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UNITED STATES v. YORK

May 30, 1995

United States of America & Government National Mortgage Association
v.
John C. York, First Commonwealth Savings Bank & USGI, Inc.



The opinion of the court was delivered by: RICHEY

 INTRODUCTION

 PROCEDURAL BACKGROUND

 FACTS

 
A. The Parties
 
B. The Quail Run Transaction
 
1) York Associates' Agency Relationship with Ginnie Mae
 
2) The York-USGI Agreement
 
3) The Quail Run Security Purchase and Redemption
 
C. The Forest Isle Transaction

 DISCUSSION

 
I. THE COURT FINDS THAT YORK ASSOCIATES VIOLATED ITS FIDUCIARY DUTY OWED TO GINNIE MAE WHEN IT PURCHASED QUAIL RUN, A SECURITY YORK ASSOCIATES SERVICED FOR THE GOVERNMENT
 
A. In Purchasing the Quail Run Security, York Associates Acquired an Interest in Conflict With the Interests of the United States
 
B. A Subservicer's Purchase and Redemption of Securities it Services for Ginnie Mae Frustrates the Statutory Purpose of the GNMA Mortgage-Backed Securities Program, Which is to Fund Low- and Middle-Income Housing
 
C. The Proper Remedy for York Associates' Breach of its Fiduciary Duty to Ginnie Mae in Connection with the Quail Run Transaction is Disgorgement of the Profits it Obtained in Said Transaction and Forfeiture of the Agency Fees that GNMA Paid York Associates as Subservicer
 
II. THE COURT FINDS THAT YORK ASSOCIATES' PURCHASE OF THE FOREST ISLE SECURITY CREATED A CONFLICT OF INTEREST IN VIOLATION OF ITS FIDUCIARY DUTY OWED TO GNMA AS AN APPROVED ISSUER OF GINNIE MAE MORTGAGE-BACKED SECURITIES
 
A. Issuers are Agents of GNMA for Purposes of Administering GNMA-Guaranteed Mortgage-Backed Securities
 
B. York Associates Breached its Fiduciary Duty to GNMA When, Having Caused a Default on the Forest Isle Loan, it Purchased and Redeemed the Forest Isle Security
 
III. YORK ASSOCIATES' UNCLEAN HANDS WARRANT A COMPLETE DENIAL OF ANY MONETARY RELIEF IN CIVIL ACTION NO. 91-3094

 CONCLUSION

 INTRODUCTION

 Before the Court are cross-Motions for Summary Judgment. *fn1" Broadly speaking, the key question presented in said Motions is whether an issuer or subservicer of Ginnie Mae securities may itself purchase Ginnie Mae securities that it issues or services, thereby profiting from Ginnie Mae on the redemption of the securities. The Plaintiffs contend that, by engaging in such activity in connection with two particular mortgage-backed securities, Counterdefendant York Associates engaged in a conflict of interest in violation of a fiduciary duty it owed to Ginnie Mae as an issuer and subservicer of Ginnie Mae securities. The Plaintiffs further allege that York Associates' breach of fiduciary duty was induced by Defendants John C. York, First Commonwealth, and USGI, Inc.

 More specifically, Plaintiffs United States of America and the Government National Mortgage Association ("GNMA" or "Ginnie Mae") (collectively, "the Government") argue that (1) York Associates violated its fiduciary duty owed to GNMA when it purchased a security York Associates serviced for the Government ("Quail Run"); and that (2) in purchasing another security ("Forest Isle"), York Associates violated a Ginnie Mae rule that purportedly prohibits an issuer of GNMA mortgage-backed securities who occupies a fiduciary relationship with GNMA from purchasing from private investors the securities it issues and services. *fn2"

 As relief, the Government seeks disgorgement of profits earned by York Associates on the Quail Run securities transaction, as well as forfeiture of all fees received by York Associates under the Sub-Contract Servicing Agreement it had with GNMA. Moreover, the Government urges the Court to deny York Associates any monetary relief in a related case, Civil Action No. 91-3094 (which has been consolidated with the instant litigation) or, alternatively, to offset the $ 795,681.00 in profits gained on the Forest Isle transaction against any damages the Court might otherwise award in that matter because, according to the Government, the York Parties have "unclean hands."

  The Defendants, *fn3" on the other hand, assert that York Associates breached no implicit duty of its relationship to Ginnie Mae and that, in any event, the extensive relief sought by the Government in this case is not supportable even if there were such a breach. In particular, Counterdefendant York Associates, Defendant John C. York, Jr., and First Commonwealth Savings Bank ("York Parties," collectively), move for (1) summary judgment dismissing the counterclaim by the Government National Mortgage Association in Civil Action No. 91-3094, *fn4" as well as the Complaint filed by GNMA and the United States against John York and First Commonwealth in the above-captioned suit, Civil Action No. 93-839; *fn5" (2) summary judgment dismissing the "unclean hands" defenses alleged in Civil Action No. 91-3094; and (3) "further necessary and proper relief," pursuant to 28 U.S.C. § 2202, based on the Court's declaratory judgment entered in Civil Action No. 91-3094. Such further relief, in particular, would be in the form of an Order directing the Department of Housing and Urban Development ("HUD") to pay to York Associates supplemental insurance benefits calculated pursuant to said declaratory judgment.

 For the reasons set forth herein, the Court shall grant the Government's Motion for Summary Judgment, and deny the Defendants Motions, which include York Associates' request for "further necessary and proper relief" in Civil Action No. 91-3094. As a remedy for York Associates' breach of fiduciary duty owed Ginnie Mae and its co-Defendants' inducement of the same, the Court shall require disgorgement of the profits York Associates obtained in the purchase and redemption of the Quail Run security, and shall direct York Associates to forfeit all fees it received from GNMA under the Sub-Contract Servicing Agreement.

 PROCEDURAL BACKGROUND

 York Associates, Inc. was a multifamily mortgage lender that issued mortgage loans insured by HUD pursuant to "contracts of coinsurance" authorized by Section 244 of the National Housing Act, 12 U.S.C. § 1715z-9. In December 1991, York Associates filed Civil Action No. 91-3094, a suit against HUD and the Government National Mortgage Association regarding the calculation of mortgage insurance benefits payable by HUD to York Associates in connection with twenty separate coinsurance loans made by York Associates on which borrower defaults had occurred.

 HUD and GNMA filed an Answer alleging "unclean hands" and several other affirmative defenses. *fn6" Thereafter, HUD and GNMA filed an amended Answer which added a permissive counterclaim by GNMA against York Associates based on an alleged breach of fiduciary duty by York Associates under a Sub-Contract Servicing Agreement between York Associates and GNMA.

 GNMA and the United States also filed a separate action, Civil Action No. 93-839, against John C. York individually, First Commonwealth Savings Bank, and USGI, Inc., alleging that each had "induced" the breach of duty by York Associates and were jointly liable therefor.

 The Court on Motions for Summary Judgment found for York Associates on the question of statutory construction, but declined to grant any relief other than a declaration of the meaning of the statute, reasoning that the resolution of the instant suit, as well as the counterclaim and defense raised by the Government in the first suit, may affect the parties' rights to monetary relief. York Associates, Inc. v. Secretary, Dep't of Housing and Urban Development, 820 F. Supp. 14 (D.D.C. 1993). The Court also consolidated the injunctive relief phase of York Associates' case with the Government's new case, which is now before the Court as Civil Action No. 93-839. Id.

 FACTS7

 A. The Parties

 The Government National Mortgage Association is a wholly-owned government corporation within HUD. 12 U.S.C. § 1717(a)(2)(A). Ginnie Mae administers the mortgage-backed securities program, which is authorized under section 306(g) of the National Housing Act. 12 U.S.C. § 1721(g).

 Counterdefendant York Associates, Inc. ("York Associates") was at all relevant times an approved issuer of mortgage-backed securities guaranteed by GNMA ("GNMA securities"), while Defendant John C. York, Jr. was a 65% shareholder, as well as President and chief executive officer, of York Associates. John York was also at such times a 65% shareholder, as well as Chairman of the Board and chief executive officer, of Defendant First Commonwealth Savings Bank ("First Commonwealth") which, at all times relevant to the Complaint, was a Virginia savings bank.

 Finally, Defendant USGI, Inc. ("USGI") is a corporation headquartered in Norwalk, Connecticut. At all relevant times, USGI was a mortgage banking institution that was an approved issuer of GNMA securities, but was not an affiliate of York Associates, John York, or First Commonwealth.

 B. The Quail Run Transaction

 1) York Associates' Agency Relationship with Ginnie Mae

 DRG Funding Corporation ("DRG") was a mortgage banking institution (unrelated to the Defendants and Counterdefendant) that issued GNMA securities backed by mortgage loans insured by HUD and coinsured by DRG. On September 16, 1988, DRG defaulted under its Guaranty Agreements and its mortgages and securities became the property and responsibility of GNMA.

 GNMA requested York Associates, among other approved issuer-lenders, to bid for the award of a subservicing contract for the DRG portfolio. York Associates submitted a bid, received the award, and took over the responsibility for subservicing the portfolio on GNMA's behalf on September 22, 1988. On that date, GNMA entered into a Sub-Contract Servicing Agreement with York Associates "as [GNMA's] agent for these limited purposes to perform loan servicing, loan management and loan enforcement, work-out and liquidation services" with respect to the DRG loans insured by HUD and corresponding GNMA securities issued by DRG. Between 1988 and January 1991, York Associates was paid fees of $ 5,874,531.87 as Ginnie Mae's subservicing agent.

 The Agreement transferred to York Associates custody of all DRG records regarding DRG's portfolio of HUD-insured mortgages and GNMA mortgage-backed securities, and the Agreement specified that York Associates received this "property and information for the purpose of performing its duties under this Agreement." The Agreement further stated that York Associates was

 
appointed as agent for GNMA and as special attorney-in-fact for GNMA in that certain Sub-Contract Servicing Agreement dated September 22, 1988 between GNMA and York [Associates] and pursuant thereto, York is authorized to act under a certain special power of attorney for GNMA, in its name, place and stead, on behalf of and for the use and ...

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