COURT OF
APPEALS DECISION DATED AND
RELEASED October
9, 1996 |
NOTICE |
A party may file with the Supreme Court a petition to review an
adverse decision by the Court of Appeals.
See § 808.10 and Rule
809.62, Stats. |
This opinion is subject to further editing. If published, the official version will appear in the bound
volume of the Official Reports. |
No. 95-2781
STATE OF WISCONSIN IN
COURT OF APPEALS
DISTRICT II
PEPPERKORN
BROS., INC.,
Plaintiff-Appellant,
v.
NATIONAL
INCOME REALTY TRUST,
Defendant-Respondent,
JOHN
L. HILL and
RICHARD
DAVID MORGAN,
Third Party Defendants.
APPEAL
from a judgment of the circuit court for Manitowoc County: FRED H. HAZLEWOOD, Judge. Affirmed.
Before
Anderson, P.J., Brown and Snyder, JJ.
PER
CURIAM. Pepperkorn Bros., Inc., appeals from a judgment
dismissing its action to recover from the National Income Realty Trust (NIRT)
the unpaid balance of a mortgage made when NIRT purchased Pepperkorn's
commercial property. The note was found
to be unenforceable as contrary to public policy. Pepperkorn argues that we should overrule precedents regarding
the unenforceability of contracts and that the evidence does not support the
court's decision. We affirm the
judgment.
Pepperkorn
operated a carpet and furniture store in Manitowoc. The location was referred to as the Eighth Street property. The building was leased from Pepperkorn's
sole shareholder and controlling principal, John Hill, and his wife for $32,000
a year.
NIRT
owns a shopping center located in the outskirts of Manitowoc known as the
Lakeview Centre. Lakeview Centre was
managed by TARA Group, Inc. In January
1991, Richard David Morgan, TARA's president and minority shareholder,
contacted Hill to see if Pepperkorn was interested in relocating its business
to the Lakeview Centre. Hill was
interested but wanted to sell the Eighth Street property as part of the
transaction.
Ultimately
in July 1991, Hill and his wife sold the Eighth Street property to
Pepperkorn. Pepperkorn sold the Eighth
Street property to NIRT for $1,150,000, a sum in excess of market value. NIRT made a cash payment of $130,000 and a
mortgage was made for the remaining amount due. In a leaseback arrangement, Pepperkorn leased the Eighth Street
property from NIRT for $135,000 a year.
Under a separate agreement, Pepperkorn also leased space at Lakeview
Centre. Due to the high interest rate
utilized in the mortgage, NIRT's monthly payments on the mortgage note fully
offset Peppercorn's monthly rent on the Eighth Street property and monthly
common area and maintenance payments due under the Lakeview Centre lease. As a result, Pepperkorn did not actually pay
rent under the Eighth Street property lease.
Pepperkorn
moved its store to the Lakeview Centre.
The leased space at the Eighth Street property was used solely for an
oil change operation and some storage.
TARA was retained by Pepperkorn to serve as the management agent of the
Eighth Street property.
It
is undisputed that during negotiations between Hill and Morgan, both knew that
the city of Manitowoc would be condemning the Eighth Street property in order
to complete a bridge project.
Appraisers hired by the city determined that the leaseback arrangement
was not reflective of market rental values and would not support use of the
income valuation approach of the Eighth Street property. The property was taken by condemnation on
July 1, 1993 and the condemnation award was only $175,000.
The
mortgage note required NIRT to pay the outstanding balance if any portion of
the property was taken by governmental condemnation. When NIRT failed to pay off the over $1 million balance,
Pepperkorn withheld money due under the Lakeview Centre lease. NIRT counterclaimed in this action for a
declaration that the note was unenforceable because it was part of an illegal
scheme to defraud the city of Manitowoc on the value of the Eighth Street
property.
The
matter was tried to the court. The
trial court found that Hill and Morgan knew that the sale of the Eighth Street
property involved misrepresentations about the value of the property in an
attempt to exact greater compensation in the condemnation proceeding. It also found that there was no legitimate
business purpose for the leaseback arrangement and that it was merely to create
an appearance of a healthy rental stream to support a valuation in excess of
the property's fair market value. It
found that Hill knew that the structure of the transaction would be used by
Morgan to establish that the purchase price approximated fair market value in
order to obtain NIRT's approval of the transaction. The trial court concluded that the mortgage note was
unenforceable. Because it found NIRT to
be "culpably negligent" in protecting its own interest in the
transaction, Pepperkorn was not required to repay rent and maintenance charges
owed under the Lakeview Centre lease.
"An
agreement which `contemplates or necessarily involves the defrauding or
victimizing of third persons as its ultimate result' is void as against public
policy." Shea v. Grafe,
88 Wis.2d 538, 544, 274 N.W.2d 670, 673 (1979) (quoted source omitted). "A promise may be unenforceable if it
involves conduct offensive to public policy, even though the promise does not
actually induce the conduct." Blossom
Farm v. Kasson Cheese, 133 Wis.2d 386, 395, 395 N.W.2d 619, 623 (Ct.
App. 1986). See also Associate
Wis. Contractors v. Lathers, 235 Wis. 14, 17, 291 N.W. 770, 771 (1940)
("[I]f the mere tendency or purpose of a contract works against public
policy, it is illegal, even though no actual damage be shown.").
Pepperkorn
argues that the holdings of Blossom and Lathers
should be overruled so that a contract may not be void for public policy
reasons unless the contract itself is illegal on its face or, while facially
valid, the contract itself has an illegal or improper purpose or by necessary
implication calls for the performance of an illegal act. Pepperkorn claims that only by tempering the
"draconian rule" set out in Blossom and Lathers
is the freedom of contract between parties preserved. We decline the invitation to overrule or modify those
holdings. We are bound by the decisions
of the supreme court and the published decisions of our court. State v. Clark, 179 Wis.2d
484, 493, 507 N.W.2d 172, 175 (Ct. App. 1993); Ranft v. Lyons,
163 Wis.2d 282, 299-300 n.7, 471 N.W.2d 254, 261 (Ct. App. 1991). They represent good law. A contract with an illegal purpose is not
rendered enforceable simply because the illegality was not successful.
Likewise,
we reject Pepperkorn's argument that Lathers should be limited to
contracts whose terms have not been fully disclosed to the third parties upon
whom the potential fraud could have been perpetrated. Pepperkorn suggests that by fully disclosing the structure of the
transaction to the city of Manitowoc, no fraudulent use was made of its
contract with NIRT and the contract was "revitalized" to
enforceability. The argument Pepperkorn
makes is nothing more than a challenge to the sufficiency of the evidence to
support a finding that there was an intent to deceive the city as to the income
stream of the Eighth Street property.
There is no basis to limit Lathers as Pepperkorn
suggests.
Peppercorn
claims that the trial court erred in concluding that the facts here were
similar to Shea and Blossom. Peppercorn's attempt to distinguish those
two cases fails.
In
Shea, inflated figures were used to induce a loan. "Insofar as the inflated contract
figures were designed to induce the lending institution to finance the
transaction, the contract contemplated misleading the institution and therefore
is tainted with illegality." Shea,
88 Wis.2d at 544, 274 N.W.2d at 673.
Here, an inflated purchase price and a sham leaseback arrangement to
support that price were used to induce NIRT's approval of the transaction and
to attempt to deceive the city. The
contract is tainted.
In
Blossom, a supplier chose to overlook its customer's illegal use
of its product and continued to supply volume shipments. The court concluded that the contract was
unenforceable because the supplier engaged in a course of dealing which
facilitated the customer's improper conduct and the contract anticipated such
improper conduct to the benefit of the supplier as well. Blossom, 133 Wis.2d at 395-96,
395 N.W.2d at 623. Here, Pepperkorn had
knowledge that the structuring of the transaction was for the improper purpose
of creating an above market income stream to support an excessive property
value. Like the supplier in Blossom,
Pepperkorn facilitated that end and benefitted from it. The trial court correctly relied on Shea
and Blossom.
The
remaining issues are whether the evidence supports the trial court's finding
that Hill and Morgan had the intent to induce a higher condemnation award and
mislead NIRT about the value of the property and that Hill and Morgan were in
pari delicto. The trial court's
findings will not be set aside unless clearly erroneous. Blossom, 133 Wis.2d at 391,
395 N.W.2d at 622. For purposes of
appellate review, the evidence supporting the court's findings need not
constitute the great weight and clear preponderance of the evidence; reversal
is not required if there is evidence to support a contrary finding. Bank of Sun Prairie v. Opstein,
86 Wis.2d 669, 676, 273 N.W.2d 279, 282 (1979). Rather, the evidence in support of a contrary finding must itself
constitute the great weight and clear preponderance of the evidence. Id. In addition, the trial court is the ultimate arbiter of the
witnesses' credibility when it acts as the fact finder and there is conflicting
testimony. Id. We accept the inference drawn by the trier
of fact when more than one reasonable inference can be drawn from the
evidence. Id.
Pepperkorn
argues that the trial court ignored the "reliable and credible"
testimony of its expert witness on real estate transactions, Samuel
Freshman. Freshman testified as to
possible reasons why the transaction was structured as it was. He suggested that for tax reasons Pepperkorn
may have wanted to recharacterize an incentive it was receiving for leasing at
Lakeview Centre and obtain storage space at the Eighth Street property. He also indicated that NIRT may have sought
to capitalize the lease incentive in a manner which would not adversely affect
the valuation of Lakeview Centre or its cash flow, that it may have sought to
avoid other Lakeview Centre tenants from thinking that Pepperkorn received a
substantial incentive, and that it may have sought to keep insurance premiums
down by having the Eighth Street property under lease. He indicated that it was not unusual for a
shopping center to pay a premium price for a prospective tenant's
property. Pepperkorn contends that if
the trial court had given any weight to Freshman's testimony, NIRT could not
meet its burden of proof.
Freshman's
testimony did not preclude the trial court from determining that while other
reasons may exist for structuring the transaction as was done here, those
reasons did not come into play. On
cross-examination, Freshman admitted that he had never viewed the properties at
issue, that he had not examined the tax returns, and that the $135,000 yearly
rental for the Eighth Street property was an excessive storage charge. NIRT presented contrary expert testimony
that no reasonable landlord under the circumstances then existing in the
Manitowoc area would have paid a lease premium anywhere approaching the amount
Freshman contended that NIRT gave as an incentive to Pepperkorn. He gave three reasons why the alleged
incentive payment was unreasonable.
The
trial court made a credibility determination between the two experts. We reject any notion Pepperkorn has that the
trial court was required to explicitly reject the credibility of its expert
witness. See Marshall v.
Lonberger, 459 U.S. 422, 433 (1983) (where it is clear that the trial
court would have granted the relief sought by the defendant if it believed the
defendant's testimony, its failure to grant the relief is tantamount to a
finding against the defendant's credibility).
We must accept the trial court's credibility determination. The evidence was sufficient to find that
there was no legitimate business reason to structure the transaction as the
parties did here and that Hill and Morgan had the intent to create a false
income stream to support a higher property value.
Pepperkorn
argues at length that NIRT's attorney and Morgan drafted all of the contract
documents, and therefore, Hill did not participate with Morgan to structure the
transaction. It asserts that Morgan's
conduct should not be imputed to Hill or Pepperkorn.
We
conclude that there was ample evidence to support an inference that Hill knew
what Morgan intended through the structuring of the transaction. Hill knew that the most he could expect out
of the condemnation proceeding was between $400,000 and $700,000. He received a continuing interest in the
condemnation proceeds in the event that they exceeded the principal due on the
mortgage. Hill acknowledged that he
knew in April 1991 that Morgan was attempting to structure the transaction for
use in establishing the fair market value in the later condemnation
proceeding. He also knew that Morgan
could not complete the transaction unless an appraisal was obtained for the
Eighth Street property substantially equivalent to the purchase price. The leaseback arrangement arose when Morgan
had difficulty obtaining a high enough appraisal. Morgan told Hill that the leaseback was necessary to justify NIRT's
investment and possible recovery of the investment in the condemnation proceeding. Hill was aware that the $135,000 annual rent
far exceeded that ever obtained on the Eighth Street property. Previously, Pepperkorn had only paid $32,000
annually to lease the property. We
sustain the trial court's finding that Hill and Morgan acted together to
structure the contracts which were declared unenforceable.
Finally,
Pepperkorn argues that because of NIRT's "culpable negligence,"
voiding the mortgage note is an inequitable result. It reasserts its claim that because the city was never defrauded,
the contract should not be voided.
Under controlling precedents it is not necessary that the wrongful
purpose of the contract have been successfully completed.
Pepperkorn
asserts that it should not suffer simply because NIRT mistakenly analyzed the
value of the transaction or persons within NIRT exceeded their authority in
signing contracts. Pepperkorn
conveniently ignores Hill's knowledge of the purpose of structuring the
transaction to create the false income stream and to hopefully exact a
condemnation award in excess of that which Hill knew the property could
command. Had the condemnation award
been higher than the inflated purchase price, Pepperkorn would have received
additional monies. Hill and Pepperkorn
were not innocent bystanders to what Pepperkorn portrays as the secret mission
of Morgan.
The
trial court's finding that NIRT was "culpably negligent" was based on
NIRT's failure to have adequate monitoring systems within its organization with
regard to execution of the transaction.
It does not suggest "unclean hands" by NIRT in structuring the
agreement for the purpose of deceiving the city. The finding was made in balancing the equities in devising a
remedy between the parties once the contract was declared unenforceable. We cannot conclude that the trial court
erroneously exercised its discretion in fashioning a remedy which declared the
mortgage note unenforceable and prevented NIRT from recovering past rent or
avoiding the Lakeview Centre lease.
By
the Court.—Judgment affirmed.
This
opinion will not be published. See
Rule 809.23(1)(b)5, Stats.