Forest Inc. of Knoxville v. Guaranty Mortg. Co., Inc.

• Decision Date: 23 October 1975
• Citation: 534 S.W.2d 853
• Parties: FOREST INC. OF KNOXVILLE, Plaintiff-Appellant, v. GUARANTY MORTGAGE COMPANY, INC., Defendant-Appellee. 534 S.W.2d 853
• Court: Tennessee Court of Appeals

Page 853

534 S.W.2d 853

FOREST INC. OF KNOXVILLE, Plaintiff-Appellant, v. GUARANTY MORTGAGE COMPANY, INC., Defendant-Appellee.

534 S.W.2d 853

Court of Appeals of Tennessee, Eastern Section.

Oct. 23, 1975 Certiorari Denied by Supreme Court March 8, 1976.

W. Keith McCord, Knoxville, for plaintiff-appellant; Egerton, McAfee, Armistead, Davis & McCord, Knoxville, of counsel.

E. Bruce Foster, Ronald C. Koksal, Knoxville, for defendant-appellee; Frantz, McConnell & Seymour, Knoxville, of counsel.

OPINION

DAVIS, Special Judge.

The parties will be referred to as they appeared in the trial Court, plaintiff and defendant, as indicated above.

By its complaint plaintiff avers defendant is indebted to it in the sum of $26,550.00, the sum of certain notes constituting the balance of the consideration for building lots it sold to Dean Cate, the notes being secured by Cate's deed of trust on said lots.

Plaintiff alleges there was an accepted practice custom and policy in the area that a land developer, such as plaintiff, sells lots to a contractor, such as Cate, who borrows money from a construction lender, such as defendant, to finance the construction of buildings on the lots; that the lender obtains a deed of trust from the contractor to secure its loan, which deed of trust is recorded prior to the developer's deed of trust, or failing in that, the lender takes a subordination agreement from the developer giving the construction lender a prior lien over the developer's deed of trust; that during the construction of the buildings the lender agrees to advance funds to the contractor at certain stages of construction in sums substantially on a ratio equal to the percentage of completion after the lender inspected the construction; that part of the custom was for the lender to inspect the construction, not over-advance funds to the contractor thereby protecting the interests of suppliers, materialmen, the developer and all having an interest, monetary in nature.

Plaintiff alleges that it did subordinate its indebtedness owed it by Cate to deeds of trust and notes of defendant so defendant would, and did, furnish construction funds to Cate. It asserts that defendant failed to properly inspect and supervise the construction, over-advanced funds to Cate before the buildings were completed, the funds were depleted to the point Cate could not finish the work, with the result, that defendant foreclosed under its deed of trust and kept the proceeds of the sale after advising plaintiff there were not enough funds to pay its subordinate notes in the sum of $26,550.00. It alleges it suffered the losses for which it sues because of defendant's action. Basically, as indicated in argument in open court on this appeal, the plaintiff asserts it is entitled to recover on contract, if not express, implied, that the consideration flowing from defendant to plaintiff was a duty of defendant to follow the custom existing in the industry in return for subordinating its security to that of defendant.

Pertinent parts of the defendant's answer include its denial of the existence of a practice or custom that construction lenders inspect the construction to protect the seller of the lots, the developer, but that such inspection was solely for its own protection, not for benefit of others with whom it had no contractual relationship. Defendant averred all loan commitments were made on basis of 75% Of estimated cost of land and improvements when fully completed; that its absolute policy was not to accept any security less than a first mortgage except on rare occasions it might enter into a written agreement to pay some specifically designated obligation for a builder; denies the subordination agreement was executed for consideration of the assumption by defendant of any fiduciary relationship with plaintiff and denies any fiduciary relationship ever existed between them. Defendant asserts it did not inspect the construction for benefit of the plaintiff and had no duty to do so; that its commitment to Cate was based only on estimates of cost of completion of the houses, and for only 75% Of the estimated cost of the land and completed houses, and it was never intended that defendant advance the total cost to Cate. Defendant denies it wrongfully advanced funds to Cate or indiscriminately disbursed funds to Cate or that its actions prevented Cate from finishing the work. Defendant admits Cate defaulted and that it foreclosed its mortgage after plaintiff refused defendant's tender of offer to permit plaintiff to complete the construction and thus minimize losses on plaintiff's mortgage; denies any action of defendant caused plaintiff harm or damages or losses; denies it is obligated to plaintiff in any sum for any reason.

After a somewhat lengthy trial the trial judge held there was no contractual relationship established between the parties that would support a recovery; that no equitable relationship was shown justifying a recovery and that defendant did not estop itself from relying on plaintiff's subordination agreement. The plaintiff has appealed the dismissal of its action and assigned the following errors:

ASSIGNMENTS OF ERROR

1. The Trial Court erred in ruling as a matter of law that the plaintiff could not recover from the defendant because there was no contractual relationship between defendant and plaintiff, notwithstanding the fact that the Trial Court found that there such a custom, practice and standard in the industry which had been violated by the defendant.

2. The Trial Court erred in ruling as a matter of law that the plaintiff could not recover from the defendant in equity because there was no equitable relationship between the parties and therefore. 'The custom of the trade which otherwise might control does not apply to their situation'.

It appears that the evidence establishes the following facts;

In June 1972 there existed in the housing construction and development industry in the Knoxville area a custom and practice that land developers sell lots to a contractor or builder of dwellings, taking notes for unpaid portion of the purchase price secured by a deed of trust. The contractor would then borrow money from a construction lender, giving notes secured by deeds of trust, which deeds of trust were made a first lien on the property by the execution by the developer of a subordination agreement to that effect. It was part of the custom and practice of the industry that the construction lender not advance the construction loan to the contractor in substantially greater portions than the advancement bore to the stage of completion of construction at the time of the particular advancement of money. Advances would usually be made after periodic inspections of the construction work.

The foregoing stated custom and practice was one that varied some with different construction loan lenders, particularly as to the number and dates of inspection in relation to the stage of construction. It was a custom loose, general, but usually adhered to as compared to another practice or custom in the industry which was inflexible and strictly followed and understood by developers, builders and lenders alike. This latter practice and custom was that construction loan lenders never loaned any sum unless secured by a first mortgage or lien; that the party executing a subordination agreement did so with no qualifying conditions contained in it; that unquestionably such lender held the prior security. It was also generally believed, understood and accepted in the industry that the execution of an unconditional subordination agreement did not carry with it or create on the part of such lender any duty to protect the lot seller's interest, nor did it create a fiduciary obligation on the lender to the developer which in any manner equaled or excelled the lender's first duty and right to protect its own investment.

Plaintiff owned certain sub-division lots and sold at least nine of them to Dean Cate. It took notes, secured by deed of trust, for the unpaid portion of the purchase price. It was understood between them that plaintiff would subordinate its security or lien to one that Cate would give to a construction lender from whom he would borrow money to build dwellings on the property. Cate borrowed over $200,000.00 from defendant, giving his notes and securing their payment by deeds of trust dated June 8, 1972, the latter being recorded. The loan was for 75% Of the estimated value of the lots and improvements when completed.

Thereafter, on June 18, 1972 plaintiff did execute an unqualified, unambiguous, unconditional subordination agreement which made defendant the holder of the first lien on said nine lots to secure defendant's loan to Cate. This was the first business transaction or dealing either party had had with the other and was consistent with the fact that such subordination agreements used in the industry did not have any limiting conditions, especially conditions governing how or when the money was to be disbursed to the borrower.

During the course of construction defendant made over-advances of money to Cate on nine occasions, a total of about $37,000.00, that is, advances in excess of what the custom and practice indicated should have been made at the time.

It appears that plaintiff believed the defendant would disburse the advancements of construction loan money in accordance with existing custom as it understood it, but made no inspection of the property itself, made no request for inspections, and no inquiry about the status of money advancements to Cate.

It appears the primary reason for the over-advancements by defendant to Cate was it having...