The opinion of the court was delivered by: INCH
These two motions are made pursuant to Rule 53(e)(2) of the Federal Rules of Civil Procedure, 28 U.S.C.A., and involve a review of the Report of Special Master Moore, dated November 24, 1950, on the objections to the account of State Street Trust Company, as Trustee of Prudence Bonds, Tenth Series. One motion is by Prudence-Bonds Corporation (New Corporation) and the Trustee of the Debtor for an order taking action upon the Master's Report and the objections filed thereto. The other motion is by the State Street Trust Company, as Trustee, Accountant for an order (a) sustaining its objections to the Report, (b) overruling the objections made to the Report by the Objectors to the Account, (c) setting aside the Report and (d) for other and further relief.
The Account of the State Street Trust Company, hereinafter called the 'Bank', covered its acts as Trustee from the inception of the Trust to on or about May 23, 1938. To this Account three separate objections were filed jointly by Prudence-Bonds Corporation (New Corporation) and the Trustee of the Debtor, and the objections were also adopted by bondholders represented by Samuel Silbiger, Esq. and Nemerov & Shapiro, Esqs.
The objections to the Account of the Bank were tried before the Special Master, and the proof taken at the hearings consisted mainly of documentary evidence. A large number of exhibits and two voluminous stipulations of fact were received in evidence. Exhaustive briefs were presented to the Special Master, together with numerous proposed findings of fact and conclusions of law. Thereafter the Special Master filed a thorough and comprehensive report comprising 107 printed pages and containing 283 separate findings of fact and 19 conclusions of law. The Report clearly indicates that the experienced and capable Special Master has performed his work most diligently, and that he has given thorough, careful and painstaking consideration to the many complicated matters presented.
Many of the pertinent facts need not be recited here since they are fully set forth in the Special Master's report.
The first objection to the Bank's Account involved the alleged liability of the Bank in permitting four releases of cash, totaling $ 17,500, between November 26, 1930 and November 27, 1931, while mortgage collateral was in default in the payment of principal. The Special Master has found that these releases of cash did not violate the terms of the Trust Agreement, and he has recommended that the first objection be overruled and the credits claimed by the Bank for the surrenders objected to be allowed. I agree with this recommendation, and accordingly confirm the Special Master's report with respect to the dismissal of the first objection.
The second objection alleged that in connection with the partial foreclosure of the so-called Dresner-Westchester Corporation mortgage, $ 25,000 of collateral was improperly withdrawn from the Trust Fund. The Special Master has recommended that the second objection be sustained in part and that the Bank be surcharged $ 22,375, computed as follows: $ 6,250 paid upon the sale of the premises after foreclosure of the mortgage, $ 10,375 eventually paid on account of a second mortgage received on the sale, and a further collection of $ 5,750 made upon the second mortgage after the bankruptcy of Prudence Company, Inc., hereinafter called the 'Guarantor'. As to the item of $ 5,750 the Special Master concluded that it should have been the subject of a reclamation proceeding in the Guarantor's bankruptcy proceeding, or that the Bank should have filed a claim therefor in the Guarantor's bankruptcy proceeding based on the Guarantor's bankruptcy proceeding based on the Guarantor's guarantee of the underlying collateral in the Trust Fund. In my judgment the recommendation of the Special Master to sustain in part the second objection is correct, except as to the item of $ 5,750, for reasons which I shall discuss below in connection with the third objection.
The third objection involved the alleged nonfeasance of the Bank in failing to take action to enforce the guarantee by the Prudence Company, Inc., of the payment of principal and interest of the underlying collateral in the Trust Fund. It was the contention of the objectors to the Account of the Bank that there were two important situations during the administration of its trust which required action by the Bank with respect to the guarantee of the underlying collateral in the Trust Fund. It was the contention of the objectors to the Account of the Bank that there were two important situations during the administration of its trust which required action by the Bank with respect to the guarantee of the underlying collateral and that the Bank's nonfeasance in this regard resulted in substantial loss to the Trust Fund for which it should be surcharged in this accounting proceeding. These situations concerned the default of the so-called 'Hotel Guyon mortgage' and the bankruptcy proceedings of the Guarantor.
The collateral deposited in the Trust Fund consisted of three bonds and mortgages of an aggregate principal amount of $ 1,115,000 and $ 5,000 principal amount of State of Missouri bonds. The largest of the three mortgages was that on the Hotel Guyon located in Chicago, Illinois. The material facts with respect to that mortgage, as correctly found by the Master, were briefly as follows: on November 1, 1927, J. Louis Guyon and Lillian Guyon, his wife, executed their promissory note in the principal sum of $ 1,000,000 payable to bearer in annual installments beginning on May 1, 1929. The note was secured by a deed of trust (hereinafter called 'a mortgage'), to Frank Fox, Trustee, a first lien upon the premises in Chicago owned by the makers of the note. Prior to the deposit of the mortgage in the Trust Fund, the DeKalb Company, the then holder of the note, entered into a participation or ownership agreement with the Guarantor, whereby the Guarantor acquired a senior interest of $ 900,000 in the mortgage and the DeKalb Company retained a junior interest therein to the extent of $ 100,000. Under the ownership agreement payments of principal were to be made as follows:
May 1, 1929 $ 33,000
May 1, 1930 $ 33,000
May 1, 1931 $ 25,000 $ 19,000
May 1, 1932 $ 29,000 $ 15,000
May 1, 1933 $ 44,000
May 1, 1934 $ 55,000
May 1, 1935 $ 55,000
May 1, 1936 $ 55,000
May 1, 1937 $ 637,000
$ 900,000 $ 100,000
The Guyon note and mortgage were deposited in the Trust Fund on July 26, 1928 subject to the said ownership agreement. Thus, the value of the Trust Fund's share of the Guyon mortgage was $ 900,000. (The junior share of $ 100,000 was subsequently assigned by the DeKalb Company to the Guarantor who later assigned it to a wholly owned subsidiary.)
The Guyon mortgage provided that the mortgagors should make deposits on the 28th day of each month in such amounts as to accumulate the necessary funds to meet interest and principal installments when due. The deposits were to be made with the Guarantor and not with the holder of the mortgage.
The Guyon mortgage fell into default in the payment of principal at all times from and after May 28, 1929 and in the payment of interest at all times from and after May 28, 1930.
Thereafter on May 5, 1932 the Guarantor caused a foreclosure action to be instituted, and ultimately on August 23, 1943 the premises were sold for the net sum of $ 408,437.71 cash which was received by the Trust Fund. On the date of sale the arrears of principal and interest on the Trust Fund's share of the Guyon mortgage amounted to $ 1,570,862.15 computed as follows:
Principal $ 900,000.00
Balance of interest due 2/28/32 51,062.15
Interest on $ 900,000 from
3/1/32 to 8/23/43 @ 6% 619,800.00
Total $ 1,570,862.15
The surcharge recommended by the Special Master is the unpaid principal and interest on the mortgage ($ 1,570,862.15) less the net proceeds of the sale of the mortgaged premises ($ 408,437.71), or $ 1,162,424.44, together with interest thereon at the rate of 3% per annum from August 23, 1943 to the date of the decree herein.
At the outset the Special Master was of the opinion that the Guyon note and mortgage, subject to the ownership agreement, was ineligible for deposit in the Trust Fund under the terms of the Trust Agreement (Article I, Section 1, pars. (b) and (c); Article III, Section 2, last paragraph), because the so-called senior interest of $ 900,000 deposited in the Trust Fund was 'less than a co-ordinate interest' in the mortgage and was 'completely vassalized' by the junior interest. However, the Special Master found that the Bank was exculpated from receiving the Guyon mortgage because it accepted it in good faith and in reliance on the opinion of counsel contained in a letter dated July 26, 1928. I agree with the conclusion of the Special Master that the Bank received the mortgage in good faith, and that it was protected by the opinion of its counsel in accepting it into the Trust Fund. However, in my opinion, even if this were not so, the Bank may not, for reasons which I shall discuss below, be surcharged in this accounting proceeding for its acceptance of the Guyon mortgage.
The Special Master has recommended that this large surcharge be imposed on the Bank on the theory that the guarantee of the underlying collateral was an asset of the Trust Fund and that under the circumstances presented, i.e., having knowledge that the Guyon mortgage constituted 85% of the Trust Fund, and that it was in default for a substantial period of time, the Bank should have taken some action on the guarantee, and that by its failure to do so, it lost or surrendered a valuable asset of the Trust Fund. The Special Master further concluded that the Bank should have filed in the Guarantor's reorganization proceeding a claim based on the guarantee of the underlying collateral for the amounts not ultimately collected on the Guyon and other mortgages in the Trust Fund, and that its inaction in this regard also constituted a surrender of collateral.
After giving this matter serious consideration I am constrained to disagree with the Special Master's ...