well be that upon survey of the judgment he was impressed with the smallness of the award he was making against the Trustee as compared to that recommended by the Master. The Master had allowed nearly the entire amount claimed by the objectors, a total of $1,071,464.18, plus interest, while the court allowed a total of $159,216.66, plus interest — a substantial defeat for the objectors. Our judgment restoring the award to nearly that allowed by the Master would seem to leave no ground for denying costs and to make the reduction of the award by the full expense of its recovery substantially unjust. Ordinarily costs shall be allowed as of course to the prevailing party unless the court otherwise directs. F.R. 54(d). We think the direction otherwise here without justified grounds. Duke Power Co. v. Greenwood County, 4 Cir., 91 F.2d 665, 677-678, affirmed 302 U.S. 485, 58 S.Ct. 306, 82 L.Ed. 381; Gold v. Gold, 2 Cir., 187 F. 273, 274; Broffe v. Horton, 2 Cir., 173 F.2d 565, 566. As to the Master's compensation, taxable by the court, under F.R. 53(a), the amount thereof shall be a taxable cost against the unsuccessful party. Civil Rule 5 of the United States District Courts for the Southern and Eastern Districts of New York; cf. N.Y.C.P.A. § 1518; Ex parte Peterson, 253 U.S. 300, 315, 40 S.Ct. 543, 64 L.Ed. 919. We hold, therefore, that the Trustee must pay the entire taxable costs of this proceeding, including the compensation of the Special Master.