             IN THE COURT OF APPEALS OF TENNESSEE
                         AT NASHVILLE

                                                    FILED
METRIC PARTNERS GROWTH                   )          September 24, 1998
SUITE INVESTORS, L.P.,                   )
                                         )          Cecil W. Crowson
       Plaintiff/Appellee,               )         Appellate Court Clerk
                                         )
VS.                                      )
                                         )
NASHVILLE LODGING COMPANY;               )   Appeal No.
2300 ELM HILL PIKE, INC.,                )   01-A-01-9712-CH-00723
                                         )
       Defendant/Appellant,              )   Davidson Chancery
                                         )   No. 96-1405-III
and                                      )
                                         )
ORLANDO RESIDENCE, LTD.; and             )
LA SALLE NATIONAL BANK as                )
trustee under that certain pooling       )
and servicing agreement dated            )
July 11, 1995, for the holders of the    )
WHP Commercial Mortgage Pass             )
Through Certificates, Series 1995C1,     )
and ROBERT M. HOLLAND, JR.,              )
Trustee,                                 )
                                         )
       Defendants/Appellants.            )


      APPEALED FROM THE CHANCERY COURT OF DAVIDSON COUNTY
                     AT NASHVILLE, TENNESSEE

            THE HONORABLE ROBERT S. BRANDT, CHANCELLOR




ALAN T. FISTER
STEWART, ESTES & DONNELL
424 Church Street
Nashville, Tennessee 37219-2392

MIKE BUCKLEY
CROSBY, HEAFEY, ROACH & MAY
1999 Harrison Street
Oakland, California 94604-2084
      Attorneys for Plaintiff/Appellee

SAMUEL L. FELKER
JOSEPH F. WELBORN, III
BASS, BERRY & SIMS
2700 First American Center
Nashville, Tennessee 37238-2700
      Attorneys for Defendant/Appellant

EUGENE N. BULSO, JR.
BOULT, CUMMINGS, CONNERS & BERRY
414 Union Street
Nashville, Tennessee 37219-8062
      Attorney for Defendant/Appellee Orlando Residence, Ltd.

KENNETH M. BRYANT
TRABUE, STURDIVANT & DEWITT
522 Union Street
Nashville, Tennessee 37219-1738

HUNTER T. CARTER
ARENT, FOX, KINTNER, PLOTKIN & KAHN
1050 Connecticut Avenue, N.W.
Washington, D.C. 20036-5339
      Attorneys for Defendants/Appellees LaSalle National Bank
      and Robert M. Holland




                         AFFIRMED AND REMANDED




                                             BEN H. CANTRELL, JUDGE


CONCUR:
TODD, P.J., M.S.
CAIN, J.




                                     -2-
                                  OPINION


               The owner of a hotel subject to a first mortgage sold the building and its

contents to the plaintiff and took a second mortgage to secure the purchase price.

The plaintiff also operated the hotel under a ground lease with the owner. When the

owner failed to pay the first mortgage, the plaintiff sought a declaratory judgment that

the owner was in default, that the plaintiff could pay the first mortgage directly to the

mortgagee, and that the plaintiff was discharged from its obligation to the owner. The

owner resisted the declaration on the ground that it had certain defenses against the

first mortgagee. The Chancery Court of Davidson County granted summary judgment

to the plaintiff. We affirm.



                                            I.



               In 1983 National Lodging Company (NLC) borrowed the money to

finance the construction of a Marriott Hotel in Nashville. NLC signed a note and deed

of trust giving the lender a first mortgage on the property. The original lender went

into receivership and the note became the property of the Resolution Trust

Corporation.      The note passed through two other hands before it was finally

transferred to LaSalle National Bank, and it is referred to throughout the record as “the

LaSalle note.”



               In 1989 NLC sold the hotel improvements to the plaintiff, Metric Partners

Growth Suite Investors, L.P., and entered into a long term ground lease with Metric.

Metric executed a note to NLC secured by a deed of trust on the hotel improvements.

Thus, Metric made monthly payments to NLC and NLC made the payments on the

first mortgage.




                                          -3-
              As a part of the 1989 transaction, Metric, NLC, and the original lender

entered into a three party agreement. The agreement provided that in the event NLC

defaulted on the payments on the first mortgage (1) the lender would notify Metric of

the default and Metric could cure the default within ten days after receiving the notice,

and (2) Metric could then assume NLC’s obligations under the first mortgage and be

discharged from any further obligations to NLC on the second mortgage.



              In January of 1996 (for reasons we will discuss in a later part of this

opinion) NLC failed to make its payment to LaSalle, and filed a bankruptcy petition in

the United State Bankruptcy Court for the Eastern District of Wisconsin. On April 5,

1996 LaSalle notified Metric of the default. On April 15, 1996 Metric cured the default

by making the required payment directly to LaSalle. At the same time Metric notified

NLC that Metric was exercising its rights to pay LaSalle directly under the three party

agreement, and that NLC should void the second mortgage. When NLC refused to

honor that arrangement and threatened to foreclose on the second mortgage, Metric

filed this action seeking declaratory and injunctive relief. NLC’s defense rested on the

following assertions: (1) that it had a defense against LaSalle’s collection of the note;

(2) that it had a bad faith and unclean hands defense against Metric; (3) that it was

not in default on the LaSalle note; and (4) that the three party agreement did not

afford Metric relief from the second mortgage.



                                           II.

                             The Recoupment Defense



              NLC asserts that it was not in default on the LaSalle note because it had

a $1,700.00 judgment against the Resolution Trust corporation (RTC), one of the

holders in LaSalle’s chain of title. The obligation arose when the RTC became the

receiver for the original lender and repudiated a refinancing agreement NLC had with

the original lender. NLC recovered the judgment against RTC as compensation for



                                          -4-
the breach. Since LaSalle’s status as a holder in due course is disputed, we will

assume that this defense, if it exists, may be asserted against LaSalle.



              The recoupment question was litigated in the case that established

NLC’s claim against the RTC. NLC asked for a declaration that it had a right to set-off

or recoupment against the purchaser of the note from the RTC. The D.C. Circuit held

that the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA)

allowed the RTC to sell the assets of a failed thrift free and clear of any

encumbrances arising from a borrower’s counterclaims; and that the purchaser of the

NLC note did not assume the claim against the RTC. Therefore, NLC could “recover

these amounts only from the RTC in its primary claim for damages.” Nashville

Lodging Co. v. Resolution Trust Corp., 59 F.3d 236 at 247 (D.C. Cir. 1995).



              We recognize, however, that NLC’s position in this case rests on a

distinction between a defense to the note and a claim against the assignee of the

note. The D.C. Circuit acknowledged that such a distinction might be made, but the

court refused to address it because NLC had not raised it in that case. See 59 F.3d

at 247. Thus the precise question raised here was not decided by the court in the

litigation between NLC and RTC.



              Other courts have allowed a recoupment defense to a note when an

assignee has sued to collect the note. See FLSIC v. Mackie, 962 F.2d 1144 (5th Cir.

1992); DiVall Insured Income v. Boatmen’s First Nat’l Bank, 69 F.3d 1398 (8th Cir.

1995). A recoupment defense, however, even against a non holder in due course,

must arise out of the same transaction that gave rise to the instrument. See Tenn.

Code Ann. § 47-3-305(a)(3); Howard v. Abernathy, 751 S.W.2d 432 (Tenn. App.

1988). NLC concedes that the claim against the RTC arose out of the refinancing

agreement, a contract separate from the note. Therefore, we are satisfied that the

recoupment defense was not available to NLC, regardless of whether RTC had the

power to strip defenses from the assets it sells.

                                         -5-
                                           III.

                             NLC’S Default and Notice



              We have dealt with NLC’s argument that it was not in default because

of the recoupment defense. Without that defense, NLC must concede that it was in

default for not making the January and February payments in 1996. It also must

concede that LaSalle gave notice of the default by letter on April 5, 1996. Therefore,

the two conditions precedent to Metric’s action in curing the default are met. The

“other” defaults alluded to by the chancellor, of which NLC alleges it had no notice, are

now beside the point.



                                           IV.

                            The Three Party Agreement



              NLC makes a similar argument with respect to Metric’s rights under the

three party agreement, i.e., that because NLC was not in default, Metric could not

assume the NLC note and be free of the second mortgage. Our discussion in Parts

II and III of this opinion disposes of this argument as well.



                                           V.

                   The Bad Faith and Unclean Hands Defenses



              NLC traces its ill fortune to an alleged breach of a 1993 settlement

agreement entered into by NLC, Metric, and others in the California Superior Court

at San Francisco. To settle some litigation unrelated to the Nashville property, Metric

agreed to purchase the Nashville property “as is, including but not limited to title

issues.” The settlement fell through, however, when Metric discovered that NLC’s title

was clouded by two actions filed in Nashville to set aside fraudulent conveyances by

NLC and by some lien claims that had been filed against the property. NLC sued



                                          -6-
Metric in chancery court in Nashville for breach of the settlement agreement and

obtained a judgment of liability. The damages have apparently not been ascertained.



              NLC’s difficulties intensified in 1995 when Orlando Residence, Ltd.

obtained a judgment against NLC for a fraudulent conveyance. Metric was one of the

defendants in that litigation and one of the claimed fraudulent conveyances was the

sale of the hotel to Metric in 1989. After obtaining the judgment, Orlando served a

notice of garnishment on Metric in December of 1995. On January 2, 1996 NLC filed

its petition in bankruptcy. Metric filed an interpleader in the bankruptcy court and

tendered to the court its January 1996 payments under the ground lease and the

second mortgage. The interpleader alleged that Metric would continue to make its

payments to the court until further orders.



              This court reversed the judgment in favor of Orlando on December 18,

1996, and the cause was remanded for a retrial on all issues. On remand the trial

court held that Orlando was, nevertheless, a bona fide purchaser of the property at

a prior foreclosure sale. The net result is that Orlando is now the owner of the

property previously owned by NLC.



              On February 13, 1996 the bankruptcy court dismissed NLC’s petition

because it was filed in bad faith. As we have indicated, LaSalle declared a default in

April of 1996 and Metric claimed its rights under the three party agreement.



              NLC’s bad faith and clean hands defenses are primarily based on

Metric’s failure to abide by the settlement agreement in the California litigation. The

rule NLC relies on has been stated in many Tennessee cases. It can be found in its

distilled form in Gibson’s Suits in Chancery §18:

              This maxim declares that a plaintiff who has been guilty of
              unconscientious conduct or bad faith, or has committed
              any wrong, in reference to a particular transaction, cannot
              have the aid of a Court of Equity in enforcing any alleged
              rights growing out of such transaction. In the origin of the

                                         -7-
              jurisprudence, the theory was adopted that a Court of
              Equity interposed only to enforce the requirements of
              good conscience and good reason as to matters not
              equitably determinable in the Law Courts.              This
              interposition being deemed a matter of grace, it would not
              be exercised in favor of a person whose conduct in the
              matter complained of had been unconscientious, or in bad
              faith, or who had violated any of those principles of Equity
              and righteous dealing, which the Court had been
              constituted to enforce.

Although used chiefly in cases seeking equitable relief, the bad faith/clean hands

defense has been held to apply to legal claims, Continental Bankers Life Ins. Co. v.

Simmons, 561 S.W.2d 460 (Tenn. App. 1977). But the unconscientious conduct must

arise out of the particular transaction which is the subject of the litigation. Hogue v.

Kroger Co., 373 S.W.2d 714 (Tenn. 1964).



              The California litigation does have a connection to the Nashville property

since Metric was to purchase the property as part of that agreement. But the legal

rights and liabilities involved in that litigation were entirely separate from the financing

of the Nashville property or the 1989 three party agreement.



              NLC argues that Metric’s failure to purchase the Nashville property

forced NLC into default. That may or may not be true, but that claim is the subject of

a separate action for which NLC is seeking a judgment for damages. We assume that

its damages claim will include its losses resulting from its default on the LaSalle note.



              For all of these reasons, we affirm the chancellor’s decision to disallow

the good faith/clean hands defense.



              Finally, there are no facts in this record from which an inference could

be drawn that Metric acted in any way except in accordance with its best business

judgment. That does not mean that it is free of a claim that it violated NLC’s legal

rights. But it does mean that there is no proof that would meet the burden NLC has

to meet.


                                           -8-
            The judgment of the court below is affirmed and the cause is remanded

to the Chancery Court of Davidson County for any further proceedings that may

become necessary. Tax the costs on appeal to the appellant.




                                             ____________________________
                                             BEN H. CANTRELL, JUDGE



CONCUR:




_______________________________
HENRY F. TODD, PRESIDING JUDGE
MIDDLE SECTION




_______________________________
WILLIAM B. CAIN, JUDGE
