Court Opinion

ID: 1060251
Source: CourtListenerOpinion
Date Created: 2013-10-09 18:43:25.829703+00
Date Added: 2024-06-11T13:08:49.192198
License: Public Domain

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.

                                - 2 -
     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

                                 - 3 -
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.

                                 - 4 -
     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."

                               - 5 -
     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

                                - 6 -
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

                                 - 7 -
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

                               - 8 -
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.

                               - 9 -
        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.

                                  - 10 -
     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.

                              - 11 -
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

                              - 12 -
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.

                               - 13 -
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

                              - 14 -
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,"

                              - 15 -
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

                               - 16 -
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

                               - 17 -
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

                                - 18 -
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.

                                - 19 -