64 Mass. App. Ct. 277

November 18, 2004 - August 17, 2005

Court Below: Superior Court, Suffolk


Contract, Construction of contract, Loan, Assignment. Mortgage, Assignment. Loan. Condominiums. Real Property, Condominium, Sale.

In a civil action involving the administration of a participation agreement arising from the development of certain property for residential and retail condominium uses, the judge erred in ruling that the defendant was entitled to deduct expenses related to the day-to-day operation, preservation, and maintenance of the condominium units, where the participation agreement stated that a deduction was to be made for expenses arising as a result of the sales of condominium units; as the judge's ruling did not address whether certain costs came within the concept of expenses directly arising from condominium unit sales, or what differences might arise in the application of the definition of "expenses" in the participation agreement between capital expenses and ordinary expenses, this court remanded for further proceedings. [279-281]

CIVIL ACTION commenced in the Superior Court Department on April 27, 1995.

The case was heard by Barbara J. Rouse, J., on motions for summary judgment, and entry of final judgment was ordered by Gordon L. Doetfer, J.

Michael G. West for the plaintiff.

Bryan G. Killian for the defendant.

ARMSTRONG, C.J. In 1988, the Bank of New England (bank) lent a developer $75 million to convert a large building (Building 197) in the Charlestown Navy Yard to residential and retail condominium uses; Nishimatsu Construction Co., Ltd. (Nishimatsu) also lent the developer $15 million as a construction loan for the same project. (The bank took a first mortgage posi-

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tion on the units and Nishimatsu a second mortgage position.) By 1991, in the face of tightened credit and housing markets, the developer had defaulted on both loans; and Merrill Lynch, Inc., through a subsidiary formed for the purpose, Building 197 Loan Acquisition Corporation (BLAC), succeeded in buying control of the property from most creditors at substantially discounted rates. In that restructuring, Nishimatsu gave up its second mortgage position but, instead of cashing out, opted for participation in the proceeds of condominium unit sales when made.

The present lawsuit concerned several disputes that arose in the administration of the participation agreement, disputes that arose, or at least were exacerbated, because Flag Wharf, Inc., the successor to BLAC, was compelled to resort to creative marketing strategies in order to sell condominium units in the restrictive credit and sluggish housing markets. The various disputes were disposed of surefootedly by the Superior Court judge, and only one issue remains in dispute on appeal: that having to do with the expenses Flag Wharf was entitled to subtract before paying NC Finance Corporation, Ltd. (NC Finance) (successor to Nishimatsu), its specified share (6.377 percent) of the proceeds of condominium sales. The judge agreed with Flag Wharf that the terms of the participation agreement entitled Flag Wharf to pay "Expenses," as broadly defined in the agreement, [Note 2] the effect of which was to reduce the fund by $18,422,317 before calculating the 6.377 percent share to be paid to NC Finance. Specifically, the judge concluded that "expenses related to the day to day operation, preservation, and

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maintenance of the condominium units" were properly deductible. This, we think, was error.

The participation agreement divided participation into Classes A and B. NC Finance was the only Class B participant. [Note 3] Distribution rights of the two classes differed. Class B participants were entitled to receive their percentage share applied to "Capital Loan Proceeds." "Capital Loan Proceeds" was defined as "the difference of (a) any Capital Gross Loan Proceeds, minus (b) any Capital Expenses from time to time." "Capital Gross Loan Proceeds" was defined as "any and all cash amounts in respect of or pursuant to the Loan, the Loan Documents, or the Security which are derived from Capital Transactions, less (i) all Expenses arising as a result of such Capital Transactions, and (ii) any reserves for contingent liabilities arising as a result of such Capital Transactions ...." The term "Capital Transactions" was defined as "any sale, exchange or other disposition of condominium units, parking spaces and/or retail space at the Property [unsold units at Building 197], but shall not include, without limitation, the leasing of any such condominium units, parking spaces and/or retail space."

The scheme envisioned by the participation agreement, in other words, was that the "Class B participant" - NC Finance - would be paid its share s. 6.377 percent s. of the proceeds of the sales (but not leases) of condominium units, after making two subtractions from the proceeds. [Note 4]

The first subtraction to be made was of "all Expenses arising as a result of . . . Capital Transactions [i.e., sales of condominium units]." While the term "Expenses" is expansively defined, see note 2, supra, so as to include all expenses of operation, maintenance, marketing, and so forth - one is hard-pressed to think of a cost, charge, or claim it does not

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comprehend -- not all expenses are to be subtracted; instead, one subtracts only those "arising as a result of" sales of condominium units. The phrase connotes expenses one associates with sales of any real property: brokers' commissions, legal expenses, filing fees, inspections, possibly mortgage points, and the like. One could argue for a broader concept, one that would treat expenses of construction, operation, maintenance, interest on indebtedness, etc., as being "costs of sales," in the sense that they are all essential to the ultimate sale of units [Note 5]; but such a view would leave the words, "arising as a result of . . . Capital Transactions," without meaning. If the draftsmen of the participation agreement meant to have all "Expenses" subtracted from sales proceeds before the Class B distribution, they would not have qualified the word "Expenses" as they did. The deduction for "Expenses arising as a result of . . . Capital Transactions" must be limited to those costs directly and particularly associated with sales of condominium units, not the maintenance of such units or general costs of administration or operation.

Doubtless this construction will lead to disputes as to particulars, i.e., whether certain costs come within the concept of expenses directly arising from condominium unit sales. Such disputes were not reached in the trial court, as the judge's ruling allowing all expenses to be deducted made differentiation immaterial. Hence, disputes as to particulars are not now before us and must be dealt with on remand.

The second subtraction to be made was of "Capital Expenses." [Note 6] The broad definition of "Expenses" (see note 1, supra) encompassed "Capital Expenses," which were narrowly and (traditionally) defined as "expenses incurred after the date of [the participation agreement] relating to capital improve-

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ments . . . determined in accordance with generally accepted accounting principles." [Note 7] Whatever differences may arise in the application of the definition were similarly not reached in the trial court; the ruling that all expenses related to the project were deductible made the difference between "Capital Expenses" and ordinary expenses immaterial. Any issues in this regard must be dealt with on remand.

So much of paragraph numbered 1 of the judgment as relates to count one of the first amended complaint (seeking an equitable accounting), and subpar. (d) of the paragraph thereof numbered 2, are vacated, and the case is remanded for further proceedings thereon. In all other respects the judgment is affirmed.

So ordered.


[Note 1] As assignee of Nishimatsu Construction Co., Ltd.

[Note 2] "Expenses" was defined as "any expenses, . . . costs, . . . or disbursements that may . . . be . . . incurred by . . . BLAC in connection with the Loan, . . . [or] the transactions contemplated . . . thereunder . . . . Expenses shall include (a) disbursements necessary, in the sole judgment of BLAC, .. . to pay any costs related to the day-to-day operation, development, marketing, brokerage sale, leasing, and completion of construction of the Property during the term of this Agreement . . . . Expenses shall also include Capital Expenses and any amounts that BLAC may, in its sole discretion, determine to reserve in respect of any of the foregoing." (The initial capitalization of "Agreement," "Property," "Expenses," "Loan," and "Capital Expenses" indicated that they were terms specifically defined in the participation agreement.)

[Note 3] It was envisioned in 1991 that there would be multiple Class A participants, but, perhaps because of the daunting housing market, BLAC (now Flag Wharf) remained the only Class A participant, its share being the remaining 93.623 percent (i.e., 100 percent less NC Finance's 6.377 percent).

[Note 4] The Class A participants s. in effect, Flag Wharf s. were to receive the balance of the proceeds from sales of units and all other proceeds (from leases, for example) but were charged with the payment of all "Expenses." See note 2, supra.

[Note 5] A spokesman for Flag Wharf, when asked to identify an expense that Flag Wharf did not subtract from sales proceeds, answered, "The expenses to purchase Florida Shores Shopping Center in Florida."

[Note 6] Technically, the first subtraction, expenses associated with sales (and reserves for such expenses), converted actual proceeds from the sale of condominium units into "Capital Gross Loan Proceeds." The second subtraction, of "Capital Expenses," converted "Capital Gross Loan Proceeds" to "Capital Loan Proceeds," the amount from which 6.377 percent was to be distributed to Class B participants.

[Note 7] Also included as "Capital Expenses" were certain transactional costs incurred by BLAC in buying out creditor interests and negotiating the participation agreement, and the cost of settling any outstanding claims of the general contractor against the original developers.

As to the difference between capital expenses and ordinary expenses, see Kansas City S. Ry. v. United States, 231 U.S. 423, 444-447 (1913).