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First National State Bank of New Jersey v. Commonwealth Federal Savings and Loan Association of Norristown


decided: December 3, 1979.



Before Adams, Rosenn and Weis, Circuit Judges.

Author: Adams


In this diversity action, we are asked to reverse a decree of specific performance and an assessment of additional damages. Suit was brought by First National State Bank of New Jersey (First National), as assignee of a real estate developer, for breach by Commonwealth Federal Savings & Loan Association of Norristown (Commonwealth) of a standby commitment for permanent mortgage financing of a shopping center. We hold that the district court did not err, and affirm its judgment for the reasons set out below.


Mathema Developers began construction of the Glen Oaks Shopping Mall in Camden County, New Jersey, in the latter part of 1973, with the proceeds of a loan from South Jersey National Bank. In early May 1974, Central Mortgage Company applied on behalf of Mathema for a one year standby commitment "just to give (the developer) enough time to complete and secure his permanent financing when the market may look a little brighter."

As with most real estate developments, the financing here was to take place in two stages: a short-term construction loan and a long-term permanent loan. The construction loan was to finance the actual construction of the project and the permanent loan, or mortgage loan, was designed to replace or "take out" any short-term borrowings. A permanent loan is generally obtained from a savings institution or insurance company, while a construction lender usually is a commercial bank.*fn1 A standby commitment obligates the permanent lender to refinance the construction loan if called upon to do so by the developer, but in addition generally provides the borrower with the option to search for an alternative lender with more advantageous terms. The premium paid for this option is a nonrefundable fee, and the commitment enables a developer to seek short term construction financing.

On May 21, 1974, Commonwealth executed a standby commitment for a loan of $3,500,000 at an interest rate of sixteen percent or six percent above the prime rate, whichever was higher. In return for this commitment, Mathema was to pay, and did pay, one percent of the loan amount. Under its terms, the commitment could be extended by the borrower for another half-year by paying an additional one-half percent. The major condition of the commitment was that "(T)he entire project . . . be constructed according to the plans and specifications submitted to Commonwealth and as appraised by Mr. George Olassin, M.A.I."*fn2 The condition requiring an acceptable appraisal by Mr. Olassin was subsequently eliminated after the appraisal was received. As thus amended, the commitment was to expire on July 23, 1975. The district judge, sitting without a jury, found that at the time the commitment was issued, the shopping mall was between fifty and eighty-five percent completed. Neither a specific rental achievement clause nor a requirement of one hundred percent completion was included in the commitment.*fn3

Concurrent with its negotiations for the standby agreement, Mathema applied to First National for a construction loan. In deciding whether to make the construction loan, First National's vice-president, Mr. Van Sant, personally examined the mall; requested certain credit information and a copy of the standby commitment; and inquired of Commonwealth as to the developer's credit rating, Commonwealth's ability to fund its commitment, and whether it would consent to an assignment of the commitment to First National. Mr. Van Sant also directed First National's own appraiser to make a detailed inspection of the mall.

After investigating these matters to his satisfaction, Mr. Van Sant, on behalf of First National, issued a letter to Mathema, dated July 30, 1974, setting forth approval of the application for a construction loan of $3,600,000, as well as the bank's conditions before the loan could be consummated. Among the conditions was the requirement that the standby mortgage lender consent to an assignment of the commitment by Mathema to First National. Written consent was soon obtained from Commonwealth. Thus the trial judge found that "prior to its acceptance of the construction mortgage, (First National) received an assignment of Commonwealth's mortgage commitment and in fact relied upon the commitment when it funded the construction." 455 F. Supp. 464, 467 (D.N.J.1978).

At the time First National approved Mathema's request for the construction loan, it disbursed $2,850,000, the bulk of which went to pay off the existing construction loan with South Jersey National Bank. First National's appraiser had estimated then that the shopping mall was "approximately 95% Complete except tenant work which is under way or to be started," that $163,000 would be necessary to complete the work to be done, and that the entire mall should be completed by October 1974.*fn4

Nevertheless, an additional amount of approximately $500,000, exclusive of interest, was ultimately disbursed by First National to Mathema. First National's assertion that all these funds were advanced for construction already in place was disputed by Commonwealth.*fn5

On April 23, 1975, Mr. Van Sant wrote to Mathema, with a copy to Commonwealth, requesting that a closing be arranged on the permanent loan. By that time, the shopping mall was already in grave economic difficulties, inasmuch as only twenty-five percent of the available space in it had then been rented. When no answer to the request for a closing was received, First National wrote to Commonwealth, on June 13, 1975, to request immediate arrangements to close the loan before July 23, the expiration date of the standby commitment. Commonwealth sent a contractor to inspect the shopping mall, and he reported that construction was incomplete. On this point, the trial judge found: "There seems to be some serious question as to whether (the contractor) even looked at the plans before, during or after his inspections but it is clear from the testimony that he certainly made no comparison between the physical layout of the mall and the plans and specifications." 455 F. Supp. at 467.

In a letter dated July 16, 1975, Mathema also requested closing of the permanent loan. Commonwealth responded, in a letter dated the day before its commitment was to expire, that it would not close the loan because the "property has not been completed according to the plans and specifications." Neither in this letter, nor in discussions with First National prior to it, did anyone from Commonwealth elaborate as to what items were incomplete. The district court found it "clear from the evidence . . . that the only work that needed completion was so-called "tenants work.' " 455 F. Supp. at 468.

Although maintaining that neither Mathema nor First National was responsible for the work left undone, Mr. Van Sant offered to place in escrow a sum of money to secure performance equivalent to 11/2 times the value of the work that Commonwealth claimed was incomplete. This proposition was rejected by Commonwealth; also rejected was a suggestion that inspectors of the two banks meet to review the assertedly incomplete work.

The day before the expiration of Commonwealth's commitment, First National exercised the right, that had been assigned it by Mathema, to extend the commitment for half a year by delivering to Commonwealth a check for $17,500. The day after the expiration, Commonwealth returned the check on the stated ground that it had been delivered under protest. A subsequent check delivered by First National without protest was also rejected.

When the builder was unable to keep up its loan payments, First National proceeded with foreclosure, and it has operated the shopping mall ever since at a substantial loss.*fn6 Both Mathema and First National brought suit in the New Jersey state court for specific performance of the loan. Both actions were removed to federal district court and consolidated for trial, but Mathema's claim was dismissed at trial for failure to prosecute.

Following trial, judgment in favor of First National was entered. Specifically, Commonwealth was ordered to perform its obligation under the commitment, to pay interest at eight percent on the amount of the loan from the time the loan should have been made until such time as the money is turned over to First National, and to reimburse with interest the amount First National has lost in operating the mall.


Commonwealth sets forth the following points in appealing the district court's order: First, it did not breach its standby commitment because Mathema did not complete the mall in accordance with the submitted plans and specifications. Second, First National breached its obligations to Commonwealth as a third-party beneficiary of the loan agreement between Mathema and First National. Third, specific performance is not appropriate, because it is an extraordinary remedy that should not be granted either in mortgage loan agreements in general or under the particular facts and equities of this case. Fourth, the award of damages is an alternative remedy and should not be ordered as a supplement to specific performance. In considering Commonwealth's contentions in this diversity action, we follow the law of New Jersey since that is the state in which the contract was made as well as the state with the greatest interest in this dispute over property within its jurisdiction.*fn7

In seeking to avoid its contractual commitment, Commonwealth invokes the portion of the agreement which states that "(t)he entire project shall be constituted according to the plans and specifications submitted to this association," and asserts that the doctrine of substantial performance does not apply. At trial, First National's architectural expert testified to certain variances between the construction plans and the mall as built, and estimated that the variances saved the builder about $50,000. Some changes, however, were estimated to have enhanced the value of the project by twice that amount. In addition, Commonwealth discovered shortly before trial more than two and a half years after it refused to perform its loan agreement that the electrical distribution system installed in the mall did not conform to the plans. This change was assessed by Commonwealth's expert to have added substantially to the operating costs of the mall. First National's expert testified, however, that the electrical system called for in the original specifications could not accommodate the needs of the mall at full operation.

It is for the trier of fact to evaluate the credibility of conflicting testimony as to the necessity of any variance between the plans and the construction in place, as well as the overall enhancement or detriment to the project resulting from such changes.*fn8 Any lack of congruence between the original plans and specifications and the actual construction was slight, the district court found, and in fact it "enhanced the value of the property." The trial judge also found that the project was substantially completed when Commonwealth refused to "close" the loan. 455 F. Supp. at 469. We perceive no basis for overturning these findings.

New Jersey law is clear that "where there is substantial performance of a building contract, even though attended by minor shortcomings, the contract price may be recovered, less a fair allowance . . . to make good the defects." Winfield Mutual Housing Corp. v. Middlesex Concrete Products and Excavating Corp., 39 N.J.Super. 92, 97, 120 A.2d 655, 657 (App.Div.1956).*fn9 The contract we interpret here was drafted by Commonwealth, and any ambiguities are therefore to be construed against it.*fn10 If complete and perfect performance by the builder were essential before Commonwealth was required to honor its commitment, it was for the drafter explicitly so to state.*fn11


Commonwealth contends that it "was a third-party beneficiary of First National's commitment and building loan agreement with Mathema," and that as a third-party beneficiary, "Commonwealth could use those contracts as a matter of defense in this action." The New Jersey statute specifically allows "(a) person for whose benefit a contract is made" to employ that contract as a defense in an action against him. N.J.Stat.Ann. ยง 2A:15-2 (West). Even if we were to hold that Commonwealth was a third-party beneficiary of the contract between First National and Mathema, however, it is doubtful that it would be entitled to raise the issue on appeal, inasmuch as it did not set forth this affirmative defense in its pleadings as required by Fed.R.Civ.P. 8(c).

We conclude, in any event, that under New Jersey law Commonwealth is not a third party beneficiary. "The essence of contract liability to a third party is that the contract be made for the benefit of said third party within the intent and contemplation of the contracting parties. Unless such a conclusion can be derived from the contract or surrounding facts, a third party has no right of action under that contract despite the fact that he may derive an incidental benefit from its performance." Gold Mills, Inc. v. Orbit Processing Corp., 121 N.J.Super. 370, 373, 297 A.2d 203, 204 (Law Div.1972).*fn12

Neither of the cases cited by Commonwealth for the proposition that it is a third-party beneficiary of First National's loan agreement is helpful. In Graybar Electric Co., Inc. v. Continental Casualty Co., 50 N.J.Super. 289, 142 A.2d 114 (App.Div.1958), a surety for a construction company was held responsible for the debt of a subcontractor to a sub-subcontractor. The court looked only to the explicit language of the surety contract in deciding that the sub-subcontractor was a third-party beneficiary of the surety contract. The agreement stated that it was made for the benefit of "any subcontractors, materialman, laborer, person, firm or corporation having a just claim." Id. at 296, 142 A.2d at 118. Sweeney v. Veneziano, 70 N.J.Super. 185, 175 A.2d 241 (App.Div.1961), involved an assignment to one partner of the partnership's claim, with the proviso that the assignee pay all counsel fees arising from that claim. Plaintiff's decedent, Sweeney, was the lawyer who drew up the contract and who later sued for the counsel fees due on the claim. The court held that the contract by its language was partially for the benefit of a third party, and it was clear from the circumstances that Sweeney was that third party even though he was not mentioned by name in the agreement. Id. at 195, 175 A.2d at 246-47.

In this case First National may have paid out more money to Mathema than it was obligated to do under its construction loan agreement, but we find nothing in the loan agreement to indicate the requisite intent that Commonwealth be a beneficiary of any contractual limitation as to the use of the loan money. Indeed, the contract between First National and Mathema seems specifically to exclude an intent to create any third-party beneficiary.*fn13 The financial institution that eventually funded the permanent loan would benefit by First National's frugality, but this does not by itself suffice to make the eventual permanent lender an intended beneficiary.


We come now to what appears to be the most provocative issue on this appeal, namely whether the decree of specific performance was proper. Under New Jersey law, the "right to the equitable remedy of specific performance turns upon the existence of an adequate remedy at law; and the adequacy of the legal remedy of compensation depends upon the facts and circumstances of the particular case . . . . There is no definitive formula automatically resolving every case." Fleischer v. James Drug Stores, Inc., 1 N.J. 138, 146, 62 A.2d 383, 387 (1948). Generally, the remedy at law is said to be inadequate in two situations: (1) where damages would be insufficient because the subject matter of the contract is of such a special nature that it resists translation into quantitative terms the damage remedy " "would not be a just and reasonable substitute for or representative of that subject-matter in the hands of the party who is entitled to its benefit' "; or (2) where "damages are impracticable" because "it is impossible to arrive at a legal measure of damages at all, or at least with any sufficient degree of certainty." Id. at 146-47, 62 A.2d at 387.

Traditionally, courts have been reluctant to grant specific performance of agreements to lend or borrow money,*fn14 inasmuch as money is intrinsically fungible.*fn15 The more recent cases, however, and especially those involving construction loans, have shown a greater recognition that specific performance may be justified in exceptional circumstances.*fn16 Scholarly commentary is in general agreement with this trend, at least insofar as the borrower's remedy is concerned.*fn17

The district judge in this case determined that both of the Fleischer rationales for specific performance were applicable to the facts before him. He found that New Jersey law supported the principle that a contract for the financing of a shopping center is unique, in the sense that the term has been used in cases granting specific performance, because the subject matter itself is "unavailable in similar form." Further, he ascertained that the damages suffered by First National were not susceptible to accurate calculation and that "an award of damages would fail to make plaintiff whole." 455 F. Supp. at 470.

In so holding, the trial judge placed principal reliance on Selective Builders, Inc. v. Hudson City Savings Bank, 137 N.J.Super. 500, 349 A.2d 564 (Ch.Div.1975), a case from a New Jersey trial court with facts strikingly similar to those sub judice.*fn18 That decision appears to be an accurate statement of New Jersey law and represents the best authority available in predicting how the highest court of New Jersey would rule on the issue.*fn19

Commonwealth attempts to distinguish Selective Builders on two grounds, neither of which is persuasive. First, it declares that Selective Builders turned on issues of waiver and estoppel that do not apply here. Our reading of the case, however, reveals that issues of waiver and estoppel surfaced only in the chancery court's discussion of whether one hundred percent completion was required by the agreement, and that these factors were introduced as alternative rationales to the court's primary conclusion that substantial performance was sufficient. See id. at 505-06, 349 A.2d at 566-68. Second, Selective Builders is said to be distinguishable because the developer there had tried without success to secure other mortgage financing, while there is no evidence here that First National made any such effort. But the court in Selective Builders quoted approvingly from a decision of Maryland's highest court that emphasized the futility of seeking alternative mortgage financing for an obviously failed project:

"(T)he would be permanent mortgage lender must contemplate that if, at the last minute, it cancels its commitment such action would be disastrous to the borrower; that in such event obtaining a new permanent mortgage loan would be well-nigh impossible, for the reason that whatever brought about the cancellation would in all likelihood prevent another lender from entering the fray . . . ."

137 N.J.Super. at 507-08, 349 A.2d at 509 (ellipsis in original) (quoting St. Paul at Chase Corp. v. Manufacturers Life Ins. Co., 262 Md. 192, 278 A.2d 12, 36 (1971)).

After noting that neither Mathema nor First National had sought to find another lender to fund the project in this case, the trial judge stated that "it is reasonable to infer from the nature of the agreement, and the notable lack of success of this shopping mall, that there is no hope of obtaining similar financing." 455 F. Supp. at 470. Since both parties agree that the shopping mall is a financial failure, it would appear paradoxical for Commonwealth to insist that First National should have attempted to persuade some other mortgage lender to take over a bad investment. We therefore reject Commonwealth's assertion that specific performance was improper because First National should have attempted to mitigate its damages by obtaining substitute performance at a higher interest rate.*fn20

There is ample evidence in the record to support the district court's conclusion that accurate calculation of damages was impracticable in this case. The basic measure of such damages would be to subtract from the amount of the permanent loan the estimated value of the shopping mall. However, the distinct qualities of such a property preclude a definitive estimate. The trial judge would have been forced to choose among widely disparate appraisals of the value of the mall. For tax purposes the property was appraised at $1,070,000. First National's expert witness testified that at the time of trial the fair market value of the mall was $1,500,000, while Commonwealth's expert gave three valuations, all based on at least a ninety percent occupancy rate. They ranged from $2,500,000 ("pessimistic") through $2,800,000 ("most probable") to $3,500,000 ("optimistic").

If it were necessary, of course, the trial judge could choose a figure among these estimates predicated on his assessment of the witnesses' relative credibility. It is apparent from the difficulty of choosing among the estimates, though, that a decree of specific performance was appropriate because it would " "do more perfect and complete justice.' "*fn21 Commonwealth, the party breaching the agreement, would then have the burden of owning the shopping mall and would realize the true market value either by operating the mall or selling it.*fn22

As between the construction lender and the permanent lender, it does not appear unreasonable to place the risk of the success or failure of a real estate venture on the latter. Real estate developments generally are riskier than other business investments, and therefore mortgage rates are significantly higher than interest rates on most other loans. If the permanent lender can escape its commitment when a project seems to have failed, that party will have achieved a significant shifting of risks without a corresponding shift in the returns on successful ventures.*fn23 A permanent lender's primary security on such a venture is the capitalized value of the project,*fn24 and so it is the permanent lender, not the construction lender, that has the responsibility and presumably the expertise to analyze the business risks.*fn25 It is therefore appropriate to place the risk of the project's nonviability on the permanent lender. As one scholar has stated, "If the project is nonviable, the risk being allocated as between the construction lender (and associated third parties) and the permanent lender is the risk of failing to achieve satisfaction through foreclosure and a deficiency judgment. Since the earlier lenders were relying upon the property, the developer, and the permanent financing, while the permanent lender had only the property and the developer upon which to rely, it seems fair that this risk should fall on the permanent lender."*fn26

We recognize that the result in this case will work substantial hardship on Commonwealth, but any alternative would work an equal hardship on First National inasmuch as neither wants to be in the business of operating a shopping center. Because Commonwealth agreed to be the permanent lender, and because it is the party that breached the commitment, we cannot say that the trial judge abused his discretion in requiring Commonwealth to shoulder the burden.


Commonwealth's final point on appeal is that the district court erred in granting incidental damages in addition to specific performance. The object of a remedy for breach of contract is to make the aggrieved party whole. When a court decrees specific performance, it should also adjust the equities to place the parties as far as possible in the same position that they would have occupied had the agreement been completed on the prescribed day.*fn27 If Commonwealth had "taken out" the construction loan on the prescribed date, First National would have had the benefit of interest derived from the money paid to it by Commonwealth at that time. It is equally clear that had the loan come through on time, Commonwealth, rather than First National, would have had to foreclose on Mathema's debt and would have become the owner of the shopping mall. Consequently, we cannot say that it was improper for the trial court to award damages incidental to the breach covering reimbursement for interest and for losses sustained in operating the mall.

The judgment of the district court will be affirmed.

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