Contracts—Purchaser Failed to Timely Close—Seller Entitled to Retain Down Payment—Sharp Decline in Market Value of Office Buildings—Purchaser Was Looking to Avoid Performance— Seller Could Have Obtained Satisfaction of Prior Mortgage by “Defeasance” Procedure

A purchaser appealed from a trial court decision which had, inter alia, denied its motion for summary judgment and granted the seller’s cross motion for summary judgment on its claim for breach of contract and its cross motion for summary judgment dismissing the purchaser’s complaint. The Appellate Division (court) affirmed.

The parties had entered into a contract of sale for an office building. After the “time of the essence” closing failed to occur, the purchaser sued the seller, seeking return of the deposit. The purchaser alleged that the seller “had breached the…contract by failing to tender an unencumbered title at closing.” The seller brought a separate action, asserting that “it was entitled to retain the deposit” since the purchaser “had breached the agreement by failing to pay the balance of the purchase price.” The court found that the seller had demonstrated that “it was ready, willing and able to close” and the purchaser had refused to close. Thus, the court held that the seller was entitled to retain the deposit.

The purchase price was $178,500,000. The purchaser had wired a deposit of $38,550,000 to the seller’s escrow agent. The agreement was amended to permit the deposit to be released from escrow and delivered to an intermediary of the seller and approximately $600,000 in accrued interest on the deposit was paid to the purchaser. The contract provided that if the purchaser failed to complete the purchase for reasons other than the seller’s default, seller’s sole remedy was to terminate the agreement and receive the deposit back, together with interest, as liquidated damages for the breach. The amendment further provided that if the purchaser defaulted, the purchaser was required to pay the seller approximately $600,000 in pre-effective date interest it had received. If the closing did not occur for reasons other than the purchaser’s default, the deposit, along with certain other monies were to be refunded by the seller to the purchaser. After several extensions of the closing date, a final closing date was set for June 29, 2009. During the two-year period between the contract date and the closing date, “there was a sharp decline in the market value of office buildings in Manhattan.

In December 2008, the purchaser had advised the seller that “because of the decline in the market value of the property, [the purchaser] could not complete the purchase for the $178,550,000 contract price.” The seller asserted that “if [the purchaser] were to purchase the property, it would…lose upwards of $90,000,000.” On the other hand, if the purchaser breached the contract, its liability would be the loss of the $38,500,000 deposit, plus the approximately $600,000 accrued interest. The seller argued that “the drop in real estate values made it more financially advantageous for [the purchaser] to simply walk away from the deal rather than complete the purchase.” An email between the purchaser and its investors discussed a plan to “attend the closing and try for a defective tender and then sue on that basis.” The purchaser had conceded that the real estate market had declined and that “its preference was not to close.”

At the time the contract was entered into, the property had been encumbered by an existing mortgage in the amount of approximately $25,000,000. That mortgage was favorable to the seller in that “it was interest-only until the maturity date and bore an interest rate of 5.03 percent.” Although the promissory note secured by the mortgage did not permit prepayment, the seller could obtain a satisfaction of the mortgage by a process known as “defeasance.” The seller could “purchase defeasance collateral in the form of securities, chosen by the mortgage lender, which would be used to pay the remaining amounts due under the loan. Thus, the securities would, in effect, be substituted as collateral for the loan, and the property would be released from the mortgage lien.”

By letter dated May 15, 2009, the seller declared that “time was of the essence with respect to [the purchaser's] obligation to close on June 29, 2009….” On June 23, 2009, the seller sent the purchaser “a draft closing statement detailing the disbursement of the funds to be provided to [the seller] by [the purchaser] at closing.” The schedule included a disbursement by the purchaser of $28,500,000 “to pay the lender of the existing mortgage.” The purchaser did not object to the draft closing statement. On June 24, 2009, “the mortgage lender’s counsel delivered to Fidelity, the title company identified in the agreement, an executed satisfaction of mortgage releasing the property from the existing mortgage.” The lender’s counsel instructed Fidelity “to hold the satisfaction in escrow and not record the document until Fidelity received further instructions from counsel with respect to the defeasance transaction.”

On June 29, 2009, the day of closing, the seller authorized Commercial Defeasance, LLC (CD) to purchase the defeasance securities that had been designated by the mortgage lender. CD purchased the securities on the seller’s credit, at a cost of approximately $27.7 million. The figure included a premium of about $2.7 million over the $25 million principal amount “because the securities would cover not just the principal but also future interest payments.” Thus, the seller owed CD $27.7 million, which the seller was prepared to pay at the closing. “The defeasance transaction would take two days, and was scheduled to be complete on June 30, 2009, the day after the closing, after which the satisfaction of mortgage would be filed.”

At closing, the seller announced that it was ready to close, and that the mortgage satisfaction was being held in escrow by Fidelity. Fidelity’s title closer, confirmed that it had possession of the satisfaction and stated that the defeasance transaction was a two-day process. The purchaser “expressed its full understanding of the defeasance process, and stated it was ready to pay the remainder of the purchase price, but objected to the use of its funds to pay for the securities.” The seller thereafter told the purchaser that the seller would use its own funds to pay for the securities without using any portion of the purchaser’s monies, provided that the purchaser “concurrently pay the remainder of the purchase price.”

The seller also advised the purchaser that Fidelity “was prepared to issue an owner’s title insurance policy without exception for the mortgage upon [the purchaser's] payment of the remaining purchase price.” However, the purchaser refused to consummate the transaction. The seller then offered to allow the purchaser “to retain, from the balance of the purchase price, $50 million—twice the amount of the mortgage—until the defeasance process was complete, and the mortgage was removed of record.” Again, the purchaser refused to close, “insisting that the defeasance process had to be complete, and the existing mortgage discharged, before it would pay the balance of the purchase price. The closing ended without the transaction being completed.”

The next day, June 30, 2009, the seller sent a letter to the purchaser terminating the agreement.

The court found that the trial court had properly dismissed the purchaser’s complaint and granted summary judgment to the seller on its breach of contract claim. The seller had declared time of the essence and had warned the purchaser that it would be in default if it failed to perform its obligations on the closing date. The purchaser failed to perform its contractual obligations at the closing, despite being advised that the seller was ready to complete the transaction. The record showed that the seller was “fully prepared to tender performance in compliance with the parties’ agreement.” The contract required that the seller deliver at closing a “bargain and sale deed without covenants against grantor’s acts (the ‘Deed’), in recordable form conveying insurable title to the Land and Improvements, subject only to Permitted Exceptions, duly executed and acknowledged by Seller.”

The existing $25,000,000 mortgage, “although listed as an exception in the title report, was not a Permitted Exception under the agreement.” Thus, the seller was required “to deliver ‘insurable title’ with no exception made for the existing mortgage.”

Prior to the closing date, the seller had arranged with Fidelity “that Fidelity would insure title in compliance with [the contract].” Fidelity was prepared to issue a title insurance policy without exception for the mortgage based on the seller’s payment for the defeasance securities on the first day of the two-day defeasance process. The court found that the evidence demonstrated that the seller was “ready, willing and able to perform its obligations under [the contract].”

The purchaser argued that the seller had failed to comply with its contractual obligation to, on or prior to the closing date, “pay, discharge or remove of record or cause to be paid, discharged or removed of record, at Seller’s sole cost and expense, (a) all mortgages…encumbering the Property (other than the Permitted Exceptions)….”

Since the existing mortgage was not a permitted exception, and since the mortgage loan was not prepayable, the purchaser contended that such provision required that “the mortgage lien be actually discharged, and that a satisfaction of mortgage be delivered at closing, before [the purchaser] was obliged to remit the remainder of the purchase price.”

The court held that the foregoing provision did not require that the seller provide a mortgage satisfaction at or before closing. The language did not mention a mortgage satisfaction. Nor did the provision require the seller to actually discharge the mortgage. Rather, the provision required the seller to “pay, discharge or remove of record…[the existing] mortgage.” The court explained that:

in the context of this non-prepayable defeasible mortgage, the phrase “pay…[the] mortgage[],” means to pay for the defeasment securities which would entitle [seller] to a discharge and satisfaction of the mortgage. [Purchaser] unconvincingly argues that one cannot “pay” a “mortgage,” but can only “pay” a “mortgage loan.” To begin, Section 2.2 does not contain the phrase “mortgage loan,” but instead allows [seller] to “pay…[the] mortgage[].” Furthermore, paying a mortgage loan and paying for the defeasment securities here are functionally equivalent—both result in removal of the mortgage lien. Thus, we agree with the motion court that “pay[ing]…[the] mortgage[],” as that phrase is used in Section 2.2, means satisfying the conditions that entitle the borrower to a discharge.

This construction makes perfect sense in the context of real estate closings where the property is encumbered by a mortgage. In the typical case, the mortgage is paid off on the day of closing contemporaneously with the remittal of the balance of the purchase price. Of course, no rational seller would pay off a mortgage in advance of the closing, because if the closing failed to occur, the seller would have lost the mortgage loan. This is precisely the situation here. As noted above, [seller's] mortgage loan contained very favorable terms and had an attractive interest rate. If [seller] paid for the defeasance securities and completed the defeasance process before the closing and [purchaser] subsequently refused to close, [seller] would have lost its valuable loan.

The purchaser had further argued that “it had no guarantee that the defeasance process would be successfully completed the day after closing” and noted that the title company may have been unable to perform, e.g., it might have gone bankrupt or its offices might have burned down. The court found that the purchaser’s “alleged concerns were not reasonable, and appear to be pretextual, particularly in light of its expressed desire not to close.” If the purchaser had proceeded with the closing upon payment for the defeasance securities, “it would have suffered no real prejudice.”

The court noted that the purchaser was protected in two ways. The title company committed “to insure title without exception for the mortgage” and the seller had offered to permit the purchaser “to retain twice the amount of the mortgage—$50 million—from the purchase price until the defeasment process was complete, an offer [the purchaser] rejected.” The court opined that if the purchaser had “legitimate concerns that the mortgage would not be successfully defeased, holding back $50 million from a $178,500,000 purchase price would have satisfied those concerns.” Accordingly, the court found that the seller “was ready, willing and able to close, and that [the purchaser] defaulted by refusing to remit the remainder of the purchase price without lawful excuse.” The court therefore held that the seller “could terminate the contract and retain the earnest money deposit as liquidated damages” and was also entitled to recover the Pre-Effective Date interest.

Comment: The court had noted that it was “accepted practice in real estate transactions to use the purchaser’s monies to pay off existing mortgages.” Moreover, the purchaser had “made no previous objection to the draft closing statement which made clear that the mortgage would be paid off from the sale proceeds.”

Additionally, the purchaser had argued that there was no evidence in the record that its own title company, had been willing to issue the required title insurance. However, the contract only required “insurable title” and did not specify any particular company. Moreover, the contract designated Fidelity as “the Title Company,” and the purchaser made no claim that Fidelity was not “a reputable insurer.”

Donerail Corp. v. 405 Park, 7704, NYLJ 1202574718615, at *1 (App. Div., 1st, Decided Oct. 9, 2012), before: Mazzarelli, J.P., Friedman, Catterson, Richter, Manzanet-Daniels, JJ. Decision by Richter, J. All concur.

Mitchell-Lama—No Taxable Transfer Occurs Under Tax Law §1201(b) and NYC Administrative Code §11-2102(a) When a Residential Cooperative Corporation Amends Its Certificate of Incorporation as Part of Its Voluntary Dissolution, Reconstitution and Termination of Participation in the Mitchell-Lama Housing Program—Appellate Division Held That Real Property Transfer Tax Was Inapplicable to the Reconstitution of a Mitchell-Lama Project to Private Cooperative Corporation

This case involved the issue of whether a taxable transfer occurs under Tax Law §1201(b) and Admin. Code of City of New York (Code) §11-2102(a) “when a residential housing cooperative corporation amends its certificate of incorporation” (Certificate) “as a part of its voluntary dissolution, reconstitution, and termination of participation in the Mitchell-Lama [ML] housing program….” The court held that since “there is no transfer or conveyance of any real property or an interest in real property under those circumstances, no taxable event occurs.”

The plaintiff owns a residential housing cooperative complex. Upon its incorporation, the plaintiff “took title to the underlying real property that it now owns pursuant to the [ML] housing program.” The ML program was created “to encourage and facilitate the construction and continued operation of affordable rental and cooperative housing…for moderate—and middle-income families.” As an ML cooperative housing, the plaintiff received “government benefits, including a low-interest government mortgage loan and substantial exemptions from municipal real property taxation.” In return the plaintiff was subject to several restrictions, “including restrictions on resale to third parties.”

The plaintiff had remained in the ML program for approximately 45 years. In 2005, it repaid the governmental mortgage. In 2007, by a vote of its shareholders and with the permission of the State of New York, the plaintiff terminated its participation in the ML program and pursuant to Private Housing Finance Law (PHFL) §35(3), it “‘reconstituted’ itself as a corporation under the Business Corporation Law [BCL] by amending its [Certificate].”

Although the amendments to the plaintiff’s certificate eliminated all references to the PHFL, “[the plaintiff's name], the number of and names of its shareholders, the number of shares owned by each shareholder, and [the plaintiff's] tax identification number all remained the same.” There had been “no change to the public records maintained by the New York State Department of State, which continue[s] to list [the plaintiff] as an active corporation incorporated in 1961.”

The plaintiff also amended “its bylaws and the standard occupancy agreement for tenant-shareholders.” The plaintiff did not issue “new shares of stock nor transferred shares to the reconstituted corporation.” Rather, the plaintiff amended existing stock certificates by eliminating certain language pertinent only to the ML program and by adding a new legend pertinent to the amended bylaws. “Old stock certificates were exchanged for the new stock certificates, with each shareholder holding exactly the same number of shares as before.”

In August 2009, the NYC Department of Finance issued a Notice of Determination to the plaintiff of a tax deficiency in the sum of approximately $21,000,000. The Finance Department asserted that since the plaintiff “was now a private cooperative corporation that had amended its [Certificate] and terminated its participation in the [ML] program by reconstituting…it had engaged in a transaction that qualified ‘as a conveyance of the underlying real property.’” Therefore, the Finance Department reasoned that the plaintiff was required “to pay a real property transfer tax [RPTT] pursuant to Tax Law §1201(b)(1)(6) and [Code] §11-2102(a).”

The plaintiff thereafter filed the subject complaint, seeking a judgment declaring that the RPTT had been improperly imposed upon it and that it was not obligated to pay the RPTT in connection with its termination of participation in the ML program. The plaintiff argued that “on its face, the tax applies only to transfers and conveyances of real property, or economic interests in real property, from one entity to another, and not to reconstitutions under the [ML] housing program.” The trial court had awarded summary judgment to the city, declaring that “the [plaintiff's] actions constituted a ‘transfer’ and a ‘conveyance’ of real property, and that [the plaintiff] was subject to the RPTT.” The Appellate Division reversed.

The court explained:

[Code] §11-2102(a), enacted by the City pursuant to the authority delegated to it by Tax Law §1201, provides that “[a] tax is hereby imposed on each deed at the time of delivery by a grantor to a grantee when the consideration for the real property and any improvement thereon (whether or not included in the same deed) exceed twenty-five thousand dollars.” [Plaintiff] posits that the RPTT is inapplicable to an act of reconstitution pursuant to the [ML] housing program, because there is no deed, no delivery, no grantor, and no grantee involved in corporate reconstitution. However, the City defendants maintain that [plaintiff's] termination of its participation in the [ML] housing program by way of voluntary dissolution and reconstitution falls within section 11-2102(a), and that a provision added to the RPTT exemption section of the…Code in 1994 warrants the imposition of the RPTT to [plaintiff's] voluntary dissolution and reconstitution.

The court further explained that the RPTT provided that:

The [RPTT] shall not apply to any of the following deeds, instruments or transactions: …A deed, instrument or transaction conveying or transferring real property or an economic interest therein that effects a mere change of identity or form of ownership or organization to the extent the beneficial ownership of such real property or economic interest therein remains the same, other than a conveyance to a cooperative housing corporation of the land and building or buildings comprising the cooperative dwelling or dwellings. For purposes of this paragraph, the term “cooperative housing corporation” shall not include a housing company organized and operating pursuant to the provisions of article two [i.e., the Mitchell-Lama law], four, five or eleven of the private housing finance law” [Code] §11-2106[b][8]).

Additionally, [Code] §11-2101(2) defines a “[d]eed” as:

[a]ny document or writing (other than a will), regardless of where made, executed or delivered, whereby any real property or interest therein is created, vested, granted, bargained, sold, transferred, assigned or otherwise conveyed, including any such document or writing whereby any leasehold interest in real property is granted, assigned or surrendered.

The court further noted that under the ML law, “[a]bsent some specific restrictive covenant, a limited-profit housing company, aided by a loan made after May 1, 1959, may voluntarily dissolve…, the only conditions imposed on a housing company for dissolution without the consent of the supervising agency, are that it pay the remaining mortgage loan and all expenses incurred in the dissolution and that at least 20 years have elapsed since the occupancy date….” Upon the voluntary dissolution of an ML cooperative housing corporation, “title to the project may be conveyed in fee to the owner or owners of its capital stock or to any corporation designated by it or them for the purpose, or the company may be reconstituted pursuant to appropriate laws relating to the formation and conduct of corporations…. Neither the term ‘reconstituted’ nor any of its variations is defined in the [PHFL].”

The city argued that “by voluntarily dissolving and subsequently reconstituting, [the plaintiff] became a new corporation and that, accordingly, the amended [Certificate] constituted a deed.” The City asserted that “the purported deed was delivered at the time of execution, and that the purported deed was delivered by an ‘old’ [plaintiff] to a ‘new’ [plaintiff].”

The Appellate Division (court) found “no support in either case law or the record for the city defendants’ interpretation of the law.” The court reasoned that “[u]pon amending its [Certificate], [the plaintiff] remained the same entity, although it was relieved of various restrictions previously imposed upon it by the [ML] housing program….” That would be so even if the court adopted the city’s argument that “the word ‘reconstitute’ is synonymous with the word ‘reincorporate’….” Further, the Code’s definition of the term “deed” did not include the plaintiff’s amendment to its Certificate. Thus, the court held that the City failed to establish that the RPTT applied to the plaintiff’s actions and that the RPTT had been “properly imposed” upon the plaintiff.

The City had also argued that Code §11-2106(b)(8) makes it clear that the RPTT is applicable to the plaintiff’s reconstitution. However, such provision “exempts, from the imposition of the RPTT, those transfers and conveyances of real property or an interest therein that merely effect a change in the form of ownership, except where the subject land and buildings are transferred to a cooperative housing corporation.” Thus, the court held that the City could not establish the applicability of the RPTT by referring to a statutory exemption that “would only be relevant if the tax were applicable in the first instance….”

The court therefore concluded that the plaintiff had not transferred or conveyed “real property or an interest in real property within the meaning of Tax Law §1201(b) and [Code] §11-2102, and that the RPTT was improperly imposed upon it.” The court remanded the matter to the trial court “for entry of a judgment declaring that the RPTT was improperly imposed upon [the plaintiff]….”

Comment: The court noted that the Mitchell-Lama program led to the development of 269 developments, representing more than 100,000 apartments. The program was considered one of the most “successful affordable housing programs of its kind.” The subject opinion is significant since imposition of the transfer tax could have significant financial impact on the cooperative shareholders and real property tax revenue to the city and because of its interpretation of NYC Admin. Code §11-2102.

Trump Village Section 3 v. NYC, 26572/10, NYLJ 1202573726433, at *1 (App. Div., 2nd, Decided Oct. 3, 2012), Before: Eng, P.J., Skelos, Belen, Cohen, JJ. Decision by Cohen, J. All concur.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John’s University School of Law.