LONG v. SOUTH BAY SAVINGS AND LOAN ASSOCIATION (1992)

OPINION

Plaintiffs Thomas and Carol Long sued defendants Standard Pacific Savings, the successor-in-interest to South Bay Savings and Loan Association, Tim Hedding and others, seeking damages for the lenders' declaration of a default on plaintiffs' $2.65 million construction loan.   After a jury trial, judgment was entered in favor of plaintiffs for $2,341,609 plus costs and attorney's fees.¹  Although defendants raise several issues on appeal, we conclude the judgment must be reversed because the loan transaction from which this case arose was inextricably linked to an illegal kickback.

FACTS

Plaintiffs are husband and wife.   Thomas Long is a licensed general contractor operating under the fictitious business name of Omni Construction.   Before the project involved in this case, he had participated in building apartments, condominiums, single-family houses, motels and a retail store.   However, he was rarely involved in project financing, usually performing only construction work.

In the summer of 1984, plaintiffs became interested in purchasing a vacant lot in Temecula, California, and building an apartment complex on it.   The property had already been rezoned for multi-family housing and had an approved plot plan for the construction of a 66–unit complex.

In September, plaintiffs entered into a tentative purchase agreement with the owner, Temecula Creek Apartments, Ltd.   They also submitted loan proposals to several lenders including South Bay to complete the purchase and build the project.   The loan application filed with South Bay stated plaintiffs would deposit $20,000 into escrow to assist in buying the land and an additional $60,000 to pay for “county approval/plans.”

McAlister, South Bay's vice-president in charge of construction loans, contacted Thomas Long and agreed to meet with him for lunch to discuss the loan proposal.   At the meeting, McAlister said plaintiffs' financial statement was not adequate to borrow the amount of money requested, but that problem could be resolved if they were willing to allow South Bay to participate in the project.   He said South Bay could also give plaintiffs a “take-out” commitment that would allow them to purchase the apartment complex after construction was completed.

McAlister noted plaintiffs' financial statement listed a condominium in Las Vegas and suggested they trade it to him in return for a condominium he owned in Newport Beach.   Long understood McAlister to mean that if plaintiffs agreed to the condominium trade it would enhance their chances of having the loan approved.   He agreed to the exchange.

In December 1984, South Bay's loan committee approved a 12–month, $2,650,000 loan to plaintiffs.   McAlister told them South Bay would fund the loan as soon as it could.   During this period of time, South Bay's financial condition was deteriorating.   It lacked sufficient net worth to make the loan to plaintiffs on its own.   To complete the transaction, South Bay entered into participation agreements with Huntington and Malibu.

In early February 1985, the condominium exchange between plaintiffs and McAlister fell through.   McAlister's unit was completely encumbered and none of the loans was assumable.   He then suggested plaintiffs place a second trust deed on the Temecula property in the name of his nominee.   Plaintiffs did not do so and McAlister never followed up on the proposal.

On February 25, 1985, McAlister telephoned plaintiffs and told them to meet him in South Bay's office at 5 p.m. to sign the loan documents.   When plaintiffs arrived, only McAlister and his secretary were present.   In quick succession plaintiffs signed several documents, including a building loan agreement, loan instructions, promissory note, deed of trust, “take-out” commitment letter and instructions to pay a $26,500 broker's commission to Aegir Properties, Inc.   They were not given an opportunity to read the documents before signing them.

After plaintiffs received the closing statement from South Bay, Thomas Long contacted McAlister about the broker's commission.   McAlister told him South Bay had to make all loans through a broker.   Aegir subsequently paid the commission to McAlister.   Thomas Long admitted he suspected McAlister had pocketed the broker's commission.

The final purchase price for the property was $350,000.   The acquisition proceeds consisted of plaintiffs' $20,000 escrow deposit, the loan's $180,000 land draw and a $150,000 promissory note the sellers agreed to carry back secured by a trust deed subordinated to South Bay's loan.

Under the loan agreement, plaintiffs were required to make monthly interest-only payments from April 1, 1985, to March 1, 1986, at which time the entire unpaid balance would become due.   South Bay held the loan funds earmarked for the construction work.   When work was done on the project, plaintiffs prepared an invoice and sent it to South Bay who would then verify the work was done and issue a check.   South Bay was assured of receiving at least $240,000 upon sale or reconveyance of the property.

Beginning in April plaintiffs ordered plans prepared for building the complex with prefabricated housing units, grading, street improvement, water and sewer systems, storm drainage and the swimming pool.   Plaintiffs obtained a grading permit from the county on June 12.   At McAlister's request, Long prepared a construction schedule for the project and submitted it to South Bay on May 1.  Prior to that time South Bay had not requested a work schedule.   McAlister told Thomas that if problems arose with the project, he could get extensions.

In May, the prefabricated housing manufacturer informed plaintiffs the price per unit would be $5,000 more than previously quoted.   Long contacted McAlister and told him he was changing to a “stick-built” construction method.   McAlister said that would be no problem.   Plaintiffs then had plans drawn to proceed in this manner.   They anticipated completing the project by Christmas 1985 without any significant change in the overall cost of the project.

In June, plaintiffs learned McAlister was no longer with South Bay and Hedding was overseeing the project.   Hedding met with Thomas Long and his financing consultant June 24.   He told them the project was not proceeding as expected, there was a good chance South Bay would place the loan in default and South Bay was no longer honoring their disbursement requests under the loan agreement.   Hedding complained the project was a bad one and should never have been approved.

During the first meeting, Hedding suggested plaintiffs apply for a new loan and present approved building plans and a new cost breakdown for the project.   A second meeting was held with Hedding in July.   Thomas presented Hedding with plans to build the complex by the stick-built method and a new cost breakdown proposal.   However, since the expense for approved plans was between $70,000 and $100,000 and plaintiffs lacked the funds to obtain it, the plans had not been approved.   Hedding took a cursory look at the material and threw it back at Long telling him South Bay was not going to proceed with the loan.

Plaintiffs attempted, without success, to obtain financing elsewhere to complete the project.   In August, South Bay recorded a notice of default on the loan.   Plaintiffs filed for bankruptcy in an unsuccessful attempt to stop foreclosure.   The seller also sued plaintiffs on their subordinated loan and obtained a judgment for $195,000.   Plaintiffs were forced to sell their home, the Las Vegas condominium and other property.

After foreclosing on the property, South Bay and the other participating lenders unsuccessfully attempted to complete the project.   Two years later they sold the property, permits and plans to another developer.   His attempt to complete the project was also unsuccessful.

DISCUSSION

Appellants' main contention on appeal is that the construction loan was illegal because plaintiffs procured it by agreeing to pay McAlister a kickback.   Thus, the trial court erred by not taking the case away from the jury and finding the loan agreement was unenforceable.   Plaintiffs argue the evidence supports the findings there was no kickback and that the loan agreement was enforceable.

“The general principle is well established that a contract founded on an illegal consideration, or which is made for the purpose of furthering any matter or thing prohibited by statute, or to aid or assist any party therein, is void.   This rule applies to every contract which is founded on a transaction malum in se, or which is prohibited by a statute on the ground of public policy.  [Citation.]  [¶] It makes no difference whether the contract has been partially or wholly performed.   Rather, the test is whether the plaintiff requires the aid of the illegal transaction to establish his case.   If the plaintiff cannot open his case without showing that he has broken the law, the court will not assist him, whatever his claim in justice may be upon the defendant.  [Citation.]  [¶]․  Whenever the evidence discloses the relations of the parties to the transaction to be illegal and against public policy, it becomes the duty of the court to refuse to entertain the action.  [Citation.]”  (Homami v. Iranzadi (1989) 211 Cal.App.3d 1104, 1109, 260 Cal.Rptr. 6, internal quotation marks omitted.   See also Civ.Code, §§ 1607, 1608, 1667;  Russell v. Soldinger (1976) 59 Cal.App.3d 633, 641–642, 131 Cal.Rptr. 145.)

 The determination of whether a contract is illegal presents a question of law to be resolved based upon the circumstances of the case.   (Bovard v. American Horse Enterprises, Inc. (1988) 201 Cal.App.3d 832, 838, 247 Cal.Rptr. 340;  Russell v. Soldinger, supra, 59 Cal.App.3d at p. 642, 131 Cal.Rptr. 145.)   However, where a transaction is fair and regular on its face, the burden of proving the contract has an unlawful purpose falls upon the party asserting the illegality.  (Hamilton v. Abadjian (1947) 30 Cal.2d 49, 53, 179 P.2d 804;  Bovard v. American Horse Enterprises, Inc., supra, 201 Cal.App.3d at p. 839, 247 Cal.Rptr. 340.)

Here there is no question concerning the existence of an illegal transaction.   Plaintiffs' agreement with McAlister to trade condominiums in return for McAlister's assistance in obtaining approval of their loan request clearly violated Penal Code section 639.   That statute makes it a felony for a borrower to agree to give an officer of a financial institution anything of value in return for either obtaining or seeking to obtain a loan.²  Thomas Long admitted McAlister suggested the possibility of swapping condominiums during their first meeting in November 1984.   He knew the swap was tied to plaintiffs' efforts to obtain approval of a loan.   Plaintiffs' claim that McAlister offered to swap condominiums only in return for a loan not involving participation by South Bay, misstates the record.   McAlister told Long that South Bay would be willing to make the loan only if it could participate in the profits.

When plaintiffs visited McAlister's condominium in December 1984, they concluded it was worth $20,000 to $30,000 less than their Las Vegas unit.   Even so, the proposed trade proceeded and McAlister opened an escrow on his condominium.   It was not until early February 1985, one and a half months after the loan was approved, that the parties discovered the transaction could not be completed.   Thomas Long also admitted McAlister frequently stated he would have to be taken care of and that plaintiffs were willing to go along with this request.

 Even in the absence of this statute an agent cannot recover compensation from a third party for advising or influencing his principal unless the principal knows about the compensation and consents to it.  (Glenn v. Rice (1917) 174 Cal. 269, 272, 162 P. 1020;  6A Corbin, Contracts (1962), § 1457, pp. 535–538.)   Defendants admittedly had no knowledge of McAlister's kickback agreement with plaintiffs until Thomas Long told Hedding and South Bay's president about it during the June 1985 meeting.

Thus it is clear plaintiffs' agreement to give McAlister a kickback in return for helping them obtain the construction loan was an illegal transaction.   But the loan agreement was not in and of itself unlawful.   The question then presented is whether the kickback rendered the subsequent construction loan invalid and unenforceable.

“It is not the law that every transaction connected with an illegal transaction is itself illegal.   Each case must turn on its own facts.   The purpose of the statute which has been violated must be considered.   In that connection, the court should consider whether a holding that the collateral transaction is illegal will tend to assist or defeat the main purpose of the statute.”  (Robertson v. Hyde (1943) 58 Cal.App.2d 667, 672, 137 P.2d 703.)  “[T]he effect of illegality on the enforceability of an agreement depends on the facts and circumstances of the particular case including the kind and degree of illegality involved, the public policy or policies to be served, whether those public policies will best be served by enforcing the agreement or denying enforcement and the relative culpability and equities of the parties.”  (Homestead Supplies, Inc. v. Executive Life Ins. Co. (1978) 81 Cal.App.3d 978, 989, 147 Cal.Rptr. 22.)   Considering all of the circumstances of this case, we conclude the construction loan was inextricably linked with plaintiffs' agreement to give McAlister a kickback and the payment he ultimately received.³

Plaintiffs' conduct was both serious and willful.   They were aware of McAlister's desire to receive a kickback and participated in his effort to achieve that goal.   On the other hand, South Bay did not learn about the kickback until after the loan was approved and funded.

Plaintiffs assert their loan application was accurate.   But the application represents they had invested $60,000 for “county approval/plans.”   The only approval obtained at that time was the prior owner's receipt of a plot plan allowing the construction of a 66–unit apartment complex.   While the approved plot plan admittedly had value, since the prior owner obtained it, the cost of that asset was included in the property's purchase price.

 The public policy to be enforced in this case supports denying relief to plaintiffs.   No case has yet construed Penal Code section 639.   But it relates to the same subject as and has language similar to 18 United States Code section 215.⁴  Congress enacted section 215 to protect federally insured institutions by preventing its officers from extending unsound and improvident lines of credit and to remove from bank officials the temptation of self enrichment at the expense of the bank and its borrowers.   (United States v. Jumper (5th Cir.1988) 838 F.2d 755, 758;  Ryan v. United States (9th Cir.1960) 278 F.2d 836, 838.)   Because of the similarities between the two statutes, we conclude Penal Code section 639 has the same purpose.

 Here, plaintiffs did not have sufficient equity in the property.   The loan approved by South Bay required plaintiffs to have a 40% to 60% equity interest in the property.   But plaintiffs paid only $20,000 through escrow.   To cover the difference between that sum and the loan's $180,000 land draw, plaintiffs obtained the seller's agreement to take back a $150,000 promissory note secured by a second trust deed.   Lawrence Taggart, an attorney with experience in the real estate loan industry and a former California Savings and Loan Commissioner, testified plaintiffs had only nominal equity in the project.

Two of plaintiffs own witnesses testified they believed the loan should not have been made.   William Kipp, plaintiffs' financial consultant, testified in part as follows:  “Q[:] You say he went to South Bay because he got a deal for cheap there;  is that correct?  [¶] A[:] That's right.  [¶] Q[:] Meaning what?   That he didn't have to put up his own money?  [¶] A[:] South Bay made an offer that they would become his partner and make the loan.   And interestingly enough, the loan itself made by [South Bay] ․ was not to the guidelines of the Federal Home Loan Board Bank [sic ], 11th District, for anything like that type of loan.   It didn't even meet any of the requirements.  [¶] Q[:] For what type of loan are you talking about?  [¶] A[:] For any type of loan.   The general statement for making an apartment loan in those types, in 1985 or 1984, was, they required the borrower to have at least 10 percent cash on cash, which means that he had to have 10 percent of the total cost of the project or more.   And for a bank, if they were going to be an equity partner, had to live up to exactly the same guidelines.   This loan did not meet any guidelines that were put out by the FDIC, the FLIC [sic ], or the Federal Home Loan Board [sic ].  [¶] Q[:] So this loan shouldn't have been made to begin with.  [¶] A[:] That's exactly correct.” ⁵  Kipp also stated the take-out commitment was not sufficient to cover the cost of the project.

Taggart testified it would be unusual for the lender not to have any plans and if he were a lender in that position he would not fund the loan.   Plaintiffs did not begin arranging the production of the initial plans until after receiving loan approval, and the first plans prepared were not completed until April 1985.   Most of the engineering plans were not completed and approved until June.

Plaintiffs note the loan was approved by South Bay's board of directors and contend there is no evidence McAlister did or said anything to influence that decision.   Not so.   McAlister was the institution's officer in charge of making construction loans.   During the loan approval process Thomas Long dealt with South Bay almost exclusively through McAlister.   Long testified McAlister said he would be submitting plaintiffs' application to the loan committee.   The documentary evidence also reflects his department presented plaintiffs' application to the board.

McAlister was responsible for verifying the accuracy of the information contained in plaintiffs' loan application, preparing the loan documents, ensuring plaintiffs provided copies of the construction plans before funding the loan and monitoring the project for South Bay.   The record shows he failed to carry out his responsibilities in this case.   Plaintiffs application was inaccurate, they failed to obtain plans until after the loan was approved and funded, and when plaintiffs informed McAlister they intended to change the method of constructing the project, he displayed a nonchalant attitude.

Finally, plaintiffs contend South Bay's failure to extensively investigate the bribe when informed of it by Thomas Long and its willingness to extend them credit if certain terms were met reflects the bribe was not important.  “A party to an illegal contract cannot ratify it, cannot be estopped from relying on the illegality, and cannot waive his right to urge that defense.  [Citations.]   This rule has been applied in cases where the person asserted to have waived the illegality was not in pari delicto and was one of those for whose protection the statute involved was enacted.  [Citations.]”  (City Lincoln–Mercury Co. v. Lindsey (1959) 52 Cal.2d 267, 274, 339 P.2d 851.)

Here, plaintiffs knew about McAlister's desire to obtain a kickback and willingly assisted him in that endeavor to obtain the construction loan.   While plaintiffs denied knowing McAlister received the broker's commission, they knew McAlister wanted something in return for his efforts on their behalf and Thomas Long admitted he later concluded McAlister pocketed the money.   South Bay was unaware of McAlister's conduct until Long informed Hedding and the lender's president during the June meeting.   Refusal to find a waiver here will also advance the interests Penal Code section 639 is intended to protect.   Thus, we conclude defendants did not waive the illegality associated with the construction loan nor were they estopped from raising it at trial.

DISPOSITION

The judgment is reversed and the matter remanded to the trial court with directions to dismiss the action.   Appellants shall recover their costs on appeal.

FOOTNOTES

1.   Plaintiffs also sued H. Yale McAlister, a former South Bay loan officer, Huntington Savings and Loan Association and Malibu Savings and Loan.   McAlister failed to respond and a default judgment was entered against him.   Before trial, South Bay and Huntington were placed in receivership.   The Federal Deposit Insurance Corporation (FDIC) was appointed receiver for South Bay and the Resolution Trust Corporation (RTC) was appointed receiver for Huntington.   Notices of appeal were filed by South Bay, Standard Pacific, Hedding, Huntington and Malibu.   While the appeal was pending, Malibu was also placed in receivership and the RTC appointed as its receiver.   Malibu's receiver removed the case to federal court pursuant to 12 U.S.C. section 1441a(l )(3).   However, after plaintiffs dismissed the FDIC and RTC, the case was remanded to state court to permit the appeal concerning Standard Pacific and Hedding to proceed.

2.   Penal Code section 639 states:  “Every person who gives, offers, or agrees to give to any director, officer, or employee of a financial institution any emolument, gratuity, or reward, or any money, property, or thing of value for his own personal benefit or of personal advantage, for procuring or endeavoring to procure for any person a loan or extension of credit from such financial institution is guilty of a felony.”

3.   There is authority in other jurisdictions that while the question of whether a particular contract is unlawful generally presents a question of law, it may be treated as a question of fact for a jury if the terms of the contract are in dispute or the determination of whether the agreement violates public policy depends on the surrounding circumstances or the parties' intent.  (See 17A Am.Jur.2d (rev.)   Contracts, § 335, p. 340.)   There is no issue concerning the terms of the agreement in this case.   And as noted above, in California the question of whether a contract is illegal under the circumstances presents a question of law.   (Bovard v. American Horse Enterprises, Inc., supra, 201 Cal.App.3d at p. 838, 247 Cal.Rptr. 340.)

4.   At the time of the transaction involved in this case, 18 United States Code section 215 stated:  “Whoever, being an officer, director, employee, agent, or attorney of any bank, the deposits of which are insured by the Federal Deposit Insurance Corporation, of a Federal intermediate credit bank, or of a National Agricultural Credit Corporation, except as provided by law, stipulates for or receives or consents or agrees to receive any fee, commission, gift, or thing of value, from any person, firm, or corporation, for procuring or endeavoring to procure for such person, firm, or corporation, or for any other person, firm, or corporation, from any such bank or corporation, any loan or extension or renewal of loan or substitution of security, or the purchase or discount or acceptance of any paper, note, draft, check, or bill of exchange by any such bank or corporation, shall be fined not more than $5,000 or imprisoned not more than one year or both.”   The statute was subsequently amended to apply to financial institutions generally, cover offers of bribes to lending officers and to substantially increase the potential penalties.

5.   On redirect examination, Kipp testified another reason the loan should not have been made was South Bay's failure to inform plaintiffs it was in financial trouble and intended to allow other lenders participate in the transaction.

MOORE, Associate Justice.

CROSBY, Acting P.J., and SONENSHINE, J., concur.