CHILDS REAL ESTATE CO INC v. SHELBURNE REALTY CO ET AL

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District Court of Appeal, Second District, Division 1, California.

CHILDS REAL ESTATE CO., INC., v. SHELBURNE REALTY CO., ET AL.

Civ. 13951.

Decided: April 17, 1943

James A. McLaughlin, of Los Angeles, for appellant. Chase, Barnes & Chase and Lucius K. Chase, all of Los Angeles, for respondent.

Bank of America National Trust and Savings Association (hereinafter called the bank) appeals from a judgment awarding plaintiff $3,861.20 which was in the possession of defendant bank in the latter's capacity as trustee under a certain trust indenture securing a bond issue. The bank also appeals from that portion of the judgment denying it recovery of the sum of $3,073.31 sought to be obtained on its cross–complaint. We shall give consideration only to those portions of the pleadings and the evidence which relate to the issues which form the basis of this appeal.

By the second cause of action in plaintiff's complaint it was sought to recover $3,594.32 consisting of income collected by defendant Shelburne Realty Co. (hereinafter referred to as Shelburne) and paid to the bank prior to a certain lease forfeiture date of January 17, 1940. In the same cause of action plaintiff sought to recover refunded insurance premiums in the sum of $266.88, refunded to the bank upon policies insuring the interest of the bank as indenture trustee and which when added to the above mentioned $3,594.32, totals the amount of the judgment of $3,861.20 in favor of plaintiff and against defendant bank upon the former's complaint.

In addition to its answer, defendant bank filed a cross–complaint against plaintiff to recover rentals earned prior to the forfeiture date from the property involved, but collected by plaintiff from various subtenants of defendant Shelburne and aggregating $2,537.42. Defendant bank by its cross–complaint also sought the recovery of $537.31 representing unearned insurance premiums on policies which plaintiff continued in effect after the forfeiture date. Defendant bank had paid these insurance premiums on account of insurance on the property prior to the forfeiture. The second cause of action in defendant bank's cross–complaint alleged the payment by it of said sum of $537.31 prior to the forfeiture date of January 17, 1940, on policies taken over as of that date by plaintiff, and for which sum it was alleged plaintiff agreed to reimburse defendant bank.

Another cause of action in defendant bank's cross–complaint sought also the recovery of the heretofore referred to sum of $266.88, representing premiums on certain cancelled insurance policies, and which sum was pursuant to stipulation held by defendant bank subject to the judgment of the court upon the bank's claim to ownership thereof.

By the judgment rendered herein, defendant bank was denied recovery of the sums forming the basis of its cross–complaint and amounting to $3,074.73. The sum of $266.88, heretofore mentioned and referred to as the premiums on cancelled insurance policies, was awarded to plaintiff.

The issues presented by this appeal may be defined by the following epitome of the facts presented in chronological order. In the year 1922 the real property incident to this litigation, located at 639 South Hill Street in the business district of downtown Los Angeles, was leased to one Roy C. Bailie for a term of 99 years. Thereafter, by mesne assignments, Childs Company of Providence, of which corporation plaintiff herein, Childs Real Estate Company, Incorporated, is the successor, acquired the interest of Bailie and in November, 1924, the last mentioned corporation executed a 96–year sublease to The L. Harris Realty Co., which later changed its corporate name to Shelburne Realty Co., one of the defendants herein. It is this last mentioned lease to Shelburne upon which respondent predicates its lien rights to the moneys here in controversy. In this connection it is respondent's claim that by the terms of its sublease to Shelburne there was reserved to the former a first lien upon the leasehold estate conveyed to the latter and as well, upon all buildings and improvements erected by Shelburne, and upon all rents payable to Shelburne from such buildings and improvements; that this lien was to secure the payment by Shelburne of rents, taxes, assessments and other obligations relating to the demised premises. To sustain its claimed first and superior lien, respondent cites us to the following provisions of the sublease: “* * * and the rent reserved in this lease, all taxes and assessments, all other payments whatsoever, relative to said demised property which shall in fact be paid by lessor, but which, under the provisions hereof, are to be paid by lessee, and all damages to lessor and its lessors against which, by the terms hereof, lessee is to hold lessor and its lessors harmless, shall be and they are each and all of them declared to be a first lien and superior to an incumbrance created by lessee, and upon the leasehold or estate hereby granted to lessee, upon all buildings and improvements upon said premises erected by lessee, and upon all rents, from all of such buildings and improvements situated on said premises during said term and payable to lessee.” (Emphasis supplied.)

The sublease from respondent to Shelburne contained the further provision that the lessee should insure the buildings and improvements upon the premises under policies of insurance payable to a trustee, and in that clause appears the following language: “* * * should the lessee be in default hereunder, for any reason, and this lease be terminated by lessor by reason of the same, or should lessee undertake or commence work as herein provided and then thereafter neglect, fail or refuse to complete the same, and the lessor terminates this lease by reason of such neglect, failure or refusal, then all such monies in the hands of the Trustee should be paid to lessor, who may apply the same to such work or hold the same as liquidated damages.”

As of July 1, 1925, defendant Shelburne (then known as The L. Harris Realty Co.) executed a trust indenture under which one of appellant's predecessor banks was designated as trustee. The trust indenture followed the customary form of such instruments and many of its provisions are not material to a disposition of this appeal. It hypothecated the entire leasehold interest of Shelburne, and after describing the property, it contained the following: “Together with any and all buildings, improvements and appurtenances now standing or at any time hereafter constructed or placed upon said land or any part thereof, and all and singular the tenements, hereditaments and appurtenances thereunto belonging or in any wise appertaining and the reversion and reversions, remainder and remainders, rents, issues and profits thereof; it being understood however, that the conveyance made herein of said leasehold estate, as well as the conveyance made herein of any and all buildings, improvements and appurtenances, in connection with said leasehold estate and premises, is made subject to the terms, limitations and conditions of the Childs lease hereinbefore referred to.”

In it was also contained a covenant by Shelburne; “The corporation covenants and agrees that from time to time the same are executed it will assign to and deposit with the trustee for the further security of the bonds issued or to be issued hereunder each and every lease now existing or which is hereafter made by the corporation covering the whole or any part of the property described in the granting clause of this indenture, and which is for a term of one (1) year or more, and none of said leases shall be canceled or changed without the written consent of the trustee; but notwithstanding such assignment the corporation may continue to collect all rents, issues and profits thereof until and unless an event of default occur as elsewhere provided in this indenture.”

Each of the bonds issued under said trust indenture contained a reference thereto for a description of the properties mortgaged, the nature and extent of the security, the rights of the holders of said bonds under the same, and the terms and conditions under which said bonds were issued and secured.

The above mentioned bonded indebtedness was created by Shelburne to assist it in financing construction of an 8–story, class A, reinforced concrete building on the leased property. It appears that the building was completed in 1927 at a cost approximating $600,000 and that $400,000 of such cost was made available from the proceeds of the bond issue while the balance was supplied by Shelburne.

On December 1, 1939, rent in the sum of $3,000 due on that date was unpaid and there were also certain rentals totaling $6,000 that had been deferred by agreement between respondent and Shelburne, and which also became due on November 30, 1939. On December 5, 1939, taxes in the sum of $7,629.39 became delinquent by reason of Shelburne's default in the payment of same. Under the terms of Shelburne's sublease, thirty days notice of default was required to be served by respondent upon the defaulting tenant, and pursuant to the terms of a modification of the sublease, a similar notice was required to be served on appellant bank. Such notice of default was served on both Shelburne and the bank on December 15, 1939, accompanied by a demand for payment of said sums.

On January 1, 1940, Shelburne again defaulted in the payment of $3,000 in rental due on that date, and on the 10th and 11th of January a demand for payment of such last mentioned unpaid rental was served on Shelburne and appellant bank.

Shelburne failed to remedy said defaults within the required thirty days after notice thereof, and notice of termination of the Shelburne lease was served by plaintiff on Shelburne and defendant bank on January 17, 1940, upon which date respondent, pursuant to such termination of the sublease, took possession of the premises.

It appears also that Shelburne had defaulted in payment of interest on its bond issue on January 1, 1933, and in its sinking fund requirements under the trust indenture on June 1, 1932. It is indicated by the record that there was outstanding and unpaid in face amount of the bonds some $301,000.

Prior to January 17, 1940, rentals due from Shelburne's subtenants had been collected by Shelburne pursuant to an instrument bearing date of September 16, 1933, whereby appellant designated Shelburne as the former's agent to collect all rents and income from subtenants of Shelburne. This document provided that moneys so collected should be deposited with appellant bank in an account under the name of “Shelburne Realty Co., Agent”. The execution of this instrument by appellant was evidently influenced by the fact that Shelburne had defaulted under its trust indenture, under which appellant was trustee. Under the arrangement just referred to, Shelburne was authorized to draw checks against the agency account to pay necessary charges and expenses in connection with the operation and maintenance of the property and building thereon, provided that the approval of appellant should be required on any check exceeding $200. On November 30, 1939, the date of Shelburne's default under its sublease, the balance in this account was $540.55, and subsequently additional rentals were collected and deposited by Shelburne in the account so that when plaintiff terminated the sublease and took possession of the premises on January 17, 1940, there was in the account a balance of $3,594.32.

When respondent terminated the Shelburne sublease and took possession of the premises on January 17, 1940, there was also due from certain of Shelburne's subtenants unpaid rentals in an aggregate amount of $747.84, which was collected by respondent after termination of the Shelburne sublease and after respondent took possession of the premises. Also on the date when plaintiff took possession there was unpaid the sum of $1,809.58, on account of certain percentage rentals due Shelburne from one of the subtenants for the month of December, 1939, and from the first to the seventeenth of January, 1940. This amount was also collected and received by respondent on July 19, 1940, after termination of the Shelburne sublease and after respondent took possession of the premises. Except for the sum of $50, made up of the balance due from one subtenant as rental for the month of November, 1939, all of the last mentioned amounts represented rentals which accrued and became due after Shelburne's default on November 30, 1939, under its sublease, and the major part thereof accrued after service by respondent on December 15, 1939, of notice of such default.

As we view it, the main question presented may be thus framed. Under the terms of its lease to defendant Shelburne, was respondent entitled to take the rentals paid by subtenants of the lessee prior to the time that the lessor entered upon or had the right to take possession of the real estate from which such rentals accrued? We understand the rule in this state, as declared by our Supreme Court in Kinnison v. Guaranty Liquidating Corp., 18 Cal.2d 256, 261, 115 P.2d 450, to be that where the lease contains a clause which merely pledges the rents to secure the payment thereunder, the lessor acquires only a security interest and has no more rights to the subrents than he has to the property producing them. In such a case the lessor must actually acquire possession of the leased property by consent or other lawful procedure or must secure the appointment of a receiver in order to perfect his claim to the rents. However, the agreement between the parties, either by the terms thereof or by a separate instrument, may provide that in the event of default in the payment of rents under the lease, the income or rental of the leased property is assigned to the lessor. Such a provision operates to transfer to the lessor the rights of the lessee in possession to the rents rather than pledging the rents as additional security. And it is the expressed intention of the parties, as reflected by their contract in that regard, that governs.

In the case at bar appellant contends that the provisions in respondent's lease, relied upon as conferring a lien upon rentals from subtenants of Shelburne, are invalid as to rentals accruing or collected prior to the time that respondent was clothed with the right to possession of the premises on January 17, 1940, while respondent contends that immediately upon default in the payment of rentals by Shelburne under the Childs lease, an equitable lien was created upon all subtenant rentals collected by Shelburne and deposited to the credit of the trustee bank.

Upon the authority of Kinnison v. Guaranty Liquidating Corp., supra, we are persuaded that the creation of such lien depends upon the terms of the Childs lease in that regard. We have heretofore set forth the pertinent portions of that lease. We are impressed that the language in the lease which declared that the rents reserved therein “shall be and they are each and all of them declared to be a first lien and superior to an incumbrance created by lessee, upon the leasehold or estate hereby granted to lessee, upon all buildings and improvements upon said demised premises erected by lessee, and upon all rents, from all of such buildings and improvements situated on said premises during said terms and payable to lessee” indicates an expressed intention of the parties to the Childs lease not merely to pledge the rents as additional security but to transfer to the lessor the lessee Shelburne's rights to the subrentals in the event default occurred in the payment of rents by Shelburne under the Childs lease. To us the language appears to be direct and explicit in conferring upon the lessor Childs Company more than a security interest in the subrentals and gives to it an absolute assignment to subrentals upon the happening of a default.

From what we have just said, it follows that the item of $2,537.42, collected by respondent from various subtenants, was rightfully retained by it pursuant to its lien, and judgment in favor of respondent for such amount was correct.

We can not see how the fact that the rentals accrued prior to default changes the obligations of the parties. When the lessee Shelburne defaulted in the payment of his rents, the lessor Childs was empowered to collect any and all rents then due to Shelburne by reason of the mutual agreement of the lessor Childs and the lessee Shelburne. Had Shelburne collected such rentals after he had defaulted in the payment of his rent to Childs, it would have been his duty, in accordance with the lien created thereon in favor of Childs, to pay such subrentals to the latter. The agreement of September 16, 1933, between the bank and Shelburne through which it was attempted to make the rentals collected by the latter the property of the trustee bank, can not impair or defeat the lien in favor of the lessor so long as the moneys were in the possession of Shelburne or paid by him or the subtenants to respondent. The trust indenture, under which respondent bank was acting as trustee, was made subject to the terms and conditions of the Childs lease and the bank at all times acted with full knowledge thereof.

We come now to a consideration of the item of $3,594.32 which was admittedly rentals collected by defendant Shelburne from the subtenants and paid under an agreement with appellant bank, to the latter, prior to the forfeiture date of January 17, 1940.

While the principles hereinbefore enunciated by us are applicable to such rentals so long as they remained in the possession or under the control of Shelburne, we are here confronted with additional facts which in our opinion militate against the rights of respondent under its lien to recover the last mentioned amount from appellant bank. This because, at the time the bank received from Shelburne the money now in question, Shelburne was in default as to sinking fund requirements and interest payments, under the terms of the trust indenture securing the bond issue, and those defaults were never thereafter cured. Therefore, the bank acting in its capacity of trustee was a creditor of Shelburne and we do not think that either in equity or law, moneys that are paid by the lessee under a lease such as the one before us, which represent rentals from subtenants, and when such moneys are paid to creditors, can be recovered from such creditors. Under the terms of the lease here under consideration, so long as the moneys remained in the possession of the subtenants of lessee Shelburne, the lessor Childs could exercise its lien rights, but to say that such lessor could recover such moneys when paid to bona fide creditors is not consonant with the conscience of equity or principles of law. That portion of the judgment awarding the last mentioned item of $3,594.32 to respondent cannot be sustained.

We now come to a consideration of the item of $266.88 insurance premiums refunded to appellant bank on policies insuring the interest of the bank as indenture trustee. It is not denied that this sum represented premiums paid on insurance policies by appellant bank and were unearned by the insurer as of the forfeiture date January 17, 1940. In its brief respondent does not deny the contention made by appellant that there is no evidence in the record that this amount of $266.88 was originally derived from income received by appellant bank from the building rentals. On this state of the record it can not be held that respondent met the burden of proof cast upon it to prove that the money in question came from sources upon which it had a lien or to which it possessed an assignment. By stipulation this money is held by appellant bank subject to a decision upon the claim of ownership thereof. The trial court held, and we think erroneously, that it was the property of respondent. The judgment must, therefore, be modified to award the sum to appellant bank.

As heretofore noted, the remaining item of $537.31 represents unearned insurance premiums on policies which respondent continued in force after the forfeiture date of January 1, 1940. Appellant bank had paid these premiums on policies of insurance on the property prior to the forfeiture, and by the second cause of action in its cross–complaint appellant bank alleged that respondent Childs Company “promised and agreed to pay cross–complainant a sum equivalent to the unexpired premiums which had theretofore been paid by cross–complainant on account of said insurance policies”. The policies upon which these premiums were paid were taken over and continued in effect by respondent after its declaration of forfeiture. By its findings the trial court determined that the aforesaid allegation relating to the agreement to repay such premiums to appellant bank were true, but nevertheless gave judgment thereon in favor of respondent. That portion of the judgment finds no support in either the evidence or the findings and must be modified to provide that appellant recover this amount of $537.31 from respondent.

From what we have heretofore stated, it necessarily follows that respondent should have judgment entitling it to retain the sum of $2,537.42 collected from defendant Shelburne's various subtenants while appellant bank should have judgment entitling it to retain the sum of $3,594.32 consisting of rentals collected by defendant Shelburne from its subtenants and paid over to appellant bank as a creditor; to also retain the sum of $266.88 representing premiums on certain cancelled insurance policies and which money is now held by appellant bank pursuant to stipulation and dependent upon a decision as to the ownership thereof; and appellant bank should also have judgment against respondent for the sum of $537.31 consisting of unearned insurance premiums on policies of insurance assigned to respondent in exchange for the latter's agreement to reimburse appellant bank for the amount of such unearned premiums. As so modified the judgment appealed from is affirmed, appellant to recover costs on appeal.

WHITE, Justice.

YORK, P. J., and DORAN, J., concurred.