[EDITORS' NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.] *Page 104 [EDITORS' NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.] *Page 108 This case presents afterparts of the problem dealt with inMatter of Chapal (269 N.Y. 464).
In that case testamentary trustees had acquired several parcels of unproductive real property through the foreclosure *Page 111 of mortgages in which they had invested pursuant to authority conferred by the will of their testator. It was assumed by the parties that each parcel would ultimately be liquidated by a sale for all cash, with loss to both principal and income. The question was how in that event the respective interests of life tenant and remaindermen were to be adjusted.
We there approved the ruling of the courts below that the properties so acquired were to be treated by the trustees as separate units, with the result that a deficit of carrying charges pending sale of any parcel was to be advanced out of principal. The Surrogate had decreed that the proceeds of a sale should be allocated between principal and income. The Appellate Division had ordered that the sale proceeds should be returned to the capital account in every instance. In reversing that direction of the Appellate Division we said: "In such an investment situation what is involved is the salvage of a security. The security it is to be remembered is a security not for principal alone but for income as well. On a sale, therefore, the proceeds should be used first to pay the expenses of the sale and the foreclosure costs and next to reimburse the capital account for any advances of capital for carrying charges not theretofore reimbursed out of income from the property. Then the balance is to be apportioned between principal and income in the proportion fixed by the respective amounts thereof represented by the net sale proceeds. In the capital account will be the original mortgage investment. In the income account will be unpaid interest accrued to the date of sale upon the original capital. The ratio established by these respective totals determines the respective interests in the net proceeds of a sale. Since that matter has not been argued before us, we do not fix the rate at which interest is to be computed" (269 N.Y. at pp. 472-473).
(1) The question thus left open must be decided now. The Appellate Division has here affirmed the ruling of the *Page 112 Surrogate that unpaid interest is to be computed at the mortgage rate (six per cent) up to foreclosure and thereafter to the date of final sale "at the rate which generally prevailed for legal investments during this period." Such trust rate was found to have been four per cent. (158 Misc. Rep. 808, 812.)
We prefer to adhere to our ruling in Meldon v. Devlin (167 N.Y. 573; affg., 31 App. Div. 146) that interest should be computed at the mortgage rate for the whole period. It is true, as the Surrogate has said, that the mortgage had no existence after it had been foreclosed. Equally is it true, however, that the foreclosure put an end to "the original mortgage investment." Both capital account and income account, as described in theChapal case, are fictions. Doubtless the completely fair thing to do would be to ascertain the market value of the mortgaged premises by appraisal more or less continuous through the period from initial default to liquidation of the property and to give the life tenant interest at the mortgage rate on the value so ascertained currently. We think the difficulties of such a course would be too many. (Cf. Heiman v. Bishop, 272 N.Y. 83.) If, then, the remaindermen are to participate in the apportionment on the feigned basis of unimpaired principal, the share of the life tenant should be computed on the same assumption. The invention of the "original investment" is no more valid than the invention of "unpaid interest" thereon. Indulgence in both fictions keeps the balance even between the respective parties in interest.
(2) The next question is whether the life tenant should have interest on advances made from principal for foreclosure expenses and for carrying charges. It has been held below that the amount of such interest should be deducted from the gross sale proceeds before apportionment is made.
We think this gives the life tenant too much. The parties, so we have said, are engaged in a joint salvage venture. Carrying charges must be met from principal *Page 113 because there is no income wherewith to pay them. These items (e.g., taxes, water rents, insurance premiums and repair costs) accrue from time to time during the salvage operation. Interest on each item would have to be computed at the currently prevailing rate for legal investments — a fluctuating factor not always readily ascertainable. The parties can hardly be thought to have contemplated such actuarial calculations. In view of all this — and of the fact that the remaindermen here run by far the greater hazard — we think the life tenant must be supposed to have said to them, "You put up all the money for the salvage, and I won't expect any interest on it." In short, as was said inMatter of Chapal: "In the income account will be unpaid interest accrued to the date of sale upon the original capital" (269 N.Y. at p. 473).
(3) In the Chapal case, as we have noticed, a liquidation of the property by a sale for all cash was taken for granted. On one of the sales here involved the trustee received a purchase-money mortgage in part payment. It happens that the cash paid was in excess of the life tenant's share of the net proceeds. Even so, we are in accord with the ruling of the Surrogate who settled this account — "that the ratio must be applied to the cash received and that the new mortgage must likewise be equitably apportioned." (158 Misc. Rep. 808, 814.) We do not see how anything else can fairly be done except in a case in which it is conceded that the purchase-money mortgage meets the statutory test of a valid new investment.
(4) This trustee exchanged one of its defaulted mortgages for bonds of the Home Owners Loan Corporation. Sale of the bonds resulted in a loss to both principal and income. The sale proceeds "were apportioned to principal and income in the ratio which the total principal invested in the mortgage bore to the total interest due thereon." This treatment of that transaction by the trustee has been approved by the courts below. We think the principle of our decision in the Chapal case should not be thus extended. *Page 114
In times of depression a defaulted mortgage is generally as unsalable as is the land on which it is a lien. It is because of that fact that the position of a trustee in the handling of defaulted mortgage investments has had of late its unique features. The result has been that in many cases the trustee had no choice but to take over the property on foreclosure and to carry it pending a sale. This was the case presented in Matterof Chapal — "that of the liquidation of real estate acquired of necessity because of default on a mortgage investment." (269 N.Y. at p. 472.)
The general situation is different when a trust security other than a mortgage investment goes into default. A market then exists in which bids for the defaulted security are currently quoted. No carrying period is inherent in the process of liquidation in that case. Transfer of such a security by a trustee for a consideration paid in cash (or in cash plus securities lawful for trustees) is a sale or exchange of a capital asset. It is not a salvage operation. The sale proceeds go to the capital account and any loss of principal is charged thereto. Should the business soundness or propriety of the transaction be questioned in any aspect, that is a matter for consideration upon the settlement of the trustee's account. We think the same practice should be followed where a trustee transfers a defaulted mortgage for cash or for securities which square with the statutory measure of a valid trust investment.
In this view, there should here have been no apportionment of the proceeds of sale of the bonds of the Home Owners Loan Corporation. Those bonds were lawful for trust investments (Decedent Estate Law [Cons. Laws, ch. 13], § 111; Banking Law [Cons. Laws, ch. 2], § 239, subd. 16; Real Property Law [Cons. Laws, ch. 50], § 278.) The social policy of the Federal law which in this instance adventitiously made possible the substitution of the bonds for the mortgage did not alter the essential business nature of the transaction as an exchange of the one security for the other. *Page 115
(5) The courts below have held that net rents of a property acquired by a trustee through foreclosure cannot be treated as distributable income until the original capital has been fully restored. This means that, although a surplus remains after payment of carrying charges and of advances made out of principal, the life tenant can have nothing until the property is sold. We cannot take that view. "The equities of a life tenant to receive the whole income that may accrue during his tenancy are every whit as great as that of the remaindermen to have thecorpus of the trust preserved unimpaired." (CULLEN, J., inMatter of Rogers, 22 App. Div. 428, 436; 161 N.Y. 108.) On this phase of the problem, we prefer the view of the Surrogate whose decree was before us in Matter of Chapal, that is to say, that the trustee may distribute such surplus income in its discretion. (269 N.Y. at p. 470.) This discretion, moreover, should be exercised with appropriate regard for the fact that unless a life tenant gets cash he does not get anything in the here and now.
The foregoing disposes of the issues presented.
Perhaps it should be added that a general rule for such situations cannot be attained at a bound, that no rule can be final for all cases and that any rule must in the end be shaped by considerations of business policy. Accordingly, we have here put aside inadequate legal analogies in the endeavor to express fair, convenient, practical guides that will be largely automatic in their application. Only the sure result of time will tell how far we have succeeded.
The order of the Appellate Division should be reversed and the decree of the Surrogate modified in accordance with this opinion, and as so modified affirmed, without costs.
CRANE, Ch. J., LEHMAN, O'BRIEN, HUBBS, FINCH and RIPPEY, JJ., concur.
Ordered accordingly. *Page 116