Borrowers were victims of a high pressure real estate marketing scheme whereby, it was alleged, developers systematically made numerous misrepresentations about the value of the Florida vacation homes being marketed. The homes were financed through a developer-controlled lending entity. An insured Savings and Loan Association (the "Association") acquired the loans from that entity, but with qualified appraisals that indicated on their face that they did not reflect values consistent with prices outside the developer's development. Because of the weakness in the appraisals, the Association required further guarantees and assurances from the developer.

Later, the developer and the Association failed. The developer's principals went to jail. The Association devolved to the RTC. Borrowers had purchased homes from the developers and, following these failures, attempted to defend against their payment obligations by raising claims of fraud, misrepresentation and breach of contract.

Not surprisingly, the RTC raised 12 U.S.C. 1323(e) as a defense. Many have referred to this statute as the "statutory D'Oench doctrine." But, as many courts are now starting to conclude that D'Oench has no impact on federal receivers, the editor is coining a new "shorthand" term for the statute's concept: the "federal HIDC [holder in due course]" doctrine.

This statute limits the enforceability of "agreements" between obligors and depository institutions which might reduce the value of the institution's assets in the hands of the RTC. Such agreements will not be honored unless they are contemporaneous with the creation of the asset, approved by the Bank's directors (or a duly authorized committee), and appear in the Bank's records.

In this opinion, the Third Circuit panel, in a 2-1 decision, concludes that the alleged fraudulent representations constituted "agreements" within the meaning of the statute. Although the ordinary holder in due course doctrine probably didn't protect the savings Association, since it knew of the potential defenses the borrowers might raise, the "federal holder in due course" concept embodied in the statute protects the Association's "assets" in the possession of the RTC. Borrowers remain liable.

The somewhat tortuous path which the court travelled to apply Section 1323 is worth surveying:

First, we must conclude that fraudulent representations constitute "agreements." This one is easy. The U.S. Supreme Court, in Langley v. FDIC, 484 U.S. 86 (1987) concluded that misrepresentations of the value of land made by a lender in connection with the execution of a note constituted an "agreement" between the borrower and the lender, and, since the misrepresentations were verbal, and did not appear on the lender's records, could not be used defensively against the FDIC when the lender failed.

Second, we must conclude that fraudulent representations made by third parties - here the developers (who controlled the originating lender) who sold the loans to the Association in question - constituted "agreements" within the meaning of the statute. The Third Circuit had already decided that issue. Adams v. Madison Realty & Development, Inc., 937 F.2d 845 (8d Cir. 1991).

In this case, the borrowers argued that the fraudulent statements of the developer were embodied in the appraisals and the Loan Purchase Agreements by which the Association acquired the loans from the developer. They convinced the trial court and the dissenter on appeal, but the majority of the Third Circuit panel rejected this contention, concluding, without analysis, that the appraisals did not constitute contracts by which any representations were made to the borrowers.

What is left of the fraud is simply a group of unwritten representations. If they were not in writing, and they were agreements, then they cannot be used, even defensively by borrowers, to diminish the assets of the Association. So far as the majority is concerned, case closed at this point.

Much of the majority opinion constitutes a response to Judge Sarokin's opinion in dissent. Judge Sarokin agrees with the majority that misrepresentations constitute an "agreement," even when made by third parties, but concludes that the misrepresentations in this case were embodied in writing, since they were in the appraisals and were evident in the Loan Purchase Agreement, which referred to the inadequacy of the appraisals and required additional collateral as a consequence.

But Judge Sarokin would view the appraisals and the Loan Purchase Agreement as "agreements" within the meaning of the statute. Since they were in writing, they satisfy the first statutory test to qualify as exceptions to the "federal HIDC" rule. Judge Sarokin states that the developers actually provided these appraisals to the borrowers without informing them that they did not meet common industry standards. (It would be unusual in most normal institutional loan settings for the borrower to see a copy of the lender's appraisal). Given the special facts, it is hard to dispute Judge Sarokin's conclusion that the appraisals were written embodiments of the offending "agreements" (the majority had no problem so disputing, however.)

Judge Sarokin also concludes that the Loan Purchase Agreement constitutes an "agreement" between borrowers and the Association that later bought their notes. He seems to assume that the borrowers were aware that their notes would be transferred to another institution, although there is nothing in the stated facts to suggest this. Perhaps Judge Sarokin is concluding simply that the Association, through the Loan Purchase Agreements, became a written "co-conspirator" in the original appraisal misrepresentations.

Although Judge Sarokin can thereby create a written agreement, he has a more difficult time establishing that the agreement is "contemporaneous" with the bank's acquisition of the asset. Again, he relies upon a "continuous transaction" notion, which would make more sense if there was some kind of continuous understanding between the Association and the developer by which the Association acquired the developer's paper. Judge Sarokin cites cases in the Eighth and Ninth Circuits that he claims support his view that "contemporaneous" agreements can arise in the course of a lengthy "stream of transactions" entered into over time.

Of course, Judge Sarokin also has the difficulty of showing that the fact of the misrepresentations appeared on the records of the Association. He does this by referencing the statements contained in the appraisals and the Loan Purchase Agreements that the appraisals were inadequate and did not meet market standards. This, he claims, should have put anyone reading the record "on notice" of potential misrepresentations embodied in those appraisals.

Comment 1: Except for the select few who continue to defend RTC assets, Judge Sarokin's attack on the "federal HIDC" dragon is salutory. But the factual record would have to be quite unusual for his theories to work in very many cases, even if he had been able to sell it to his colleagues on the panel.

The "continuous transaction" theory would make sense in other contexts, however, particularly where a lender has agreed to finance certain activities of a developer by acquiring the developer's paper over time. We have that concept already in negotiable instruments lore - it is called the "close connectedness doctrine." It would aptly apply in certain "federal HIDC" cases as well.

Comment 2: If, indeed, one could make out complicity of an institutional lender in an overall fraudulent scheme, one might be able to allege tortious conduct and separate tort damages. Recent cases have indicated that such allegations might not be barred by the federal HIDC doctrine and that the common law version of the concept, the D'Oench case itself, may not apply to the federal receivership situation because the federal statute preempts it. Therefore, defrauded borrowers, back to the drawing board!!

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