Markham v. Fay

[670] MEMORANDUM RE: AMENDED JUDGMENT TO BE ENTERED IN ACCORDANCE WITH THE MANDATE OF THE COURT OF APPEALS FOR THE FIRST CIRCUIT COLLINGS, United States Magistrate Judge. INTRODUCTION The historical facts shall be recited in summary fashion for contextual purposes.1 This is an interpleader action commenced by the trustee in bankruptcy of the debtor, Louis Almeida; at issue, a determination of the rights of various claimants to an interpled fund of approximately $70,000 representing mortgage payments due from Almeida to the defendants Highland Avenue Nursing Home Trust, Parker Hill Nursing Home Trust, Green Pastures Nursing Home Trust and Regina Nursing Home, Inc. The debtor, Almeida, had purchased a number of nursing homes from these defendants, as well as other entities controlled by defendant Claire M. Fay (hereinafter “Fay”), executing notes and mortgages as payment of the purchase prices. These mortgages constituted the only assets of the trusts. The defendant, the United States of America (hereinafter “United States”), asserted an interest in the interpled fund by virtue of federal tax liens against Fay resulting from tax assessments made against her under 26 U.S.C. § 6672. The premise of the government’s claim was that Fay retained such power and control over the trusts that her tax liabilities could be satisfied out of her interest in the assets of the trusts. Following a non-jury trial, the Court issued findings of fact, which were undisputed on appeal, and conclusions of law thereon in accordance with Rule 52(a), Fed.R.Civ.P. Inter alia, it was noted that Fay was the settlor, trustee and a beneficiary of each of the defendant trusts. With respect to the Parker Hill Nursing Home Trust and the Green Pastures Nursing Home Trust, both of which were created by identical declarations of trust, it was decided that Fay reserved such pervasive powers to herself under the trust documents that the trust assets were considered to be her own as a matter of law. The same conclusion was reached vis-a-vis the Highland Avenue Nursing Home Trust even though the declaration of trust incorporated different, but similar, provisions. It followed from these determinations that the United States, as a creditor of Fay, could properly reach the assets of the trusts, essentially the interpled fund, to satisfy Fay’s tax liability. In her capacity as trustee of the three nursing home trusts, Fay appealed. The First Circuit affirmed with regard to the Parker Hill Nursing Home Trust and the Green Pastures Nursing Home Trust, but reversed and remanded on the Highland Avenue Nursing Home Trust. At the outset, the Court noted that when the taxes were assessed against Fay, by statute “a federal tax lien arose ‘upon all property and rights to property, whether real or personal, belonging to’ Fay. 26 U.S.C. §§ 6321, 6322.” Markham v. Fay, 74 F.3d 1347, 1355 (1 Cir., 1996). The Court went on to find there was error in concluding that the terms of the Highland Avenue Nursing Home Trust endowed Fay with such powers, rights and interests as to give her the ability to treat the principal and income of the trust entirely as her own. Id. at 1360. However, it was decided that “[t]he (tax) lien does, however, attach to whatever aspect of Fay’s beneficial interest in the Highland Avenue Nursing Home Trust that constitutes present ‘property or rights to property’ under Massachusetts law.” Id. at 1363 (footnote omitted). More precisely, Because ‘a settlor cannot place property in trust for his own benefit and keep it beyond the reach of his creditors,’ Fay’s ‘creditors can reach the maximum amount which the trustee under the terms of the trust could pay to [her] or apply for [her] benefit.’ [671] Markham, 74 F.3d at 1364 (citations omitted). Having arrived at this conclusion, the Court remanded “to fashion an order enforcing the tax lien on Fay’s present right to receive annual distributions from net earnings in proportion to her share.” Markham, 74 F.3d at 1365. According to the First Circuit, of the inter-pled fund “[t]he Highland Avenue Nursing Home Trust is entitled to $16,046.63 (the proceeds of the sale of the Highland Avenue Nursing Home), plus the accumulated interest, less any amount determined to be presently payable to the IRS.” Id. at 1366. On remand, the directive was to “fashion an order enforcing the tax lien on Fay’s right to annual payments from the net earnings of the Highland Avenue Nursing Home Trust.” Id. After mandate issued, on April 9, 1996, counsel were directed in a Procedural Order (# 155) to attempt in good faith to agree on a form of order. Apparently unable to do so, the United States and Fay have filed memo-randa in support of their respective positions (## 157, 158) on the final outstanding question in this litigation. DISCUSSION The terms of the Highland Avenue Nursing Home Trust provide that “[t]he Beneficiaries of this trust shall be the said Claire M. Fay; her sister, Theresa Dzialo; and her sons, James Daniel Fay and Timothy James Fay, in equal shares.” Record Appendix at p. 57. The United States argues that it is entitled to 25% of the $16,046.63 plus 25% of the interest that has accrued on this amount during the time that the fund has been interpled. Fay repudiates the government’s position, contending that the United States is only entitled to Fay’s right to the interest accrued on the trust corpus, i.e., 25% of the interest earned on the $16,046.63, and no more. Thus, the divisive issue is whether the United States should be paid $4,011.66 over and above the 25% of the accumulated interest upon which the parties agree. In support of its contention, the United States focuses upon the terms of the mortgages in question. Almeida, the buyer, and Fay, the seller, entered into an amended agreement with respect to the Highland Avenue Nursing Home in September of 1976. Pursuant to that agreement, Fay sold the nursing home, real estate and personal property, to Almeida for $220,000; payment was to be made in the following manner: (1) The sum of Ten Thousand and no/100 ($10,000.00) Dollars shall be paid in cash forthwith; (2) A promissory note and a mortgage in the amount of Ninety-seven Thousand Three Hundred Forty-nine and 19/100 ($97,349.19) Dollars shall be payable in or within Ten (10) years but the Monthly payment shall be payable on a twenty year payout schedule; (3) A security agreement (chattel mortgage) in the amount of Twenty-five Thousand and no/ 100 ($25,000.00) Dollars to secure a promissory note in the same amount of Twenty-five Thousand and no/100 ($25,000.00) Dollars shall be entered into for the personal property and shall be payable in or within ten (10) years but the monthly payment shall be payable on a twenty year schedule; and (4) and encumbrances in the total amount of Eighty-seven Thousand Six Hundred Fifty and 81/100 ($87,650.81) Dollars that are due and payable on the two existing mortgages of record and set out as follows: a first mortgage to the Fairhaven Institution for Savings with an outstanding balance of Sixty-six Thousand Eight Hundred Sixty-three and 86/100 ($66,863.86) Dollars, and a second mortgage to Louis Dronge and Nicholas H. Thisse, Trustees of Hemlock Trust, with an outstanding balance of Twenty Thousand Seven Hundred Eighty-six and 95/100 ($20,786.95) Dollars; (5) The Buyer is to make payments to the two existing mortgage holders through the third mortgage holder or the seller and interest at the rate of eleven (11%) percent shall be due and payable on the total unpaid balance to the third mortgagee or seller, as spelled out in the terms of the original agreement. That is, it is the agreed upon intention of the parties that the buyer shall pay to the seller interest at eleven (11%) percent on the outstanding mortgage and shall pay the difference from the existing mortgage rate to the first two mortgagees to the third mortgag [672] ee for a service charge of that amount of interest to bring it to eleven (11%) percent of the unpaid balances so that eleven (11%) percent shall be due and payable on the outstanding unpaid balance of each mortgage payable through or to the seller. Additionally, if there is an existing mortgage encumbering the property where the interest is more than eleven (11%) percent, the seller or the third mortgagee shall still receive from the buyer the eleven (11%) percent. Amended Agreement, Trial Exh. 3D. Almeida defaulted on these obligations2, and, in 1978, filed for bankruptcy. The $16,046.68 at issue, part of the proceeds of the bankruptcy trustee’s sale of assets, represents essentially the sole “payment” made by Al-meida under the terms of the amended agreement.3 The United States argues that under Massachusetts law the $16,046.63 payment on the mortgages held by the Highland Avenue Nursing Home Trust represents a payment of interest, not principal. As interest, such a payment would be income or earnings to the trust. Pursuant to the provisions of the trust instrument, the trustee, Fay may from time to time, but not less frequently than once a year, make disposition to the beneficiaries out of the net earnings of the trust estate of such sum and sums in cash as she shall see fit in the proportion to the shares owned by the beneficiaries. Record Appendix at p. 64. Being one of four named beneficiaries in equal shares, Fay had a 25% proportional interest in the net earnings of the trust. As trustee, Fay was empowered to distribute to herself as beneficiary, and to the other three beneficiaries in proportionate share, any or all of the net earnings of the trust at least on an annual basis. Under Massachusetts law, interest payments on a mortgage note are considered income to a trust. Hayward v. Blake, 247 Mass. 430, 432-33, 142 N.E. 52, 53 (1924). Moreover, It has long been the rule in this Commonwealth that, absent any express agreement to the contrary, partial payments on an interest bearing debt are applied first to the interest due, with any excess payment to be applied to reduce the principal debt. Indeed, in Blanchard v. Cooke, 144 Mass. 207, 222, 11 N.E. 83 (1887), this method of applying partial payments is called “the Massachusetts rule”. Plasko v. Orser, 373 Mass. 40, 42-43, 364 N.E.2d 1220, 1222-23 (1977) (citations omitted). Neither of the notes at issue incorporate any “express agreement” to depart from the “Massachusetts rule”. The opposite is true: the notes provide for the payment of “interest at the rate of eleven (11%) per centum per annum, during said term, and for such further time as said principal sum, or any part thereof, shall remain unpaid.” Amended Agreement, Trial Exh. 3 (emphasis added). The plain implication of this language is that payments would first be applied to unpaid interest; to apply such payments first to principal would undercut the further accrual of interest. Under the “Massachusetts rule”, the entire $16,046.63 would be viewed as interest on the mortgage notes, and, consequently, income to the Highland Avenue Nursing Home Trust. Fay does not dispute the government’s statement that this fund would represent unpaid interest for about the first year of the mortgage. Given that the property was sold by Fay and the mortgage and notes taken back in September, 19764, and Almeida did not file for bankruptcy until 1978, at the time that the debt was frozen by the bankruptcy [673] proceedings, well over one year of interest payments were due and owing to the trust, The sum of the interest due and owing at the time of the bankruptcy filing exceeds the amount of interpled fund, i.e., $16,046.63. Thus, Fay’s argument that the filing of bankruptcy halted the accrual of interest is immaterial, as is the government’s contention that the two mortgage notes would have accrued over $800,000 in interest to date. Fay also contends that the government’s position with respect to the characterization of the impleaded fund as interest, and thus income to the trust, is incorrect under federal tax law. Fay’s argument quite simply is inapplicable to the issue at hand; the matter is governed by state law. Markham, 74 F.3d at 1355-56. Finally, although the United States argues at some length that the recent amendment to the Highland Avenue Nursing Home Trust whereby Fay was removed as a beneficiary does not vitiate its right to the fund, Fay herself advances no such argument. Moreover, neither party argues that the removal of Fay as a beneficiary of the trust in any way implicates the government’s right to 25% of the interest earned on the fund. Indeed, it is the defendant’s position that the Court should “award[ ] the government Fay’s right to the interest accrued on the Trust corpus, which is twenty five percent (25%) of the interest earned on the Highland Avenue Nursing Home’s bankruptcy award of $16,-046.63.” Defendant’s Opposition, # 159 at p. 2-3. CONCLUSION Under Massachusetts law, the fund of $16,-046.63 is considered to be a partial payment on the outstanding interest bearing debt. As such, it would be applied to the interest due and owing under the notes, rather than to principal. As interest, the monies would constitute income to the trust. Thus, the United States is entitled to recover 25% of the fund itself, as well as the 25% of the interest that has accrued on the fund since it was inter-pled upon which the parties agree, that amount representing “Fay’s present right to receive annual distributions from net earnings in proportion to her share.” An Amended Judgment reflecting these conclusions shall enter this date. Footnotes [1] This narrative is gleaned largely from the government's statement of the case in its post-appeal brief with which Fay concurs. See, United States’ Post-Appeal Brief # 157 at pp. 1-5, Defendant's Opposition to United State's (sic) Post-Appeal Brief # 159 at p. 1. For a complete and detailed rendition of the facts of this case, see Markham v. Fay, 884 F.Supp. 594, 596-602 (D.Mass., 1995), aff'd in part, rev. in part and remanded, 74 F.3d 1347 (1 Cir., 1996). [2] From all that appears, Almeida made few, if any, payments on these notes and mortgages. [3] According to the United States, as of February 20, 1996, the total outstanding balance on the subject mortgages would amount to approximately $946,087, consisting of $122,349.19 of principal and $823,737 in unpaid interest. The February 20th date is significant because on that date the Highland Avenue Nursing Home Trust was amended to remove Fay as a beneficiary. [4] For the sake of clarity, it is noted the nursing home was conveyed in June, 1976. However, reference throughout has been made to the Amended Agreement dated September 8, 1976, pursuant to which the relevant mortgages and notes were given.