The opinion of the court was delivered by: LUMBARD
Plaintiff, the Public Service Company of Colorado (PSCC), brought this diversity action against The Chase Manhattan Bank in 1978. PSCC charges that Chase breached its fiduciary obligations as trustee for PSCC's pension fund -- that Chase negligently monitored a mortgage investment it had made on behalf of PSCC and sixteen other pension funds. Consequently, Chase was unable to bring an overall and knowledgeable judgment to the decision whether and how to sell the loan at a time when Chase knew or should have known the loan had become an imprudent trust investment. The investment eventually declined to a fraction of its original worth. Plaintiff claims damages in excess of $300,000.
This Court conducted a seven-day bench trial ending on December 1, 1982. For the reasons stated below, the Court finds Chase liable for PSCC's loss.
Chase failed to respond in any way to early indications that the condition of the mortgaged property was deteriorating. In general, it inspected the property much too infrequently and collected superficial reports from such inspections as it conducted. From the late sixties on, the property, a large apartment complex, suffered poor maintenance. Conditions deteriorated steadily, culminating in near total uninhabitability by the time of trial. By no later than late 1973, Chase could no longer count on the continued viability of the complex under its then current debt structure, and the unsuitability of the mortgage as a trust investment should have been apparent. However, Chase failed to recognize the situation because of its negligence in monitoring the loan. Consequently, between 1973 and 1975, Chase failed to take reasonable steps to sell the loan at a price reflecting the deteriorated condition of the underlying security. Had Chase taken reasonable steps, it would have sold the loan by mid-1975 at a twenty percent discount. Accordingly, Chase is surcharged in the amount for which the loan could have been sold, plus interest, with appropriate set-offs for subsequent payments of principal and interest.
PSCC appointed Chase trustee of its pension fund by a July 1, 1952 agreement, which gave Chase sole power to make investments for the fund. PSCC retained no right to control the making, retention or disposal of trust investments. On January 29, 1964, Chase made the $4.7 million Glassmanor loan as trustee for 17 pension funds and gave PSCC a 3/47ths share, or $300,000. The loan was approved by Chase's Real Estate and Mortgage Loan Committee and the Pension Trust Investment Committee,
composed of individuals experienced in trust management. The mortgage was payable over 15 years, with a maturity balance of $2.5 million, commonly called a "balloon balance." It was secured by the Glassmanor apartments, a then thirteen year old complex consisting of approximately thirty buildings and 771 apartment units, conveniently located near downtown Washington, D.C., in Prince Georges County, Maryland. At the time the loan was made, an independent appraiser found the apartments in generally good condition and valued them at $6.8 million, providing a 69% loan to value ratio. Income was more than adequate to pay debt service.
Both the Real Estate Department and the Trust Committee were responsible for managing the Glassmanor investment. Under Chase's policies, the Real Estate Department was responsible for inspecting the complex every eighteen months and for reappraising it every three years. In accordance with the regulations of the Comptroller of Currency, Chase also required the Trust Committee to review the mortgage yearly or within fourteen months of the last review.
Although review sessions were attended by a member of the Real Estate Department, the Trust Committee relied almost entirely on the information contained in the "mortgage review sheets" prepared by the Real Estate Department. The committee did not review the underlying inspection and reappraisal reports on which the review sheets were based.
Between 1967 and 1970 Chase received indications that the property was being poorly maintained, was subject to vandalism and was in need of remodeling. In January, 1967, Harold Nyhus, who had appraised the property for Chase in 1963, reported that he had learned during an October 1966 fire inspection that Glassmanor suffered over one hundred vacancies. Nyhus visited the apartments again in January, 1967, and found that there were 120 empty apartments, for a vacancy rate of 15.5%. He reported that the manager claimed to have advised the owner that increased vacancy might be avoided by remodeling the units in one building where the majority of the vacancies occurred.
By letter dated January 16, 1967, the owner requested a two month moratorium to finance a $50,000 pilot remodeling project in one of the buildings with the poorest occupancy. The owner noted that remodeling was necessary to make the somewhat obsolete apartments competitive with new apartments in the area. In addition to increasing occupancy, remodeling would permit rent increases which would provide a gain in income of $7,500 per year for each remodeled building. If the project were successful, the owner proposed to convert approximately "20 of the . . . buildings in the same manner." Total cost of remodeling twenty buildings would have been about $1 million.
By letter dated January 24, 1967, Chase's Second Vice President, Norman Caridi, informed the owner that Chase was aware of the conditions the owner had reported. Caridi wrote, however, that after reviewing the request personally and discussing it with various members of the committee, "we cannot see how it would be possible for us to provide the necessary equity money required for the rehabilitation of the pilot building, for to do so would presume that similar requests would be made with respect to the other apartments." Chase inspectors noted some progress in 1968 and 1969; however, it appears that three-fourths of the apartments were never remodeled. In 1969 when the property was sold to the Wisconsin Real Estate Investment Trust (WREIT), the new owner proposed to spend $1 million upgrading the complex. It does not appear that any significant upgrading ever occurred.
In addition to receiving indications in the late sixties that the property was in need of modernization, Chase was alerted to a vandalism problem. In 1969, after viewing repairs to a fire damaged storage bin, an inspector recommended that Chase ask the owner to install adequate lighting in the area. The owner informed Chase that this would not be possible because the property was plagued by an "overbearing amount of vandalism." The owner noted that at one time it had installed better lighting, "only to have it broken, torn out and generally dismantled the following morning." Chase failed to respond. It made no effort to determine whether the owner was taking care of the problem.
Chase was also alerted to the fact that the complex was not being properly maintained. Chase's 1968 inspection report noted that several public halls had been painted and that the exterior trim was in need of paint. Chase's 1969 appraiser apparently found the trim and the public halls still in need of paint. His report noted that "[a] maintenance program ha[d] been instituted regarding the painting of building trim and public areas"; "approximately 42 halls out of 124 ha[d] been completed and a contract regarding the painting of trim and facade ha[d] been signed."
The next inspection report on October 9, 1970, showed that the "maintenance program" had not been carried out; the "public halls, exterior trim and window moldings [were still] in need of painting." More significantly, the inspector found the property in only "fair condition"
and noted that "adequate maintenance appears generally lacking."
Chase failed to respond in any way to the indications that the property was not being properly maintained. Indeed, in violation of its own policies it failed to review the loan in 1971 and 1972 and after 1970 failed to conduct its regularly scheduled inspections for five years.
The only reliable testimony at trial concerning the property and neighborhood during this crucial period was from plaintiff's witness Joseph Murray. Murray had managed the Glassmanor apartments for several years, from their completion until 1955. He subsequently joined a real estate firm which, beginning in the mid-sixties, managed two new complexes adjacent to Glassmanor.
Murray testified that during the mid- to late-sixties, maintenance at Glassmanor "slipped badly"; it failed to keep up "with the fact of life that there were people moving in and out of the development." Consequently, the complex did not "remain as desirable a place to live as it had been." The exterior appearance of the apartments did not attract new tenants, especially those "who had some pride in their home."
The racial and socio-economic composition of the Glassmanor neighborhood changed about this time. Murray testified that although the high turnover required particular sensitivity to maintenance, "it appeared . . . that the management or the owner's attitude was that if this place is going to be going, if you will, downhill because we are changing race, then there's not much point in keeping it up . . ."
By the late sixties, the complex "showed signs of heavy wear and tear and poor maintenance particularly in public areas." Murray saw "the beginning of abandoned cars, cars sitting up on blocks, indicating a serious decline in the level of tenancy and the management's response."
Murray also testified that the racial composition changed at similar properties in the area. However, where management was responsive to the situation, the properties did not experience as significant a decline as Glassmanor.
Murray testified that by the early seventies he would occasionally see boarded-up windows at the basement level; he saw more and more abandoned cars and noted the lack of sweeping and cleaning on the parking lots around the complex, "almost as though . . . the place . . . wasn't being managed for habitability." During the seventies, deterioration and decline in habitability spread like a "cancer" across a project "that once was a very fine place to live."
Murray's testimony is supported by other evidence. In July 1971, inspectors from the Prince Georges County Department of Licenses and Permits visited the property. They found over one hundred building-code violations.
They found that "walkways, parking lots, steps, curbing and retaining wall[s] throughout the complex are deteriorated and in a state of disrepair"; "exterior premises around numerous structures have high weeds and are littered with trash," and "benches throughout [the] complex are in a state of disrepair, and/or the wood and metal surfaces are exposed to the weather." The violation notice also reported fences in disrepair, broken windows, doors that did not fit within their frames, trash in numerous window wells, light fixtures in disrepair, numerous leaking roofs and holes and cracks in exterior walls. Finally, as Chase personnel had noted in 1968, 1969 and 1970, the exterior trim was in need of paint. Inspection of interior public areas revealed a great deal of flaking paint, holes in walls and ceilings, broken glass, missing floor tiles, stairs in disrepair and numerous storage rooms with accumulations of trash. The inspection of individual apartment units revealed more flaking paint, numerous cracks and holes in walls and ceilings, numerous bathroom defects likely to cause water leakage into apartments below and numerous other violations. The County inspectors continued to cite the apartments throughout the remainder of 1971 for similar violations.
The same year, the Trust Committee decided to dispose of four to five hundred mortgage loans it held as trustee, because of the low yield and illiquidity of such investments. Steven Owen, a member of the Real Estate Department who had no prior experience in selling mortgage loans, was given the responsibility for disposing of the investments. He offered the loans to savings and thrift institutions and mortgage bankers in the New York area.
In May of 1971, Chase arranged to sell the Glassmanor loan to the New York Bank for Savings as part of a package of 75 mortgages for a total price of about $35 million. The Glassmanor loan was priced at about $3.3 million, representing the discount to present value of the future payments on outstanding principal and interest. On June 10th, the New York Bank returned the Glassmanor loan to Chase, under a provision of the purchase agreement requiring Chase to repurchase any loans "declared unsatisfactory because of appraisal qualifications or other matters impairing the securities of the loans in question."
Meanwhile, as Murray testified, the property continued to deteriorate. During 1973, County inspectors visited the property several times and reported hundreds of violations. Indeed, by the time of Chase's 1973 reappraisal, County inspectors had noted public halls and windows so dirty as to be unsanitary; holes, cracks and breaks in walls, ceilings and floors of several apartments; numerous cases of water damage to ceilings; broken windows and broken walkways.
Chase reappraised the property in June, 1973, a year late according to its own policy. The reappraisal report failed to provide any data on comparable properties in the area, an especially problematic omission given that Chase did not operate a field office which might have provided continuous information on market conditions. More significantly in the circumstances established by the evidence, the report, like those preceding it, gives too little detail to permit Chase officials to form an intelligent opinion as to the condition of the property generating the reported figures for expenses and income.
Indeed, the report simply states that "subject property suffers more from general wear and tear due to age rather than anything specific . . ." The report notes three apparently random details from the large variety of circumstances prevailing at a complex of Glassmanor's size: "B & C boilers do require some repair for leaks and missing insulation. Also correct a leak in the laundry room at 359 Irvington and patch the sidewalk in front of 349 Irvington." This reappraisal report was a wholly inadequate substitute for the more thorough inspection report Chase needed in order to keep abreast of the situation.
Five months later, when the County sent its thirteenth Glassmanor violation notice of 1973, it listed 284 violations. The notice provides a compelling picture of the deteriorating state of the complex and a clear sign of what was to come. The notice reported generally that the exterior public walkways and parking lot curbing throughout were in disrepair; the "laundry rooms, storage areas, boiler rooms and basement areas throughout have cracked and missing window panes" and "hazardous accumulation[s] of wood, debris and trash," and laundry rooms throughout suffered the pervasive water damage noted elsewhere in the complex. Inspection of some of the individual buildings revealed many violations for peeling and flaking paint in public hallways; numerous broken windows; numerous entry doors in disrepair; several buildings whose exterior premises were littered with trash, debris and uncut grass and weeds; many inoperative light fixtures; storage areas and laundry rooms with holes in the walls; entry steps in disrepair; eroding groundcover and dozens of other violations. Inspection of several individual apartment units revealed thirty eight instances of cracked plaster or flaking paint, several doors in disrepair, broken windows, leaking plumbing, water damage to ceilings, electrical outlets in disrepair, numerous bathtubs with inadequate caulking and many other violations.
The Court finds on the basis of all the evidence that the apartments were, as Murray testified, not being maintained for habitability, that they were not in "satisfactory" or "fair" condition, and that the 1973 report that the project suffered from "wear and tear due to age" was a wholly inadequate appraisal or description of the situation.
Had Chase responded with appropriate inquiries when it learned that the neighborhood was undergoing a racial and socio-economic transformation and that maintenance at the complex was poor, or had it conducted the reasonably thorough inspections called for by its own policies during the interval from 1970 to 1975 -- inspections necessary to monitor a situation 200 miles from Chase's offices -- it would have learned of many of the highly visible problems evidenced by the violation notices. Chase would have learned that the property was in need of considerable repair and that the future profitability of the complex under the then current debt structure was uncertain, rendering the investment improperly speculative for a trust fund. Despite the realities, when the Trust Committee met to review the loan in September, 1973, after a two year hiatus, it had before it a mortgage review sheet based on the inadequate reappraisal for 1973 ...