State of Wis. Inv. Bd. v. Hurst

• Decision Date: 12 August 1987
• Docket Number: 15531 and 15534,Nos. 15522,s. 15522
• Parties: STATE OF WISCONSIN INVESTMENT BOARD, Plaintiff, Appellee and Cross-Appellant, v. Gene R. HURST; Alice L. Hurst; Roger W. Anderson, Trustee; and O.B. Rekow, Trustee, Defendants, Appellants and Cross-Appellees, Brookings Mall, Incorporated; Calvin Fercho; Brookings Mall, A Partnership; James A. Craig, Trustee in Bankruptcy; and Fred O. Watson Co., Defendants and Cross-Appellees.
• Court: South Dakota Supreme Court

Page 560

410 N.W.2d 560

STATE OF WISCONSIN INVESTMENT BOARD, Plaintiff, Appellee and Cross-Appellant, v. Gene R. HURST; Alice L. Hurst; Roger W. Anderson, Trustee; and O.B. Rekow, Trustee, Defendants, Appellants

and Cross-Appellees,

Brookings Mall, Incorporated; Calvin Fercho; Brookings

Mall, A Partnership; James A. Craig, Trustee in

Bankruptcy; and Fred O. Watson Co.,

Defendants and Cross-Appellees.

Nos. 15522, 15531 and 15534.

Supreme Court of South Dakota.

Argued April 23, 1987.

Decided Aug. 12, 1987.

Stuart L. Tiede of Woods, Fuller, Shultz & Smith, Sioux Falls, for plaintiff, appellee and cross-appellant.

Alan F. Glover of Denholm and Glover, Brookings, for defendants, appellants and cross-appellees.

Robert E. Hayes of Davenport, Evans, Hurwitz & Smith, Sioux Falls, for defendants and cross-appellees.

MILLER, Justice.

Gene R. Hurst (Hurst) and Roger W. Anderson (Anderson) (collectively "Owners") owned twenty acres of real estate located in the City of Brookings, South Dakota. Hurst and Anderson were real estate speculators and desired to develop the land for use as a shopping mall. In December 1971, Owners executed a ninety-nine-year lease with Ericson Development Company, Inc. (Ericson) under which Ericson would construct, operate, and maintain a shopping mall on the leased property. The lease contract also provided that Owners would join in any mortgage necessary to finance such a mall.

In April 1974, Ericson assigned, with Owners' approval, its interest as lessee to Brookings Mall, Inc. (Mall). Construction was completed on Mall by early 1975. (Mall was built on Lot 2 of Owners' land which land was platted as containing Lots 1 and 2, of roughly equal size.)

In August 1976, Mall secured a $3,050,000 loan from the State of Wisconsin Investment Board (SWIB). This loan represented the permanent financing for the project and apparently was used to pay off the interim financer. SWIB required that Owners join in execution of the mortgage and security agreement pledging Lot 2, among other things, as security for repayment of the promissory note.

By June 1982, Mall was in default under the terms of the promissory note. That same month, SWIB and Mall entered into a "mortgage note modification agreement," agreeing that the $27,715.37 monthly payments of interest and principal would be reduced to monthly payments of $19,382.04. The parties also agreed that $4,551.25 would be added to the principal amount each month beginning in March 1982 and continuing through September 1984. Under this schedule, the principal balance after the September 1984 payment was $3,013,083.89. Following the February 1982 payment, the principal balance on the note was $2,871,995.14. Owners had no knowledge of the modification agreement or the terms thereof until SWIB commenced foreclosure proceedings in 1984.

In December 1984, SWIB filed its complaint for foreclosure and a motion to enforce the assignment of leases and rents. In January 1985, Mall filed a voluntary petition for bankruptcy. In March 1985, SWIB obtained relief from the automatic stay imposed by the bankruptcy proceedings. The circuit court then granted SWIB's motion to enforce the lease and rents assignment. After a trial on the merits, the circuit court, in July 1986, entered findings of fact and conclusions of law. A judgment and decree of foreclosure in favor of SWIB was filed on August 18, 1986.

The proceedings in the circuit court also involved a counterclaim by Owners, claiming the right to receive rents from Mall and its sublessees under their original lease with Mall. Owners were paid no rent after December 1984. SWIB purchased the property at the mortgage foreclosure sale in September 1986. The trial court ruled for SWIB on this issue.

ISSUES

Owners argue on appeal that they signed the mortgage of their property as sureties rather than principals; that the mortgage note modification agreement entered into between Mall and SWIB without their knowledge or consent exonerated them as such sureties; and that they continue to be entitled to the rents from the Mall through the period of redemption. By notice of review, SWIB argues that it is entitled to foreclose the leasehold interests of Owners and Mall in Lot 1, as well as Lot 2.

DECISION

1. WHETHER OWNERS ARE PRINCIPALS OR SURETIES.

South Dakota statutes dealing with suretyship include SDCL 56-2-1 which defines suretyship as "a contract by which one who at the request of another and for the purpose of securing to him a benefit becomes responsible for the performance by the latter of some act in favor of a third person or hypothecates property as security therefor." SDCL 56-2-7 states: "Whenever property of a surety is hypothecated with the property of the principal, the surety is entitled to have the property of the principal first applied to the discharge of the obligation." SDCL 56-2-2 provides that: "One who appears to be a principal whether by terms of a written agreement or otherwise may show that he is in fact a surety except as against persons who have acted on the faith of his apparent character of principal."

On its face, Owners argue, and it would seemingly appear, that the mortgage of their reversionary interest in the real estate fits within the definition, rights and liabilities of suretyship as set forth in SDCL ch. 56-2. However, we must look to case authority for an interpretation of the statutory language.

Suretyship is a contractual relationship, which results from two persons becoming obligated to the same creditor with one of them bearing the ultimate liability. In other words, if the debt is enforced against the surety, he then is entitled to be indemnified by the one who should have paid the debt before the surety was compelled to do so. However, "one who receives and retains the consideration or benefit of a contract cannot occupy the position of surety." 74 Am.Jur.2d Suretyship Sec. 3 (1974). Hence, a person who makes a contract for the purpose of securing to himself a benefit rather than for securing to another a benefit, may be classified as a principal. Heinrich v. Magee, 52 S.D. 371, 217 N.W. 631 (1928).

It is immaterial in what form the relation of principal and surety is established, or whether the creditor was or was not contracted with in that relation. The relation is vested by the arrangement and equities between the debtors, and may or may not be known to the creditor....

....

'[Suretyship] is determined by inquiring who received the consideration of the contract, or who, according to the arrangements between the parties, ought to pay the debt.'

Heinrich, 52 S.D. at 378, 217 N.W. at 634 (citations omitted); 72 C.J.S. Principal & Surety, Secs. 4, 9 (1987).

A California court in Matthews v. Hinton, 234 Cal.App.2d 736, 44 Cal.Rptr. 692 (1965), decided a suretyship/principal issue similar to the one currently before us. The Matthews owned an unimproved tract of land which they leased for sixty-five years to a developer. Matthews gave the developers the power to sublet and assign. The agreement also provided that the Matthews would subordinate their title and join in any deed of trust given to secure construction loans for improving the property. The developers' sublessees borrowed $100,000 from a finance corporation and secured the loan with a deed of trust executed by both the Matthews and the sublessees. As in this case, the owner/mortgagors did not sign the promissory note evidencing the debt. The sublessees defaulted on the note and the finance corporation foreclosed. Matthews sued the corporation, alleging that they wrongfully sold the property at a trustee sale. Matthews argued that since they were sureties only, the finance corporation was required to resort to the assets of the principal debtors prior to executing on the owners.

In holding the Matthews to be principals, the California court stated:

The role in which appellants contracted is depicted on the face of the papers. Appellants were the owners of unimproved land. They leased it to a developer for sixty-five years for ground rentals aggregating $309,000. As lessors they had a direct financial interest in the construction of improvements which would produce income and ground rent.... For the promotion of their personal financial interests appellants agreed with their tenants to subordinate their reversionary estate to any future trust deed securing a construction loan. They fulfilled that agreement by means of a trust deed in which they joined with their tenants as 'trustor.' In so doing, they contracted directly with the lender, exposing their...