Middlebrook-anderson Co. v. Southwest Sav. & Loan Assn.

• Decision Date: 29 July 1971
• Docket Number: MIDDLEBROOK-ANDERSON
• Citation: 96 Cal.Rptr. 338,18 Cal.App.3d 1023
• Court: California Court of Appeals Court of Appeals
• Parties: CO., et al., Plaintiffs and Appellants, v. SOUTHWEST SAVINGS AND LOAN ASSOCIATION et al., Defendants and Respondents. Civ. 10449.

Page 338

96 Cal.Rptr. 338

18 Cal.App.3d 1023

MIDDLEBROOK-ANDERSON CO., et al., Plaintiffs and Appellants, v. SOUTHWEST SAVINGS AND LOAN ASSOCIATION et al., Defendants and Respondents.

Civ. 10449.

Court of Appeal, Fourth District, Division 2, California.

July 29, 1971.

Hearing Denied Sept. 22, 1971.

[18 Cal.App.3d 1026] Wenke, Kemble & Burge, and John R. Schilling, Santa Ana, for plaintiffs and appellants.

Nagel, Regan & Davidson, and Stephen C. Drummy, Santa Ana, for defendants and respondents.

OPINION

GABBERT, Associate Justice.

The plaintiffs appeal from a judgment of dismissal entered after defendants' general and special demurrers were sustained without leave to amend in this complicated land development action. Plaintiffs are two California corporations, doing business as Middlebrook-Anderson Co., a partnership, hereinafter referred to as 'seller'.

The seller owned real property consisting of 28 lots in Orange County. It entered into a land sale contract with certain developers, hereinafter referred to as 'buyers', who are not before us in this action. An escrow at a bank was opened between seller and the buyers; the instructions specified the sale price to be $365,000, which was to be partially paid by a purchase money deed of trust in the amount of $169,500. This deed was to be second and junior to a construction loan to be obtained at some later time by the buyers.

During a period of several months buyers negotiated for a construction loan from defendant Southwest Savings and Loan Association, hereinafter referred to as 'lender'. Defendant Western Escrow Company was the escrow agent for the buyers and the lender. The buyers represented to the seller that the bank escrow would have to be revised to provide for a purchase money deed of trust in favor of seller in the sum of $69,500 and to allow the lender to obtain priority over seller's deed of trust by priority of recording. The bank escrow between seller and buyers was amended accordingly.

After these terms were agreed to by the seller and the buyers, the construction loan was consummated. Western Escrow prepared 28 deeds of trust in favor of lender with Western named as trustee, each in the amount of $52,300. A deed of trust in favor of seller in the amount of $69,500, expressly stating it was junior to the lender's deeds of trust, was also prepared. These 26 trust deeds were recorded on April 22, 1966. Three days later, to repair, the distortion caused by the $100,000 reduction in the apparent size of the purchase money loan, the $69,500 deed was reconveyed and 28 new ones prepared and recorded, each in the amount of $6,053.

The third amended complaint alleges the lender disbursed $1,464,400 into a construction loan account, and allowed the buyers to use $300,000 of this for purposes other than for construction improvements. When the loan funds ran out in November 1966, the buyers abandoned the unfinished apartment houses on the property. In the same month, Western Escrow gave notice of default and election to sell under lender's trust deeds. Seller tendered payment of the due principal, interest, and late charges to cure the default, but Western and lender demanded in excess of $50,000, in addition, to repay lender for sums it claimed it had expended for repairs caused by vandalism on the property and completion of the construction. Lender purchased the property at a series of foreclosure sales in April and May 1967, remained in possession and collected rents for a period of time, and then sold the properties to members of the public not parties to this action.

This litigation was commenced by a complaint filed before the foreclosure sales were complete. After plaintiffs' third amended complaint, attempting to state seven different causes of action against Southwest Savings and Loan and Western Escrow was filed, the trial court sustained defendant's general demurrers to the complaint on grounds of failure to state a cause of action, and 44 special demurrers on grounds of uncertainty.

Plaintiffs' causes of action are based essentially on the failure of lender to limit the use of the loan funds to construction purposes. The theories of recovery and remedies sought in the respective numbered causes of action are:

(1) a restoration of the priority of seller's trust deeds;

(2) damages for rendering seller's trust deeds valueless by foreclosure on lender's first trust deeds;

(3) either restoration of priority or money damages based on lender's knowingly permitting the use of $300,000 for non-construction purposes;

(4) either restoration of priority or damages based on seller's status as a third party beneficiary of the construction loan contract between lender and the buyers;

(5) setting aside the trustee's foreclosure sale of the property, or damages, based on lender's and Western Escrow's refusal to accept seller's tender of principal, interest and late charges to cure the default on the construction loan;

(6) an accounting of funds received by lender from the property after the foreclosure sales, both as rents and proceeds of re-sales, and application of such funds to repayment of the construction loan, plus reasoanble rental value of the property for the period lender was in possession;

(7) (labeled 'tenth' because the seventh, eighth, and ninth causes of action named only the buyers) punitive damages based on alleged malice involved in every act of the defendants.

The pleadings allege an original contract existed between the seller and buyers; the escrow at the bank was solely between seller and buyers; the sellers were to receive a purchase money trust deed which would be junior to a construction loan that was to be negotiated. Thereafter negotiations with the lender by the buyers resulted in a commitment by the lender to the buyers on the condition, as represented by the buyers to the seller, that the lender would make a construction loan and would require documents to show the buyers had made a greater cash investment in the property than originally contemplated and would require subordination of seller's trust deed by priority of recording rather than through a formal subordination agreement.

The complaint further alleges the buyers represented to the seller the funds received from the lender would be used exclusively for construction of improvements on the property and, based on these representations, the seller agreed to the terms. The buyers then entered into the escrow with Western Escrow which, acting as agent for the buyers and the lender, received a copy of the escrow instructions between the seller and buyers.

The seller alleges the lender had knowledge of the second trust deeds taken by the seller and had a duty to inquire of the seller as to the terms and conditions under which the seller agreed to accept a junior lien. The complaint further alleges the lender voluntarily undertook to control disbursements from the construction loan fund and that the seller did not attempt to follow the progress of the construction or status of disbursements because it relied on such control by the lender, who knew and intended that seller so rely.

The seller continues that the lender owed a duty to seller because of lender's conduct which induced the seller to 'subordinate' its lien, because of lender's voluntary assumption of control of disbursements and because of the lender's knowledge of the security interest of the seller and knowledge that the seller would subordinate its lien on condition the loan funds were to be used only for construction improvements. Seller alleges the lender disbursed $300,000 in funds which were not for construction purposes, in wanton, reckless disregard of the security interest of seller.

The complaint also alleges that by reason of these improper disbursements the construction of the project was not completed and the market value of the property did not increase through the construction of improvements to a sufficient extent to support the security interests of both seller and lender. The value of seller's security interest in the property was thus diminished to the extent of the alleged wrongful disbursements. The seller finally contends that at the time of the commencement of the case the unpaid balance on the trust deeds in favor of sellers was in the sum of $141,250.23, plus interest.

All of plaintiffs' causes of action depend upon a conclusion that seller's agreement to take a second trust deed constituted a subordination agreement or an agreement in the nature of a subordination agreement. Lender, on the other hand, claims seller got what it bargained for--a second trust deed--and thus had no prior lien to subordinate. Lender would thus conclude no priority existed which could be restored, the seller could not state any cause of action, and the trial court correctly sustained the demurrers.

As we state below, we conclude that the duties owed by a lender to a seller under a formal subordination agreement do not differ from the duties owed by a lender to a seller when the lender obtains priority over the seller under an agreement by the seller to record after the lender. We thus conclude that, in part, the complaint is sufficient to withstand defendants' general demurrers.

Subordination is, strictly speaking, a status, not an agreement or form of litigation. It refers to the establishment of priority between different existing encumbrances on the same parcel of property, by some means other than the basic priority involved in the concept of 'first in time, first in priority', or the automatic priority accorded purchase money liens. (See Lascher, Vol. 1, San Fernando Valley Law Rev., p. 2, 'Subordination Clauses in Court: Is California Unfair to Unfairness?')

By statute, a purchase money deed of trust is prior to other liens on real property. (Civil Code, § 2898.) But banks and savings and loan institutions may not lend money on the security of real property unless they hold...