S.S. Silberblatt, Inc. v. East Harlem Pilot Block-Bldg. 1 Housing Development Fund Co., Inc., No. 715

• Court: U.S. Court of Appeals — Second Circuit
• Writing for the Court: Before WATERMAN, FEINBERG and MANSFIELD; MANSFIELD; Pollack
• Citation: 608 F.2d 28
• Parties: S.S. SILBERBLATT, INC., and S.S. Silberblatt, Inc., on behalf of itself and all other persons entitled to share in funds allocated for the improvements of real property owned by East Harlem Pilot Block Building 1 Housing Development Fund Company, Inc., East Harlem Pilot Block Building 2 Housing Development Fund Company, Inc., East Harlem Pilot Block Building 3 Housing Development Fund Company, Inc., and East Harlem Pilot Block Building 4 Housing Development Fund Company, Inc., Plaintiffs-Appellants, v. EAST HARLEM PILOT BLOCK BUILDING 1 HOUSING DEVELOPMENT FUND COMPANY, INC., East Harlem Pilot Block Building 2 Housing Development Fund Company, Inc., East Harlem Pilot Block Building 3 Housing Development Fund Company, Inc., East Harlem Pilot Block Building 4 Housing Development Fund Company, Inc., Patricia Roberts Harris, as Secretary of the United States Department of Housing and Urban Development and Chemical Bank, Defendants-Appellees. ocket 78-6191.
• Decision Date: 23 October 1979
• Docket Number: D,No. 715

Page 28

608 F.2d 28 S.S. SILBERBLATT, INC., and S.S. Silberblatt, Inc., on
behalf of itself and all other persons entitled to share in
funds allocated for the improvements of real property owned
by East Harlem Pilot Block Building 1 Housing Development
Fund Company, Inc., East Harlem Pilot Block Building 2
Housing Development Fund Company, Inc., East Harlem Pilot
Block Building 3 Housing Development Fund Company, Inc., and
East Harlem Pilot Block Building 4 Housing Development Fund
Company, Inc., Plaintiffs-Appellants,
v.
EAST HARLEM PILOT BLOCK BUILDING 1 HOUSING DEVELOPMENT FUND
COMPANY, INC., East Harlem Pilot Block Building 2 Housing
Development Fund Company, Inc., East Harlem Pilot Block
Building 3 Housing Development Fund Company, Inc., East
Harlem Pilot Block Building 4 Housing Development Fund
Company, Inc., Patricia Roberts Harris, as Secretary of the
United States Department of Housing and Urban Development
and Chemical Bank, Defendants-Appellees. No. 715, Docket 78-6191. United States Court of Appeals,
Second Circuit. Argued April 23, 1979.
Decided Oct. 1, 1979.
As Amended Oct. 23, 1979.

Page 30

A. David Benjamin, New York City (Kenneth M. Block, Richard S. Fries, Demov, Morris, Levin & Shein, New York City, of counsel), for plaintiffs-appellants.

Jerome T. Orans, New York City (Gary H. Greenberg, Orans, Elsen, Polstein & Naftalis, New York City, of counsel), for defendants-appellees East Harlem Pilot Block Buildings 1-4 Housing Development Fund Co., Inc.

Patrick H. Barth, Asst. U. S. Atty., New York City (Robert B. Fiske, Jr., U. S. Atty. for the Southern District of New York, Peter C. Salerno, Asst. U. S. Atty., New York City, Patricia Roberts Harris, Secretary of the Dept. of Housing and Urban Development, Washington, D. C., of counsel), for defendant-appellee Patricia Roberts Harris, Secretary, HUD.

Ann M. Galvani, New York City (Ralph L. McAfee, Richard S. Simmons, Lynne M. Barry, Cravath, Swaine & Moore, New York City, of counsel), for defendant-appellee Chemical Bank.

Page 31

Before WATERMAN, FEINBERG and MANSFIELD, Circuit Judges.

MANSFIELD, Circuit Judge:

The principal question raised by this appeal is whether the Secretary of Housing and Urban Development may be held liable to a general contractor for amounts due on a project financed under § 236 of the National Housing Act, as amended, 12 U.S.C. § 1715z-1 (the Act). ¹ Plaintiff-appellant, S.S. Silberblatt, Inc., agreed as general contractor with East Harlem Pilot Block Buildings 1-4 Housing Development Fund Co., Inc. (East Harlem) to construct a large apartment structure, Taino Towers, located in the East Harlem section of Manhattan. East Harlem is a non-profit, assetless community organization. The building was planned and supervised as a joint venture of East Harlem and HUD. Construction financing was provided by Chemical Bank, with the mortgage insured under § 236(j) of the Act.

As a result of financial problems and construction delays encountered by the project in early 1976, Chemical Bank assigned the mortgage to HUD. Silberblatt suspended construction and some time later was dismissed by East Harlem prior to completion of the project. Silberblatt sued HUD, East Harlem and Chemical Bank in the New York State Supreme Court seeking to recover amounts allegedly owing it for work performed on the project. At the instance of the Secretary the action was removed to the District Court for the Southern District of New York under 28 U.S.C. § 1442(a)(1) and assigned to Judge Milton Pollack. After a lengthy period during which the litigation was held in abeyance while the parties engaged in unsuccessful settlement negotiations, Judge Pollack rendered a decision on November 8, 1978, granting summary judgment in favor of the Secretary and Chemical Bank, and partial summary judgment to East Harlem, with remaining state law claims against East Harlem remanded to the state court.

Judge Pollack ruled that Silberblatt was precluded from recovering on its federal quantum meruit claims against the Secretary and East Harlem because it had not completed the contract work and that Silberblatt's attempt to impress a lien on funds held by Chemical Bank must fail because Chemical held no funds for the account of the Taino Towers project. Judge Pollack also denied Silberblatt's motion for leave to amend its complaint against Chemical Bank to restate a cause of action against it as one for breach of contract. ² We reverse the grant of summary judgment in favor of the Secretary and East Harlem on the ground that Silberblatt's failure to complete construction does not necessarily preclude it from obtaining payment for work it performed on the project as general contractor. We also reverse the denial of Silberblatt's motion for leave to amend its complaint against Chemical Bank, which had not yet filed an answer when leave was sought.

Section 236 of the National Housing Act, as amended, 12 U.S.C. § 1715z-1, is part of a multifaceted statutory scheme serving the dual purposes of providing affordable housing to millions of Americans and of stimulating the building trades and the economy as a whole through various forms of federal insurance of private-sector financing of residential construction. Section 236(j) pertains

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specifically to federal mortgage insurance for certain multifamily rental and cooperative housing projects for lower income, elderly, or handicapped families. Taino Towers, located in one of New York's most impoverished neighborhoods, is one such project.

Section 236 also relieves the owner of such projects of most of the financing costs, thereby enabling the owner to charge below-market rents, by making available "interest reduction payments" equal to the difference between the monthly payment for principal, interest, and mortgage insurance premium, which the project owner as mortgagor is obligated to pay under the mortgage, and the amount which the owner would pay if the mortgage bore interest at the rate of 1 percent a year. 12 U.S.C. § 1715z-1(c). ³

The relationships among HUD, the project owner, the mortgagee, and the general contractor are defined by a set of interlocking agreements, all of which are entered on forms prepared by the Federal Housing Administration (a bureau of HUD). The building loan agreement, mortgage, and mortgage note form the agreement between the project owner and the mortgagee setting out the terms of the loan evidenced by the note and secured by the mortgage. These documents expressly refer to the fact that the mortgage is insured by HUD. The other important document is the construction contract entered into by the owner, in this case East Harlem, and the general contractor, Silberblatt.

Like virtually all construction contracts, public and private, the contract used in a § 236 project provides that the general contractor is to receive monthly payments in an amount equal to the value of work performed plus materials and equipment delivered to the site in the preceding month, less a "holdback" or "retainage" of 10%. The accumulated retainage, which in the ordinary course of events is paid to the contractor upon completion of the contract work and satisfaction of certain formalities, provides an incentive for the contractor to complete the work and the owner a fund to pay for completion of the construction in the event of default by the contractor. Similarly, the building loan agreement provided that the construction loan would be advanced in monthly instalments equal to the monthly payments owed to the general contractor.

Under the building loan agreement, in the event of default by the borrower, the "Lender," which includes anyone to whom the note and mortgage have been assigned, may elect either to terminate the loan agreement, in which event funds held by it for the loan are to be used as the Secretary directs, or not to terminate it and enter into possession of the premises to complete construction. This provision, paragraph 9 of the loan agreement, states that "(a)ll sums . . . expended by the Lender (to complete construction) shall be deemed to have been paid to the Borrower and secured by the Mortgage." To collect on the mortgage insurance, however, the mortgagee must assign the mortgage and its companion documents to the Secretary (or foreclose and deliver title to the property to the Secretary). 12 U.S.C. §§ 1713(g), 1715z-3(a)(2); 24 C.F.R. § 207.259. Upon assignment or transfer of title, the mortgagee receives, with some adjustments, the unpaid amount of the mortgage money advanced to the owner less a one percent penalty, which the Secretary may waive. 12 U.S.C. §§ 1713(g), 1715z-3(a)(2); 24 C.F.R. § 207.259(b). Upon assignment of the mortgage, the Secretary succeeds to all the rights and obligations of the lender under the building loan agreement.

By virtue of the mortgage insurance, the mortgagee in a § 236 project has only a limited financial exposure. Its principal risk is the loss of the one percent penalty upon an assignment of the mortgage to HUD. The building owner as a practical matter assumes little risk since a § 236 project owner is invariably judgment proof, its only asset being the loan or the building

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which, as pointed out below, is beyond reach of the contractor. HUD seeks to shield itself from any direct liability to the contractor, except pursuant to the mortgage insurance, by avoiding any contractual relationship with the contractor.

The general contractor bears the risk normally assumed by any contractor who enters a fixed-price contract or, as in this case, a cost-plus contract with a ceiling, namely, that the cost to complete the contract work will exceed the amount of money he is entitled to receive under the contract. From the contractor's financial point of view, however, a § 236 project differs from most construction projects in two respects. First, the person with whom he contracts, the project owner, ordinarily has no resources other...