Daily Development for Thursday, March 29, 1995

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

LENDER LIABILITY; FRAUD: An informal promise by a lender that the lender would not enforce its mortgage lien until it had pursued other security interests, and the subsequent foreclosure on the property described in the mortgage, is not fraud in the inducement absent evidence that the lender's words were false when spoken.

Capital Impact Corporation v. Munro, 642 A.2d 1175 (Vt. 1994).

One of the principals of a corporate borrower of working capital pledged his house as collateral security for the loan. This pledge was made pursuant to a written guaranty agreement which included the execution of a mortgage deed. There had been discussions with an officer of the lender to the effect that the lender would attempt to liquidate corporate or business assets first in a commercially reasonably fashion; only after this was done would it look to the house for its remedy. The court ruled that there was no evidence from which it could conclude that the promise of the loan officer was made with the intention not to perform it. In the absence of such evidence, the written agreement and mortgage deed superseded these prior discussions between the parties.

The statements were held to be a prior parol promise which was rolled into the later written agreement. The court explained that, while a future promise might be fraudulent if it is a part of a general scheme or plan to induce a person to act to his detriment, this was not the case. The claim of intentional fraud was weak at best. Furthermore, the argument that there was a fiduciary relationship between the loan officer and the guarantors was rejected: there was no showing on the record of anything but a debtor-creditor relationship between the parties. In order for a fiduciary relationship to ripen, the guarantors would have had to become dependent on, and repose trust and confidence in, the lender in the conduct of their affairs. The documentation was too clear and arm's length to infer such a relationship.

Comment: For a somewhat different view, see the recent 10th Circuit decision in Duffield v. First Interstate Bank of Denver, 13 F.3d 1403 (10th Cir. 1993), finding that a similar statement by a bank officer imposed a general duty of good faith and fair dealing on the bank not to depart from its promised conduct without prior notice.

LENDER LIABILITY; DUTY OF GOOD FAITH AND FAIR DEALING; IMPLIED NOTICE DUTY: The contract doctrine of an implied covenant of good faith and fair dealing applies to all terms, ambiguous or not, of loan documents, including express terms appearing to permit the lender to act unreasonably. Duffield v. First Interstate Bank of Denver, N.A. ____ F.3d ____, 1993 WL 530786 (10th Circ. 1993). The borrower had first obtained a loan on an unsecured basis, and later he pledged his interest in oil and gas wells as collateral for the loan under a promissory note, mortgage, deed of trust, assignment, security agreement and financing statement when the borrower fell behind in payments, his business manager contacted the bank with a proposal calling for the sale of one of the properties and the application of the sale proceeds to cure delinquent payments and to meet obligations next due to the bank. The borrower claimed the bank representative orally agreed to the proposal, but instead the bank applied all sale proceeds to principal in inverse order, as permitted under the loan documents. With the loan still in default, the bank exercised its rights to collect proceeds from the wells' operations, the borrower's credit suffered, and finally the borrower lost his properties.

In the district court, the borrower asserted claims against the bank including breach of the oral contract regarding application of the collateral sale proceeds, breach of notice provisions in the loan documents, and breach of the covenant of good faith and fair dealing. The jury awarded $6,000,000 in damages.

On appeal to the Tenth Circuit, the bank argued that the contract unambiguously defined the parties' duties, and the bank cited Colorado decisions suggesting that under Colorado law, the duty of good faith and fair dealing applied only to ambiguous contract clauses. The court disagreed with the bank's interpretation of Colorado law and took guidance instead from the state's adoption of the Uniform Commercial Code and other decisions based on the contract theory of an implied covenant of good faith and fair dealing. On this reasoning, the court found the bank had breached the covenant by invoking the loan document remedies without reasonable prior notice or good faith grounds. Further, the court let the award of consequential damages stand, inasmuch as the bank could have foreseen the extent of the damages to the borrower's business resulting from the bank's actions, and the jury's award did not shock the conscience or suggest that improper considerations had tainted the decision.

Note that the court's opinion is not premised on the breach of an implied or oral understanding arising from the conversation between the bank officer and the business manager. Rather, it is based upon a construction of the agreement itself - although the bank had an absolute contract right to resort to remedies in the event of default, the court held that the implied duty of good faith and fair dealing imposed, under the circumstances here, a duty on the part of the bank to give to the borrower notice and opportunity to cure before exercising certain remedies.

Comment: This is a major lender liability decision - few important lender liability verdicts have survived appeal this far, particularly those premised, as is this one, on the bank's simply standing on its contract rights. The court does cite some special circumstances in the loan itself, and does not conclude that every contract giving an absolute right to seek remedies carries with it a duty of notice and opportunity to cure. But Colorado lenders (and probably all lenders in the Tenth Circuit) should exercise some preventive law and assume that such duty exists.

Dirt Readers: Who is right here? There is a "great debate" going on among legal scholars. Some argue that the duty of good faith and fair dealing is simply a duty to comply with the "moraes of the marketplace" - that is, to be fair on issues that are not specifically determined in the contract. Others say that the duty goes beyond this. Even when the contract is definite and certain, a party may not take advantage of contract rights in ways that would disadvantage the other side. Those who oppose this view argue that "reasonable" is in the eyes of the beholder, and parties to a commercial contract should not be subjected to a retrospective second judgment as to their business practices when they have reserved specifically the right to make a discretionary judgment. When we are talking about tortious breach of the duty, as we are in many of the big cases, the stakes are considerable.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

Items in the Daily Development section generally are extracted from the Quarterly Report on Developments in Real Estate Law, published by the ABA Section on Real Property, Probate & Trust Law. Subscriptions to the Quarterly Report are available to Section members only. The cost is nominal. For the last six years, these Reports have been collated, updated, indexed and bound into an Annual Survey of Developments in Real Estate Law, volumes 1‑6, published by the ABA Press. The Annual Survey volumes are available for sale to the public. For the Report or the Survey, contact Maria Tabor at the ABA. (312) 988 5590 or mtabor@staff.abanet.org

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