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TEACHERS INS. & ANNUITY ASSN. OF AMERICA v. BUTLER

January 28, 1986

TEACHERS INSURANCE & ANNUITY ASSOCIATION OF AMERICA, Plaintiff, against DAVID L. BUTLER, JAMES L. GRAUER, JAMES E. KASSIS, and ONE CITY CENTRE ASSOCIATES, A CALIFORNIA LIMITED PARTNERSHIP, Defendants


The opinion of the court was delivered by: WEINFELD

EDWARD WEINFELD, D.J.

Plaintiff, Teachers Insurance and Annuity Association of America ("Teachers"), is a New York nonprofit corporation which provides annuities and insurance programs to colleges, independent schools and other educational institutions, and derives income for such programs from various investments, including long-term loans on commercial real estate.

The defendant, One City Centre Associates ("OCCA"), is a California limited partnership which undertook the development and construction of a high rise office building, One City Centre, in Sacramento, California. It has three general partners, David L. Butler, james E. Kassis and James L. Grauer, also named as defendants (collectively "defendants" or "the Butler group").

 In connection with the development of the building, OCCA needed temporary or construction financing for the period during which the building was under construction and upon completion "permanent financing," which would be applied to the repayment of the construction financing. Bank of America made the construction loan.

 Teachers, after extended negotiations with representatives of Sonnenblick-Goldman Corp., mortgage bankers and realtors who acted as the defendants' agents, and with Butler and Kassis on behalf of OCCA, issued on September 9, 1982 a Commitment Letter which was accepted by the individual defendants on behalf of OCCA. Under the Commitment Letter, which the parties acknowledge constituted a binding agreement between them, Teachers agreed to lend and OCCA agreed to borrow $20,000,000 for a thirty-five year term at a fixed interest rate of 14.25% per annum, to be secured by a first deed of trust on the building. *fn1" The Commitment Letter, among other matters, granted Teachers a contingent interest in the rental returns over the life of the loan, referred to as a "kicker." One provision precluded the defendants from prepayment of the mortgage during the first seventeen years (the "Lock-in Period") and another permitted prepayment during the remainder of the loan upon payment of a premium ("Prepayment Premium") at 6% in the eighteenth year and in reduced amounts thereafter until the expiration date of the loan. These provisions, to be discussed hereafter, are at the heart of this litigation.

 In October 1982, Teachers, OCCA and Bank of America, the construction lender, executed a related agreement called a Take-Out Agreement. It provided that Teachers would "take out" (i.e., purchase) Bank of America's construction loan or repay it the sums it advanced for construction of the building and succeed to its rights.

 In July 1983, Teachers' counsel sent to OCCA for review and comment the closing documents which Teachers proposed be executed by OCCA at the closing of the loan, including a California Deed of Trust and California Deed of Trust Notes, which in relevant part provided:

 In the event Holder exercises its right to accelerate the maturity date following default by Maker, any tender of payment of the amount necessary to satisfy the entire indebtedness secured hereby made thereafter at any time prior to a foreclosure sale, either by Maker, its successors or assigns or by anyone in behalf of Maker, shall be deemed to constitute evasion of the prepayment privilege and shall be deemed to be voluntary prepayment herein and such prepayment, to the extent permitted by law, shall include the premium required to be paid under the prepayment privilege set forth herein. If such occurrence takes place prior to the eighteenth loan year then the agreed premium due and owing one [sic] the unpaid indebtedness shall be the product of the premium otherwise due under the formal herein for prepayment during the eighteenth loan year multiplied by three.

 The parties refer to this provision as the "Default Prepayment Fee Language" and to the second sentence thereof as the "Lock-In Period Default Prepayment Fee Language."

 Prior to the time set for the closing on April 30, 1984, Teachers and OCCA, through their respective counsel, had resolved all disagreements with respect to the language of the closing documents except the Default Prepayment Fee Language. On April 30, 1984, Kassis and Grauer (with a power of attorney authorizing them to act for Butler) appeared at the office of the escrow agent the parties had mutually agreed upon and made certain changes in provisions unrelated to the Default Prepayment Fee Language which had been agreed upon by their respective attorneys. However, they also struck the Default Prepayment Fee Language in each Deed of Trust Note and the Deed of Trust before signing the documents. Later that day, OCCA's attorney informed plaintiff's attorney that OCCA was unwilling to accept the Teachers loan as long as the documents contained the Default Prepayment Fee Language. Teachers then drew the full amount of a $200,000 letter of credit which previously had been provided by OCCA under the Commitment Letter. Soon thereafter, Teachers commenced this diversity action. *fn2"

 Plaintiff seeks to recover damages upon a claim of breach of contract -- that defendant failed to negotiate in good faith the dispute with respect to the Default Prepayment Fee Language and that OCCA's claimed objection thereto was not more than a pretext for its unwillingness to proceed with the transaction as a result of a dramatic decline in interest rates from the date the Commitment Letter was signed to the date of the closing; that OCCA adamantly refused to negotiate the amount of the Default Prepayment Fee and insisted upon its deletion in its entirety -- in sum that its position was wholly arbitrary and in bad faith. Plaintiff seeks to recover as damages the sum of $3,991,408, the difference between 14.25%, the rate of interest set forth in the Commitment Letter and 11.89%, the prevailing rate of interest on Teachers' loans during the month after the closing, over the thirty-five year period of the loan, discounted to present value. Plaintiff also seeks to recover $170,000 covering interest over a six-month period following defendants' refusal to close the deal, which period it claims was reasonably required before it could place a new loan, and $22,441 for the fees of its outside counsel retained for the closing.

 The defendants reject plaintiff's claim, essentially upon the ground that the Commitment Letter makes no provision for a Default Prepayment Fee payable after Teachers' exercise of a right to accelerate for default during the first seventeen years of the loan. The essence of their position is that although the Commitment Letter contains a detailed provision entitled "prepayment," that provision does not mention anything about Teachers' right to an 18% default prepayment fee. Therefore, according to the defendants, it was plaintiff that breached the contract by insisting on the inclusion of a provision in the closing documents that was not in the Commitment Letter. Defendants counterclaim to recover the $400,000 commitment fee retained by plaintiff and the $25,000 appraisal and engineering inspection fee paid to plaintiff.

 DISCUSSION

 After a study of the entire record *fn3" of the six-day nonjury trial at which plaintiff's representatives and those of the Butler group testified, principally David Butler and James Kassis, who participated in the negotiations that led to the Commitment Letter and in events prior to the closing, and upon an evaluation of the credibility of the witnesses and consideration of the legal contentions advanced by the parties, the Court finds that the plaintiff has sustained its burden of proof upon its claim for breach of contract, *fn4" ...


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