Daily Development for Monday, January 29, 2001

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; WASTE; NONPAYMENT OF TAXES: Mortgagor is liable for tortious waste for deliberate nonpayment of taxes, and for punitive damages when nonpayment was used as a weapon against mortgagee in continuing negotiations to revise existing loan.

The Nippon Credit Bank. Ltd. v. 1333 North California Blvd., 2001 WL 51611 (1/23/01)

This important is a relatively important one because there are relatively few cases standing for the proposition that nonpayment of taxes can be tortious waste, and there are some cases contra.

Diller's LLC , Sunset, was the general partner in a limited partnership that had borrowed $73 million secured by some office buildings in California. The partnership had already paid substantial amounts to Diller and Dillerrelated entities to "take them out" of equity positions they had earlier held in the project. The note had an adjustable rate feature.

When the real estate market deteriorated, it appeared that the partnership would start to lose money on its investment, and made a number of proposals to the bank to restructure the loan. Under one of the earliest proposals, the borrower asked simply to postpone an interest adjustment for six months. The bank refused.

In response to this, Diller caused the partnership to fail to pay $350,000 in property taxes owed on the property, although it had the cash on hand to do so. Soon thereafter, the partnership paid over $600,000 to Diller in another move to reduce Diller's equity position. Diller testified that he took this action because he did not feel that the bank was being fair in the restructuring negotiations, and that it should "feel the pain" of the problems with the buildings. He also indicated that he thought the bank was squeezing as much money as it could from him and other outside investors during the course of restructuring negotiations and that it would then ultimately refuse to restructure and take the property at foreclosure. He admitted, however, that the bank had no legal obligation to defer the interest rate adjustment.

Later, the bank paid the taxes and added the claim to the debt. Then, apparently before even completing a judicial foreclosure (the case report is not clear), the bank sued, the limited partnership, Diller, and Diller's LLC bad faith tortious waste to the bank's security interest. Apparently it was clear that the property was worth millions of dollars less than the loan, according to the court (p. 7) even though elsewhere the court, apparently in a typographical error, characterizes the balance of the loan as about $1 million. (p.3)

The jury found that waste had occurred, and that the waste was malicious and in bad faith, and awarded compensatory damages of $394,000, and then awarded punitive damages in the amount of $8.3 million. The trial court granted a remittitur down to $1.9 million, and both sides appealed.

On appeal, the appeals court upheld the tortious waste verdict, noting that there was a split in the jurisdictions as to whether nonpayment of taxes could amount to waste, but agreeing with the Restatement on Mortgages and, especially, with an article by DIRTer Greg Stein, a professor at Tennessee Law School, that the best policy was to recognize such an action. It disregarded the argument that it should not recognize a tort action where a contract action would lie for breach of the mortgage. The court noted that the property relationship between a mortgagor and a mortgagee, as holders of a present interest and a contingent future interest in land, has long supported the recognition of tort protections, and California even as a statute recognizing the tort of waste. (California whose founding fathers adopted substantial portions of the Field Code an effort to implement a code based approach to American law has statutes on many things that are not covered elsewhere).

In this case, the waste claim was necessary because the loan apparently was nonrecourse. The court discussed the famous Cornelieson v. Kornbluth, 125 Cal. Rptr. 557 (Cal. 1975) case, which permitted a tortious waste claim even as against California's statutory prohibitions against deficiency deficiency judgments on purchase money mortgages. Cornelieson applied, however, only against "bad faith" waste, and not if the waste occurred as a result of economic pressures. The court found that the waste involved in the instant case fit within the Cornelieson standard, although the editor questions whether such a finding ought to be necessary when the only question is whether the claim will be allowed as against a nonrecourse mortgage and no public policy against deficiency claims are applicable.

Comment 1: California had already permitted recognition of a waste claim for nonpayment of taxes in a case in which the security was lost in a tax foreclosure. Osuna v. Albertson, 184 Cal. Rptr. 338 (Cal. App. 1982). This case includes a great deal of policy analysis in following Osuna, perhaps because the defendant had invested in a substantial firm the authors of a leading California treatise on real estate law, to fire at the trial court's decision.

Comment 2: Many courts draw a distinction between "affirmative waste" and "permissive waste." "Permissive waste" is the failure to do something, such as failure to repair a leaky roof, that leads to further damage to the property. Although a life tenant need not fully maintain the property, the life tenant must do enough to keep the property "wind and weather tight," and to pay carrying charges on the property, which might include property taxes. In the context of life tenants vs. remaindermen, where waste claims usually arise, "permissive waste" is actionable only where the life tenant had monies available from the income of the property to make the necessary repairs or payments.

The editor would prefer to see the court pursue this kind of analysis in evaluating tortious waste in the case of a nonrecourse mortgage, rather than to look for some kind of "bad faith," such as Cornielson might suggest. But under the facts of this case we come out to the same point.

If the mortgagee wants to impose an affirmative duty to pay taxes, even when the property is not generating revenue, then the mortgagee can and should negotiate a "carve out" from the nonrecourse aspect of the mortgage.

Comment 3: Jack Murray, one of several who sent me this case, feels it is a critically important decision, but the editor sees it as the natural outgrowth of earlier decisions in the area. Perhaps Jack will file later to let us know why this case is so vital, in his view.

The finding of punitive damages for "playing hardball" is an interesting feature of the case, however. It is common for parties in troubled real estate relationships to withhold various kind of contract performance in order to bludgeon the other side into some kind of economic compromise. Normally, no tort liability will accrue. Recent "good faith and fair dealing" cases leave the door open, but in most appellate decisions involving tortioius breach of good faith and fair dealing duties, there has been little for the plaintiffs to like. Here, however, there is the independent doctrine of waste a tort remedy recognized by the common law for hundreds of years, and recognizing that special relationships arise in property contracts that might not be present elsewhere. Sum if you're going to play hardball, try some tactic other than one that can be characterized as tortious waste.

Comment 4: The attorneys who were able to convince a California jury to award $8.3 million in punitive damages against a California borrower in favor of a Japanese Bank in a straight commercial loan deal deserve a little publicity Senn Palumbo Meulemans, LLP. The appeals court here, however, upheld the remittutur order. Happy settlement negotiations!!!

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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