Kennedy Associates, Inc. v. Fischer
667 P.2d 174 (Alaska Sup. Ct. 1983)

Rabinowitz

    This appeal arises from a real estate loan agreement entered into by Kennedy Associates, Inc. (Kennedy), and Richard and Teri Fischer (Fischer). In March 1980, Kennedy, an investment advisor representing several pension trusts, issued a commitment to participate as lead lender in a long-term $1.25 million loan to Fischer on commercial rental property in Anchorage. Shortly thereafter, Kennedy notified the joint lender, Alaska Mutual Savings Bank (AMB), that it had decided not to participate in the project. Fischer and AMB refused to accept the withdrawal and Fischer filed suit for breach of contract.   The superior court concluded that Kennedy was liable to Fischer on a theory of anticipatory repudiation. This appeal followed. We conclude that the superior court erred in holding that Kennedy was in breach of contract and therefore reverse.

I.

    Fischer is an Anchorage real estate investor and developer. His holdings include the Anchorage Fish and Game Building, the subject of the instant litigation. It was constructed in 1971-72 for occupancy by the Alaska Department of Fish and Game. The original three-year lease has been extended several times and will expire July 31, 1985 unless Fish and Game exercises its renewal option and extends the lease through July 31, 1990.

    On September 13, 1979, Fischer negotiated an amendment to the lease with Fish and Game which required him to construct an addition to the building. He obtained interim financing for the expansion from SeaFirst Mortgage Corporation and subsequently sought $1.5 million in long-term financing from AMB. He submitted a loan package to AMB comprised of a copy of the appraisal report on the property, which included sketches of the existing floor plan and preliminary plans and specifications for the addition, a financial statement, a copy of the leases on the building, and cash flow information.

    AMB's representative, Paul Baker, approached a Kennedy loan officer, John Parker, with a proposal that several of the pension trusts which Kennedy represented as an investment advisor participate in the loan to Fischer.  Baker forwarded the Fischer loan package to Parker on or about February 27, 1980, stating in the cover letter that AMB would be limited to 10% participation in the loan. Exclusively on the basis of that information, Kennedy decided to issue a commitment to participate in the loan. The commitment letter sent to Baker on March 31, 1980 stated that Kennedy was willing to contribute 90% of the funds needed for the $1.25 million loan. Interest on the 25-year loan was set at 13.125%, and the loan was to be secured by a first deed of trust on the building. Kennedy did not inspect the property prior to issuing the commitment. The letter explicitly stated that "disbursement will be made on or before June 1, 1980," and that "express condition[s] precedent to the disbursement of the loan proceeds or any portion thereof" included

(i) Inspection by Participants. Representatives of Lead Lender and Participants shall be permitted to inspect the completed property and this commitment is subject to the inspection and approval by said representatives.

Parker testified that the purpose of the inspection clause was primarily to permit Kennedy to determine whether the building would provide adequate security for the long-term loan.

    AMB and Fischer executed and returned the commitment to Parker on April 21, 1980.  The sole reservation Fischer and AMB expressed in the accompanying cover letter pertained to the role Mrs. Fischer would play in the transaction, as Fischer did not want his wife's name on the loan.

    Baker offered to accompany Parker on an immediate inspection of the premises. The inspection was conducted on May 6 or 8, 1980. Baker and Parker walked through the building together. Construction of the addition was completed sufficiently to permit the lenders to conduct a meaningful inspection. Parker subsequently contacted a general contractor and independent consultant, Wayne Cherrier, who inspected the building in early May, both alone and accompanied by Parker. In a written report, Cherrier gave the building a "poor" rating for a variety of reasons, including the difficulty of converting it for multi-tenant use and his conclusions that it was barely constructed up to code and had been poorly maintained.

    As a result of Cherrier's report and Parker's personal inspection, Kennedy decided not to go forward with the loan to Fischer. Parker telephoned Baker on May 12, 1980 to advise him of Kennedy's decision. Parker informed Baker that the decision was based on the fact that the condition of the building was so poor that Kennedy's officers were worried that the State would move out after its current lease expired, compromising the security for the loan.

    Fischer and AMB refused to accept Kennedy's withdrawal and did not accept a check for the $12,500 commitment fee which Kennedy had returned to AMB. AMB and Fischer continued to make arrangements to satisfy the conditions set out in the commitment letter. Fischer's attorney wrote to Baker on May 30, 1980, stating that he had gathered the documents necessary to complete the closing and was ready to do so. He admitted at trial, however, that he had been "somewhat stretching the truth" in making such a statement.

    The closing never took place and Fischer sought alternative sources of financing. Although he eventually liquidated other holdings to strengthen his financial position, he did not locate another long-term lender.  Rather, he continued to pay "prime plus two," or 17 1/2%, the rate of interest on his interim loan.

    Fischer filed suit for breach of contract alleging that Kennedy had wrongfully failed to honor its loan commitment.  The case was tried to the superior court, sitting without a jury. The court found that a contract was formed between AMB and Kennedy, whereby Fischer was to be a third-party beneficiary of a loan to be funded jointly by AMB and Kennedy; that the parties to the transaction contemplated that construction would be complete on or before June 1, 1980, the final date for closing of the loan, and that the inspection would take place on or about that date; that the inspection occurred substantially before the June 1 deadline; and that Kennedy terminated the commitment solely on the basis of the inspection. The court concluded that Kennedy's withdrawal occurred several weeks before Fischer's duty to perform matured and that the May 12 termination constituted an anticipatory repudiation of the loan commitment. Fischer was awarded damages and attorney's fees. This appeal and cross-appeal followed.

II.

    The central issue before us is the propriety of the superior court's construction and application of paragraph 14(i) of the letter of commitment. As the court implicitly concluded, paragraph 14(i) stated a condition precedent to Kennedy's obligation to fund the Fischer loan because it expressly provided that Kennedy's obligation was "subject to" its approval of the building after it conducted an inspection.  Since, in general, the non-occurrence of a condition precedent precludes an action by the promisee to enforce the contract, Kennedy's reliance upon 14(i), if justified, would operate as a complete defense to Fischer's suit.

    The superior court rejected Kennedy's contention that the repudiation was justified under paragraph 14(i) because it found that the inspection occurred prematurely. . . .

    Review of the record persuades us that the superior court erred in concluding that the inspection was untimely. Although paragraph 14(i) did refer to an inspection of the "completed property," there is ample evidence in the record supporting Kennedy's contention that construction of the addition to the Fish and Game building was substantially complete at the time the commitment was executed, and that the parties did not intend that the inspection be delayed until the closing date. Baker, AMB's agent, stated in his April 21, 1980 cover letter to the executed loan commitment that "I would be more than glad to walk through the building with you [Kennedy's agent] at your convenience." Baker met Kennedy's representative at the building on May 6 or 8, 1980 to conduct the "walk through" inspection. He testified that only "minor items" such as concrete stoops and touch-up painting were not complete on that date, and that as they left the site he was under the impression that the 14(i) condition had been satisfied.

    Both parties understood that the purpose of the inspection clause was to permit Kennedy to withdraw its commitment if it found that the building would not provide adequate security for the long-term loan.  This purpose could not have been served if, as Fischer now contends, the inspection clause was to be construed as constituting a "condition subsequent" to the loan closing.

    . . .

III.

    We turn now to the question of whether Kennedy acted reasonably in terminating the contract following the 14(i) inspection. Paragraph 14(i) is a classic example of a "satisfaction clause," of a contractual provision making the obligor's duty contingent upon the obligor's satisfaction with the obligee's performance. We have previously upheld such provisions against allegations that they render illusory the obligor's promise to perform by reading them "to require the exercise of honest judgment and good faith." Hausam v. Wodrich, 574 P.2d 805, 809 (Alaska 1978). Thus, we must determine whether Kennedy exercised "honest judgment" and "good faith" in terminating the contract on the basis of its dissatisfaction with the Fish and Game Building.

    Anticipating that we might reverse its conclusion that the inspection was untimely, the superior court addressed this issue and found, after "full consideration," that Kennedy had acted in good faith in terminating the commitment. The superior court articulated several grounds in support of its decision. First, Kennedy commissioned an independent third party to inspect the premises, and in fact relied upon his recommendation in concluding that the property would not furnish adequate security for a long-term loan. Second, interest rates on long-term loans were declining when it withdrew from the agreement. Third, it acted promptly in inspecting the building and notifying AMB of its decision and the reasons therefor. The court also concurred with the conclusions reached by Wayne Cherrier, Kennedy's consultant, that the building had been "marginally" constructed and poorly maintained, and that it could not be easily converted for multi-tenant use. These factors lend support to the superior court's finding that Kennedy acted honestly and did not invoke 14(i) as a pretext for escaping from a bargain it found unsatisfactory for other reasons. See Restatement (Second) of Contracts § 228 comment a (even if only honest dissatisfaction is required, "the dissatisfaction must be with the circumstance and not with the bargain").

    In his cross-appeal, Fischer challenges the superior court's finding that Kennedy acted in good faith. His argument rests primarily upon the contention that the court erred as a matter of law in applying a subjective rather than objective standard of good faith in assessing Kennedy's conduct. The superior court expressly relied upon Mattei v. Hopper, 51 Cal. 2d 119, 330 P.2d 625 (Cal. 1958) (en banc), in concluding that a subjective good faith standard should be utilized to evaluate a party's reliance upon a satisfaction clause dependent upon judgment. n7

    The question of whether a court should utilize an objective rather than a subjective standard of good faith in gauging the validity of reliance upon a satisfaction clause dependent upon commercial judgment is one of first impression in this jurisdiction. It is well-established that where the condition requires satisfaction as to commercial value or quality, operative fitness, or mechanical utility, an objective standard is to be used in determining whether the clause has been satisfied. See Mattei, 330 P.2d at 626-27 and cases cited therein; see also Meredith Corp. v. Design & Lithography Center, Inc., 101 Idaho 391, 614 P.2d 414, 416 (Idaho 1980) (satisfaction requirement contained in contract between printing corporation and door manufacturer for printing advertising catalogue sheets was to be determined by an objective standard, since "in most cases involving commercial parties, idiosyncratic preferences are not relevant"). On the other hand, if a judgment dependent upon personal taste or fancy, such as design of a dress or execution of a portrait is involved, a subjective test is appropriate. See Restatement (Second) of Contracts § 228 illustration 4 (1981); Mattei, 330 P.2d at 627; Meredith, 614 P.2d at 416. The difficulty of the case before us lies in the fact that it arises in a commercial context but involves a judgment dependent upon consideration of a multiplicity of factors.

    We conclude that the superior court should have applied an objective standard in determining whether the paragraph 14(i) condition was satisfied. Our choice of standard is predicated on the principle that a forfeiture of contractual rights is to be avoided, whenever possible. Therefore, just as "conditions" are construed as covenants, unless the parties have clearly agreed otherwise, so must a preference be given to application of an objective test of reasonable satisfaction whenever practicable and not precluded by the express terms of the parties' agreement. n10

    The conditions which would warrant making an exception to the preference for an objective test are not present here. Paragraph 14(i) simply stated that the agreement was "subject to the approval" of the lenders representatives; it did not explicitly provide for the application of a subjective test. The subject matter of the satisfaction clause involved a judgment dependent upon commercial rather than aesthetic or artistic standards. It is practicable to apply an objective test in gauging its validity as it cannot reasonably be deemed an "idiosyncratic" decision.  Thus, we conclude that the superior court should have applied an "objective" standard in determining whether Kennedy's reliance upon paragraph 14(i) in terminating the agreement was justified.

    However, the record before us reveals that the superior court's failure to apply the proper standard was harmless error. Kennedy's dissatisfaction with the building was objectively reasonable. Kennedy hired an independent consultant, Wayne Cherrier, to inspect the building on its behalf. Cherrier testified that

it was a very, very poorly maintained building . . . . [which] needed painting inside; all the doors on the inside were marred and . . . . they were having problems with . . . . the heating system . . . . they had tape over most of the air ducts in [some] of the offices . . . . [In the new portion] the quality [of] construction didn't seem to be up to par . . . . it was poor to adequate. [The quality of the pre-existing structure was] poor.

In his report to Kennedy, Cherrier stated that

the existing structure has had little or no maintenance, both to the exterior and the interior of the building.  There appears to be very little pride of ownership.

Every part of the building needs some repair or maintenance work. The new addition is not complete as of this writing.

It appears that both structures: existing building and the new addition, were built to meet just the basic code requirements.

I rate the overall project as POOR.

    The superior court expressly concluded that the evidence "preponderate[d] in favor of the proposition" that the consultant was a "disinterested, unbiased third party," and that Kennedy relied exclusively upon his report in terminating the commitment.

    Fischer offered no independent testimony contradicting this assessment. He relied in part upon statements in the appraisal included in the original loan package to the effect that the building was of "average to good quality." Kennedy presented expert witnesses who testified that the building failed to conform in several respects to the description set out in the appraisal. In rebuttal, Fischer relied solely upon his own testimony. He stated that as a former real estate appraiser, he considered the building to be of

average quality. There's a -- it's a little better than some, and not as good as a lot of others.

    On the basis of such a record, we are persuaded that the superior court was justified in accepting the conclusion of Kennedy's consultant that the building was "marginal[ly]" constructed and that maintenance was "substandard."

    We think it reasonable that Kennedy would be concerned that such a building would not provide adequate security for a long-term loan. The impact of the deficiencies in maintenance and construction was aggravated by the probability that the building was not one which could easily be converted for use by several other tenants. Kennedy was concerned that the deterioration of the building would lead the state to decide not to extend the lease at the expiration of the five-year term. If the building could not be easily converted for multi-tenant use, its cash flow would be seriously compromised, affecting the borrower's ability to make payments on the 25-year loan.

    In support of its contention that the building would not be easily convertible, Kennedy relied in part upon Cherrier's report which stated that:

The design of this building appears to be for the express purpose of a one time, one agency tenant. In my opinion, no thought was given for a conversion factor, if the present agency moved out. The design is poor.

    The superior court expressly found that this conclusion regarding the building's poor conversion factor was well-founded in light of

the small size of the offices . . . . the length of the hallways . . . . the small size and location of the restrooms . . . . the limited number and placement of the entrances . . . . [and] the cost of relocating the stud sheetrock walls.

Fischer admitted during cross-examination that the building would not be "easily convertible" and attempted to temper the impact of this concession by alleging that "nothing is easily convertible." This evidence is insufficient to warrant reversal of the superior court's finding under the clearly erroneous standard.

    In sum, we conclude that Kennedy's concern that the condition of the building was deteriorating and that it would not be readily convertible to multi-tenant use was well-founded. We are persuaded by the uncontradicted testimony of Kennedy's officers that they were justified in concluding that these attributes of the structure rendered it unsuitable as security for a long-term loan. Kennedy exercised its contractual right to terminate the agreement in good faith and in a timely, objectively reasonable fashion. Its duty to fund the loan was discharged accordingly.

    The superior court's judgment and award of attorney's fees are therefore REVERSED, and the case is REMANDED for entry of judgment in favor of Kennedy.