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United States Land Resources, LP v. JDI Realty LLC

2009 WL 2488316 (U.S. Dist. Ct. D. N.J. 2009) (Unpublished)

MORTGAGES; CONSUMER FRAUD — A mortgage is not a sale of real estate for purposes of the New Jersey Consumer Fraud Act and it would not serve the purposes of the Consumer Fraud Act to impose liability under the Act.

The owners of commercial property obtained a mortgage. They also received second mortgage financing on the condition that they enter into a partnership agreement with that lender and transfer, to the lender, 99% of their partnership interest in the entity that contracted to purchase the property. This structure, to which the mortgagors agreed, was designed to allow the second position lender to effectively foreclose on the property without instituting a foreclosure proceeding. The second mortgagee represented that when the mortgagors paid off the second mortgage financing, it, the second mortgagee, would be “bought out” of any ownership interest in the property. The second mortgage originally had a three year term, at the end of which the mortgagors were to pay off the principal balance. The mortgagors did not pay the end of the loan’s original term, and agreed to accept a loan extension because the lender assured them that as long as they continued to make interest and principal payments, the lender would honor their agreement. Then, without notice to the mortgagors, the lender renegotiated a lease with one of the tenants at the property for a lower rent. The mortgagors claimed that this lowered the value of the property. The lender later sold the property, again without notice to the mortgagors, who first learned of the sale when they received a check from the lender for a sum that the lender claimed was the mortgagors’ share of the proceeds. The mortgagors sued the lender alleging: (a) fraud; (b) breach of contract; (c) breach of implied duty of good faith and fair dealing; (d) breach of fiduciary duty; (e) waste; and (f) violation of the New Jersey Consumer Fraud Act (CFA). The lender moved to dismiss these claims.

The United States District Court dismissed some of the claims and sustained other claims. First, it dismissed the fraud claims. In dismissing the fraud claim related to the original time of contract, the Court held that if the parties agreed at the original time of contract that the lender would not do anything to disturb the mortgagors’ interest in the property, any claim by the owner relating to such promise should be grounded in breach of contract, not in fraud. It noted that the mortgagors’ fraud claim would have to allege that the lender made misrepresentations as to a matter distinct from the contractual agreement. Here, the mortgagors did not do so. Further, it held that not only was it implausible that the lender would give such an assurance, but also unreasonable for the mortgagors to reasonably rely upon such an alleged promise when the transaction was deliberately structured to permit the lender to “foreclose” without the necessity of a formal foreclosure procedure. With regard to the allegation of fraud occurring at the end of the original term of the loan, the Court held that the mortgagors failed to sufficiently plead which of the numerous defendants in its suit made the assurances. It thus dismissed the claim with leave to amend.

Second, it dismissed the breach of contract claims. The Court, however, did grant the mortgagors the opportunity to proceed to trial on one of the mortgagors’ breach of contract theories – that the original second mortgage agreement was modified by the equitable mortgage law of New Jersey. It held that, under New Jersey law, the mortgagors had a colorable argument that a right of redemption was incorporated into the financing agreement. According to the Court, it is a long-standing rule of property law (applicable to all transactions where the parties intend that real property be the security for the transaction, as was the case here) that any agreement that cuts off a mortgagor’s right to redeem is void and is unenforceable against public policy.

Third, the Court refused to dismiss the breach of good faith and fair dealing claim. It held that based on the mortgagor’s continued payments, it was reasonable to infer that the lender knew that the mortgagors did not anticipate renegotiation of the lease or sale of the property. According to the Court, because these actions were done without notice to the mortgagors, there was an inference that the lender acted with ill motive. Further, the mortgagors had alleged that the lender, with knowledge of information critical to mortgagors, acted against their interest even while the lender was complying with the contract.

Fourth, the Court denied the lender’s motion to dismiss the breach of fiduciary duty claim. It believed that when the mortgagors transferred 99% of its equity interest in the partnership, the lender owed a fiduciary duty to the mortgagors not to prefer their own interests over those of the mortgagors. Whether upon a default by the mortgagors the lender could, consistent with its fiduciary duty, renegotiate the underlying lease and secretly sell the property was held to be questions of fact.
Fifth, it dismissed the waste claim, with leave to amend. It ruled that although it appeared that the mortgagors were claiming mismanagement of assets, the details were unclear. It required the mortgagors to be more specific as to which property was involved, which defendants caused the waste, and which of the plaintiffs suffered damages in future pleadings. Finally, it dismissed the CFA claim. The Court held that the CFA is pointed to products and services sold to consumers in the popular sense. It also opined that this transaction was not excluded from the protection of the CFA simply because the parties were sophisticated, but it did look at the nature of the transaction. In that regard, it ruled that: (a) a mortgage is not a “sale” of real estate for purposes of the CFA; (b) even if it were to view the transaction as a sale of partnership interests, the CFA would not apply; and (c) imposing CFA liability in this case would not serve the purposes of the CFA because the second mortgage financing, where the parties engaged in extensive negotiations unique to a particular property and had crafted a novel financing structure involving the transfer of partnership interests as security, did not reflect the ordinary meaning of a consumer good.

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