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U.S. v. BERK & BERK
May 2, 1991
UNITED STATES OF AMERICA, PLAINTIFF,
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.
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.
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.
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.