Home LORRAINE STARR vs. J. ABRAMS CONSTRUCTION CO., INC. (and a companion case).

16 Mass. App. Ct. 74

April 11, 1983 - May 23, 1983

Suffolk County


This court let stand an arbitral award to enforce an oral "side agreement" providing for additional payments to supplement those required under a written building contract, notwithstanding possible illegality of the oral agreement by reason of the contractor's failure to disclose its existence to the Federal agency insuring the mortgage on the project, where the parties appeared equally at fault in misleading Federal authorities as to the construction costs and where, in the circumstances, the nondisclosure was not so detrimental to Federal policy respecting mortgage insurance as to warrant the imposition of sanctions additional to those provided by criminal statutes. [78-82]

CIVIL ACTIONS commenced in the Superior Court Department on March 8 and March 26, 1982, respectively.

The cases were heard by Ford, J.

Alan R. Hoffman for Lorraine Starr.

Brian M. Hurley for J. Abrams Construction Co., Inc.

GREANEY, J. We deal here with an arbitration award of $66,856 on an oral side agreement to a written contract. Under the written contract, the appellee, J. Abrams Construction Co., Inc. (Abrams Construction), had undertaken to build a nursing home for the appellant, Lorraine Starr. In separate actions filed in the Superior Court, Abrams Construction moved to confirm the award of the arbitration panel, see G. L. c. 251, Sections 11 & 15, which, without making findings of fact, granted the full amount Abrams Construction had sought under the side agreement; Starr moved, pursuant to G. L. c. 251, Sections 12(a)(3) & 15, to vacate the

Page 75

award. Abrams Construction's motion to confirm was allowed; Starr's motion to vacate was denied. Separate judgments reflecting these orders were entered. The cases are consolidated here.

The oral agreement essentially called for Starr to pay for anticipated costs of completing work on the nursing home in excess of the $1,710,000 contract price. The mortgage on the home is insured by the Federal Housing Administration (FHA). Starr asserts that enforcement of the agreement exceeds the powers of the arbitrators because the agreement is against public policy. This claim rests on the assertion that Abrams Construction made a false statement which had the effect of representing to the FHA that the project would be built for the contract price, thereby inducing FHA financing arrangements predicated on that figure, although the company's principals were aware that the contract sum would be insufficient to complete the desired facility. This course of conduct, it is asserted, violates 18 U.S.C. Section 1010 (1976) [Note 1] and G. L. c. 266, Sections 30, 33 & 34, [Note 2] and the Federal regulatory scheme underlying FHA financing commitments. It is contended that enforcement of the side agreement would condone this illegal conduct and violate public policy.

There was evidence before the arbitrators from which they could have concluded the following facts. The $1,710,000

Page 76

construction cost figure was reached at an August 8, 1975, meeting of Julius Abrams, president of Abrams Construction, Larry Smith and Henry Fitzgerald. Smith was the developer hired by Starr to handle the design, construction and financing of the project. Fitzgerald was the project's architect. At an October 6, 1975, meeting, which was likewise attended by Abrams, Smith and Fitzgerald, there was a discussion of changes which would have the net effect of adding some $50,000 to the cost. Smith told Abrams that the $1,710,000 figure had been established as the basis of financing arrangements with the FHA and that the figure was "sacred" and untouchable. Everyone agreed that an attempt would be made to do the job for that amount, but that if the net effect of changes, deletions and items which had not previously been figured into the computation forced the cost over $1,710,000 the excess would be paid by the owner. Starr attended a meeting on October 14, 1975, with these same individuals. It was agreed at the meeting that after the job was completed Abrams would calculate the value of any work which exceeded the "sacred" amount, and Starr would give Abrams Construction notes (on rather indefinite payment terms) for the appropriate sum at no interest. Starr also attended meetings on December 19, 1975, and June 9, 1976, at which this payment plan was confirmed. Throughout this period (and indeed up until construction began) the plans and specifications for the nursing home were in constant flux as was the estimate of the cost overrun, a situation not unusual in private sector construction. Despite this, a construction contract was signed on November 10, 1975, in order to lock in a favorable sales tax rate and to exempt the project from new safety regulations scheduled to become effective in 1976. [Note 3] The contract recited

Page 77

the $1,710,000 cost figure. Construction began on June 14, 1976, approximately two months prior to the FHA closing.

Starr's allegations of illegality focus on FHA form no. 2328, which was executed by Abrams for Abrams Construction on March 31, 1976, and by Starr as mortgagor on April 5, 1976. That form is headed "Contractor's and/or Mortgagor's Cost Breakdown," and it contains the following inscription: "This form represents the Contractors [sic] and/or Mortgagors [sic] firm costs and services as a basis for disbursing dollar amounts when insured advances are requested." On the form, construction costs are broken down by category. The total cost reported was $1,710,000. It is not disputed that at all times, from and including the dates on which the form was signed, cost overruns of varying proportions were projected and that at the time of the final requisition for payment, which was based on the form no. 2328 figures, the amount of the overrun had crystallized at $66,582. Yet at no time was any attempt made to amend the original contract figure of $1,710,000 which was used in the completion of all official FHA documents, including the final requisition. Abrams testified that revision of the "sacred" figure was rejected because everyone involved knew that such a revision would result in having to start the project over again "from stage one." The decision to handle the extra costs outside of FHA channels was made, he said, in order to allow the project, already in gestation for a number of years, to proceed apace. As previously indicated, Starr asserts that this conduct violated 18 U.S.C. Section 1010 (1976) (see note 1, supra), which punishes those who knowingly make false statements for the purpose of obtaining a loan to be insured by the Department of Housing and Urban Development (of which the FHA is a part) or for the purpose of influencing that department in any way. A violation of State criminal statutes punishing larceny by false pretenses, G. L. c. 266, Sections 30, 33 & 34, is also alleged.

Page 78

It is not contended that the agreement to pay for the overrun is illegal, per se, nor do we think it could be. We are aware of no law which expressly forbids the performance of a contract to pay for construction costs which exceed the figure used as a basis for obtaining financing, federally insured or not. The issue, therefore, is whether the failure to disclose the oral side agreement to the FHA is so repugnant to public policy that a court should add to any potential liability under criminal statutes [Note 4] the additional sanction of vacating an arbitration award which enforces the agreement. Assuming, without deciding, that the nondisclosure was illegal and, a fortiori, a violation of public policy, we conclude, with some hesitation, that the decision in Town Planning & Engr. Associates v. Amesbury Specialty Co., 369 Mass. 737 , 746 (1976), causes us to enforce the arbitrators' award.

There is a rule that "[a]rbitration . . . may not `award relief of a nature which offends public policy or which directs or requires a result contrary to express statutory provision.'" Lawrence v. Falzarano, 380 Mass. 18 , 28 (1980), quoting Eager, The Arbitration Contract and Proceedings Section 121(6), at 316 (1971). That rule, however, is subject to the recognized qualification that "an award of arbitrators is valid and sustainable if there may be a lawful compliance therewith on any rational basis." Eager, supra at 316. We believe that a rational basis exists for enforcing the arbitration award on this oral agreement. "Our cases warn against the sentimental fallacy of piling on sanctions unthinkingly once an illegality is found." Town Planning & Engr. Associates, supra at 746. "Courts do not go out of their way . . . to impose hardship upon the parties beyond that which is necessary to uphold the policy of the law." Nussenbaum v. Chambers & Chambers Inc., 322 Mass. 419 , 422 (1948). In a case such as this, "we have to ask whether a consequence, beyond [any] prescribed by statute, should

Page 79

attach, inhibiting recovery." Town Planning & Engr. Associates, supra at 745. "To find a proper answer, all the circumstances are to be considered and evaluated: what was the nature of the subject matter of the contract; what was the extent of the illegal behavior; was that behavior a material or only an incidental part of the performance of the contract (were `the characteristics which gave the plaintiff's act its value to the defendant . . . the same as those which made it a violation . . . of law'); what was the strength of the public policy underlying the prohibition; how far would effectuation of the policy be defeated by denial of an added sanction; how serious or deserved would be the forfeiture suffered by the plaintiff, how gross or undeserved the defendant's windfall." Id. at 745-746 (footnotes omitted).

We think the following factors are significant to the required analysis in this case. Of primary importance is the fact that neither the oral agreement itself nor its performance is, per se, illegal. If an illegal act took place, it involved intentional understatement of the costs of construction by nondisclosure of the oral agreement, with the intent improperly to influence the mortgage lender or insurer. The law provides a criminal penalty for such activity. However, "[i]n general, illegality in a contract is a defence only because it is against public policy that the court should be called upon to enforce contracts that the parties have been expressly or impliedly forbidden by law to make or to perform." Nussenbaum v. Chambers & Chambers Inc., supra at 421-422.

No such circumstance exists here because the illegality, if any, was separately identifiable and punishable and tangential to and apart from the agreement itself. Secondly, it would be difficult to avoid the conclusion that Starr was as much a party to the allegedly fraudulent statement as Abrams Construction. She, too, was a signatory to the form in question, which was labeled "Contractor's and/or Mortgagor's Cost Breakdown" (emphasis added). The record before the arbitrators amply supports the conclusion that both Starr and the developer to whom she delegated the task

Page 80

of overseeing construction and financing arrangements were continually advised of the extent of the anticipated overruns as the plans and specifications were developed and altered, and therefore knew at the time the breakdown form was signed that it understated the best current estimate of the actual costs of construction. It should also be noted that the actual application for mortgage insurance (on yet another FHA form) was made not by Abrams Construction but by Starr, apparently working from the form no. 2328 figures. A third factor of some importance is that the $66,856 claim of Abrams Construction appears from the record to represent only actual extra costs of construction. It contains no element of overhead or profit over that which was contained in the "official" contract figure of $1,710,000. Thus, if the arbitration award is enforced, Abrams Construction will realize no real gain; if it is vacated, the result is pure windfall to Starr, the repudiating party.

Finally, there is the question of subversion of FHA policy. It appears that the FHA may insure mortgages, such as that here involved, in a principal amount of not more than ninety percent of the value of the facility. See 12 U.S.C. Section 1715w(d)(2) (1976). There was testimony before the arbitrators to the effect that the FHA's determination of the maximum amount of the mortgage is based on the ability of the facility to support the mortgage, looking on that score to projections of the income-generating capacity of the facility. The net effect of the oral arrangement here could only have been to reduce the mortgage as a percentage of the true value of the facility, since the agreement in essence called upon Starr to increase her own direct investment in the equity. Since there was no agreement to secure the notes, which were to be given in payment by Starr, by an interest in the income of the nursing home or in the home itself, there was no demonstrated impact on the income-producing potential used by the FHA to compute the maximum allowable mortgage. For the same reasons, the security provided by the mortgage itself was not diminished

Page 81

or endangered. We thus have some difficulty in finding that the agreement actually undermined FHA mortgage insurance policies and practices in any significant respect. We conclude, although the question is close, that the "vector of considerations" relevant under the Town Planning decision favors Abrams Construction. See Town Planning & Engr. Associates, 369 Mass. at 746-747.

The cases cited by Starr are inapposite. In Poskus v. Braemoor Nursing Home, Inc., 6 Mass. App. Ct. 896 (1978), the court never reached the question whether a note entered into to circumvent an FHA fee limitation was unenforceable on grounds of illegality or public policy. The case was decided on contract principles. Id. at 897. Unlike the present case, Fouquette v. Millette, 310 Mass. 351 (1941), involved an agreement, the very performance of which involved an illegal act. In Council v. Cohen, 303 Mass. 348 (1939), it was held that one who has agreed with a governmental agency to accept bonds and cash for a full release of his claims against property may not insist that the property owners execute a second mortgage on property, unauthorized by the agency, as a condition to the release. In Council, the property owners' mortgage had been foreclosed, and their only hope of recovering their home was through the arrangement insisted upon by the mortgagee. The facts here are much less onerous. Parties of equal bargaining strength appear to have come to an accommodation by which they would circumvent official procedures, thereby providing themselves with a benefit (of time not lost to the bureaucratic process) of value to each. As the Council court indicated, "[t]he court should proceed with extreme caution when called upon to declare a transaction void on grounds of public policy, and prejudice to the public interest should clearly appear before any such declaration is made." Id. at 352. Under the guidelines of the Town Planning & Engr. Associates decision [Note 5] which are informed

Page 82

by the careful study advised by Council, we conclude that the public interest will not be done a disservice by enforcement of the arbitrators' award. In so doing, we do not condone sharp practices or suggest that unlawful acts will routinely by judicially approved. In an area where decision making necessarily must proceed on a case by case basis, we hold only that facts must be viewed under the considerations governing claims of illegality and the general policy favoring enforcement of arbitral awards. When so viewed, if the result reached by balancing the competing considerations appears tenable on any rational basis, enforcement of the arbitrators' award is justified.

Judgments affirmed.


[Note 1] This statute provides: "Whoever, for the purpose of obtaining any loan or advance of credit from any person, partnership, association, or corporation with the intent that such loan or advance of credit shall be offered to or accepted by the Department of Housing and Urban Development for insurance, or for the purpose of obtaining any extension or renewal of any loan, advance of credit, or mortgage insured by such Department, or the acceptance, release, or substitution of any security on such a loan, advance of credit, or for the purpose of influencing in any way the action of such Department, makes, passes, utters, or publishes any statement, knowing the same to be false, or alters, forges, or counterfeits any instrument, paper, or document, or utters, publishes, or passes as true any instrument, paper, or document, knowing it to have been altered, forged, or counterfeited, or willfully overvalues any security, asset, or income, shall be fined not more than $5,000 or imprisoned not more than two years, or both."

[Note 2] Larceny and larceny by false pretenses.

[Note 3] A second contract was executed on an FHA form on June 1, 1976, also reciting a $1,710,000 contract amount. Parol evidence issues raised by reason of the respective dates of the contracts and the discussions which formed the oral side agreement were before the arbitrators and implicitly decided against Starr. Absent fraud, not asserted here, the arbitrators' determination of such issues must stand, notwithstanding errors of fact or law made in arriving at the decision. Trustees of Boston & Me. Corp. v. Massachusetts Bay Transp. Authy., 363 Mass. 386 , 390-391 (1973). Lawrence v. Falzarano, 380 Mass. 18 , 27 (1980).

[Note 4] Nothing we say here should be taken as intimating our view on the viability of a criminal case against any party.

[Note 5] Similar factors would be relevant were we to apply the analysis suggested by the Restatement (Second) of Contracts to the questions of the agreement's enforceability and the availability of a restitution remedy where one party has performed. See Restatement (Second) of Contracts Sections 178 & 197 comment b and illustration 5 (1979).