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UNITED STATES v. GREGORY PARK

March 26, 1974

UNITED STATES of America, Plaintiff,
v.
GREGORY PARK, SECTION II, INC., et al., Defendants


Lacey, District Judge.


The opinion of the court was delivered by: LACEY

The United States sues to foreclose upon two mortgages held by the Secretary of Housing and Urban Development (HUD) on two high rise apartment complexes, Gregory Park Section 1 (GP 1) and Gregory Park Section 2 (GP 2), owned by the defendant Gregory Park, Section II, Inc. (GP II). The Government claims that defendant has defaulted on payments due, has made prohibited advances to affiliates, and otherwise breached the mortgages and other agreements between the parties. Defendant resists, stating it is not in default; that if it is, plaintiff is to blame; and that the Government, in regulating the rent levels in the two buildings, would not allow rent increases in an amount sufficient for defendant to meet its payment obligations and to recover a reasonable return on its investment. By way of counterclaim, defendant seeks an affirmative recovery of a reasonable investment return allegedly denied it by reason of the foregoing.

 The following constitutes my findings of fact and conclusions of law. Fed. R. Civ. P. 52(a).

 This court has jurisdiction by virtue of 28 U.S.C. § 1345.

 This is only one of five related actions presently before the court involving the Padula enterprises. *fn1" The facts developed in the preliminary stages of these various matters have been introduced into this proceeding largely through extensive stipulations between the parties (paragraphs thereof will be hereinafter referred to as (St. [*]), and Joint Exhibits (J.E. [*]). *fn1"

 The Government is seeking to foreclose mortgages held by HUD on each of five buildings (including GP 1 and 2) owned by the Padula-controlled and run companies, and constructed or purchased with HUD's assistance. These apartment complexes have all been managed by Arthur H. Padula t/a Arthur H. Padula Management Co., and most have been constructed by Arthur H. Padula Construction Corp. (AHPCC), which Mr. Padula owns. The defendant, which owns GP 1 and GP 2, is the wholly owned subsidiary of Mid-Center Redevelopment Corp. (Mid-Center), which in turn is wholly owned by Arthur H. Padula. Mr. Padula is also the President of Mid-Center and the defendant (St. 25), and, as well, of Gregory Park Section 3, Inc. (GP 3), which owns a high rise apartment house across from GP 1 and GP 2. The three together from the Gregory Park complex in Jersey City, New Jersey. GP 3 is also a wholly owned subsidiary of Mid-Center. *fn2" In addition, Mr. Padula owns two apartment houses in Newark known as the Weequahic Park Tower and the Weequahic Park Plaza (J.E. 64); and through Mid-Center and AHPCC, he caused to be constructed two additional apartment houses in Newark, Zion Towers and Carmel Towers (St. 110, J.E. 21). Finally, Mr. Padula, t/a Arthur H. Padula Management Co., manages the Weequahic Park Tower; the Weequahic Park Plaza; the Zion Towers; the Carmel Towers; until September 11, 1973, GP 1 and GP 2 (St. 29); and, until February 25, 1974, GP 3. *fn3" HUD holds the mortgages on all of these buildings, except Zion and Carmel Towers.

 BACKGROUND

 On June 12, 1961 the Federal Housing Administration (FHA) insured a $5,517,200 loan by the National State Bank of Newark to Gregory Park No. 1, Inc. for the construction of a high rise apartment building located in Jersey City, New Jersey, hereinabove and hereinafter referred to as GP 1. This loan was insured pursuant to Section 220 of the National Housing Act, as amended, 12 U.S.C. § 1715k, to aid in the rehabilitation of blighted areas. See 1955 U.S. Cong. & Admin. News p. 2918.

 Thereafter defendant GP II, a limited dividend housing corporation, was formed, pursuant to the New Jersey Limited Dividend Housing Corporations Act, N.J.S.A. 55:16-1 et seq. (St. 2), and its Certificate of Incorporation was approved by the Public Housing and Development Authority, Department of Conservation and Economic Development of the State of New Jersey, and filed on October 30, 1964 (St. 111, J.E. 94). One of defendant's corporate purposes (Certificate of Incorporation, Art. II, paras. b and c) was to obtain financing for the construction and ownership of rental housing with the assistance of mortgage insurance under the National Housing Act.

 Prior to defendant's incorporation, the FHA, pursuant to 12 U.S.C. § 1715k(d) (3) (A) (i), issued a Project Income Analysis and Appraisal for GP 2 on FHA form 2264, dated August 31, 1964 (St. 113, J.E. 96), revised and reissued on November 23, 1964 (St. 15a, J.E. 9). The amount of mortgage insurance the FHA can issue is limited to a fixed percentage of the estimated replacement cost of the property, which, in the revised form, was set at $7,592,811. The form also included, inter alia, estimates of income, operating expenses (including management fees), and, under the heading "Estimated Replacement Cost", a section for carrying charges, financing, and Builders' and Sponsors' profit and risk.

 On February 4, 1965, the FHA agreed to insure all advances to the defendant by the State Bank of Albany for construction of GP 2 (St. 16a); and on that same date the State Bank of Albany loaned $6,790,000 to the defendant, taking defendant's mortgage note (St. 17, J.E. 10) and a mortgage (St. 18, J.E. 11), covering GP 2, and dated February 4, 1965. Also on the same date, defendant entered into a regulatory agreement with the Federal Housing Commissioner (St. 20a, J.E. 15), the defendant agreeing to abide by the restrictions and regulations recited therein in exchange for the FHA's issuance of mortgage insurance to the mortgagee. The mortgagee, the State Bank of Albany, obtained further security for its loan to the defendant in the form of a security agreement and financing statement covering all personal property of GP 2 (St. 19, J.E. 12, 13, 14).

 On December 20, 1966 defendant, pursuant to the New Jersey Limited Dividend Housing Corporations Act, entered into an agreement with the City of Jersey City to have GP 2 exempted from all municipal property taxes for 20 years, upon the condition that it pay an annual service charge in lieu of taxes (service charge) within 60 days after the end of each calendar year, which generally equals 15 percent of the gross shelter rents (St. 21a, J.E. 16). This agreement was to result in substantial savings for defendant and relieved it of property taxes equivalent to approximately 30 to 40 percent of gross rents.

 On January 19, 1967 defendant received a third Project Income Analysis and Appraisal on FHA form 2264 covering GP 2 (St. 115, J.E. 97) but listing no replacement value because it was issued as part of a rental increase authorization, authorized on or about July 21, 1967. In June 1968 the mortgage covering GP2 was assigned to the Comptroller of the State of New York as Trustee of the Common Retirement Fund, and pursuant to an option exercised by that mortgagee in January 1971, it is now held by HUD (St. 22-24).

 Approximately nine months after defendant gave its mortgage note and mortgage for GP 2, the FHA, on November 2, 1965, issued a Project Income Analysis and Appraisal on form 2264 for GP 1, estimating the replacement cost, before rehabilitation, at $7,061,043 (St. 5a, J.E. 1). Then, on December 30, 1966, defendant entered into an agreement to buy GP 1 from the FHA for $100,000 and a note and mortgage for $6,625,000 (St. 6, J.E. 2). The contract of sale required Mr. Padula to guarantee personally any operating deficits of both GP 1 and GP 2 for a period of two years from the closing, to pledge the stock of GP II and GP 3 *fn4" as security, and to assign to the FHA all dividends from GP 3 for a three-year period for this purpose. FHA, as the seller, disclaimed all representations as to the physical condition or valuation of the building.

 On February 10, 1967 defendant took title to GP 1 from HUD pursuant to the aforesaid terms and conditions (St. 8), and gave to HUD its mortgage note, mortgage, and security agreement covering GP 1 (St. 9, 10, 11, J.E. 4-7). On the same date, defendant entered into a regulatory agreement for GP 1 with the Federal Housing Commissioner (St. 12a, J.E. 8) and entered into an agreement with Jersey City to have GP 1 exempt from all property taxation for 20 years upon the condition that it pay within 60 days after the end of each calendar year an annual service charge, again amounting to approximately 15 percent of the gross shelter rent (St. 7a, J.E. 3).

  On September 18, 1970 Mid-Center, AHPCC, and Arthur H. Padula, individually, filed a Petition for Arrangement under Chapter XI of the Bankruptcy Act and Leo Neiwirth, Esq. was appointed receiver (St. 26, 27). *fn5" The defendant itself was not made a debtor in the Chapter XI proceeding; however, because of the estate's ownership of the defendant's stock, Mr. Neiwirth immediately commenced overseeing defendant's operations, and those of GP 3, and continued to do so until December 18, 1972, when the Plan of Arrangement was confirmed by the bankruptcy court and the debtors were revested with their assets. *fn6" Mr. Padula continued to act for defendant in a managerial capacity during the term of the Receivership (T. 94) and no action was taken by the Receiver without Mr. Padula's knowledge and consent. As of the filing of the Chapter XI proceeding, defendant and GP 3 had outstanding and unpaid bills to general creditors of approximately $500,000 (St. 71). Moreover from September 18, 1970 until April 10, 1971 defendant defaulted on the mortgage notes and mortgages held by HUD covering GP 1 and GP 2 by not making a single required payment (St. 35, 70), while it accumulated large sums of cash which were converted to certificates of deposit.

 On or about November 16, 1970, negotiations with the Government were commenced by Mr. Padula to persuade HUD to forego action on the existing defaults and defer principal payments for one year. Thus, on November 16, in confirmation of an earlier telephone conversation, Mr. Padula wrote to Julian B. McKay, Acting Director, Loan and Contract Servicing Division of HUD, and advised that he, and his related corporations, with the exception of the defendant, had filed a Chapter XI petition, and that the debtors were prepared to submit a plan to the bankruptcy court, to fund it, and be discharged on or about December 31, 1970 (St. 31a, J.E. 90). He asked that HUD agree to a workout agreement whereby the amortization and reserve for replacement payments due under the GP 1 and GP 2 mortgages would be waived for one year. Extensive discussions were then held between Mr. Padula and various HUD representatives. Mr. Padula stressed the loss the Government would suffer if forced to sell the buildings after foreclosure, and that foreclosure would mean loss of the property tax exemption from Jersey City. Thereafter, on February 23, 1971 Mr. Neiwirth wrote a letter to Mr. McKay in which he said that, as Mid-Center's bankruptcy receiver, he was managing the defendant and that on February 9, 1971 the bankruptcy court had approved a Plan of Arrangement (St. 31b, J.E. 24). Mr. Neiwirth advised that Mr. Padula needed $1,500,000 to fund the approved Plan and requested that HUD recast the five mortgages it held on GP 1, 2 and 3 and the Weequahic Park Tower and Plaza by increasing them a total of $1,425,502 and waiving the amortization payments until April 1972. Discussions continued between Mr. Padula and HUD officials until April 1971. On April 1, 1971 Mr. McKay addressed a letter to Mr. Padula questioning his good faith in his offer of November 16, 1970 (J.E. 91). Nevertheless, on April 16, 1971 Robert P. Kalish, the Deputy Director of the Loan and Contract Servicing Division of HUD, wrote to Mr. Padula setting forth the minimum conditions which HUD insisted would be required before it would agree to forebear on foreclosing the mortgages (St. 33, J.E. 26):

 
1. Delinquent service charges to the date of any Work-Out Agreement must be brought current by a lump sum cash payment. We calculate this figure to be $42,530 as of March 31, 1971.
 
2. All real estate taxes must be current.
 
3. All tenants' security deposits must be fully funded.
 
4. Commingling of funds among projects or advances to affiliated companies will not be tolerated and a violation of this provision will result in immediate cancellation of the appropriate Work Out Agreement.
 
5. Gregory I, 031-32007; Gregory II, 035-32015; Gregory III, 031-55017; and Weequahic Towers, 031-00204.
 
A monthly payment for a one year period equal to service charge, tax accrual and interest plus 1/60 of the respective interest delinquency. Beginning the second year, a monthly payment equal to service charge, tax accrual and interest plus a supplemental payment equal to the sum of the respective amortization payment and 1/60th of the respective interest delinquency.
 
* * *

 Additionally, Kalish's letter questioned the continuing of Mr. Padula's management of the projects and said that a full explanation of defendant's disbursements totalling $359,705 to Mr. Padula's related corporations now in bankruptcy was in order.

 By letter of April 24, 1971 Mr. Padula replied to Mr. Kalish, stating in part:

 
1. Delinquent service charges : We hereby agree to pay a lump sum cash payment computed as of April 30, 1971 on or before May 10, 1971, during which period we presume that you will have prepared the necessary agreements and that they will be approved and executed to everyone's satisfaction.
 
2. Real Estate Taxes : All real estate taxes will be current.
 
3. Tenants security deposits : Tenants security deposits will be fully funded and evidence of same will be made available to you.
 
4. Commingling of funds : We hereby agree that there will not be any advances or commingling of funds at any time.
 
5. Gregory I, 031-32007; Gregory II, 031-32015; Gregory III, 031-55017; and Weequahic Towers, 031-00204 : We hereby agree to this payment schedule commencing May 1, 1971. Payments to be made on or before May 10, 1971 assuming all of the necessary documents will have been fully executed.

 In support of his continued management, Mr. Padula stated that he would not draw any management fees "unless all monthly debt service and the conditions contained above are fully carried out," pointing out that another management organization would require a fee prior to debt service. Mr. Padula said in explanation of the defendant's disbursements to his related corporations that of the $183,871 in advances remaining after subtracting the amounts constituting repayment to affiliates, all of that sum was "washed out" due to credits for initial rental fees, and paid or accrued management and insurance fees through September 30, 1970. Finally, Mr. Padula added that he required an additional clause permitting his projects to use "any excess funds over and above those required to pay the debt services agreed upon excluding Weequahic Park Plaza . . . to implement the Chapter 11 proceedings." (St. 34, J.E. 27).

 After a subsequent meeting on May 27, 1971, Mr. Kalish prepared and signed two Provisional Work Out Arrangements for GP 1 and GP 2 which had a two-year term running from May 1971 to April 30, 1973, forwarding them to HUD's Newark Area Office for submission to Mr. Padula (St. 38). When he received these agreements, Mr. Padula called Mr. Kalish, stating the agreements were in error in that they had discussed a five-year term. I credit the testimony of Mr. Kalish who stated that, although the agreements called for a five-year payment plan to cure the delinquencies, they were initially to run for only two years; that although the delinquencies would not be cured by that time, HUD would then have had an opportunity to evaluate the defendant's progress under the agreements, and if dissatisfied, avail itself of its foreclosure remedy then and there. However, he said, Mr. Padula had thereafter called requesting a five-year term to assist him in funding the Plan of Arrangement in the bankruptcy court, stating that the bankruptcy court and creditors would not be satisfied with a two-year plan but wanted assurance that HUD would not foreclose before 1976. Mr. Padula also stated to Mr. Kalish that the success of the Plan in the bankruptcy court depended upon his ability to use moneys generated in excess of the payments required for the workouts to implement the Chapter XI. Mr. Padula requested permission to make the desired changes in the agreements and Mr. Kalish assented. Mr. Padula then amended the agreements by extending them until April 30, 1976 and by adding the following to paragraph 4 of each agreement: "Any excess funds over and above those herein required may be used to implement the Chapter 11 proceedings". Mr. Padula then executed the agreements, dating them June 22, 1971, and returned them to Mr. Kalish by letter of June 21, 1971 (St. 39, J.E. 30, 31 and 32). Mr. Kalish received the amended agreements and accepted the changes (St. 40).

 Thus, under the terms of the Provisional Work Out Arrangements, HUD agreed to take no action on defendant's default until April 30, 1976, provided that the defendant complied with the following conditions:

 
1. On or before the 10th of each month commencing May, 1971 and continuing through April, 1976 there shall be submitted:
 
A. A monthly payment during the first year equal to service charges, tax accruals, current interest plus 1/60th of the outstanding interest delinquency through April 30, 1971.
 
B. A monthly payment during the second year equal to [all items listed in 1A] plus a supplemental payment equivelent [sic] to the regular monthly amortization installment.
 
C. An accounting of all cash receipts and disbursements for the previous month on forms prescribed by the Assistant Secretary for Housing Management.
 
* * *
 
4. It is further understood that there will be no commingling of funds among the projects or advances to affiliates and any violation of this provision will result in the immediate cancellation of the Agreement. Any excess funds over and above those herein required may be used to implement the Chapter 11 proceedings. (J.E. 31, 32)

 In seeking foreclosure the Government claims that defendant has breached its obligations under the workout agreements. Among the acts claimed to constitute breach are defendant's alleged failure to pay appropriate tax accruals (i.e., service charge in lieu of taxes) commencing October 1972; its transfer of over $395,000 to the Chapter XI debtors in December 1972, claimed to constitute a prohibited advance to affiliates; numerous other advances to affiliates; a failure to file timely monthly reports with HUD; and, beginning in May 1973, the failure to make amortization payments as required by paragraph 1B of the workout agreements.

 A. Failure To Pay Tax Accruals (Service Charge In Lieu of Taxes)

 On October 13, 1972 HUD made final payment to the City of Jersey City under a "Memorandum of Understanding" between Jersey City and Mr. Padula settling the amounts due from defendant for 1971 under the service charge in lieu of taxes. Although demands were thereafter made by HUD of defendant to reimburse it for the payment, and to increase monthly escrow payments for service charge accruals to cover the 1972 payments, defendant made no such payments. The defendant contends that the payments made by HUD were not due to Jersey City at the time they were paid by HUD, therefore rendering it a mere volunteer. Defendant also contends that HUD had sufficient escrow money on hand to cover the required payments, and thus did not have to advance HUD's funds therefor. For the issues thus raised to be properly understood, they must be placed in their appropriate factual background.

 As previously noted, defendant entered agreements with Jersey City exempting its buildings from all municipal property taxes for 20 years upon the condition that it pay an annual service charge in lieu of taxes ($24,272.39 for GP 1 and $46,638.19 for GP 2, or 15 percent of the annual gross shelter rent of each project, whichever was greater). Accordingly, each project was to pay, in equal quarterly installments, one-fourth of the minimum amount, and submit an accounting of the project's income and expenses within 60 days after the end of the calendar year. If the accounting required the payment of an additional amount (15 percent of the gross shelter rents), payment was to accompany the accounting. Thus, under these agreements, the final payment of the annual service charge in lieu of taxes for 1971 was to be made no later than the beginning of March 1972.

 On February 10, 1972 Mr. Padula wrote Jersey City regarding the 1971 service charge. He requested correction of what he said was an improper assessment and a current statement of Government payments toward the 1971 service charge. Attached were copies of previous bills indicating originals had been sent directly to HUD in Washington (J.E. 106).

 On March 10, 1972 Mr. Padula explained, in a letter to Mr. Kalish, that the Comptroller in HUD (who was servicing the mortgages on GP 1 and 2) was escrowing too much money for the service charges on GP 1 and GP 3, and was $21,789 short on GP 2. He suggested paying the GP 2 shortage with the excess funds accumulated in the GP 3 escrow account which would still leave a $25,496 surplus in GP 3. He further suggested a return of those funds to GP 3 and proposed new monthly escrow figures (J.E. 107).

 Mr. Padula then had a meeting on May 19, 1972 with Mr. Joseph F. Cahill, Director of Finance of Jersey City, concerning the specific amounts due on defendant's service charges, sewage and water bills. Mr. Padula's post-meeting letter to Mr. Cahill, dated May 22, 1972, indicated that the bills thereafter were to be sent directly to him for approval and he would then forward them to HUD with a recommendation for payment (J.E. 108). On June 8 and 9, 1972 Jersey City auditors visited the defendant, and Mr. Padula then sent a letter to Mr. Kalish, dated June 15, 1972, informing him of the foregoing and stating that when Jersey City made its final determination of the amount due, he, Padula, would then recommend payment in full by HUD (J.E. 109).

 Finally, on August 7, 1972 Mr. Padula entered into the aforementioned "Memorandum of Understanding" with Jersey City settling the amount due for the 1971 service charge. This "Understanding" stated that the 1971 net service charge due from GP 1 was $71,072 and from GP 2 $98,075.40; that the 1971 service charge was "due and owing"; that the arrears outstanding for water and sewage charges was $53,273.28; and that a resolution would be presented to the Jersey City Municipal Council abating taxes improperly assessed on one of defendant's parking lots (J.E. 38).

 Defendant now would construe this "Understanding" as not requiring the 1971 charges to be paid until Council passage of the abating resolution. This interpretation is contrary to the words used by the parties. Nothing in this agreement conditions the payment of the 1971 service charge (and the outstanding arrearages for water and sewage charges as of July 26, 1972) upon the passage of a municipal resolution that would result in a credit of $2,539.61 and $2,480.34 for two payments made on an improper assessment.

 Even if the agreement were less clear, I would have to reject defendant's interpretation in view of the conduct of the parties both before and after execution thereof. First, the agreement calls for the payment of the water and sewage charges outstanding as of July 26, 1972, which are of course independent of the service charge. Second, the original agreement called for the service charge for 1971 to be payable in full by February 28, 1972. This fact was recognized by Mr. Padula in his letter of February 10, 1972 (J.E. 106). Throughout his discussions concerning the final amounts due, Mr. Padula stated that as soon as the final amount was established, he would approve it and forward the billing to HUD recommending payment. This in fact was done. On August 29, 1972 Mr. Padula sent a copy of the "Memorandum of Understanding" to Mr. Kalish with a cover letter stating in reference to the settlement of Jersey City taxes:

 
I am happy to report pursuant to many conferences held with the new Director of Finances [of Jersey City], Joseph F. Cahill, all of these matters have been resolved in writing. All of the outstanding bills have been procured and I ...

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