of a construction company could sue the mortgagee and its assignee, HUD, for retainages withheld during construction. The court found plaintiffs to be creditor beneficiaries of a building loan agreement under both traditional contract doctrines governing third parties and explicit HUD regulations specifying the mortgagee's obligations. 328 F. Supp. at 211-14.
This Court is in accord with the Travelers holding that a contractor may sue as a creditor beneficiary of a financing agreement made on its behalf. However, a third party beneficiary is bound by the terms and conditions of the contract that it invokes. If a promise is conditional the right of the beneficiary is a conditional right. 4 Corbin on Contracts § 818 (1951). The beneficiary cannot accept the benefits and avoid the burdens or limitations of a contract. Nor can the language of a single regulation be read in such an absolute way as to nullify conditions and restrictions imposed by a contract.
In short, the Travelers court either did not consider or did not have before it the limitations in the building loan agreement which are present in the instant case.
Paragraph 4(e) of the building loan agreement provides: "The Lender shall, in accordance with the provisions of this agreement, continue to advance to the Borrower funds out of the proceeds of the loan as long as the loan remains in balance and the Borrower is not in default hereunder or under the Note or Mortgage." (Emphasis added.) MORH concededly went into default on its mortgage payments, and thus Advance Mortgage was under no obligation to continue disbursing mortgage funds. As a third party beneficiary, Trans-Bay assumes the legal rights and position of the promisee, MORH. It could claim no entitlement to further payment once MORH had defaulted.
Trans-Bay attempts to avoid the default provision by asserting that its contractual right to the retention amount vested at a time prior to default by MORH; that is, on June 30, 1973, when Trans-Bay had completed construction and fulfilled all necessary pre-conditions to payment. It also contends that the Secretary's requirement of a final closing before full payment of construction retentions is unsupported by statute, HUD regulations, or pertinent contract provisions.
The requirement and the timing of final closing have not been codified in HUD regulations. However, several items do clarify the events necessary before final closing or its equivalent, final endorsement. HUD regulations require, "prior to final endorsement," the submission of the mortgagor's certificate of actual cost and the reduction of the mortgage to an amount no greater than the total certified cost. 24 C.F.R. §§ 221.550(a), 221.555(a). Another regulation provides for final endorsement "[when] all advances of mortgage proceeds have been made and all the terms and conditions of the commitment have been complied with to the satisfaction of the Commissioner." 24 C.F.R. § 207.254(b). The building loan agreement itself does not mention final closing but does state, "The balance [of mortgage proceeds] due the Borrower hereunder shall be payable at such time after completion as the commissioner authorizes the release of the holdback." (Paragraph 4(b).) Also without specifying the time or circumstances of final closing, the FHA form on "Legal Requirements for Closing," utilized by the parties in the initial closing, lists the documents required for final closing, such as completion and cost certificates, instruments relating to the mortgage, request for final endorsement, etc. Lastly, the HUD Handbook on Construction Period to Final Closing for Project Mortgage Insurance (1972) specifically prohibits the full release of the holdback amount until final closing.
The Handbook has no enforceable status, but neither is it a "secret" document as plaintiff claims.
It is evident from the foregoing that Trans-Bay had notice of at least the necessity of a final closing, if not the timing of the event. Trans-Bay thus cannot contend that the final closing requirement was unexpected and unwarranted, or that it constituted an interference with contractual rights. As for the timing of the final closing, HUD admits that its cost certification review of the housing project was delayed several weeks because of insufficient personnel and other priorities, which in turn prevented an early final closing. Cost certification approval was not granted until October 10, 1973, although Trans-Bay had submitted the contractor's cost certification form on June 29, 1973, and MORH had provided the owner's cost certification form on August 10, 1973. Considering this delay from backlog problems as well as the comprehensive administrative review procedures required, such as cost comparisons with original estimates, examination of allowable costs and fees, disapproval of unacceptable charges, and investigation of possible identities of interest between subcontractors and the general contractor and/or mortgagor, the Court does not believe that a two-month delay in cost certification approval was unreasonable or designed to impair the rights of the mortgagor and the general contractor. The average time for HUD certification processing was about six weeks during the period of June to December, 1973. (Affidavit of William L. Wallace, Acting Head, Cost Certification Section, HUD San Francisco Area Office.) An additional two or three weeks delay in the complicated certification process seems both understandable and justified in light of the circumstances of the present project. (Ibid.)
After cost certification approval, final endorsement of the project could have taken place at any time; as previously stated, notice of default was not filed until over three months after approval (i.e., on January 16, 1974). However, on the date of certification, MORH's costs exceeded the balance of mortgage proceeds by $43,183. Because of this shortfall, resulting at least in part from MORH's invalid transfer of project funds to another housing project, the project was not able to go forward to final closing. (Affidavit of Betty J. Kercher, Senior Auditor, HUD San Francisco Region.) The shortfall was not subsequently cured, and the default by MORH removed the possibility of any eventual final closing on the project. Without final closing, Trans-Bay was not entitled to the retention sum under the building loan agreement upon which it relies. No rights vested in Trans-Bay during the period between submission or approval of cost certification documents and the default by MORH.
Apart from its alleged contract claim, Trans-Bay asserts that surety and equitable lien principles entitle it to payment of the retention amount. In several cases, retention percentages have been viewed as an indemnity or surety fund to assure completion of construction and to protect the surety company if it is required to complete construction. See, e.g., Pearlman v. Reliance Ins. Co., 371 U.S. 132, 136-42, 9 L. Ed. 2d 190, 83 S. Ct. 232 (1962); Henningsen v. United States Fidelity & Guar. Co., 208 U.S. 404, 410-11, 52 L. Ed. 547, 28 S. Ct. 389 (1908); Travelers Indem. Co. v. First Nat'l State Bank, 328 F. Supp. 208, 215-16 (D.N.J. 1971). The present case, however, is distinguishable on its facts. Each of the above cases involved suits by a surety company to acquire retention amounts after payment had been made to laborers and materialmen following a contractor's default; the retainage sums were obviously not for the contractor's benefit, but principally for the protection of the surety. In Pearlman the Supreme Court specifically declined to award the retention amount to a defaulting contractor's trustee in bankruptcy -- and in the present action, Trans-Bay stands in the shoes of a defaulting project owner. But most important of all, there are explicit contractual provisions and undertakings between the parties in this case, discussed supra, that govern the release of the retention amount. These terms were not present in the above cases, and cannot be nullified in the contracts before the Court by the invocation of the surety doctrine.
Likewise, equitable lien principles cannot create vested rights in Trans-Bay which are contrary to express and implied contractual undertakings. It may be that Trans-Bay has completed its construction obligations down to the last nail in the building, that it is wholly without fault in the project's financial failure, and that it has relied exclusively upon the mortgage fund as a source for payment of the retention sum. It may also be, as in G. L. Wilson Bldg. Co. v. Leatherwood, 268 F. Supp. 609, 622 (W.D. N.C. 1967), that "[the] United States at all times was fully acquainted with each step however minute, that took place from the very inception of the dealings herein, down to and including the absolute completion of the project." Still, equity will not set aside legal obligations in order to provide relief for parties later disadvantaged, nor will equity rewrite contracts to expand an insurer's liabilities or to restrict a promisee's risks and duties. In the present case, there has also been no convincing demonstration of the comparative value of Trans-Bay's performance vis a vis the total injury caused to HUD by the default. See 5A Corbin on Contracts § 1125 (1951) (Defaulting Contractor). Equitable principles are thus unavailing to plaintiff Trans-Bay.
Since HUD is not liable for the retention amount, Advance Mortgage, of course, is not. In addition, though, Advance Mortgage by its assignment of the mortgage to HUD has transferred "all rights and interests arising under the mortgage" to HUD 12 U.S.C. § 1713(g)(1). An assignment ordinarily does not operate to relieve the assignor of duties under the contract. Here, however, statutory provisions and case law support the view that the mortgagee is no longer liable to suit after the mortgagor's default and the mortgagee's assignment to HUD, absent any impropriety on the mortgagee's part in regard to the contract. 12 U.S.C. § 1713(g); Lindy v. Lynn, 395 F. Supp. 769 (E.D.Pa. 1974) aff'd, 515 F.2d 507 (3d Cir. Pa. 1975) (following assignment, Secretary "clothed with all the rights and obligations" of the mortgagee); Travelers Indem. Co. v. First Nat'l State Bank, 328 F. Supp. 208, 211 (D.N.J. 1971). Moreover, HUD has expressly agreed to be "bound as successor to honor any obligation owed by the mortgagee pursuant to agreements approved by the Secretary in connection with this insurance transaction." (Opposition of Defendant Lynn to Motion of Plaintiff for Preliminary Injunction, p. 20.) Advance Mortgage is therefore entitled to a summary judgment not only as to counts 1 and 2 (pertaining to the retention sum, plus interest), but also as to counts 3, 4, 5, and 6 of the complaint, which relate to contract modifications and additional construction costs incurred by Trans-Bay.
Accordingly, upon consideration of plaintiff's Motion for Partial Summary Judgment, defendant Advance Mortgage Corporation's Motion for Summary Judgment, and defendant Lynn's Motion to Dismiss or, in the Alternative, for Summary Judgment, the memoranda of points and authorities in support thereof and in opposition thereto, oral argument of counsel having been heard, and for reasons set forth in the attached Opinion, it is by the Court this 20th day of May, 1975
ORDERED that plaintiff's Motion for Partial Summary Judgment be, and the same hereby is, denied; and it is further
ORDERED that defendant Advance Mortgage Corporation's Motion for Summary Judgment be, and the same hereby is, granted as to counts 1, 2, 3, 4, 5, and 6 of the complaint; and it is further
ORDERED that defendant Lynn's Motion for Summary Judgment be, and the same hereby is, granted as to counts 1 and 2 of the complaint.
John Lewis Smith / United States District Judge.