The opinion of the court was delivered by: SAND
The issue to be resolved in this non-jury proceeding is whether the sum of $ 1,261,937.50 held by defendant First National City Bank ("Citibank") should be distributed to holders of subordinated debentures issued by Continental Mortgage Investors ("CMI") or whether said funds should be returned to CMI. In resolving this issue, we must determine whether a certain transfer of funds from CMI to Citibank was made pursuant to a Trust Indenture or pursuant to a letter agreement between the parties. If the transfer was made pursuant to the Indenture, the Court must consider the consequences of a failure on the part of CMI to comply with its two-day notice provision. If the transfer was pursuant to the letter agreement, the Indenture notice provision is irrelevant and the funds should be returned to CMI. We conclude that the transfer was made pursuant to the letter agreement and that consequently the funds should be returned to CMI.
CMI is a Massachusetts business trust created under a Declaration of Trust dated November 29, 1961, as amended, under the laws of the Commonwealth of Massachusetts and has its principal place of business in Boston, Massachusetts. Citibank is successor by appointment to Chemical Bank as Trustee and paying agent under an Indenture between CMI and Chemical Bank dated as of February 15, 1970 pursuant to which there are outstanding $ 40,328,000 in principal amount of Convertible Subordinated Debentures due February 15, 1990. Subject to the provisions of the Indenture, the terms of each Debenture provide that interest on the principal sum outstanding is payable at the rate of 61/4% Semi-annually on August 15 and February 15 of each year. The Debentures (principal and interest) are subordinated to the Senior Indebtedness of CMI which consists primarily of a Domestic Credit Agreement and a Eurodollar Credit Agreement, involving approximately 96 banks. The interests of the Senior Indebtedness are being represented in this litigation by Bankers Trust Company ("Bankers").
Section 3.03 of the Indenture provides that in the event CMI is in default under the Senior Indebtedness "no payment of principal of, premium, if any, or interest on the Debentures . . . shall be made by CMI . . .". Section 3.04 of the Indenture provides:
"Nothing contained in this Indenture or in any of the Debentures shall (a) affect the obligation of CMI to make, or prevent CMI from making, at any time except as provided in Sections 3.02 and 3.03, payments of principal of, premium, if any, or interest on the Debentures, or (b) prevent the application by the Trustee of any moneys deposited with it hereunder to the payment of or on account of the principal of, premium, if any, or interest on the Debentures, if, prior to the second business day preceding the date upon which such moneys become payable for any purpose, the Trustee at its principal office shall not have received written notice as provided in Section 3.06."
On December 1, 1975, CMI did not pay the principal and interest due on the Senior Indebtedness. As a result, CMI was in default under the Senior Indebtedness on December 2, 1975. The next interest payment date was February 15, 1976. On December 3, 1975, a meeting was held of representatives of CMI, Citibank and Bankers at which time the default of CMI and the steps being considered to remedy the default were discussed. At that meeting a representative of Bankers stated that a proposed new credit agreement would be circulated to the participating banks and that it was anticipated that the new credit agreement could be executed by January 16, 1976. Citibank was to be kept informed of the progress being made in connection with the new credit agreement. CMI also requested at the meeting that an agreement be executed extending, until January 16, 1976, a waiver of a default under the credit agreements which waiver had expired on December 1, 1975.
Section 8.07 of the Indenture provides that within 90 days after the occurrence of any default under the Indenture, the Trustee shall notify the debentureholders of such default unless such default is cured prior to the giving of notice, except that "in the case of default in the payment of . . . interest . . . the Trustee shall be protected in withholding such notice if . . . the Trustee in good faith determine(s) that the withholding of such notice is in the interest of the debentureholders."
At the request of Citibank and pursuant to the terms of the Indenture, CMI delivered to it an Officers' Certificate, dated December 11, 1975 but received December 16, 1975, stating that CMI was in default with respect to the Senior Indebtedness. Citibank did not notify the bondholders
of the default.
The amendment to the Senior Indebtedness extending the waiver to January 16, 1976 was executed and became effective on or about January 9, 1976 on which date Citibank received another Officer's Certificate from CMI stating that it was no longer in default under the Senior Indebtedness. As late as January 13, 1976, Citibank knew that all participating banks had not executed the proposed new credit agreements and that if all banks did not consent by January 16th, CMI would again be in default on the Senior Indebtedness.
On or about January 6, 1976, Mr. William Hayes, Vice-President in the Corporate Trust Department of Citibank, suggested to Mr. T. Frank Armstrong, an officer of CMI in charge of communications among CMI, Citibank and Bankers, that CMI consider depositing with Citibank funds equal to the amount of interest due on February 15, 1976. In a letter dated January 13, 1976 to Mr. Eugene J. Jaworski, a senior trust officer in the Corporate Trust Department of Citibank and responsible for the administration of the CMI Indenture, Mr. Armstrong advised Citibank that he had arranged for the transfer of the funds. The letter stated: "hold these funds for our account and use them to pay the interest which will be due on February 15, 1976 on our 61/4% Convertible Subordinated Debentures due February 15, 1990, unless instructed by us to the contrary." On or about January 15, 1976, CMI caused $ 1,261,937.50 to be transferred to Citibank which funds were held by Citibank in a special account. This special account was not the account upon which checks would be drawn for payment of the interest to the bondholders.
On January 16, 1976, the waiver expired, the new credit agreements were not in effect, and CMI was in default in the payment of over $ 500 million due on the Senior Indebtedness. Between January 15 and February 11, 1976, Citibank had no communications with CMI or Bankers and was not advised whether the new credit agreement had been executed.
On February 11, 1976 Citibank was notified by telex from CMI and by letter from Bankers that CMI was in default on the Senior Indebtedness and therefore pursuant to Section 3.03 of the Indenture, no interest payment was to be made.
Citibank also received a telex from CMI requesting the return of the funds pursuant to the January 13, 1976 letter. These communications were not received by Citibank prior to two business days before payment was due: February 12, 1976 was a Thursday, Lincoln's Birthday and a bank holiday in the State of New York. Therefore, Friday was the only business day prior to Monday, February 16th, 1976, when the interest payment was to be made.
On this basis, Citibank stated that it would make the interest payments to the bondholders in accordance with the Indenture.
This action was promptly commenced by CMI against Citibank on February 13, 1976 to obtain a preliminary and final injunction enjoining Citibank from paying out the sum of $ 1,261,937.50. On February 13, 1976, the Court entered an Order to Show Cause and Temporary Restraining Order, forbidding Citibank from paying out the monies until authorized to do so by further order of the Court or written authorization from CMI. On March 8, 1976, all proceedings in this action were stayed by CMI's filing a petition under Chapter XI of the Bankruptcy Act in the United States District Court for the District of Massachusetts (76-0593-G). On June 28, 1976, the stay was lifted. Bankers intervened in the action as a party plaintiff alleging, in addition to supporting CMI's claim to have the money returned to it, an independent right on behalf of the Senior Indebtedness that the money be delivered to Bankers for payment to the Senior Indebtedness. By stipulation the claims of Bankers were severed, to be tried separately at a later date if such claims were not resolved in this proceeding.
This decision, which constitutes our findings of fact and conclusions of law (Fed.R.Civ.P. 52(a)), is rendered after a trial on the merits of CMI's claim to the funds. Bankers was permitted to file an amicus brief with respect to CMI's claim. The position of Citibank is that, since it did not receive two days prior written notice of CMI's default, it is not prevented from making the payment of interest to the holders of the Debentures. CMI argues on the other hand that it should not be denied the right to call back the funds because: (1) the delay in giving notice under the indenture was short, inadvertent and caused no prejudice to the Trustee since it had taken no action towards payment or (2) alternatively, because the funds were deposited with Citibank under a letter agreement separate and apart from the Indenture permitting recall of the funds at any time prior to payment.
The initial question here is whether the funds were transferred to Citibank under the Indenture or whether they were transferred under a separate arrangement. If deposited under the Indenture, then the two-day notice provision of Section 3.04 is relevant. The mere fact that the transfer was conditioned upon CMI's right to recall the funds does not in and of itself demonstrate that the deposit was not pursuant to the Indenture since under section 3.04 of the Indenture, CMI could prevent the application by the Trustee of moneys deposited with it for the payment of interest. However, from all the surrounding circumstances, we find that Citibank did not receive the money under the Indenture and ...