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U.S. v. BERK & BERK

May 2, 1991

UNITED STATES OF AMERICA, PLAINTIFF,
v.
BERK & BERK, DEFENDANT AND THIRD-PARTY PLAINTIFF, V. YORK ASSOCIATES, INC., THIRD-PARTY DEFENDANT.



The opinion of the court was delivered by: Lifland, District Judge.

    MEMORANDUM AND ORDER

The United States of America moves for partial summary judgment on its claim for the appointment of a receiver. In addition, the United States moves to dismiss defendant's counterclaims and to strike its jury demand. Third-Party Defendant, York Associates, Inc. ("York"), moves to dismiss the third-party complaint. Defendant Berk & Berk ("Berk") opposes the motions. The court will address all motions on the papers pursuant to Fed.R.Civ.P. 78.

BACKGROUND

In 1985, Berk purchased Hunters Glen Apartments, an apartment project, with funds loaned by DRG Funding Corporation ("DRG"). The loan was coinsured against nonpayment by the United States Department of Housing and Urban Development ("HUD") pursuant to the National Housing Act, 12 U.S.C. § 1713, 1715n(f) and 1715z-9. Where the loans are co-insured, the Government National Mortgage Association ("GNMA") has specific authority to purchase, service and sell mortgages in its own name. DRG was responsible for servicing the loan, and for supervising the rehabilitation of the project. To obtain coinsurance from HUD, Berk executed a regulatory agreement with DRG in which Berk agreed to comply with detailed requirements concerning, inter alia, the financial and physical management of the project and the use of project income. See HUD Appendix 18, 20-30.

In September of 1988, GNMA removed DRG as the servicer of the loan "for cause", and appointed third-party defendant York Associates, Inc. ("York") to service the loan. See Appendix 42. GNMA acquired DRG's interest in the mortgage and note by assignment, which was promptly recorded. See Appendix 50. DRG also assigned its interest in the regulatory agreement to GNMA. See Appendix 39, 54.

HUD, as assignee of the mortgage agreement and the regulatory agreement, moves to foreclose based upon Berk's default. In its answer, Berk raises numerous defenses to foreclosure and asserts counterclaims against HUD based upon HUD's alleged liability for actions taken by York.

I. PARTIAL SUMMARY JUDGMENT

To prevail on a motion for summary judgment, the moving party must demonstrate the absence of an issue of material fact and its entitlement to judgment as a matter of law. Fed.R.Civ.Pro 56(c). This burden may be "discharged by showing . . . that there is an absence of evidence to support the non-moving party's case." Celotex Corp. v. Catrett, 477 U.S. 317, 323-25, 106 S.Ct. 2548, 2553, 91 L.Ed.2d 265 (1986). The court must view the facts and inferences therefrom in the light most favorable to the non-moving party. Goodman v. Mead Johnson & Co., 534 F.2d 566, 573 (3d Cir. 1976), cert. denied, 429 U.S. 1038, 97 S.Ct. 732, 50 L.Ed.2d 748 (1977).

The appointment of a receiver in this foreclosure action is governed by federal law. View Crest Garden Apartments, Inc. v. United States, 281 F.2d 844 (9th Cir.), cert. denied, 364 U.S. 902, 81 S.Ct. 235, 5 L.Ed.2d 195 (1960); United States v. Chester Park Apartments, Inc., 332 F.2d 1, 4 (8th Cir.), cert. denied, 379 U.S. 901, 85 S.Ct. 191, 13 L.Ed.2d 176 (1964); United States v. St. Paul Missionary Public Housing, Inc., 575 F. Supp. 867, 868 (N.D.Ohio 1983). A district court, in its discretion, may appoint a receiver to collect rents and profits and manage the property during the pendency of a foreclosure proceeding. View Crest, 281 F.2d at 847-48. No hearing is necessary where the facts support the appointment of a receiver. United States v. Mansion House Center North Redevelopment Co., 419 F. Supp. 85, 87 (E.D.Mo. 1976). Factors that the court may consider include: the property is inadequate security for the loan; the mortgage contract contains a clause granting the mortgagee the right to a receiver; the continued default of the mortgagor; the probability that foreclosure will be delayed in the future; the unstable financial status of the mortgagor; the misuse of project funds by the mortgagor; and furthering the policy of the National Housing Act. Id.; United States v. American National Bank & Trust Co., 573 F. Supp. 1317, 1318 (N.D.Ill. 1983); United States v. Queens Court Apartments, Inc., 296 F.2d 534, 539-40 (9th Cir. 1961); Gardon Homes, Inc. v. United States, 207 F.2d 459, 460 (1st Cir. 1953); United States v. Mountain Village Co., 424 F. Supp. 822 (D.Mass. 1976); United States v. Chester Park Apartments Inc., 332 F.2d 1, 5 (8th Cir.), cert. denied, 379 U.S. 901, 85 S.Ct. 191, 13 L.Ed.2d 176 (1964); Mansion House Center, 419 F. Supp. at 87; St. Paul Missionary, 575 F. Supp. at 869. The appointment of a receiver serves the policy of the National Housing Act by protecting the treasury and the government's investment, which in turn promotes the policy of funding lower income housing. American National Bank, 573 F. Supp. at 1318; View Crest, 281 F.2d at 848; Queens Court Apartments, 296 F.2d at 540.

HUD states that it is entitled to judgment as a matter of law, since it has a contractual right to the appointment of a receiver, and the appointment of a receiver is warranted on equitable grounds. The mortgage contains a clause which affords HUD the absolute right to the appointment of a receiver and the waiver by the owner of all defenses to receivership. See Appendix 16 at ¶ 11. In addition, HUD states that Berk has conceded that it has used project funds to litigate this case, in violation of the regulatory agreement. See Appendix 23, ¶ B.3.b. Harvey Berk, the principal of Berk, admitted that he was informed by his counsel that such use of the funds violated the agreement, but states that only a portion of the funds was spent improperly. See affidavit of Harvey Berk at ¶¶ 34 and 35. Holly Larisch, asset manager for Ervin and Associates, the current mortgage servicer, states that Harvey Berk informed her that he would continue to use mortgage funds to litigate the case until ordered to stop by a court. See Declaration of Larisch, Appendix 60 at ¶ 10. Berk has subsequently repaid a portion of those funds, but over $200,000 of project funds spent on legal expenses remains unreimbursed. See Appendix 59 ¶ 7.

In addition, HUD argues that a receiver is warranted because Berk is voluntarily in arrears in its payments. Berk's operating expenses for June and August of 1990 show a surplus of approximately $1,100,000. See Appendix 84-87 and 89-91. HUD notes that this amount would be sufficient to pay three full mortgage payments. HUD also notes that Berk intends to resist foreclosure, making a prompt resolution unlikely. Finally, HUD asserts that Berk has suffered a net operating loss, leading to a high probability of its insolvency, with no personal liability on the partners of Berk, thus leaving HUD with no recourse for deficiencies after foreclosure.

In opposition, Berk makes six arguments: 1) the appointment of a receiver is a drastic remedy; 2) the legal expenditures are "reasonable operating expenses"; 3) unresolved issues of material fact preclude summary judgment; 4) HUD failed to comply with its own policy by "refusing" to continue with the workout plan; 5) its default is in question, since York, not Berk, created the default by its refusal to pay the mortgage out of escrow funds; and 6) Berk is entitled to set off against the mortgage debt funds it expended to operate the project.

1. The appointment of a receiver. Berk argues that the appointment of a receiver is a drastic remedy, citing Mintzer v. Arthur L Wright Co., 263 F.2d 823, 824 (3d Cir. 1959). Berk's reliance on Mintzer is misplaced, as it dealt with state receivership law. As noted supra, federal law governs the appointment of a receiver in an action by HUD to foreclose. Under Federal law, the appointment of a receiver is not a drastic remedy. See supra at p. 597.

2. The legal expenses. Berk argues that its use of project funds for legal fees is a reasonable operating expense, citing In re Garden Manor Assoc., 70 B.R. 477 (N.D.Cal. 1987). Garden Manor merely states that legal fees expended to collect rents is a reasonable operating expense, citing Thompson. Legal expenses may be reasonable and necessary to the operation of the project within the meaning of the regulatory agreement in this action, if they are expended to collect rent, evict tenants, or defend lawsuits "growing out of the operation of the project". Mansion House, 419 F. Supp. at 87; United States v. Thompson, 272 F. Supp. 774, 787 (E.D.Ark. 1967), aff'd, 408 F.2d 1075 (8th Cir. 1969). Thompson holds that expenses which benefit the owner, not the project, are not permissible expenses. Funds expended on legal fees to defend a foreclosure action do not constitute expenses relating to the operation of the project. In re EES Lambert Assoc., 63 B.R. 174 (N.D.Ill. 1986). It is undisputed that Berk employed project funds for legal expenses to litigate this foreclosure action. See Berk affidavit at ¶ 36. Berk attempts to minimize its fault by stating that it returned a portion of the funds upon being informed that such use of the funds did not constitute a project expense. However, it is undisputed that Berk has not repaid funds used to repay operating costs personally advanced by Harvey Berk, Berk's principal. See Berk affidavit at ¶¶ 34 and 35. The court concludes that Berk used project funds for the benefit of the owner, not the project, in violation of the regulatory agreement and Thompson.

3. Unresolved issues of material fact. Berk argues that unresolved issues of fact exist which preclude summary judgment. Berk fails to point to any material issue of fact which would preclude the appointment of a receiver. While Berk attempts to point to an issue of fact concerning its claims against York and HUD, such claims do not preclude the appointment of a receiver during the pendency of the foreclosure proceeding. St. Paul Missionary, 575 F. Supp. at 869.

4. Workout policy. Berk argues that HUD failed to comply with its own policy to enter into workout agreements whenever possible. Assuming arguendo that HUD has such a policy, HUD is not obligated to accept or even consider a workout plan. United States v. Beacon Terrace Mutual Homes, Inc., 594 F. Supp. 53, 58 (D.Md. 1984); United States v. Victory Highway Village, Inc., 662 F.2d 488, 497 (8th Cir. 1981); United States v. American National Bank & Trust Co., 595 F. Supp. 324 (N.D.Ill. 1983), aff'd without opinion, 727 F.2d 1112 (7th Cir. 1984) (rejected defense that HUD failed to pursue workout or other alternatives to foreclosure). In any event, as noted supra, any claims Berk may have against HUD and York do not preclude the appointment of a receiver.

5. Default. Berk's argument that it is not in default is frivolous. Berk argues that there is a question whether Berk can be considered to be in default, since it alleges that the default was caused by York's refusal to pay the mortgage charges out of the escrow funds. Berk asserts that York agreed to make mortgage payments out of escrow funds, and that HUD "acquiesced" in such payment. Contrary to Berk's assertions, the record shows that York agreed to pay the January 1989 mortgage payment out of escrow funds, but specifically informed Berk that it would only do so for that month. See Appendix 58, 62. A similar argument that HUD waived a default by accepting funds under a workout agreement was rejected in United States v. Gregory Park, Section II Inc., 373 F. Supp. 317, 349 (D.N.J. 1974). Moreover, neither York nor HUD have a duty to pay the mortgage out of the escrow funds. Id. at 345; Queens Court Apartments, 296 F.2d at 538. In Queens Court, the court rejected the argument that the government was required to use replacement funds for delinquent payments or credit the mortgagor with such funds. Instead, the court held that the government had the right to hold the replacement funds as a set-off against any possible amount due after a foreclosure sale. Id. at 538.

It is undisputed that Berk has not made a full mortgage payment since January of 1989. The amount necessary to bring the mortgage current to November 1, 1990 is $6,406,716.60. See\ Appendix 2-3. There is no dispute that Berk unilaterally decided to withhold the mortgage payments to "set off" money allegedly owed to Berk. See Berk affidavit at ¶¶ 34-36. Finally, even if HUD paid the delinquent mortgage charges out of the escrow fund, the delinquency would be almost 5 million dollars ($6,406,716.60 [amount due] — $1,700,000.00 [Berk's claimed set-off]). Berk's assertion that it is not in default is without basis in fact or law.

6. Set-off. Berk concedes that it unilaterally stopped making payments under the mortgage in order to "set off" $1,700,000 in operating costs allegedly owed to Berk. See Berk affidavit at ¶ 36. The principal of Berk, Harvey Berk, alleges that he used his personal funds to enable the project to continue, due to understatements and other erroneous projections made by DRG. Berk appears to argue that its voluntary payment of this sum to continue the viability of the project excuses it from its obligations under the mortgage, although this excuse is not expressly stated anywhere in the relevant documents. As noted supra, it is undisputed that Berk has not made a full mortgage payment since January of 1989. The fact that Berk may or may not have a defense against foreclosure or a claim for equitable recoupment does not preclude the appointment of a receiver during the pendency of the foreclosure proceeding. See St. Paul Missionary, 575 F. Supp. at 869.

The court finds that the appointment of a receiver is warranted for the following reasons: Berk has misused project funds to pay for legal expenses; there is a substantial likelihood that foreclosure will be delayed due to Berk's intention to oppose it; HUD has a contractual right to the appointment of a receiver; and Berk has refused to pay the mortgage despite the availability of funds to do so in 1990. The court will grant partial summary judgment on HUD's claim for the ...


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