City’s payment agreement unenforceable

The court held that the Defendant, the City of Buena Vista, Virginia, had no legally enforceable obligation to make payments pursuant to agreements with Plaintiff UMB Bank.

This case is about soured financing for a municipal golf course in the City of Buena Vista. Through agreements in 2005, the City procured funds to renovate and service debt on the golf course, much like a mortgage: The City and its Recreational Authority received cash from UMB Bank. In return, the City pledged – “subject to appropriations” – to repay the loan. The golf course property served as security to protect the bank from nonpayment. But the City also pledged unusual collateral: City Hall, the police department, and the local courthouse.

Since 2015, the City has not made payments. Rather than seeking foreclosure on the secured properties, however, the Plaintiffs – the bank and its loan insurer, ACA Financial Guaranty Corporation – filed this suit seeking damages under various contract, quasi-contract, and tort theories.

Deed of trust validity

As an initial matter, the court rejects the City’s contention that the deed of trust covering its municipal properties is void under the Virginia Constitution. The City points to article VII, § 9, which states that no rights of a city in or to public places “shall be sold except by an ordinance or resolution passed by a recorded affirmative vote of ¾ of all members elected to the governing body.” But a deed of trust is not a sale; it is merely an encumbrance on real property. As far back as 1902, the Supreme Court of Virginia explained that a mortgage or deed of trust is simply security for a debt. If a deed of trust did effectuate a sale, the grantor would not own the property (encumbered though it may be) to be able to pass it to a subsequent purchaser.

The case law, common sense, and ordinary language all indicate the same result: A deed of trust, like a mortgage, is not a “sale” of real property, but a method of encumbering the property to secure a debt. And that’s precisely what the parties set out to do in this case. Moreover, because a grantor of a deed of trust retains power to sell the property in question, the deed of trust cannot itself be a sale.

In the alternative, the City cites Code § 15.2-1800(B) for the proposition that the Virginia Constitution’s ¾ requirement applies also to the “pledge” of real property under that statute. But again, the constitutional requirement applies only to sales. The property transactions authorized by the statute are far broader than those limited by the constitutional ¾ requirement. Because article VII, § 9 does not require a supermajority vote to approve a “pledge” of public property, the ¾ requirement is not imported into § 15.2-1800(B) for that type of transaction.

Breach of lease

To analyze the Plaintiffs’ contract claims, the court begins with the Lease giving the City possession of the golf course in exchange for rent to the authority, as this document was the lynchpin of the project financing. Notably, the Lease created third-party rights for the bond insurer and the bank.

The central issue that transcends several counts in this matter is whether the City was contractually obligated to make the rent payments. In Dykes v. N. Va. Transp. Dist. Comm’n, 242 Va. 357 (1991), the Supreme Court concluded that a county would not incur a long-term debt proscribed by the constitution. The Supreme Court focused on contractual language in financing and trust agreements stating that the county’s payments were “subject to” and “contingent” upon annual appropriations by the board of supervisors. The court stated bluntly: “‘Subject to appropriation’ financing does not create constitutionally cognizable debt because it does not impose any enforceable duty or liability on the county.” Put another way, when a locality promises to pay subject to its future decision to allocate those payments, it has not made a legally enforceable promise to pay at all.

Here, the Lease plainly makes the City’s rent payments subject to the City’s later decision to make future appropriations. It recognizes that the “City is not empowered to make any binding commitment to make [rent payments] beyond the current fiscal year” (although the City’s “intent” at the time was to make the payments). Moreover, the lease unambiguously provides that, “notwithstanding anything in this Lease Agreement to the contrary,” the City’s payment obligations under the Lease, “including without limitation its obligation to pay all [rents], shall be subject to and dependent upon appropriations being made from time to time by the City Council for such purpose.” The same stipulations apply to the Forbearance Agreement between the bond insurer, the City, and the Authority.

All roads of the Forbearance and Lease Agreements lead to the “subject to appropriations” condition. Ultimately, then, there is no breach of the Lease or Forbearance Agreements for the City’s refusal to appropriate rent payments, because the City was not legally (as opposed to morally) obligated to make those payments in the first place. All of this comports with what these sophisticated parties would have understood at the time, especially against the backdrop of the Virginia Constitution’s prohibition on future financial commitments by municipalities.

Good faith/fair dealing

A good-faith/fair-dealing claim sounds in contract. The court has already explained that, under the plain language of the financing documents, the Defendants had no enforceable contractual duty to appropriate payments. Therefore, this claim must be rejected insofar as it rests on the Defendants’ failure to pay.

The Plaintiffs claim that the City unfairly induced them to defer the exercise of their rights under the Forbearance Agreement, but they do not explain what rights they had under that document. Moreover, the Complaint does not contain facts identifying what conduct the Defendants undertook after the agreement that unfairly forestalled the Plaintiffs’ action.

What’s more, Virginia law placed the onus on the Plaintiffs to themselves confirm that the agreements they signed with the City were within its lawful authority, so they cannot now complain of the City’s assertion that the Deed of Trust is void. Since at least the 19th century, it has been a general and fundamental principle of law that all persons contracting with a municipal corporation must, at their peril, inquire into the power of the corporation or of its officers to make the contract. Those who deal with public officials must take cognizance of those officials’ power and its limits. The Plaintiffs’ theory – that the City breached a duty by asserting that its deed of trust was void under Virginia law – would turn this longstanding policy on its head, shifting onto the municipality (rather than those dealing with it) the risk of wrongly ascertaining the municipality’s authority.

There is no enforceable obligation that requires the Defendants to pay the Plaintiffs. As for the real estate seemingly secured by the deeds of trust, the Plaintiffs have not sought foreclosure, and the Defendants have not contested Plaintiffs’ ability to foreclose upon nonpayment. As the issue of foreclosure is not presented in this case, the speculative prospect of it does not avert dismissal.

Conclusion

These are sophisticated parties: a national bank; an insurance company; municipal entities represented by in-house counsel and a prominent regional law firm. They entered into complicated, yet entirely rational, agreements, with calculated risks and benefits to each side.

Through a bond purchase, a bank loaned several million dollars to a municipality for a golf course, to be repaid through “rent” payments (actually, municipal appropriations) and backed by municipal property as collateral. The bank further protected itself from the danger of municipal nonpayment with bond insurance.

The bond insurer received premiums from the bank, but agreed to be on the hook for servicing the bonds if municipal appropriations ceased.

The municipality got an infusion of cash for its golf course, with an unenforceable “moral” obligation to repay the funds, but one backstopped by the threat of the bank and insurer coming after its property.

The parties’ central arguments in this case would upset the delicate balance created by these interlocking agreements. For the reasons set forth herein, this case will be dismissed.

ACA Fin. Guar. Corp. v. City of Buena Vista, Case No. 6:17cv13, Feb. 8, 2018; WDVA at Lynchburg (Moon). VLW No. 018-3-042, 37 pp.