Hoffman v. Key Federal Savings & Loan Ass'n

Wilner, J., delivered the opinion of the Court. ⁴³⁹ Appellants, Paul and Judith Hoffman, for themselves and a class they seek to represent, appeal from an order of the Circuit Court for Baltimore County sustaining appellee’s demurrer to Count I of their Amended Declaration, without leave to amend, and from the court’s refusal to allow the action to proceed under Maryland Rule 209 as a class action. 1 The principal question is whether the court erred in concluding, from the facts alleged in Count I (and the exhibits incorporated in it), that a certain loan transaction between the parties was not usurious. The loan transaction in question was in the nature of construction financing convertible into a “permanent” mortgage, in order to allow the Hoffmans to build a home on a lot they purchased in Howard County. Appellants used $53,000 of their own money, and desired to borrow $14,000 from appellee, Key Federal. Pursuant to a previous commitment letter, Key Federal agreed to make the loan, settlement of which occurred on January 29, 1976.

At that time, and in accordance with the terms of the commitment letter, Key Federal delivered to the Hoffmans its check for $14,000, the full proceeds of the loan. The Hoffmans immediately endorsed that check (and delivered as well one of their own for $53,000) to Robert L. Kolscher and George G. Wachter, trustees. The delivery of these funds was accompanied by the execution of a trust agreement governing, among other things, the future disbursement of the funds. The $14,000 loan was evidenced by a promissory note, secured by a deed of trust upon the Hoffmans’ lot and improvements.

The note required repayment in equal monthly installments of $105.75, principal and interest, commencing May 1,1976, and continuing for the ensuing 25 years. Interest commenced running on the $14,000 from the date of closing, and, apparently, was separately billed for. the period from January 29, 1976, through April 30, 1976 — -the construction ⁴⁴⁰ period. An annual interest rate “on the unpaid balance” was stated in the note to be 7%%. The critical agreement, in terms of the legal issue presented, is the trust agreement between the Hoffmans and the two trustees, both of whom are alleged to be “officers, agents and employees of Key Federal and were acting on behalf and under the control and direction of Key Federal.” The agreement recited the loan from Key Federal, and stated that a “condition precedent” to the loan was that the Hoffmans erect and complete certain improvements within nine months from that date.

It stated further that “for the purpose of guaranteeing the completion of said improvements”, the Hoffmans had turned over to the trustees the proceeds of the mortgage loan, and that such proceeds were “to be deposited by said Co-Trustees, in their own names, with Key Federal Savings and Loan Association as a pending fund to secure the erection of the aforesaid improvements”. These funds were to be advanced to the Hoffmans in six installments as certain specified levels of completion were achieved. The agreement prohibited the commencement of any work until written authorization was received from Key Federal. However, once such authorization was received, work must commence within 30 days; otherwise, the agreement “may be . voided by the Co-Trustees and all monies paid to Key Federal ,.. on account of their mortgage loan____” 2 In that event the Hoffmans released the trustees from “any suits, legal actions, etc.”, and “by the signing of this agreement ... hereby expressly give their permission to the said Co-Trustees to follow the above stated course of action.” In similar vein, the agreement provided that, if work on the improvements stopped for a period of 20 consecutive days, or was not completed within nine months, the trustees, “in their discretion, have the authority to use the balance of the aforesaid loan then in their hands towards the cost of ⁴⁴¹ completing said improvements or to pay [Key Federal] on account of its aforesaid mortgage loan.” Finally, the agreement provided that “by the acceptance of this trust by the [trustees] and the agreement by them to perform the duties imposed upon them... they do not assume any personal responsibility, and [the Hoffmans] do ... not hold them responsible and do... expressly release them from such responsibility and no claim shall be made upon them for or on account of any matter or thing in excess of the sum of money paid into their hands or such balance thereof as may be remaining and undisposed of in accordance with the terms and agreements as hereinbefore set forth.” Pursuant to this agreement, the trustees deposited the entire sum (presumably the $67,000) in a noninterest bearing account at Key Federal, withdrawing and disbursing the same as construction proceeded.

Although the Amended Declaration did not specifically allege this, the court, in lieu of granting leave to amend, considered the pleading as implicitly alleging that, whilé on deposit with Key Federal, these funds were not segregated in any way, but were instead intermingled with Key Federal’s general funds, and were thus usable and used for the general purposes of the association. The basis of the Hoffmans’ complaint is that, between January 29, 1976 (the date of closing) and the time the last advancement was made pursuant to the trust agreement, the Hoffmans paid $800 in interest to Key Federal, this being interest on the full amount of the $14,000 loan for that period, notwithstanding that the loan proceeds were advanced in installments. Their claim is that they were required to pay interest on amounts that had not been advanced to them, and that did not, therefore, constitute an “unpaid balance” upon which interest could properly be charged. This $800, they assert, amounted to usury in that it constituted interest on amounts not actually lent to and within the exclusive control of the Hoffmans; and they sought, as damages $2,400. 3 In ⁴⁴² addition, as representatives of a class, on behalf of each other person in the class who obtained a residential construction loan from Key Federal under similar arrangements, they claimed the greater of $500 or treble the amount of “usurious” interest charged.

Appellants’ theory of recovery emanates primarily from the principles announced by the Court of Appeals in Tri-County Fed. S. & L. v. Lyle, 280 Md. 69 (1977); and, in large part, the initial question is whether the transaction alleged here is but a variation upon a theme or something substantially different from that considered by the Court in that case. Lyle also involved a residential construction loan, obtained in order to finance both the purchase of a lot and construction of a house on it. At closing, a check for $60,000 was issued to the Lyles, which they immediately endorsed back to the savings and loan association. The association then paid out $15,000 to the seller of the lot, that being the purchase price of the property, but retained the balance of $45,000, which became part of its general funds.

No separate escrow account was maintained. The $45,000 was to be paid out by the association in nine installments as work progressed. Evidencing the transaction was a note for $60,000, bearing interest at the rate of 8% per annum, secured by a deed of trust. Five months later, before any part of the $45,000 had been disbursed, the Lyles abandoned their plans and repaid the association $15,000 plus $573.29 accrued interest on the $60,000.

During the interim, an additional $1,600 in interest had been paid. Thereafter, Mr. and Mrs. Lyle sued to recover three times the amount of interest paid on the $45,000. With respect to this undisbursed sum, the Court stated, at page 73: “At no time was this under the Lyles’ control, or under their partial control, as it might have been had it been held in escrow by others for their account, even though subject to restrictions. It was deposited in Tri-County’s general account, and remained there from the day the Lyles signed the note until repayment was made.” ⁴⁴³ For that reason, said the Court, that sum was not part of any “unpaid balance” owed by the Lyles, and any interest charged on it was usurious.

At page 76: “Here the ‘unpaid balance’ referred to by Art. 49, § 3 [the predecessor statute to Commercial Law article, § 12-103] was the $15,000.00 owed by the Lyles to Tri-County; the $45,000.00 was a balance beyond their control, to which they had no access until they commenced the construction of their house. So long as it remained in the sole control of Tri-County, and was not utilized by the Lyles, the imposition of the interest charged was usurious, because the $45,000.00 was not and could not be a part of the unpaid balance of the loan to the Lyles.” Seizing upon the Court’s comment about the absence of an escrow account in Lyle , Key Federal attempts to distinguish that case, and thereby escape from the meaning the Hoffmans ascribe to it, by pointing to the trust agreement existing here. It relies on Toney Schloss v. Union Federal, 233 Md. 224 (1964), and the cases cited in it for the proposition that the full $14,000 became “presently loaned” to the Hoffmans, and therefore constituted the “unpaid balance”, at time of settlement, when the proceeds of the loan were actually, though only momentarily, disbursed to them. Toney Schloss involved a construction loan arrangement very similar to that used here.

The mortgage loan proceeds were disbursed to the borrower at settlement, and, as part of the overall agreement with the lender, these proceeds were immediately deposited with trustees selected by the lender, to be further disbursed in stages as construction progressed. The ease did not involve the question of usury, or whether interest could properly be charged prior to disbursement by the trustees. Bather, the sole question was whether such an arrangement constituted a mortgage to secure “future advances”, and, as to any disbursement made by the trustees that they were not required to make under the loan agreement, whether the construction mortgage became subordinate to another mortgage given to a third party of ⁴⁴⁴ which the construction lender had actual notice. 4 It was in this context that the Court concluded ( 233 Md. at 233 ) that “the money loaned by the [construction mortgagee] to the mortgagor was money presently loaned and it did not constitute future advances”. Consequently, said the Court, the construction mortgage “was a lien for the full amount of the consideration named therein from the time of its recordation____” The argument of Key Federal has a certain facial appeal: if, under Toney Schloss (and a number of cases that preceded it), the full amount of the loan proceeds are considered to be “presently loaned” when disbursed at time , of settlement, notwithstanding their immediate deposit under a trust agreement, surely they must also constitute the “unpaid balance” owed as of then.

This argument overlooks, however, the very different considerations involved in the two types of situations. The device of disbursing the entire loan proceeds at timé-' of settlement, and then requiring the borrower to deposit them in trust pending further disbursement based upon the progress of construction, was developed and used primarily to avoid the effect of an 1872 statute making the priority of future advances date from the time of the advancement, rather than from the date of the mortgage, as against the rights of intervening creditors. See Comment to Former Article 21 (noted in footnote 4). The obvious policy embodied, in that statute was to protect subsequent creditors by assuring that thosé claiming prior liens had, in fact, given value for those liens.

Thus, a lien could not be claimed with ⁴⁴⁵ respect to money that had not been advanced. As against this policy, however, a construction lender had to be assured that the funds lent, or obligated to be lent, would, in fact, be used for the intended purpose, and that the security of his lien would not be jeopardized by collateral transactions occurring after he committed himself and during the progress of construction. To conclude, in that context, that the entire sum was “presently loaned” at time of settlement, when the lender actually committed the funds, to the borrower under an arrangement that assured their ultimate actual disbursement to the project, was a reasonable and pragmatic resolution to what otherwise would have been a serious statutory impediment to efficient construction financing. As between the construction mortgagee, the mortgagor, and intervening creditors, no one was injured by such a result, and the statutory goals could be achieved. 5 Constructive notice of the full amount of the lien was given to the world when the mortgage was recorded; thus, prospective intervening creditors would know what lien was ahead of them, and the construction lender was assured of his first lien on the entire amount of his construction loan.

The considerations at issue with respect to the usury laws are quite different. These laws deal not with the co-relative rights of creditors, but with the relationship between lender and borrower. They deal with interest, which the law defines as compensation imposed by a lender “for the extension of credit for the use or forbearance of money____” (emphasis supplied), Commercial Law article, § 12-101 (e); and their purpose is to limit the amount of such compensation that may lawfully be exacted by lenders. The point addressed by Lyle is that, in