HELLER FINANCIAL f/k/a WALTER E. HELLER & COMPANY vs. INSURANCE COMPANY OF NORTH AMERICA, and GUARANTY BANK & TRUST CO.

This action presents a novel question of law for determination. The plaintiff, Heller Financial ("Heller") formerly known as Walter E. Heller & Company, seeks a determination as against Guaranty Bank & Trust Company ("GBT") and Insurance Company of North America ("INA") that a certain mortgage from George Klein, Trustee of N.E.R. Realty Trust to it, dated September 15, 1981 and recorded with Worcester District Deeds. [Note 1] Book 8311, Page 210 (Exhibit 8) is entitled to priority as against a mortgage from George Klein, Trustee as aforesaid to Guaranty Bank & Trust Company dated April 21, 1981 and recorded in Book 7213, Page 388 (Exhibit 13) assigned to John E. LeComte, Nominee for INA, by instrument dated October 18, 1982 and recorded in Book 7583, Page 17 which the plaintiff contends either has been discharged or subordinated to the lien of its mortgage. Subsequent to the filing of the complaint the two mortgagees sold the premises to the principal of the debtor, and the dispute now concerns the allocation of the proceeds of the sale of the mortgaged premises. The Amended Complaint also set forth counts of breach of contract embodied in an estoppel letter against GBT, interference with a contractual relationship against INA, counts against both defendants pursuant to the common law of deceit and G.L. c. 93A. [Note 2] Chief Justice Marilyn M. Sullivan was designated a Superior Court Justice for the purpose of hearing certain counts by order of Chief Administrative Justice Arthur M. Mason. The defendants denied the allegations of the complaint. Defendant GBT claimed that it was not liable to Heller for its actions since there was no duty contractual or otherwise, and that Heller had suffered no damages. Defendant INA claimed that there was a valid assignment of the GBT Mortgage, and that INA did not violate any duty to Heller and thereby caused no damage to Heller.

A trial was held at the Land Court on June 16, 1988, October 4 to October 6, 1988 inclusive, November 28, 1988 to November 30, 1988 and December 9, 1988. A stenographer was appointed each day to record and later transcribe the testimony for each day of trial. Virginia Norkevicius of GBT; Robert Ogar of Heller; Roy C. Angel, formerly of GBT; Jean Brusso of GBT; Charles Mason of GBT; Donald Vigliatura, formerly of GBT; Marshall Goldberg of Contract Surety Consultants; Donald Bayston of Heller; Jacob Kojalo, formerly of Consumers Savings Bank; Robert Kimball, Esq. ; and Melvyn Glickman, Esq. all testified. Fifty-nine exhibits were introduced into evidence, some of multiple parts. One chalk was presented for the assistance of the Court and two items were marked for identification purposes only. Both defendants made motions for directed findings at the close of the plaintiff's case and renewed the motions at the close of all the testimony; these motions are denied.

On all the evidence I find and rule as follows:

1. George E. Klein and his brother (and perhaps their wives) were the sole stockholders of New England Roofing Co., Inc. ("Nerco") and its related companies other than one in which there were minority interests.

2. The entities which the Kleins controlled in addition to Nerco were D & S Roofing Inc., Inter-city Roofing Co., Inc., Nielk Building Supply Co., Inc., Nerco hearing Corp., Nerco Automotive Service, Inc., Skylighhts, Inc., Energy Consultants, Inc., N.E.R. Realty Trust and THD Realty Trust. None of such entities were subsidiaries of Nerco; rather the Klein's ownership was the common thread.

3. Guaranty Bank & Trust Co. of Worcester had been financing the Klein Companies for many years beginning about 1961, the obligations to the Bank secured in part by a series of mortgages on the real estate where Nerco's principal office was located as well as by other collateral not directly concerned in this litigation.

4. The Kleins were engaged in the roofing business and held contracts with many public authorities and private corporations in a far flung operation. Its equipment and inventory accordingly was situated in many different locations.

5. Beginning about 1979 the Kleins fell on hard times in part caused by neighborhood difficulties arising from the plant operation, the economic recession in the construction industry and Proposition 2 1/2. In early 1981 their obligations to GBT were approximately $2,200,000. So far as the real estate was concerned, this was represented by two promissory notes from Klein, as Trustee of N.E.R. Realty Trust to GBT, one dated April 21, 1981 in the principal amount of $720,000 (Exhibit No. 3) secured by a mortgage of even date therewith, recorded in Book 7213, Page 388 (Exhibit No. 13). There was an earlier note in the principal amount of $809,388.83 dated December 12, 1979 secured by a mortgage of the same date and duly recorded. (Exhibit No. 2) The latter mortgage was subordinated to that of April 21, 1981 by an instrument recorded in Book 7213, Page 387.

6. The factors set forth above led George Klein to seek additional financing. After an unsuccessful approach to GBT he applied to Heller's local office for a loan of $1,500,000 which was approved by the home office in Chicago, Illinois in the amount of $550,000. During the time necessary to process the loan including a title examination of the properties involved, Mr. Robert Ogar, Heller's Regional Manager and Donald Vigliatura, a then Assistant Vice President and an Account Officer with GBT spoke, Heller having been referred to the bank officer by George Klein and his counsel.

7. The closing of the Heller loan was held at the main conference room of GBT in Worcester on November 12, 1981. Present were Mr. Vigliatura, Mr. Ogar, Mr. Klein and his counsel, Melvyn Glickman. The question as to whether GBT's counsel, Robert Kimball, was present is a matter of dispute, but I find that he was not. The discharge of the 1979 GBT mortgage was executed prior to the closing at which it was delivered. The note to Heller from Nerco had been executed in September, but the closing with the delivery of the funds was delayed by the completion of a title examination. The other documents, also executed in advance were a) the mortgage to Heller from Klein, as Trustee of NER Realty Trust, which was stated to secure "the guaranty of George Klein, individually and as Trustee of N.E.R. Realty Trust, of even date which guarantees the obligation of New England Roofing Company, Inc., under its note to Walter E. Heller & Company of even date in the amount of $550,000 [Note 3] and b) mortgages from Mr. Klein, as trustee of N.E.R. Realty Trust to Heller dated September 15, 1981 and recorded in Book 7340 Page 63 (Exhibit No. 9) and from Mr. Klein, as trustee of T.H.D. Realty Trust dated September 15, 1981 and recorded in Book 7340, Page 95 (Exhibit No. 10). The latter two mortgages secure the same obligations as the first above mentioned, and the registry stamp indicates they all were recorded on October 13, 1981. It is unclear whether duplicates subsequently were signed at the closing since there was testimony as to the execution of documents at that time. In any event it is immaterial.

8. The $550,000 Nerco note to Heller (Exhibit No. 6) provides fo the payment of $550,000, with interest thereon, in eighty-four monthly installments of $12,844.27. The stated interest rate is 22 per cent, a violation of G.L. c. 271 § 49 unless Heller had registered with the office of the Attorney General. Begelfer v. Najarian, 381 Mass. 177 (1980). The note fails to state whether it is on a direct reduction basis and is ambiguous in its provisions, but in calculating the correct application of each payment made by or on behalf of Klein it should be applied first to interest then due and the balance to principal.

9. The N.E.R. Realty Trust note to GBT dated April 21, 1981 originally provided for interest at the rate of 18 1/2 per cent per annum to be adjusted at each payment date to reflect the prime rate charged by the holder, the new rate to be 1 1/2 per cent per annum above the prime rate for the next ensuing month. The note provided for fixed payments of principal and interest (Exhibit No. 3). The note was revised, without the registry records being supplemented by a mortgage amendment, (Exhibit No. 14) by a promise to pay apparently dated November 12, 1981 with fixed payments of principal in the amount of $3,064 together with interest payments at a rate one per cent above prime. There is no evidence that Heller was aware of the change in the pay down of the Klein obligations. See Shane v. Winter Hill Savings Bank, 397 Mass. 479 (1986).

10. G B T and Heller disagree as to the execution on behalf of the bank of the so-called estoppel letter (Exhibit No. 7A), no copy of which could be found in the Bank's records. At the most GBT conceded that its officer whose signature appears thereon read only the second page thereof. Since paragraph 6 starts the reverse side of the estoppel letter, Mr. Vigliatura either read or should have read the first page thereof. He had no authority to sign the undertakings set forth therein in behalf of the bank which were couched in the phraseology of confirmation, but he did have apparent authority.

11. The funds advanced by Heller representing its loan of $550,000 were disbursed to GBT in the amount of $525,000 and to Nerco in the amount of $25,000.

12. The Heller loan was monitored in Chicago. In July of 1982 the local office was advised by Chicago that there had been a non payment. By letter dated July 19, 1982 Heller advised Nerco of the default and suggested it might accelerate the borrower's obligations. (Exhibit No. 19).

13. In July of 1982 George Klein was meeing with representatives of GBT to advise them of Nerco's difficult financial picture and to suggest the possibility of filing for bankruptcy or reorganization. GBT learned at this time that Heller's obligations were in arrears and that INA had come into the picture.

14. The Klein entities were bonded by INA which also became aware of their financial difficulties in July 1982 and the possibility of bankruptcy. As of August 3, 1982 Nerco had 61 projects under way for a total contract price of $6,347,841.00. INA had bonded 44 of the projects for a total of $5,739,030.00. As of August 3, 1982 $2,332,023.00 of the $5,739,030.00 had been billed, approximately $1.3 million of which had been collected. Thus, if the bonded jobs were completed, there would be an additional $4.4 million received by New England Roofing. If the non-bonded jobs were completed, there would be another $887,00.00 received. However, approximately $500,000.00 to $1 million turned out to be uncollectible. INA had several options. They could do nothing, but this would probably lead to a large loss exposure. INA also had the alternatives of buying back its bonds from the various owners or infuse funds into New England Roofing. INA decided to fund payments to New England Roofing in order that Nerco would be able to make payments to Heller. INA would accomplish this by drawing a check on its account and forwarding it to its attorney John LeComte who would deposit the funds into a trust account which had been established. Funds were then transferred from the trust account into the various accounts where monies were needed to satisfy the bonded obligations. Payments then were made with New England Roofing checks. This method was followed with funds that were used to pay the Heller obligations. As New England finished a bonded job, part of the exposure of that job (apart from the warranty and guaranty obligations) was removed as far as INA was concerned. The decision to fund New England was made at meeting in Philadelphia in the early part of August, 1982. It was also decided that all payments for work completed would be placed in a trust account without regard to whether it was payment on a bonded or unbonded job.

15. INA had employed the services of Contract Security Consultants ("CSC") who assigned Marshall Goldberg to advise it on the resolution of the Nerco difficulties. Mr. Goldberg monitored receipts and the payment of money by Nerco. Mr. Goldberg continued to authorize payments to Heller until either September or October of 1983. Heller was being paid since Heller officials were pressing Nerco for payment whereas GBT, the holder of the first mortgage, was not pressing and so originally not paid. INA funded payments to Heller totalling in excess of $200,000.00, approximately $60,000.00 of which was principal reduction as computed by Heller. At that time New England had substantially reduced its work program from July, 1982. CSC remained involved with Nerco until sometime in 1985. Until that time Mr. Goldberg still had to approve requests for payment by Nerco. Monies that came into Nerco were deposited into an INA trust account over which Mr. Goldberg had control. INA did not fund payments for all creditors. A determination was made whether or not the obligation fell under the bond umbrella. If it did, INA then determined whether the account was current or needed funding. The trust accounts were later moved to Consumers Savings Bank after the agreement between INA and GBT was executed. During the time Mr. Goldberg was involved with Nerco he would conduct periodic surveys. Mr. Goldberg also determined that Heller was in a second position on most of the parcels of real estate but held first position on some pieces.

In the beginning, Mr. Goldberg was at Nerco almost daily; as time progressed he was there less frequently. Mr. Goldberg did not make any decisions with regard to the conduct of the construction operations; his involvement was to monitor the progress of work and the finances of the company.

16. INA elected to fund Nerco in order to complete the bonded contracts and thereby to reduce its potential liabilities. It also followed the same course in some instances on jobs where it had issued no bonds in order to avoid creditor problems. To complete the work INA needed to use, or have available for Klein's use, the Nerco headquarters, its equipment and inventory much of which was located on diverse jobs all over the northeast. Consequently, negotiations were begun to take over GBT's position. Payments also were made to Heller to bring its loan current and to avoid future defaults since INA needed to use certain Klein assets which were subject to a Heller security interest to keep Nerco in business. The arrears due in the summer of 1982 were brought current by a Nerco check #245 drawn on Consumers Savings Bank in the amount of $38,652.90 and payable to Heller. (Exhibit No. 48).

17. Extensive and intense negotiations were conducted between Guaranty, INA and Klein in the office of Boston counsel of INA in August of 1982. Present were representatives of the three parties and their counsel. Officers or counsel of Heller were neither present nor notified of the workout sessions. Indeed the payments to Heller were designed in part by INA to keep Heller in darkness as to the Klein companies. Of course, Heller knew from the July default in its note and thereafter presumably could have learned from credit sources available to it of Klein's financial difficulties if it had so elected.

18. The agreement between INA, Guaranty and Klein culminated in an agreement dated August 31, 1982 by which INA agreed to advance funds to complete the bonded projects, and was given authority to operate the financial aspects of the Klein business including the authority to supervise and monitor all income and disbursements with the right to disapprove the purchase of equipment, the acceptance of new contracts, the hiring of employees, the choice or retention of a CPA firm, and the approval or rejection of executing contracts. INA also agreed to guarantee payment to GBT of interest on the Klein notes with provisons for the right to prepay them. As to the real estate it was provided that it would be sold for $1,200,000.00 with the net proceeds to be applied first to the principal of outstanding mortgage notes. [Note 4] The property was in fact placed on the market and then withdrawn.

19. INA elected to pay off GBT. GBT agreed to accept $1,700,000.00 in full payment of the obligations due to it which were approximately $250,000.00 more and to assign to INA all security held by it for payment of the indebtedness. INA obviously would have been able to borrow the moneys directly to pay GBT, but as an insurance company the loan would affect its reserves so it was decided to have the moneys borrowed by Nerco, and payment guaranteed by INA, from Consumers Savings Bank. The approach to the latter lender was made by George Klein, but the loan would not have been approved without INA's guaranty. The $1,700,000 note was executed by George Klein on behalf of Nerco (Exhibit No. 42) and was guaranteed by INA in a separate instrument. (Exhibit 43) At the direction of Nerco Consumers Savings Bank paid the loan proceeds, $1,700,000, directly to GBT by its check no. 331707 dated October 18, 1982 and drawn on the Worcester County National Bank. On the same day Nerco paid GBT the sum of $37,889.80 by its check no. 208005 drawn on the payee and representing interest for the period from August 31, 1982 to October 18, 1982 (Exhibit No. 4). GBT then assigned Nerco's Amended Mortgage Note to John E. LeComte, Nominee of INA, and without recourse and without warranties (Exhibit No. 29) similarly assigned the mortgage securing it to Mr. LeComte by instrument dated October 18, 1982 and duly recorded on the following October 25. (Exhibit 28) In addition, other obligations of Nerco and the other Klein entities to GBT were assigned to Mr. LeComte (See Exhibits 30 to 34 inclusive, the latter exhibit having 18 subparts).

20. INA continued to fund payments to Heller until September, 1983, and the Heller note remained current until September 19, 1983. After the default, memoralized in its letter to Klein, Heller's obligations remained current. However, by letter dated November 16, 1982 (Exhibit No. 52) George Klein informed Heller of Nerco's severe financial difficulties, and a meeting was held the next month in Framingham at which Heller's representatives, George Klein and his attorney and accountant were present. For the first time Heller learned that Chapter XI bankruptcy proceedings had been staved off, that INA had been funding Nerco and controlling the company operations and had reached agreements with GBT into whose position it had stepped. Heller also learned that INA would substantially have met its bonded indebtedness by the following June and would make some determination then as to whether to cause Nerco to be liquidated or to continue as a going corporation. At this point Heller took a watching brief.

21. This action was filed on July 20, 1984. INA thereafter paid Consumers Savings Bank in full in December of 1984 as more fully set forth in a letter of its counsel dated December 14, 1984. (Exhibit 49B). The pay-off figure was $1,788,612.89 (Exhibit 47C) together with any interest which accrued during the period of clearance of INA's check.

22. INA and Heller entered into a proceeds holding and cooperation agreement dated May 20, 1987 (Exhibit No. 49) in which the creditor agreed to release their respective security interests to the various Klein interests in return for the payment of $900,000 less certain accrued real estate taxes to be deposited in escrow with their attorneys. After it was determined that Heller alone had a mortgage interest in certain real estate parcels, the value thereof was determined and the proportional part of said proceeds ascertained, all as set forth in an Agreement dated July, 1988 between Heller and INA. Pursuant thereto Heller's attorneys were authorized to distribute to Heller the sum of $141,330.64.

23. Testimony at the trial suggested that Heller was applying the so-called Rule of 78's to the Klein obligations. The note to it, however, does not so provide. Rather each payment made, of which there were twenty-two, should have been applied first to the interest then due and thereafter to principal. Also applied to principal should be the July 1988 payment. Once the note went into default in September 1983 interest continued to accrue thereon at the rate hereafter decided.

Mortgage Priority

Heller's principal contention is that the assignment by GBT to INA was pursuant to a payment made by the party obligated and that therefore the assignment in effect was a discharge or at the least was subordinated to Nerco's obligations to it. INA conversely contends that it as guarantor paid the GBT loans since Consumer Savings Bank would not have made the loan to Nerco without INA's guaranty and that there was a true assignment.

It has long been established in Massachusetts, although the cases are few, that an assignment may be treated as a discharge if an injustice would be wrought by recognizing form over substance and preserving to the detriment of a given mortgagee the lien of a mortgage rather than finding it to be extinguished. The most recent case to discuss this subject also originated in the Land Court. It is Widett & Widett v. Snyder, 392 Mass. 7789 (1984) where at pages 784-5 Justice Wilkins spoke for the Supreme Judicial Court as follows:

Whether one views the purported assignment of the mortgage to Newbury Prime as in fact a release instead of an assignment (see Carlton v. Jackson, 121 Mass. 592 , 596 [1877]; McCabe v. Swap, 14 Allen 188 , 192 [1867]), or whether on views the assignments as merging the Snyders' equity of redemption and the third mortgage, thus extinguishing the mortgage (McCabe v. Swap, id. at 191), the result is the same. "[A] court of equity will go behind the form to reach the substantial merits of the case." Ryer v. Gass, 130 Mass. 227 , 229 (1818). Although in certain instances we have treated intention as controlling whether a mortgage was extinguished or assigned (see Flanagan v. Babineau, 332 Mass. 379 , 381 [1955]; Shapiro v. Bailen, 293 Mass. 121 , 123 [1936]; Cheffee v. Geageah, 253 Mass. 586 , 589 [1925]; Gibson v. Crehore, 3 Pick. 475 , 482 [1826]), we will not permit intention to control when to do so would be unfair to third persons. See Lydon v. Campbell, 198 Mass. 29 , 33 (1908) ("The mortgage debt having been extinguished by the payment under these circumstances, the owner of the equity could not keep it alive even by causing an assignment to be made, even to a third party who contributed in no way to the payment:); McCabe v. Swap, supra at 191-192 (Mergers are odious in equity "whenever injustice will be worked thereby. But when a party, for the purpose of defeating a meritorious right in another, sets up . . . a mortgage which it was his duty to pay, equity is equally ready to manifest its aversion to such an attempt; and we think both law and equity coincide in declaring against it . . . Accordingly as assignment in form is held to be an extinguishment, when the justice of the case requires it"); 3 R. Powell, Supra at 696.29; 5 H. Tiffany, Real Property § 1482, at 512 (3d ed. 1939); Swaim, Crocker's Notes on Common Forms § § 532, 533. (7th ed. 1955)

In the complicated factual situation in Widett & Widett v. Snyder, supra, it seemed that the only apparent purpose of the assignment was to maintain the mortgage to the law firm in a subordinate position. In the scenario now before me it seems that the purpose of the convoluted dealings was to maintain the position of GBT's mortgage as prior to Heller. That should not be countenanced.

There are two facets of the applicable doctrine for Heller to meet in obtaining the benefit of the Lydon rule. The doctrine mandates that the party making the payment is obligated to do so. Sharpiro v. Bailen, 293 Mass. 121 , 123 (1936). INA argues persuasively that Consumers Savings Bank would not have made the loan without its guaranty, and I so find. The loan was structured, however, for business reasons of INA as a loan to Nerco which executed the note to the Bank and was primarily liable for its payment. The loan ultimately was paid by INA, but the funds of the Klein companies from the work in progress were commingled with moneys infused by INA, and there was no showing of the actual source of the final payoff. In any event it is the payment of GBT with which we are primarily concerned, and it was channeled through Nerco and brought the Lydon doctrine into play.

The parties did not stress the other element within which Heller had to fall. The GBT note was made by Mr. Klein in his capacity as trustee while the note to Consumers Savings Bank was executed by Nerco, and the GBT payoff proceeds thereof were generated by Nerco. For all intents and purposes, however, George Klein was Nerco and all the other legal entities which had lien formed to carry on the roofing and related businesses (except that of minority interests). The Supreme Judicial Court gave short shrift to this point, the variances in the corporate and individual ownerships, in Widett. The Klein role was very similar, if not even more controlling, than that of Hasseotes in Cumberland Farms as described in My Bread Baking Co. v. Cumberland Farms, Inc., 353 Mass. 614 (1968).

The parties (or non party, as the case may be) in the Nerco workout are not school boys engaged in a playground game of pick up baseball but seasoned financial professionals adept at hard ball and seeking to preserve their assets in a crumbling situation. INA succeeded to a large extent in accomplishing its goals, but in so doing it used a framework which I hold to constitute a discharge in relation to the second mortgage to the interests of which it is subordinated.

Heller is not, however, entitled to priority as to certain aspects of its claim. As to any unpaid interest it would be against public policy for the Court to recognize a rate greater than twenty per cent (20%) prior to default, interest thereafter is to be the same rate until Judgment when G.L. 231 § 6C calls for, twelve prcent (12%). The necessary computations are an area where the parties should be able to agree on the final sums due and as to which I find and rule Heller has priority in the disbursement of the proceeds of the sale of the mortgaged premises now held by counsel.

Breach of Contract

The Count for breach of contract against GBT is grounded in its failure to observe the terms of an estoppel letter signed on its behalf by an assistant vice president who did not have actual, but did have apparent, authority to execute it. There was consideration for the execution of the estoppel letter in that the major proceeds of the Heller loan were used to pay down the Klein obligations to GBT and were not released until the closing even though the documentation was largely signed in advance and some proceeds advanced directly to Klein. However, the estoppel letter is couched in terms of a courtesy request, and it would be inequitable to imply legally binding obligations from its precatory terms on the facts as I have found them.

Interference with Contractual Relationship

In view of the Court's finding as to the lack of a contractual relationship between GBT and Heller there can be no recovery by Heller against INA on this Count.

Deceit and Chapter 93A

I find and hold that INA had no duty to inform Heller of Klein's financial position. It can, of course, be an actionable misrepresentation if one misspeaks or volunteers false information. However, it is hard to see how the payment by INA in Nerco's name falls into that classification. And even if it did, Heller on the result here has not been hurt. Failure by Klein to pay real estate taxes was a default under the statutory condition set forth in Heller's mortgage, and the status of such taxes was public information readily available to Heller if it had monitored its loans as a real estate transaction. Thus it was in a position to obtain the status of the Nerco or trust obligations and to proceed individually against Nerco if it had so elected. In addition, by November 7, 1982 it had learned from Klein of INA's involvement and chose not to act at that time.

On all the evidence as revealed herein I find no violations of G.L. c. 93A § 2.

GBT submitted a request for findings of Fact and Rulings of Law. I have not dealt with them specifically since I have made my own findings of fact and rulings of law.

Judgment accordingly.