Roskamp Manley Associates, Inc. v. Davin Development & Investment Corp.

• Decision Date: 28 July 1986
• Citation: Roskamp Manley Associates, Inc. v. Davin Development & Investment Corp., 229 Cal.Rptr. 186, 184 Cal.App.3d 513 (Cal. App. 1986)
• Court: California Court of Appeals
• Parties: ROSKAMP MANLEY ASSOCIATES, INC., a California Corporation, Plaintiff and Appellant, v. DAVIN DEVELOPMENT AND INVESTMENT CORPORATION, a California Corporation, et al., Defendants and Respondents. and All Related Actions. Civ. B013359.

Page 186

229 Cal.Rptr. 186

184 Cal.App.3d 513

ROSKAMP MANLEY ASSOCIATES, INC., a California Corporation, Plaintiff and Appellant, v.DAVIN DEVELOPMENT AND INVESTMENT CORPORATION, a California Corporation, et al., Defendants and Respondents and All Related Actions.

Civ. B013359.

Court of Appeal, Second District, Division 6, California.

July 28, 1986.

Miller & Folse, Christopher W. Patterson, Thousand Oaks, for plaintiff and appellant.

Nordman, Cormany, Hair & Compton, Glen M. Reiser, Oxnard, for defendants and respondentsDavin Development and Inv. Corp.

STONE, Presiding Justice.

Roskamp Manley Associates, Inc.(Manley) appeals from an order granting summary judgment to Davin Development and Investment Corporation(Davin) and dismissing Manley's complaint.(Code Civ.Proc., § 437c, subd. (1).)The principal issue concerns whether the subordination agreement in the escrow instructions was enforceable.We hold it was not and affirm the judgment.

FACTS

In July 1984, Manley, a real estate developer, offered to purchase Davin's property for $450,000 with $225,000 secured by a purchase money deed of trust.Also, the "Seller agrees to subordinate to a construction loan."The parties exchanged various counter-offers, and finally agreed upon a $525,000 purchase price, including a cash down payment of $275,000 and a $250,000 purchase money deed of trust.Original escrow instructions signed by the parties made no mention of subordination.When Manley requested a subordination agreement be included in escrow, Davin's broker submitted a supplemental escrow instruction to Davin stating that Seller would execute all documents required to subordinate Seller's trust deed to a subsequent construction loan secured by a first deed provided that the following conditions were met: (1) Buyer would not be in default under any terms or conditions of either the note or trust deed; all taxes were paid and there were no further liens on the property; (2) Seller shall approve the "total principal amount" of the construction loan; and (3) All funds disbursed under the construction loan shall be used only to pay for material and labor directly incorporated into the improvements.Davin signed the instruction August 31, 1984.

November 8, 1984, shortly before the deadline to remove escrow contingencies, Manley provided Davin with a subordination agreement which deleted Davin's right of approval of the principal amount of the construction loan and substituted a term which placed no limitation upon the principal amount, so long as the loan did not exceed 80 percent of the lender's appraised value of the completed project.

Davin objected to the substitution provision and attempted to cancel escrow.At this juncture, Davin sought legal counsel, ¹ who opined that the subordination agreement delineated in the supplemental escrow instruction of August 31, 1984, was unenforceable.After attempts to negotiate acceptable terms to the subordination agreement failed and Manley refused to proceed without a subordination clause, Davin cancelled escrow and offered to return Manley's $5,000 deposit.Manley sued for specific performance or damages and for declaratory relief.

DISCUSSION

1.Subordination Agreement Not Enforceable as a Matter of Law.

A subordination agreement alters the priority of interests in or liens upon real property.A beneficiary of a deed of trust can agree that his lien is to be junior in priority to the lien of another deed of trust created and recorded subsequently.(2 Miller & Starr, Current Law of California Real Estate, § 11.170, p. 240(1968).)Subordination agreements are useful in real estate development since institutional lenders generally are limited to loans secured by a first lien.(SeeFin. Code, §§ 1227and1560.)Such agreements are "in the nature of a mutual enterprise, wherein the vendor provides the land, the purchaser the 'know-how' and the purchaser's lending agency the capital for the mutually beneficial purpose of developing the land and disposing of it (usually by sale) to provide a fund out of which the vendor is paid for his land, the lender is repaid its loan with interest, and the purchaser receives compensation for his efforts and skill."(Woodworth v. Redwood Empire Sav. & Loan Assn.(1971)22 Cal.App.3d 347, 361, 99 Cal.Rptr. 373.)

However, there are unique risks involved in a seller's subordinating his purchase money lien to construction financing--risks which make the seller's position vulnerable.(Budget Realty, Inc. v. Hunter(1984)157 Cal.App.3d 511, 516, 204 Cal.Rptr. 48.)Unlike the standard transaction where the purchaser plans to make the same of similar use of property, and the present worth is a reliable indicator of its fair market value, where the purchaser intends to develop the property for a different use, the ultimate value will be determined by the success of the venture.(Spangler v. Memel(1972)7 Cal.3d 603, 613, 102 Cal.Rptr. 807, 498 P.2d 1055.)Moreover, because construction loans are relatively large, a seller may be unable to raise the large sums of money necessary to buy in at the senior sale to protect his security.(Ibid.)Also, since construction financing is short-term, subordination to construction financing substantially aggravates the jeopardy to the seller's security.(Budget Realty, Inc. v. Hunter, supra, 157 Cal.App.3d at p. 516, 204 Cal.Rptr. 48.)

Manley contends the subordination agreement sufficiently restrictive to "define and minimize the seller's risk" and was fair and reasonable to seller.(SeeHandy v. Gordon(1967)65 Cal.2d 578, 581, 55 Cal.Rptr. 769, 422 P.2d 329.)Davin maintains that, to be enforceable, a subordination agreement must specify at least the maximum principal, maximum interest rate, maximum term and mode of repayment of the new loan.(See2 Miller & Starr, supra; Current Law of California Real Estate, § 11:178 at [184 Cal.App.3d 518] p. 249;Cal. Real Property Sales Transactions(Cont.Ed.Bar 1981), § 5.43, at pp. 389-390.)

According to Miller & Starr, "The courts have established certain guidelines in determining the terms of the new loan which the seller will be required to accept as a prior lien.Although the authorities are not consistent, [Fn. omitted] to be enforceable the subordination agreement must at least specify the maximum principal, maximum interest rate, maximum term, and the mode of repayment of the new loan.[CitingCummins v. Gates(1965)235 Cal.App.2d 532[45 Cal.Rptr. 417].]Agreements less specific than this have been held to be unenforceable.[Fn. omitted.][p ] However, even if each of these matters is clearly specified, the agreement still may not be enforceable.The test of enforceability is the fairness and reasonableness of the agreement to the seller.[CitingHandy v. Gordon, supra, 65 Cal.2d 578, 55 Cal.Rptr. 769, 422 P.2d 329;Loeb v. Wilson(1967)253 Cal.App.2d 383, 61 Cal.Rptr. 377.]"(p. 249-250.)

Other desirable provisions include limiting terms of the new loan and disbursements; minimum prepayment terms as well as maximum to avoid a burdensome balloon payment; purpose of the loan and restriction on use of funds to construct improvements on the property; amount of loan fees and costs to be covered by loan proceeds; description of improvements, and possible additional assurance that buyer has a firm commitment for a "take out" or permanent loan.(Cal. Real Property Sales Transactions, (Cont.Ed.Bar 1981) § 5.43, pp. 389-390;Miller & Starr, supra, at pp. 251-252.)

Manley contends these authorities are in error and cites Stockwell v. Lindeman(1964)229 Cal.App.2d 750, 40 Cal.Rptr. 555, for support.There, the court found enforceable a subordination agreement which stipulated only the maximum amount of loan and maximum interest.

According to Manley, Stockwell was a "landmark" case and one of the first to recognize the practical difficulties of drafting an enforceable subordination agreement concerning future loans.

In Stockwell, the subordination agreement provided that the construction loan was not to exceed $80,000 with interest not to exceed 7.5 percent per annum, payable at such times and upon such conditions as are required by the lender.The court found the agreement sufficiently certain to be specifically enforceable and noted that the modern trend is to favor enforcement of contracts, neither law nor equity requiring every term to be set forth.(Id., at p. 757, 40 Cal.Rptr. 555.)It also noted that, since details of future loans might not be known in advance, to require specificity regarding amount of monthly installments and exact duration of loan to be anticipated and stated in the sales agreement would unduly burden the parties.(Id., at p. 758, 40 Cal.Rptr. 555.)

Nevertheless, the court in Stockwell stated that of greatest importance was the maximum amount of the construction loan based on either percentage of construction costs, or in an agreed amount and maximum interest rate, since those items most directly affect the security of the property for repayment.According to Stockwell, nothing should be left for the parties' future agreement.(Id., at p. 757, 40 Cal.Rptr. 555.)

In Handy v. Gordon, supra, 65 Cal.2d 578, 55 Cal.Rptr. 769, 422 P.2d 329, defendant vendor agreed to sell land to plaintiff developer for $1,200,000 at 2 percent interest per year, payable in annual installments of $120,000, beginning three years after close of escrow, the balance due in ten years.Sellers agreed to subordinate their trust deed to other trust deeds securing construction loans.Terms of subordination were: loans in maximum amounts of $10,000 and $52,000 per lot, and maximum interest rate of 7 percent and 6.6 percent, to mature in not less than 6 and 35 years respectively.The contract did not specify the number of lots.Plaintiff sued for specific performance, and judgment on the pleadings for defendants was affirmed.The court stated: "Although the parties to a contract of sale...