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McFarland v. Gregory

decided: February 24, 1967.


Lumbard, Chief Judge, and Friendly and Hays, Circuit Judges.

Author: Lumbard

LUMBARD, Chief Judge.

Plaintiffs (the McFarland Group) and defendants (the Gregory Group) cross-appeal from two judgments of Judge Dimock in the Southern District of New York, entered February 25 and June 30, 1966, which (1) granted the McFarland Group a refund of $700,088 of the purchase price of four apartment buildings and leaseholds, (2) denied it the balance of approximately $450,000 in the "replacement funds" for the buildings, and (3) granted it $189,996.40 of the proceeds of the condemnation of a tract called "C Ground," but denied its claim for an additional $148,000 of the proceeds. As this is the third appeal in a litigation which has lasted almost a decade, a brief account of the underlying transaction and the course of the litigation is essential to an understanding of the parties' contentions.

The McFarland Group developed Arlington Towers in Arlington, Virginia, a project completed in 1955, covering eighteen acres, and consisting of a shopping center and four apartment buildings, each containing over 400 apartments. The land was owned by Arlington Towers Land Corporation (Arlington), whose stock and debentures were held by the McFarland Group, and parcels were leased for 99 years to four wholly-owned subsidiaries of Arlington, each of which constructed and owned one of the apartment buildings.

In 1957, after unsuccessful litigation with the builder of Arlington Towers, see Arlington Towers Land Corp. v. John McShain, Inc., 150 F. Supp. 904 (D.D.C.1957), Arlington entered into a consent judgment binding it to pay the builder $750,000 immediately and $1,181,589.46 with interest over 39 months. The McFarland Group financed the $750,000 payment by selling the stock and debentures of Arlington to a third party, reserving only a one-year call right. On April 15, 1957, the McFarland Group sold this call right to the Gregory Group for $250,000, and the Gregory Group exercised the call in June 1957 for $1,339,000.

By a Memorandum Agreement between the McFarland and Gregory Groups, also executed April 15, 1957, certain rights were reserved to the McFarland Group for 39 months. Paragraph 7 of the Memorandum Agreement*fn1 provided that if the stock and debentures of Arlington were sold by the Gregory Group during that period, the McFarland Group should receive 25% of the excess over $1,500,000 of the "net profit * * * above the investment of the Gregory Group" in the stock and debentures of Arlington. Paragraph 8 obliged the Gregory Group to make a sale under paragraph 7 only if the net profit would exceed $5,500,000 and a responsible purchaser's contract were tendered with a 25% deposit, and relieved it "of any and all further obligation to make any sale of Arlington stock or debentures or the property of Subsidiaries under paragraphs 7, 8 or 9" if it elected instead of selling to pay the McFarland Group its paragraph 7 participation in the potential profit. Finally, paragraph 9 required each subsidiary to sell its apartment building and 99-year leasehold (excluding the shopping center and appurtenant portions of leaseholds) at a price producing a net profit of $1,375,000 over one-quarter of the Gregory Group's investment plus the subsidiary's outstanding indebtedness on its FHA-insured mortgage, upon tender of a responsible purchaser's contract to purchase the building "as is" and a 25% deposit, if the Gregory Group's counsel were satisfied that the proceeds when distributed would be taxable as capital gain to Arlington's individual stockholders.

On July 25, 1957, the Gregory Group asserted that the McFarland Group had warranted a number of liabilities and costs to be less than they were, and gave notice that until the alleged warranties were made good it would withhold "fulfillment of any rights upon the part of McFarland under said agreement." The McFarland Group brought this diversity action in the Southern District of New York on September 13, 1957, seeking rescission of the transaction because of the Gregory Group's failure to perform.

After a trial in 1960 and 1961, Judge Dimock found that the McFarland Group neither warranted nor knowingly misrepresented liabilities or costs. Accordingly, although he held that the Gregory Group had refused performance in good faith, Judge Dimock rendered a decree of specific performance extending the McFarland Group's rights under paragraphs 7, 8, and 9 of the Memorandum Agreement for three years from the date of his opinion, approximately the period remaining of the original 39 months when the Gregory Group refused to perform. This extension was conditioned upon addition to "the investment of the Gregory Group," as a component of the formula prices under paragraphs 7, 8, and 9, of the consolidated net profits of Arlington and its subsidiaries beginning with the fiscal year starting July 1, 1960 (approximately the original expiration date of the McFarland Group's rights), less federal income taxes paid, and less dividends distributed to stockholders of Arlington "for each full fiscal year of said Corporation from July 1, 1960 to the June 30 preceding" a paragraph 7 sale or a paragraph 8 or 9 tender. Neither party appealed the 1961 decree.

In 1962 both parties raised questions concerning the implementation of paragraph 9, on which Judge Dimock ruled in a supplemental decree. He held that the Gregory Group could not elect not to convey an apartment building under paragraph 9 as it could the stock and debentures of Arlington under paragraph 8 and that the formula price under paragraph 9 did not include the prepayment penalty on each subsidiary's FHA-insured mortgage.*fn2 The supplemental decree further extended the McFarland Group's rights under paragraphs 7, 8, and 9. The Gregory Group appealed only the second extension of time, and this Court upheld it. McFarland v. Gregory, 322 F.2d 737 (2 Cir. 1963).

In February 1965 the McFarland Group again moved before Judge Dimock for rescission of the underlying transaction, claiming that the Gregory Group had clearly shown that it would not perform under paragraph 9. This motion was argued in April 1965 and led to settlement talks, which aborted on July 30, 1965. The McFarland Group immediately moved to compel the Gregory Group to accept a tender in a specified form for all four apartment buildings under paragraph 9. The Gregory Group interposed three objections to the tender: First, the tender credited the McFarland Group with $1,000,000, its potential profit participation on a sale of Arlington at the formula price under paragraph 8. Second, it called for immediate conveyance of the property, whereas the Gregory Group sought a 25% deposit and a month or more to convey, since section 337(c) of the Internal Revenue Code of 1954, 26 U.S.C. ยง 337(c), required that Arlington be dissolved before the subsidiaries received the sale price if recognition of gain by the subsidiaries was to be avoided under section 337. Finally, the tender provided that the Gregory Group should subordinate or satisfy a mortgage on the fee.

These differences were compromised in three days of argument and negotiation before Judge Dimock in early August. The McFarland Group agreed to tender the formula price computed by the Gregory Group, $19,899,870, without the $1,000,000 credit, but specifically stated that it did not intend to "give up the rights that we have retained under the contract or under the judgments." Although Judge Dimock ruled that the Memorandum Agreement did not require that the subsidiaries be assured nonrecognition of gain, the McFarland Group also consented to the liquidation of Arlington, but reserved its paragraph 7 and 8 rights for a limited time as though Arlington had not been liquidated. The Gregory Group agreed to accept a deposit of $500,000, and to subordinate or satisfy the mortgage on the fee. The parties finally stipulated, in language suggested by Judge Dimock, that they would accept the tender agreed on "as one which complies with and one having only the consequences of one which complies with paragraph 9."

When the paragraph 9 purchase by the McFarland Group was consummated on August 31, 1965, the Gregory Group found that the McFarland Group had obtained two mortgages on the buildings and leaseholds for a total amount exceeding the price paid. It then claimed that the Memorandum Agreement required the McFarland Group to pay the fair market value of the buildings and leaseholds, but this contention was unsuccessful both before Judge Dimock and in this Court. McFarland v. Gregory, 363 F.2d 857 (2 Cir. 1966).

The McFarland Group then bid for the assets of Arlington at the formula price under paragraph 8. Instead of selling, the Gregory Group elected to pay the McFarland Group its participation in the potential profit, $1,000,000.

At this point the McFarland Group advanced the three claims whose disposition by Judge Dimock on February 25 and June 30, 1966 is ...

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