Daily Development for Wednesday, July 21, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu

MORTGAGES; MORTGAGEE’S REMEDIES; ATTORNEY’S FEES: Attorney fees relating to torious waste claim are not available where non-recourse carve out excepts liability for waste, but does not specifically mention attorney’s fees for tort claims based upon waste.

Aozora Bank, Ltd. v. 1333 North California Boulevard, 2004 Cal. App. LEXIS 1033 (June 29, 2004),

This case is an interesting postscript to Nippon Credit Bank, Ltd. v. 1333 North California Boulevard, 86 Cal. App. 4th 486 (2001), (the DIRT DD for 1/29/01). In the Nippon case the court affirmed a jury verdict that the borrower partnership and its general and managing partners were guilty of the tort of bad-faith waste for failure to pay real estate taxes while the nonrecourse mortgage was delinquent. See John C. Murray, Nonpayment of Taxes as Tortious Waste in Nonrecourse Mortgage Loans, 19 Cal. Real Prop. J. 22 (Spring 2001) (reviewing case law, including Nippon, supra, finding that mortgagor's nonpayment of real estate taxes constitutes actionable waste under contractual or tort theory).

The California appellate court here ruled, however, that the bank lender (now known as Aozora Bank Ltd.,, which was the beneficiary of the court's ruling, was not entitled to attorneys' fees under the contractual language in the loan documents.

The jury at the trial court level had found the defendants liable for approximately $395,000 in compensatory damages and $8,333,333 in punitive damages. But the trial court remitted the amount of punitive damages to $1.6 million. The appellate court (in an unpublished portion of the opinion) upheld the remittur of punitive damages and the order for new trial on the amount of punitive damages only. At the second trial, in which the jury awarded no punitive damages to the bank, the bank moved for an award for the attorney's fees it incurred in the case, in the amount of approximately $1, 434,000. The trial court approved this request by the bank, which included a 1.5 multiplier for "the complex and cutting edge nature of the issues litigated." The borrower then appealed this ruling to the appellate court.

The appellate court reversed the trial court's determination that the bank was entitled to attorney's fees under the contractual language in the loan documents. The court first noted that attorney's fees are not generally available to prevailing parties in tort actions, citing applicable California statutes and case law. According to the court, "Since there is no statutory or other legal authority for an attorney fee award in this instance, Bank's entitlement to fees hinges entirely on the terms of the parties' contract."

Turning to the contractual language, the court rejected the bank's argument that the borrower was liable under the general attorney's fee provisions contained in the note and mortgage. According to the court, "even if those provisions extended to the fees in question, the Partnership would not be liable for them unless such liability was excepted from the nonrecourse feature of the note and deed of trust," i.e., if the carveouts did not expressly include liability for attorneys' fees, they would only be recoverable from the real estate collateral.

The applicable nonrecourse carveout in the note and deed of trust stated that, "nor shall such limitation of liability apply if and to the extent that [Borrower/Trustor] . . . commits fraud, material representation or waste." The court seized on this language to find the following reasons to reject the trial court's determination that it was broad enough to make the borrower partnership liable for attorney's fees as well as waste damages: (1) the carveout did not specifically refer to attorney's fees, and would not be implied because attorney's fees generally are not awarded in tort actions; (2) given the importance of this issue, which the court noted is one of the key concerns of lenders when negotiating nonrecourse carveouts, "it is unlikely that the carve-out would be silent on attorney's fees if they were intended to be included" (the court noted the uncontradicted testimony of an expert who testified that carveouts were "always expressed, and never implied"), and (3) because the carveout only applied "if and to the extent" that waste was committed, this undercut the bank's argument that the carveout entirely negated the nonrecourse aspect of the agreement when waste is committed. The court summarized by stating that, "the most reasonable reading of the agreement is that the waste carve-out does not implicitly include attorney's fees for prosecuting a waste action. As a consequence, recovery of these fees from the Partnership is barred by the nonrecourse provisions of the note and deed of trust." .

The appellate court also dismissed the bank's argument that if it were precluded from obtaining attorney's fees, it would "void the general purpose" of the general attorneys' fees provisions in the note and mortgage but the borrower would be able to invoke the attorney's fees clause against the lender, thus violating the California statutory provision (Cal. Civ. Code Sec. 1717) that makes attorney's fees clauses reciprocal. The court responded that because the partnership borrower was not the prevailing party in the case, it need not decide the issue of reciprocity, and that the bank still could benefit from the attorney's fees provisions of the note and deed of trust even though the loan was nonrecourse, because it could recover such fees from the mortgage security and add them to the amount required to reinstate the loan or add them to the amount of a credit bid at a foreclosure sale. The court stated that, "If bank wanted additional recourse against the Partnership personally i t should have negotiated for an attorney fee carve-out in the loan documents."

Finally, the appellate court rejected the bank's argument that it was entitled to attorney's fees as well as waste damages under the reasoning of the court's prior ruling in this case. The appellate court noted that the bank had sued in tort, not under the contract, and had never mentioned the waste carveout. The court stated that, "our analysis was focused on whether the evidence in the first trial supported a bad faith finding," and "[w]e had no occasion in the prior appeal to consider the nonrecourse provisions of the note here - they plainly include a carve-out for waste damages, and no issue was made of them."

Reporter’s Comment 1: This decision unveils yet another trap for the unwary, and is a cautionary tale and "wake-up" call for lenders not to be careless when drafting attorney's fees provisions in commercial loan documents that contain nonrecourse provisions with specific carveouts. The lender easily could have prevailed in this case -- and picked up another $1,434,000 -- if it had merely inserted the "magic words" in the carveout language of the nonrecourse provision. The appellate court even set forth the "roadmap" to follow in a footnote, where it referred to the "waste carve-out exemplar" in a 1999 PLI publication entitled What Borrowers and Lenders Need to Know Now. The court cited the following language from this publication, which provides that the waste carveout provision should cover "all loss, cost (including [reasonable] attorneys' fees and expenses), expense, claim, liability or damage incurred by Mortgagee as a result of waste of the Mortgaged Premises, which [materia lly] reduces the value of the Premises.".

Attorneys' fees provisions in loan documents generally are not favored by courts (as demonstrated by the Aozora case), and such clauses must be specific, conspicuous, and comprehensive or they will not be enforced. Lenders should also be cautioned to provide, in a modification agreement, that all rights under the original mortgage are preserved, and specifically provide in the modification agreement for the right to collect attorneys' fees even if the original loan documents contain an attorney's fees provision. Otherwise, if the lender sues based on provisions in the modification agreement, and it doesn't contain a specific right to attorneys' fees, the lender may not get them.

Reporter’s Comment 2: See Wheeling Trust & Savings v. Citizens National Bank, 142 Ill.App.3d 333, 491 N.E.2d 866 (1986), in which the borrower brought an action against the bank lender for a declaratory judgment that language in the Extension Agreement executed by the parties, which provided an interest rate of 6% over prime, but 5% over prime if no default in note and payments timely made, was an unenforceable penalty. The court held that the interest rate provision was not a penalty before maturity, but also held that the bank was not entitled to attorney's fees (which the bank had petitioned for). The mortgage contained a covenant that the borrower would pay for any expenses and attorney's fees incurred by the bank in "any action or proceeding to protect its security or in which it was made a defendant by reason of its mortgage". The bank argued that the language referred to "any proceeding," not just proceedings enforcing its security. The Extension Agreement specifically ref erenced the original mortgage and provided that it secured the Extension Agreement. The court nevertheless reasoned that the action was brought in connection with the interest rate provided for in the Extension Agreement, which was a document separate from the mortgage. (The Extension Agreement itself made no provision for payment of attorneys' fees, nor did the bank contend that the note so provided.) The court ruled that contractual agreements for payment of attorneys' fees must be strictly construed, and must be provided for by "specific terms of the mortgage". The court acknowledged that the intention of the parties should control, but stated that in declaratory actions, the underlying action is to declare rights, not to enforce mortgage obligations, and thus attorneys' fees for actions "relating to enforcement of mortgage" are uncollectible. The moral of this decision: The intention of the parties is controlling, so make certain (in an abundance of caution) to insert a specif ic clause for attorneys' fees in modification agreements, and don't limit collection to impairment of the security or enforcement of the obligations of the borrower under the mortgage. (It may be wise to refer specifically, without limitation, to declaratory actions and suits to quiet title, or "actions to determine rights of parties or any other actions or proceedings whatsoever arising out of or in connection with the mortgage, as hereby modified".)

Editor’s Comment: Another interesting attorney’s fee case, going for the fee claimant, is Honey Baked Hams, Inc.v. Dickens, 43 Cal. Rptr. 2d 596 (Cal. App. 1995), the DIRT DD for 10/16/95. (Contract provision permitting recovery of attorney's fees to "the successful party . . . whether or not such action is prosecuted to judgment" requires landlord to pay tenant's attorney's fees when landlord dismisses unlawful detainer action.) The result seems obvious, but the case was necessary because another California case had held that contractual provisions for award of attorney's fees may not be enforced when the action is dismissed, as the dismissal may not necessarily reflect that the action is without merit and to penalize a party for dismissing when appropriate could result in clogged courts and interfere with the efficient administration of justice.

The Reporter for this item was Jack Murray of First American Title Insurance, Chicago Office.

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