Tues. Jan. 20, 2015

Can Equitable Defenses Ever Be Waived Pre-Dispute?*

                        In a recent opinion, a California Court of Appeal correctly concluded that certain equitable defenses were not subject to pre-dispute contractual waiver. However, the opinion left unresolved the greater question:  in California, can equitable defenses such as fraud, bad faith, unclean hands or non-disclosure ever be waived by contract prior to the existence of a dispute?  According to the public policy stated by the California Legislature and the reasoning of the cases interpreting that policy, the most likely answer to that question  is “no”.

                        In California Bank & Trust v. Del Ponti, Case No. E053187 (2014) WL 690 8141), the Fourth District Court of Appeal held that pre-default waivers of guarantors’ defenses are “limited to legal and statutory defenses expressly set out in the agreement”, and do not include equitable defenses if the waiver of those equitable defenses would permit the lender to profit from its own wrongdoing.  Id. at p. 40.  The court specifically held that the guarantors’ equitable defense of unclean hands remained applicable, despite the fact that the guarantor had expressly waived statutory defenses in the guaranty.  On that basis, the appellate court sustained a trial court order exonerating the defendant guarantors.

                        The facts in Del Ponti were not favorable for the bank.  The credit facility in that case  involved a typical California construction loan with draws paid monthly.  Draws one through 16 were paid; the bank thereafter withheld advances on draws, paying only draw 19 among requested draws 17 through 22.  In justification for this refusal to perform, the bank alleged that the loan-to-value ratio exceeded the contractual limits, constituting a default under the loan agreement – but the bank never notified the borrower or guarantors at the time in question that an event of default had occurred.  The units could not be completed without the necessary funding, so the developer could not obtain certificates of occupancy; the units were not sold, and the loan was not repaid on the maturity date. The parties entered into a workout agreement pursuant to which the contractor completed the units but a total of $1,071,185 on the loan remained unfunded.

                        The borrower worked with the bank to auction the units off as a “builder close-out”, as opposed to a “bank owned” foreclosure sale, in order to obtain the best possible price for the units.  Nonetheless, the bank unilaterally caused the auction to be canceled, and instead proceeded to foreclose.  The contractor filed suit and the bank cross-complained.  In 2009, California Bank & Trust successfully bid at the FDIC auction for the original bank, which failed.  It also cross-complained for, among other things, a judgment against the guarantors.  The trial court held in favor of the guarantors because a) the bank breached the loan agreement by failing to make the four loan advances; and b) the bank had misled the guarantors into thinking they would be exonerated under their guaranties if they performed under the workout agreement.

                        California Civil Code Section 2856 provides that any guarantor or surety may waive 1) the rights to subrogation, reimbursement, indemnity, contribution; and 2) any rights the guarantor may have as a result of the original debt being secured by real property, including anti-deficiency defenses.  Such waivers have thus been routinely included in California guaranties since the 1920s.

                        The guaranty in Del Ponti presumably had such ordinary waiver provisions.  However, the Court of Appeals viewed the central issue as a question of whether the guaranty included a pre-default waiver of the bank’s own misconduct.  Not having found other authorities on point, the court held that a guarantor’s waiver of defenses is limited to 1) legal defenses, and 2) statutory defenses expressly set out in the agreement.  Such a waiver “is not deemed to waive all defenses, especially equitable defenses, such as unclean hands, where to enforce the guaranty would allow the lender to profit by its own fraudulent conduct.”   The court went on to point out that in creditor/debtor relationships, the creditor owes the surety a duty of continuous good faith and fair dealing, citing Sumitomo Bank of California v. Iwasaki (1968) 70 Cal.2d 81, 85.  See also, First Hawaiian Bank v. Bartel (D.C. Hawaii 2009) Civ. No. 08-00177, p. 20-25 [under Rest. 3d Suretyship § 124, creditor owes guarantor good faith duty to disclose possibility that enforcement of guaranty more likely]. 

            The Del Ponti court specifically noted that the types of duties cited in Sumitomo and Bartel were not expressly waived in the guaranties.    What the court did not clarify, as it could have, is that the same rule against pre-dispute contractual waiver applies to all similar equitable defenses generally.

            California’s Civil Code sets forth the public policy that one who has committed a “fraud, or other willful injury to the person or property of another” may not profit thereby by relying on the victim’s waiver.  Cal. Civ. Code § 1668; Manderville v. PCG & S Group, Inc. (2007) 146 Cal.App.4th 1486, 1500.  The rule has been extended to prevent waiver of future gross negligence as well.  City of Santa Barbara v. Sup. Ct. (2007) 41 Cal.4th 747, 777.  In light of this clear public policy and under the reasoning of the cases interpreting the statute, it becomes clear that equitable defenses such as fraud, bad faith, and unclean hands – all of which are firmly based in the intentional wrongdoing of the plaintiff – cannot be waived in advance under any circumstances.

            As the Del Ponti court recognized, public policy considerations prevent the enforcement of a guarantor’s pre-dispute waiver of the unclean hands defense where enforcement would permit the beneficiary of the guaranty to profit from its own wrongdoing.  This same logic applies to all similarly fault-based equitable defenses, and outside the limited context of guaranties.  It would be beneficial for the Del Ponti court to make this point clear in its opinion.  

* Originally published in Lender Liability Newsletter.  Reprinted with Permission.  © 2014 Thomson Reuters. 

Fri. Sept. 19, 2014

Drummond & Associates Represents HOA Members

    In two closely-watched cases, Drummond & Associates represented homeowners association members in actions under California’s Davis-Stirling Common Interest Development Act.
    In the first case, the firm represented two members of an HOA’s board of directors and three election inspectors in an action brought by the recalled president of the board. The former president sued under Davis-Stirling to void the recall election, alleging that a) the ballots improperly included candidates who had not been nominated by the board and b) the election inspectors had not been appointed by the board. The case was dismissed after the firm’s three successful demurrers to the complaint.
   In the second case, the firm represented members of an HOA suing to enjoin the HOA from proceeding with a recall election. The members had issued notice of an election to recall the board of directors pursuant to Corporations Code § 7511(c) after the board failed to issue the notice within 20 days after receiving the members’ request for the recall election. After the members issued notice of the election, the board then sent out its own notice of a different meeting for the purpose of voting on whether to proceed with such a recall. The court enjoined the HOA from proceeding with the board’s competing election, stating that under Section 7511(c), once the board failed to act within 20 days, the members had the exclusive right to proceed with the election.

    In both cases, the HOA members were represented by Donald F. Drummond and Bridget B. Laurent.

Thurs. Sept. 4, 2014

Claim on $3 Million Personal Guarantee Dismissed

    A lender dismissed its claim against a real estate developer who personally guaranteed $3.7 million in debt. After Drummond & Associates filed a motion for summary adjudication on behalf of developer Mitch Covington on the grounds that the bank’s claim was barred by California’s anti-deficiency statutes, U.S. Bank dismissed its first cause of action against for breach of a $3 million guaranty.

    Covington moved for summary adjudication on the grounds that when the underlying loan in his name was later assumed by California corporation subject to his personal guaranty, the bank included in the assumption agreement an express condition subsequent stating that if the developer or his successor-in-interest “should ever dispute, repudiate, or attempt to delay, hinder, restrain, or impede” the bank’s enforcement of the guaranty, then Covington would once again be directly liable on the underlying loan as though the assumption had never happened. Since under this condition subsequent Covington was effectively both a borrower and a guarantor, he was therefore entitled to the protection of Code of Civil Procedure § 580(a)-(d), California’s anti-deficiency statutes, which provided a complete defense to the bank’s claim. The bank dismissed its claim rather than oppose the motion.

    Covington was represented by Donald F. Drummond and Bridget B. Laurent of Drummond & Associates, and his bankruptcy counsel Riley C. Walter and Tracy E. Blair of Fresno’s Walter Wilhelm Law Group.

Tues. April 16, 2013

Lender Liability News: Three Game-Changing Decisions

    A trio of recent decisions California have changed the landscape for lender liability litigation.  These significant changes in the law of promissory estoppel, parol evidence and negligence will allow such cases to reach a jury where for approximately forty years, legal roadblocks have otherwise stymied those efforts.
I.  Aceves v. US Bank (2011) 192 Cal.App.4th 218
    The doctrine of promissory estoppel is a substitute for consideration in some jurisdictions, and in others is used when contract terms are too indefinite to enforce.  (See, Rest. 2d, Contracts, §90.)  In Aceves, the plaintiff borrower lost her home to foreclosure by the bank.  She alleged that the bank promised it would “work with her” to consider a loan mitigation proposal if she 1) did not convert her bankruptcy from a Chapter 7 bankruptcy proceeding to a Chapter 13; and 2) did not oppose the bank’s application for relief from the automatic stay imposed by 11 U.S.C. § 362(a).  After Aceves complied, the bank nonetheless foreclosed.  

    The court held that, as alleged by the plaintiff, the bank’s promise was clear and unambiguous, Aceves relied upon the promise, her reliance was both reasonable and foreseeable in light of the circumstances, and she relied upon the promise to her detriment; thus satisfying all necessary elements of a promissory estoppel claim. The court’s holdings apply a liberal test to the first and third elements of the doctrine; and importantly, also held that because the doctrine of promissory estoppel provided a substitute for consideration, Civil Code Section 1698 did not bar the plaintiff’s claim.  It seems likely that the Aceves court’s more liberal standard in relation to promissory estoppel will result in trial courts increasingly finding triable issues of material fact that prevent lenders from obtaining summary judgment on similar claims.    

II.  Riverisland Cold Storage v. Fresno-Madera Production Credit Association (2013) 55 Cal.4th 1169
    In January, 2013, the California Supreme Court substantially revised California’s parol evidence rule, which prevents the admission of evidence of a prior oral agreement made by parties to an integrated written agreement.  The rule has many exceptions (see, Capello, Lender Liability (4th ed.) §112.04, p. 154 and cases cited therein), one of which is fraudulent inducement to enter into the written contract in question.  

    In Riverisland Cold Storage, Inc. v. Fresno Madera Production Credit Assoc. (2013) 55 Cal.4th 1169, the California Supreme Court reconsidered its prior ruling in Bank of America v. Pendergrass (1935) 4 Cal.2d 258, 263, in which the court had previously held that in order to justify the application of California’s statutory fraud exception to the parol evidence rule, evidence of the fraud must tend to establish “some independent fact or representation, some fraud in the procurement of the instrument, or some breach of confidence concerning its use, and not a promise directly at variance with the promise in writing.” [Italics added.]  The Pendergrass holding has long been criticized, including by such authorities as Professor Witkin.

    Reconsidering that holding almost 80 years later, the high court concluded that the Pendergrass limitation finds no support in the language of the statute codifying the parol evidence rule and the exception for evidence of fraud.  It is difficult to apply; it conflicts with the doctrine of the Restatement, most treaties and the majority of sister state jurisdictions.  Further, the court held, while intended to prevent fraud, the rule established in Pendergrass may actually provide a shield for fraudulent conduct.  Finally, the court held that Pendergrass departed from established California law at the time it was decided and neither acknowledged nor justified that abrogation.  Accordingly, the Supreme Court held that Pendergrass was ill-considered, and overruled it.  

The Riverisland decision removes the hurdle previously posed by Pendergrass.  Although presenting credible evidence to a trier of fact will continue to be a challenge for counsel, these cases will no longer be easily disposed of on summary judgment.
III.  Jolley v. Chase Home Finance (2013) 213 Cal.App.4th 872
    In Jolley, the First District Court of Appeal revisited the rule that there is no such thing as “banker malpractice”.  With certain limited exceptions, courts have historically been reluctant to impose duties upon lenders vis-à-vis borrowers, including a duty of reasonable care.  (Capello, supra, §18.02, p. 254 and cases cited therein.)  In Jolley, the plaintiff took out a construction loan from Washington Mutual in order to renovate a Tiburon home.  WaMu handled the loan administration sloppily, forcing Jolley to advance his own funds and suffer other alleged losses.  WaMu later agreed to a loan modification in order to compensate for its errors and provide for completion of the construction project.  Upon completion of the project, the balance of the construction loan was to roll over into a fully-amortized mortgage on the remodeled home.

    Approximately two years after the loan modification, the FDIC took over WaMu and sold its assets to Chase.  Shortly thereafter, Jolley defaulted on the construction loan, which he alleged was caused by WaMu’s breaches and negligence in its funding.  He tried to obtain a loan modification from Chase, and was told by its employee that there was a “high probability” that Chase would modify the loan, and also that it was “likely” that Chase would honor the rollover provision when construction was complete.  He therefore borrowed heavily in order to finish the project.  Ultimately, Chase refused the modification and proceeded to sought to foreclose, prompting Jolley to file his complaint seeking an injunction against the foreclosure as well as damages.  Chase moved for summary judgment, contending that it had no liability for loan mismanagement because it did not assume WaMu’s liabilities to borrowers along with the loan assets it had purchased.  The trial court granted its motion.        

    In reviewing Jolley’s fourth cause of action for negligence, the First District Court of Appeal noted the generally accepted rule that a lender does not owe a borrower or third party a duty beyond those expressed in the loan document.  The court held that in light of the ongoing dispute between the borrower and the bank over its performance of the loan which “bridged” the Chase acquisition, and a Chase representative’s alleged specific representations to Jolley, summary judgment could not be granted as to the negligence claim “based on lack of duty alone.”  Examining the particular facts of the case, the court held that Jolley properly alleged that Chase was negligent in failing to review the loan history, make further disbursements, review his loan modification request in good faith and conform to industry practices in order to protect him from further losses.  The court applied the familiar factors enumerated in Baikanja v. Irving (1958) 49 Cal.2d 647, 650, and found that Chase owed Jolley a duty of care.  The court further noted that new California statutes and case law concerning the “dual tracking” strategies commonly utilized by banks in loan modification situations supported this conclusion, highlighting that public policy considerations weigh in favor of imposing a duty of care.    
    The application of the former rules governing promissory estoppel, parol evidence and negligence normally resulted in successful summary judgment motions for the lender.  (Banco Do Brazil, SA v. Latain, Inc. (1991) 234 Cal.App.3d 973; Price v. Wells Fargo Bank (1989) 213 Cal.App.3d 465.)  These three reexaminations of the doctrines will now permit issues of fact to survive such motions, requiring resolution by the ultimate trier of fact.  The questions of reliance and causation will take on heightened importance in such matters. As occurred following numerous lender liability cases in the 1980s, it is anticipated that these opinions will spur dramatic improvement in loan practices generally, for the benefit of all.


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