Daily Development for
Tuesday, April 9, 1996

by: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law

BANKING; FEDERAL RECEIVERS; D'OENCH DOCTRINE: Has the Second Circuit noticed that D'Oench is dead? FDIC v. Suna Associates Inc., et al., 2d Cir., No. 95-6022, 3/26/96.

The Second Circuit here affirmed a lower court ruling that had held that under the D'Oench doctrine a guarantor is barred from presenting evidence as to the parties' understanding of the meaning of the term "base rate" appearing in a note.

Borrower executed a mortgage note payable to Bank. The terms of the note provided that the interest rate would be 1 percent per annum floating above the bank's base rate, as same may change from time to time. The note was secured by a mortgage on certain condominium units and the individual guaranties of several parties with interests in the transaction, including an attorney who had represented the bank. Under the terms of the attorney's guaranty, the bank was empowered to modify or otherwise change any terms of all or any part of the indebtedness or the rate of interest thereon. . . .without notice to the guarantor and without affecting in any way its rights. The guaranty subjected guarantor to a maximum of $1,289,000 liability for any deficiency.

In a weakened financial condition and under orders from the FDIC to improve its capital position, the Bank did not lower its base rate when New York banks reduced their prime around May 1990. The next year, the Bank commenced foreclosure against borrower -- just a few months before being placed in receivership by FDIC. FDIC removed the foreclosure to federal court.

The Federal District Court entered a deficiency judgment against guarantors for just over $1 million. Attorney guarantor appealed, arguing that there was an understanding that the bank's base rate would at all times adhere to the New York prime rate and that the bank therefore impermissibly changed the base rate on the note. However, the lower court ruled, and the Second Circuit agreed, that on its face, the note left the Bank with discretion to unilaterally change its base rate. Any agreement to the contrary which is not found on the face of the document cannot be enforced pursuant to either D'Oench or 12 U.S.C. Sec. 1823(e).

The Second Circuit stated that the express language of the note, together with the relevant case law, compels the conclusion that D'Oench and 12 U.S.C. Sec. 1823(e) bar parol evidence that would vary the terms of the note. Moreover, the court stated that prior to signing the note, the borrower was free to bargain for language that would have limited changes in the base rate according to calculation by a particular.

Comment 1: Some banking authorities have argued that the court ought to have admitted evidence of custom and practice as to the ordinary understanding of the meaning of the terms of the note. The court doesn't really discuss this argument. It simply holds that the note on its face was not ambiguous, and that therefore evidence provided to interpret it is not relevant.

Assuming that the argument was properly before the court, it would be inappropriate for the court to rely upon D'Oench or any other doctrine to establish the ordinary meaning given to language within the industry at the time of the note. This does not vary the express terms of the note. It simply defines what those terms are. All language is susceptible of varied interpretations. And these interpretations depend upon context. Any legal instrument, including a note, is replete with terms that must necessarily be defined in terms of the iindustry practices. To admit such evidence is no different than relying upon a dictionary or other ready reference as to the meaning of language. It is quite different from admitting evidence of the individual understandings of the parties, which D'Oench, if applicable, would bar.

It is not at all clear to the editor that industry practice evidence would have helped the guarantor here, but, assuming that the court had the issue before it, it should have admitted such evidence.

Comment 2: The Second Circuit panel refers constantly to both the common law and statutory versions of D'Oench in this case. It seems to have no understanding of the fact that other courts have concluded that the common law version of D'Oench is not applicable to federal receiverships, having been superceded by the federal statute. See, e.g.: Murphy v. Federal Deposit Ins. Corp., 61 F.3d 34 (D.C. Cir. 1995), (discussed in the Fall, 1995 Edition of the Quarterly Report);. DiVall Insured Income Fund L.P. v. Boatmen's First National Bank of Kansas City,. No. 95-1081WM (8th Cir. 11/13/95). Is the court telling us something, or can we simply conclude that the guarantor saw no point in stressing the cases discussing the common law version of D'Oench because in this case the application of the statutory version made any issue concerning the common law moot?

Thanks to Mindy Parsons of the Bank Bailout Litigation News for sharing information about this case.

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