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February 28, 1975

LOUIS J. LEFKOWITZ, as Attorney General of the State of New York, Defendant

The opinion of the court was delivered by: COSTANTINO

COSTANTINO, District Judge.

This suit attacks the constitutionality of the recently enacted New York Statute, Chapter 119 of the Laws of 1974, *fn1" which requires mortgage lending institutions to pay interest on mortgage "escrow" accounts. The complaint requests the convening of a three-judge court pursuant to 28 U.S.C. §§ 2281 and 2284, preliminary and permanent injunctive relief enjoining enforcement of Chapter 119, and a declaratory judgment that the section is unconstitutional as applied. Defendant has cross moved to dismiss the complaint for lack of federal jurisdiction, failure to state a claim for which relief can be granted and failure to join indispensable parties. Specifically plaintiff argues that the statute contravenes the contracts clause of the Constitution, art. I, section 10, and the equal protection and due process clauses of the Fourteenth Amendment. The action is brought under the aforementioned sections of the Constitution, 42 U.S.C. § 1983, 28 U.S.C. §§ 2201 and 2202 and jurisdiction is founded upon 28 U.S.C. §§ 1331 and 1343 (3). By order dated August 29, 1974 plaintiff's application to convene a three-judge court was granted.


 The facts have been stipulated to and those relevant to this decision can be briefly stated. It is the general practice of the mortgage lending industry to require that a borrower to whom a mortgage loan has been extended deposit with the lending institution funds to ensure payment of real estate taxes and assessments, and insurance premiums on the mortgaged premises. These deposits, called "escrow" accounts, protect the lending institution from being subjected to the superior claims of taxing authorities if there is a failure to pay taxes and a loss from destruction of the mortgaged property if insurance policies lapse.

 When plaintiff entered into the mortgage contracts at issue it did not intend to segregate these deposits or account to mortgagors for profits arising from the use of the escrow funds. The contract provisions establishing the escrow accounts, however, did not refer to the disposition of any income from the accounts nor did they indicate any intention of the parties as to who shall have use of the funds in the accounts between the day of deposit and the due date of the taxes and insurance premiums. Paragraph 12 of the stipulation of facts is important to the disposition of this suit and accordingly will be included verbatim:

At all times when the 12,000 mortgage loans referred to in Paragraph 4 above were made, it was JSB's [plaintiff's] policy to commingle escrow accounts with other funds of JSB and not to pay any specific return on the escrow accounts to the mortgagors. This policy was made known to anyone who inquired as to what the policy of JSB was in this regard. It was well known to all experienced real estate attorneys and certainly to attorneys representing mortgagors in their dealings with JSB. With relatively rare exception, all of the 12,000 mortgagors referred to above were represented in loans by counsel of their own choosing; and most of the exceptions were themselves attorneys. Any mortgagor or potential mortgagor who has inquired as to whether he might earn a return on the escrow account has been informed that no such return is available. If any such return had been insisted upon, it would have been the policy of JSB to refuse to make the loan.

 Chapter 119 requires the plaintiff and other mortgage lending institutions to pay homeowner mortgagors a minimum of two percent interest on escrow funds deposited with the mortgagee for the future payment of taxes and insurance premiums, except where the mortgages were executed before the enactment and expressly provide that no interest is to be paid.


 Plaintiff first contends that chapter 119 "impaired" the mortgage contracts entered into prior to April 1, 1974 -- the date of enactment -- since under then-existing law it had no obligation to pay interest. In determining if there has been an impairment the initial inquiry must be whether there is in fact a contract as to the use of the escrow funds. Plaintiff argues in essence that non-payment of interest on the escrow accounts became an unstated term of the mortgage contracts because of the knowledge of the attorneys for mortgagors that the bank would pay no interest and the attorneys' acquiescence in that arrangement. Further, the bank contends that non-payment of interest was a "bargained for" term, citing as proof its assertion that it would not have entered into any mortgage arrangement had it been required to pay interest on the escrow accounts. The bank maintains that the knowledge of mortgagors' attorneys of the policy of no interest "[shows] that the use of the escrow funds was bargained for by Jamaica Savings Bank in a legal sense even if in particular instances the question may have not been raised by the mortgagors."

 This assertion necessarily leads the court to consider whether non-payment of interest became an "implied in fact" term of the mortgage contracts. Like express terms, implied in fact terms must be agreed to to become part of the contract, 1 Williston, Contracts § 3; Crosby v. Paul Hardeman, Inc., 414 F.2d 1, 7 (8th Cir. 1969). Basic contract law teaches that each party must agree with definiteness to the terms of a contract and manifest its intention to create an obligation to the other party. Simpson, Contracts, §§ 3, 9 (1954). Even when contracts do not so expressly state it is sometimes possible to infer that certain unstated terms are part of the contract because of the circumstances. Baltimore & Ohio R.R. v. United States, 261 U.S. 592, 598, 67 L. Ed. 816, 43 S. Ct. 425 (1923). The New York Court of Appeals many years ago stated the rule most cogently:

A contract cannot be implied in fact * * * against the intention or understanding of the parties; * * * The assent of the person to be charged is necessary and unless he has conducted himself in such a manner that his assent may fairly be inferred, he has no contract.

 Miller v. Schloss, 218 N.Y. 400, 406-07, 113 N.E. 337 (1916). See also Gray v. Kaufman Dairy & I.C. Co., 162 N.Y. 388, 397, 56 N.E. 903 (1900).

 In the case under consideration the persons "to be charged" are the mortgagors. Therefore, it is necessary to prove that they agreed that no interest would be received. The only proof offered here as to the assent of the mortgagors is that their attorneys may have known of the bank's policy. How this indicates a "bargained for" term that has been agreed to is not explained by the bank. The absence of a provision in a series of contracts providing that no interest will be paid on escrow accounts cannot raise the implication that non-payment of interest became a term of the contracts. Since there were no provisions in the contracts as to the use and disposition of the profits derived from use of the escrow accounts, legislation which provides for a specific allocation of those profits cannot be said to impair the contracts.

 The plaintiff implies alternatively that, even without an express provision to that effect in the mortgage, under New York law interest is not payable on escrow funds. If New York law were clearly to that effect it might be an implied negative term of the mortgage agreement that conceivably could raise a question under the obligation of contracts clause. The cases cited by plaintiff fall short, however, of establishing such a principle of New York law. New York State Thruway Authority v. Hurd, 25 N.Y.2d 150, 303 N.Y.S.2d 51, 250 N.E.2d 335 (1960) is cited in support of the proposition. In Hurd the Court of Appeals decided that in the absence of an express obligation, the Thruway Authority was not required to pay interest to the State of New York for advances made to it by the State. In that case there were advances to the obligee. Here there is a deposit of money to be paid to a third party. In Hurd the considerations were ...

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