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Mellon Bank Corp. v. First Union Real Estate Equity and Mortgage Investments

argued: November 14, 1991.

MELLON BANK CORPORATION AND MELLON BANK, N.A., APPELLANTS IN NO. 90-3712
v.
FIRST UNION REAL ESTATE EQUITY AND MORTGAGE INVESTMENTS, APPELLANTS IN NO. 90-3790



Appeal from the United States District Court for the Western District of Pennsylvania. (D.C. Civil Action No. 88-00775)

Present: Hutchinson and Cowen, Circuit Judges, and O'neill, District Judge*fn*

Author: Hutchinson

Opinion OF THE COURT

HUTCHINSON, Circuit Judge.

I.

These consolidated appeals arise out of a diversity action, controlled by Pennsylvania law, that was removed from the Court of Common Pleas of Allegheny County, Pennsylvania, to the United States District Court for the Western District of Pennsylvania. At Docket No. 90-3712, Mellon Bank Corporation (Mellon) appeals from a final order of the district court granting summary judgment to First Union Real Estate Equity and Mortgage Investments (First Union), a real estate investment trust (REIT), on Mellon's claims for breach of contract and fraudulent misrepresentation. By those claims, Mellon sought to enforce oral promises it said First Union made in connection with two formally separate but functionally related transactions evidenced by written agreements between Mellon and First Union. In one transaction, Mellon agreed to lease an office building from First Union with an option for Mellon to purchase the property on an installment sale basis. In the other, Mellon agreed to loan First Union an amount that approached the purchase price for the office building. The lease-purchase agreement for the office building expressly denied Mellon any right to prepay First Union, but the loan agreement gave First Union the right to prepay Mellon's loans to it. First Union prepaid Mellon's loans to it on September 19, 1983.

On February 22, 1988, Mellon filed this action for breach of contract alleging an oral side agreement by which First Union promised either not to prepay Mellon's loans or, if it did prepay, to otherwise protect Mellon against the market risk of a decline in interest rates. Alternately, Mellon sought to recover from First Union on a theory of fraudulent misrepresentation of First Union's intent not to prepay or to protect Mellon in the event it did prepay. First Union moved for summary judgment in October, 1989. The district court granted the motion in September, 1990. It held that Pennsylvania's version of the parol evidence rule barred introduction of First Union's alleged oral promises, that the so-called "fraud exception" to the parol evidence rule did not apply, and that Mellon's claim for fraudulent misrepresentation failed because it had not produced clear and convincing evidence that First Union had falsely misrepresented its present intention with respect to prepayment, or to protect Mellon, and that Mellon could not have reasonably relied on First Union's oral promises not to prepay without protecting Mellon against a decline in interest rates. See Mellon Bank Corp. v. First Union Real Estate Equity & Mortgage Invs., 750 F. Supp. 711 (W.D. Pa. 1990).

On October 8, 1990, after the district court entered judgment in its favor, First Union moved for Rule 11 sanctions against Mellon claiming there was no "good ground to support" Mellon's claims. See Fed. R. Civ. P. 11. This motion was made nearly two and one-half years after this suit was removed to federal court. At Docket No. 90-3790, First Union cross-appeals the district court's order denying its motion for Rule 11 sanctions. In that connection, Mellon now seeks double costs and damages from First Union under Federal Rule of Appellate Procedure 38 for pursuing what Mellon says is a frivolous appeal from the denial of Rule 11 sanctions.

For the reasons explained below, we will affirm the order of the district court granting summary judgment in First Union's favor. We will also affirm the district court's order denying First Union's motion for sanctions against Mellon under Federal Rule of Civil Procedure 11. Finally, we will deny Mellon's Rule 38 request for double costs and damages against First Union on account of First Union's appeal from the district court's denial of the Rule 11 motion.

II.

In 1981, Mellon, in need of more office space, approached First Union to see whether it was interested in selling the One Oliver Plaza building. First Union's management, faced with the prospect of a hostile takeover bid, needed cash. The basic ingredients for a mutually beneficial deal seemed present.

As often happens, in the negotiations that ensued it became clear the parties had conflicting interests. These conflicts made it hard to reach a meeting of the minds. Mellon wanted to pay cash to purchase the building because it could generate funds internally at rates below the market. First Union would not accept an all-cash transaction because of severely adverse tax consequences to its investors. First Union's status as a real estate investment trust required it to distribute to its beneficiaries 95 percent of its earnings from the transaction in one year. See generally 26 U.S.C.A. § 4981(b) (West 1989) (capital distribution requirement of real estate investment trusts). Thus, it needed to structure the deal as a tax-free exchange or as an installment sale that would spread its income from the transaction over a number of years.

On January 25, 1982, the parties reached an agreement in principle. Under it Mellon would lease One Oliver Plaza from First Union with an option to purchase. If the option was exercised, payment of the purchase price would be in deferred installments in order to meet First Union's need to spread its gain on the sale over the term of the lease-purchase agreement. The agreement was structured so that Mellon would pay for the building in a combination of cash, the assumption of the underlying building mortgages and the execution of a $48 million note and purchase money mortgage. It also gave Mellon the right to assign its option to purchase if it guaranteed the mortgage debt of its assignee. The agreement denied Mellon the right to prepay the $48 million dollar debt the mortgages secured.*fn1 The note that was to evidence this debt stated:

The undersigned shall not have any right or privilege to prepay all or any portion of the written obligations prior to the maturity date.

Joint Appendix (Jt. App.) at 451.

In order to meet its need for immediate cash to counter a hostile takeover bid, First Union asked Mellon to loan it $46 million secured by mortgages on two shopping malls First Union owned (the "mall loans"). The $46 million loan was to be evidenced by documents formally unconnected with the lease-purchase agreement for One Oliver Plaza. In contrast to Mellon's obligation to First Union under the One Oliver Plaza agreement, Mellon's loan to First Union did permit First Union to prepay the debt. The two notes evidencing First Union's obligations under the mall loans stated:

Upon giving the holder hereof at least ten (10) days prior written notice, the Maker [First Union] reserves the right to prepay the unpaid principal balance of this Note, in whole or in part.

Jt. App. at 435, 441.

The parties do not dispute that the One Oliver Plaza transaction and Mellon's mall loans to First Union were formally drafted as separate transactions. While First Union says that the two transactions were entirely separate funding options explored by First Union's president, Donald Schofield, to counter a hostile takeover bid, Mellon characterizes the two as "matched" or "back-to-back" transactions. Mellon says that it agreed to make the mall loans to First Union only if they were matched with the mortgage from First Union to Mellon to finance Mellon's contemplated purchase of One Oliver Plaza, both loans having identical interest rates of 14 percent. Thus, Mellon contends the matched interest rates of the two transactions reflect Mellon's intent to avoid the risk of declining interest rates that would otherwise result from its agreement to assume the $48 million mortgage on One Oliver Plaza. Mellon says that it had insisted on a prepayment prohibition in the mall loans to preserve their matched nature with the One Oliver Plaza mortgage, but that Schofield refused, because he wanted to avoid any appearance that the two transactions were tied together.*fn2

Mellon produced evidence to show that before the deal was finalized Schofield made an oral promise to two high-level Mellon officials that he would not prepay. One says Schofield said he had "no incentive to prepay" but promised: "If I prepay the mortgages on the shopping centers I will do something or allow you to prepay [the One Oliver Plaza note]. I won't do anything to harm you or to hurt you." Id.. at 185. "We'll index them to some number on your cost of funds so that you won't be hurt." Id. at 190. The other says Schofield said "he might want to prepay because he might sell a mall, et cetera," id. at 271, but promised "that if he did prepay, that he would provide [Mellon] with the same security and the same payment terms on another instrument." Id. at 272. First Union denies that these promises were made. One of Mellon's attorneys testified on deposition that these oral promises explain why the loan documents do not contain the usual boilerplate integration that the full agreement of the parties is represented in the written contract.

Although the mall loans had been approved by Mellon's real estate department in mid-February, the purchase of One Oliver Plaza required approval of Mellon's board of directors. The board members were not apprised of First Union's alleged oral promises. The lease-purchase agreement and the mall loans closed on March 10, 1982. Before Mellon's right to exercise its option to purchase expired, another building became available. Mellon then decided not to purchase the One Oliver Plaza building itself, but instead assigned its option to purchase to a limited partnership known as One Oliver Plaza Associates (Associates) in February 1983. Thus, Associates instead of Mellon executed the One Oliver Plaza mortgage note on May 13, 1983. Mellon, however, guaranteed payment of Associates' $48 million note to First Union in the event that Associates defaulted.*fn3

In February of 1983, First Union had already filed a shelf registration with the Securities Exchange Commission (SEC) for a public offering of securities in the amount of $50 million. It intended to use the proceeds to prepay the two mall loans. In late August of 1983, First Union notified Mellon that it intended to prepay the mall loans. First Union prepaid the mall loans on September 19, 1983. First Union did not offer Mellon any other security following its prepayment. By 1986, interest rates had fallen far below the rate Mellon had guaranteed on the $48 million mortgage from First Union. First Union denied Mellon's request to refinance the One Oliver Plaza mortgage. With its estimated loss of over $10 million, Mellon initiated this action.

III.

We have jurisdiction over the final orders of the district court granting First Union's motion for summary judgment and denying its motion for Rule 11 sanctions pursuant to 28 U.S.C.A. § 1291 (West Supp. 1991). The district court had subject matter jurisdiction under the removal statute, 28 U.S.C.A. § 1441(a) (West 1973),*fn4 based on diversity of citizenship pursuant to 28 U.S.C.A. § 1332(a) (West Supp. 1991).

We exercise plenary review over the district court's grant of summary judgment in favor of First Union. See International Union, UMWA v. Racho Trucking Co., 897 F.2d 1248, 1252 (3d Cir. 1990). In conducting this review, we address the record and issues in the same manner as the district court ruling on such a motion. Wood v. R.R. Donnelley & Sons Co., 888 F.2d 313, 314 (3d Cir. 1989). Accordingly, all facts in the record, and all reasonable inferences deduced therefrom, will be construed in the light most favorable to Mellon, the non-moving party. Turner v. Schering-Plough Corp., 901 F.2d 335, 340 (3d Cir. 1990).

In reviewing the district court's Rule 11 determination, we apply an "abuse-of-discretion standard." Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 110 S. Ct. 2447, 2461, 110 L. Ed. 2d 359 (1990); Ford Motor Co. v. Summit Motor Products, Inc., 930 F.2d 277, 289, 18 U.S.P.Q.2D (BNA) 1417 (3d Cir.), cert. denied, 116 L. Ed. 2d 324, 112 S. Ct. 373 (1991). We employ an objective test in deciding whether an appeal is frivolous under Federal Rule of Appellate Procedure 38. See Hilmon Co. (V.I.) v. Hyatt Int'l., 899 F.2d 250, 253 (3d Cir. 1990).

IV.

Mellon contends that the district court erred in granting summary judgment in favor of First Union, both on its breach of contract theory and its theory of fraudulent misrepresentation.*fn5

A.

On Mellon's breach of contract claim, the district court held that the parol evidence rule barred Mellon's attempt to use the alleged oral promises that First Union would not prepay its mortgage on the mall loans or "take care of" Mellon if it prepaid. The Restatement ...


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