Paradise Restaurant, Inc. v. Somerset Enterprises, Inc.

PARADISE_REST_V_SOMERSET_ENTRPRSE.95-085; 164 Vt 405; 671 A.2d 1258

[Filed 08-Dec-1995]


       NOTICE:  This opinion is subject to motions for reargument under
  V.R.A.P. 40 as well as formal revision before publication in the Vermont
  Reports.  Readers are requested to notify the Reporter of Decisions,
  Vermont Supreme Court, 109 State Street, Montpelier, Vermont 05609-0801 of
  any errors in order that corrections may be made before this opinion goes
  to press.


                                 No. 95-085


Paradise Restaurant, Inc.                         Supreme Court

                                                  On Appeal from
     v.                                           Bennington Superior Court

Somerset Enterprises, Inc.                        September Term, 1995



Ellen H. Maloney, J.

       Peter H. Banse of Banse & Banse, P.C., Manchester, for
  plaintiff-appellee

       Robert F. Woolmington of Witten, Saltonstall, Woolmington, Bongartz &
  Campbell, P.C. Bennington, for defendant-appellant


PRESENT:  Allen, C.J., Gibson, Dooley, Morse and Johnson, JJ.

       JOHNSON, J.  Defendant purchased a restaurant in Bennington from
  plaintiff for cash and a promissory note, and appeals from an order of the
  Bennington Superior Court granting plaintiff's foreclosure petition on the
  purchase-money mortgage securing the note.  Pursuant to a stipulation of
  the parties, the court granted defendant's motion for permission to appeal. 
  We reverse.

       The purchase and sale transaction closed on September 20, 1988.  The
  total purchase price for the restaurant was $750,000, defendant paying
  $250,000 in cash and financing the balance with a $500,000 promissory note
  secured by a first mortgage on the property.  The note provided for

       interest at the rate of nine and half (9 1/2) per annum payable as
  follows:

     A) No payments due from September 19, 1988 to July 1,
        1989.

     B) $3,132.69 including principal and interest each month

 

        payable on the first of each month from July 1, 1989 to June
        30, 1991.

     C) $5,224.95 including principal and interest each month
        payable on the first of the month from July 1, 1991 to June 30,
        2004.


  The note did not contain any provision for a balloon payment, i.e., a
  lump-sum payment of outstanding principal, at the end of the term.

       Defendant made timely payments under the note until early 1993, when
  the parties engaged in a dispute relating to parking rights on an adjacent
  parcel owned by Paradise and leased to its subsidiary.  Paradise claimed a
  breach when defendant's February 1, 1993 check was returned for
  insufficient funds, and brought the present foreclosure action.  Defendant
  answered that sufficient funds to cover the check were deposited promptly
  after the check was dishonored and there was no default, and that the
  foreclosure had been brought in bad faith, in retaliation for defendant's
  action against plaintiff's subsidiary.

       After plaintiff's motion for summary judgment was denied, defendant
  moved for a determination of the full amount of principal and interest then
  due, intending to pay the balance in full upon that determination.  The
  sole issue before the court was the amount due under the note, and there
  was agreement that as of December 31, 1993 defendant had paid plaintiff
  $231,933.06 on the note.

       It was also undisputed that both parties had allocated principal and
  interest as to each payment in exactly the same manner on their respective
  tax returns, using the straight-line method of accounting, under which the
  total payments to be made during the term of the loan were totalled, and
  the principal amount subtracted. The balance remaining was the interest to
  be paid over the term, which figure was divided by the number of years in
  the term.  The result yielded both the amount and rate of annual interest,
  which would remain constant throughout the term.  Plaintiff's accountant
  testified that it was he who suggested the straight-line method of booking
  the loan payments.  As of December 31, 1993, both parties reported the same
  amount

 

  of remaining principal on the note to the Internal Revenue Service,
  $385,256.83.

       At trial, plaintiff's accountant testified that he should have
  amortized the note at an annual rate of 9.5% using the declining-balance
  method and that under this approach the total amount due as of June 30,
  1994 was $535,276.11, rather than $361,600.75.  The accuracy of plaintiff's
  accountant's calculations under the declining-balance method was not
  disputed.  It was also undisputed that the declining-balance method did not
  comport with the payment schedule set forth in the note, and left a
  significant balloon payment at maturity.

       Defendant did not dispute that the straight-line method actually
  followed by the parties until 1993 yielded an interest rate of about 4.5%,
  rather than the 9.5% rate set forth on the face of the note.  Nevertheless,
  defendant urged the court to adopt this reading of the note in establishing
  the total amount due, arguing that plaintiff was estopped to repudiate its
  own adoption of the straight-line accounting method at all times since the
  closing.

       The court found that it was not possible to give effect to all of the
  note terms without rendering at least one of the terms inconsistent, but
  added that "[t]he 9 1/2% interest rate, however, is unambiguous and must
  clearly reflect the intent of the parties.  The straight line calculation
  results in interest at a rate of approximately 4 1/2%.  This is
  significantly lower than what the parties intended at the time of
  contracting."  The court concluded that the declining-balance methodology
  most closely reflected the parties' intentions and that the interest rate
  of 9.5% stated in the note should govern over the payment schedule stated
  therein.  The court rejected defendant's estoppel argument, concluding that
  the facts did not square with the elements we described as necessary for
  estoppel in Greenmoss Builders, Inc. v. King, 155 Vt. 1, 7, 580 A.2d 971,
  974-75 (1990).  The court adopted plaintiff's total of $535,276.11,(FN1) the
  calculation of which is not in dispute, assuming use of a declining-balance
  approach.  The

 

  present appeal followed, by stipulation of the parties and permission
  of the court.

       The parties agree that the promissory note was internally
  inconsistent, since the stated interest rate of 9.5% could not be
  reconciled with the payment schedule set forth in the note.(FN2) Defendant
  argues that the court erred in failing to resolve the inconsistency by
  following the "uniform practical construction" of the terms, which the
  parties themselves had adopted in employing the straight-line accounting of
  interest and amortization over nearly five years, and that the court erred
  in rejecting defendant's estoppel argument.

                                I.

       Defendant contends that the court erred in failing to adopt the
  "uniform practical construction" of the parties during the period of
  performance, citing 3 Corbin on Contracts Sec. 558, at 249 (1960) to the
  effect that a court is justified in adopting the practical interpretation
  that the parties themselves have given the contract.  The treatise,
  however, is clear that the principle applies only where there is an
  ambiguity in the language of an agreement.  Corbin states in text
  immediately preceding defendant's quotation that "[t]he process of
  practical interpretation and application, however, is not regarded by the
  parties as a remaking of the contract; nor do the courts so regard it." 
  Id.

 

       Cases relying on the principles underlying Sec. 558 make the same point. 
  See, e.g., Teamsters Indus. Employees Welfare Fund v. Rolls-Royce Motor
  Cars, Inc., 989 F.2d 132, 137 (3d Cir. 1993) (pension fund's failure to
  demand contributions on behalf of probationary employees relevant where
  collective bargaining agreement ambiguous as to whether such contributions
  were required); Overseas Dev. Disc Corp. v. Sangamo Constr. Co., 686 F.2d 498, 504 n.10 (7th Cir. 1982) (subsequent conduct of parties relevant where
  contract ambiguous as to whether certain rights were delegable); Chapman
  College v. Wagener, 291 P.2d 445, 448 (Cal. 1955) (where promissory notes
  departed from language of contract, subsequent conduct of parties was
  relevant to proper interpretation).

       The note in the present case is not ambiguous.  It is defective and
  incapable of consistent interpretation.  The contract might have been
  deemed implicitly modified by subsequent conduct. See Globe Transp. &
  Trading (U.K.) Ltd. v. Guthrie Latex, Inc., 722 F. Supp. 40, 44 (S.D.N.Y.
  1989) (parties' actions impliedly modified contract to endow third member
  of arbitration panel with full rights).  But defendant did not argue
  modification, and in any case, the record indicates that the straight-line
  accounting of loan payment proceeds by both parties was a routine adopted
  by fiscal officers prior to learning of the defect in the note.  Cf. In re
  Jansen v. United States, 344 F.2d 363, 369 (Ct. Cl. 1965) (court rejected
  "practical construction" evidence where double payments apparently made
  routinely by government finance office).(FN3)

 

                                II.

       Defendant next argues that the court erred in concluding that the 9.5%
  interest rate "must clearly reflect the intent of the parties" and that
  "[t]he parties clearly agreed to lend and borrow the $500,000 at a 9 1/2%
  interest rate."  We agree.  There is no evidence in the record tending to
  resolve the irreconcilable conflict in the wording of the promissory note
  one way or the other. The court acknowledges that the only relevant
  document is the note itself, which both parties agreed at trial was
  defective and could not be enforced in accordance with all of its terms.

       Although, as plaintiff argues, the parties did agree on a 9.5%
  interest rate, they also agreed that the amount due would be paid by the
  borrower's adherence to a payment schedule set forth on the face of the
  instrument as clearly as was the interest rate.  Put another way, the
  parties appear to have agreed that a $500,000 note could be fully paid at
  an interest rate of 9.5% via the payment schedule set forth on the note --
  an illusory agreement, incapable of performance since its premise was
  contrary to fact.  The court could not rely exclusively on the stated
  interest rate on grounds that it was "unambiguous," since the payment
  schedule was equally unambiguous.  Nor does plaintiff call our attention to
  any rule of construction that favors a stated interest rate over a payment
  schedule.

       The court's conclusion that the parties "clearly agreed" to the 9.5%
  interest rate, or, more precisely, that the agreement on a 9.5% interest
  rate was the only clear understanding expressed by the parties in the note,
  was not supported by the record and cannot stand.  See Marble Bank v.
  Heaton, 160 Vt. 188, 191, 624 A.2d 365, 367 (1993) (court had no factual
  basis on which to rule that defendant must pay judgment held by bank
  against defendant under trustee process).

                               III.

       As the matter must be remanded for further proceedings to determine
  the correct payout amount, further discussion is appropriate to guide the
  court on remand.  See Town of Sherburne v. Carpenter, 155 Vt. 126, 131, 582 A.2d 145, 148-49 (1990).

       It is undisputed that the note is a defective instrument, that it
  cannot be interpreted by giving effect to all of its terms, and that the
  mistake in executing the instrument was mutual. The usual remedies applied
  to a mistake in contract formation are rescission and reformation.

 

  Reformation is inappropriate because a prerequisite to reformation is
  evidence of the terms of the actual agreement, which the writing in
  question failed to record.  See Burlington Savings Bank v. Rafoul, 124 Vt.
  427, 429, 209 A.2d 738, 740 (1965) (noting that party seeking reformation
  has burden of establishing beyond reasonable doubt the true agreement to
  which contract is to be reformed).  Here, the problem is that we cannot
  discern the actual agreement of the parties.

       Rescission is impractical and would yield an inequitable result. 
  Defendant has operated the restaurant as its apparent owner since 1988.  If
  the sale transaction were treated as a nullity, the economic and other
  issues raised by attempting to put the parties in status quo ante would
  make the question of the proper interest rate on the note executed by the
  parties seem simple in comparison.  If the restaurant has significantly
  increased in value since the sale, then rescission would tend to favor the
  seller; if the restaurant has declined in value, or was purchased at a
  price that in retrospect was higher than its fair market value, the
  rescission would tend to favor the buyer, who in effect enjoyed a
  relatively risk-free venture.  See 330 P.B. Corp. v. Murphy, 532 So. 2d 1,
  3 (Fla. Dist. Ct. App. 1988) (rescission not appropriate where parties to
  mortgage financing condominium sales could not be returned to original
  positions).

       Modern courts and commentators have taken a broader view of other
  remedies in cases where a purported agreement does not reflect a meeting of
  the minds.  One commentator has argued that courts should resolve such
  disputes in the way most likely to enforce the parties' expectations.  3
  Corbin on Contracts Sec. 536(B), at 42 (1994 Supp.);  see also Restatement
  (Second) of Contracts Sec. 158 cmt. c (1981) (if mistake provisions of
  Restatement "will not suffice to avoid injustice, the court may supply a
  term just as it may in cases of impracticality of performance and
  frustration of purpose").

       In Thieme v. Worst, 745 P.2d 1076 (Idaho Ct. App. 1987), buyers sought
  rescission against sellers of property conveyed under the mutually mistaken
  belief that irrigation water was available.  The trial court declined to
  rescind but required sellers to provide a water delivery

 

  system, and granted damages to purchasers.  In affirming the trial
  judge's decision, the court stated:

          [R]escission is not the exclusive remedy for mutual mistake; a
          court may consider other equitable remedies in fashioning a just
          result.  Indeed, the avoidance rule of the Restatement Sec. 152
          expressly recognizes that the materiality of the parties' mistake
          may be alleviated by other equitable relief.  Correspondingly, Sec.
          158(2) of the Restatement acknowledges the power of an equity
          court to eliminate the effect of mistake by supplying a new term
          or otherwise modifying the agreement as justice requires, thus
          protecting the parties' reliance interests.

  Id. at 1080.

       Using an analogous approach in this case, the trial court on remand
  may use its power as an equity court to fashion an appropriate remedy.  The
  court is not limited to calculating the balance due on the note using
  either the stated 9.5% interest rate or the 4.5% interest rate implied by
  the payment schedule.  The court should determine on the basis of the
  record after remand what remedial approach comes closest to treating each
  party fairly and equitably.

       Reversed and remanded for further proceedings in accordance with this
  opinion.

                              FOR THE COURT:

                              _______________________________________
                              Associate Justice



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                                  Footnotes

FN1.  For reasons that are not clear from the opinion and order below,
  the trial court, after adopting plaintiff's methodology, found the amount
  due on the note to be only $531,266.09, rather than $535,276.11.

       The error may have resulted from an initial computation of an
  amortization schedule for a fifteen-year loan of $500,000 at 9.5% simple
  interest, commencing on July 1, 1989 and running to July 1, 2004, which
  results in a monthly payment of $5,224.95 -- the figure set forth in
  paragraph C of the note -- to commence on July 1, 1991.  Had that monthly
  payment been made at and after August 1, 1989, the loan would have been
  fully paid out, with 9.5% interest and with no "balloon," on July 1, 2004.

FN2.   It is plausible, though not verified by evidence in the record,
  that the parties began their negotiations with a starting and uniform
  $5,224.95 monthly payment in mind, later modifying the note to ease
  defendant's debt burden in the restaurant's startup years.

FN3.   Even if this speculation were proven fact, it would not answer
  the question of whether the parties thereby tacitly assented to a lower
  effective interest rate than 9.5%, or rather intended some other means of
  making up for the lower starting rate, either during the out years of the
  note or with a balloon payment at its maturity. Defendant also argues that
  the court erred in declining to adopt its estoppel theory, which closely
  parallels the practical construction argument.  The court made findings as
  to all of the factors in Greenmoss Builders, Inc. v. King, 151 Vt. 1, 7,
  580 A.2d 971, 974-5 (1990) and defendant has not demonstrated that the
  court's findings were clearly erroneous as to any of the Greenmoss factors.