November 22, 2011
In This Issue:
- Borrower Has Different Rights and Obligations Under Swap Agreement and Loan Agreement
- Jury Trial Waivers in Complex Swap Transactions May Not Always Be Effective
- California High Court Rules That Lender Can Exclude Convicted Felon From Real Estate Deal
- Lerch Early Welcomes Creditors' Rights and Bankruptcy Attorneys
Borrower Has Different Rights and Obligations Under Swap Agreement and Loan Agreement
A court in Tennessee recently found that a borrower was obligated to pay a termination fee under the terms of a swap agreement notwithstanding that under the related loan agreement the borrower could prepay the loan at any time without penalty or premium.
In 2002, BKB Properties, LLC obtained a construction loan from and entered an interest rate swap with SunTrust Bank to finance a project located in Tennessee. The loan was for a 20 year term, had a variable interest rate and both the loan and the swap were secured by a deed of trust on the real property. BKB had requested a fixed rate loan, and SunTrust suggested the parties enter into the interest-rate swap agreement to achieve that goal.
Under the Construction Loan Agreement, BKB had the right “at any time or from time to time, to permanently prepay the Note in whole or in part, without penalty or premium.” However, under the swap agreement, SunTrust had “the right (but not the obligation) to terminate all or a pro rata portion of any Transaction related to the Loan Agreement and will be entitled to receive from . . . [BKB] the fair market value for such termination . . . [i]f the indebtedness under the Loan Agreement is (for whatever reason, in whatever manner) partially or fully paid or discharged (except with respect to any scheduled amortization) . . . .”
In 2006, BKB sought to refinance the loan, and SunTrust allegedly informed BKB that it would be required to pay a “substantial penalty” to refinance. Instead, BKB waited and later informed SunTrust of its intention to prepay the loan and end the swap agreement. According to BKB, SunTrust refused to accept payment, cancel the swap agreement or release its lien of the property, unless BKB paid the prepayment fee under the swap agreement. SunTrust took the position that the payment of the termination fee was consistent with the parties’ agreement under the swap transaction. Following unsuccessful negotiations to resolve the dispute, BKB filed a lawsuit claiming breach of contract, libel of title and a violation of the Tennessee Consumer Protection Act, and paid the swap termination fee under protest. SunTrust filed a motion to dismiss, which was granted by the district court.
On appeal, BKB argued, among other things, “that the termination fee assessed under the Swap Agreement served as the functional equivalent of a prepayment penalty on the Note and ‘therefore contradicts the agreement that BKB could prepay the loan without penalty or premium.’” SunTrust countered that the terms of the swap agreement clearly obligated BKB to pay an early termination fee, and that “the district court ‘properly rejected BKB’s attempt to bootstrap the ‘no prepayment penalty’ provision of the Loan Agreement onto the separate obligations between BKB and SunTrust under the Swap.” The court agreed with SunTrust, upholding the district court’s decision.
The court noted that, under the loan agreement, BKB had the right to prepay the note at any time, without penalty or premium. However, the court pointed out that, under the swap agreement, SunTrust had the right to receive from BKB the fair market value for such termination if the indebtedness under the loan agreement was partially or fully paid or discharged. The court found that “BKB had distinct obligations under the loan portion of the agreement and under the swap portion of the agreement—that is, BKB had an obligation to repay the Note and a separate obligation to make payments under the Swap.” As such, the court concluded when BKB prepaid the note, terminating the loan and the swap, SunTrust became entitled to the early termination fee by virtue of BKB’s separate, unambiguous obligation under the swap agreement. The court also noted that although BKB claimed the termination fee was functionally a prepayment penalty, BKB had not “identified any contractual language indicating that calling the Note would absolve it of its continuing duties under the interest-rate swap.” This case is cited as BKB Properties, LLC v. SunTrust Bank, Nos. 09-6260, 10-5065 (6th Cir. 07/12/11).
Jury Trial Waivers in Complex Swap Transactions May Not Always Be Effective
A North Dakota Court recently denied a defendant’s motion to strike a plaintiff’s jury trial demand, despite the fact that the plaintiff waived this right in the swap agreement, because the waiver was not made knowingly and voluntarily.
In 2007, a loan officer at Wells Fargo Bank, NA was contacted by Robert Nelson concerning construction financing. The financing was for a new building owned by one of Nelson’s companies, County 20 Storage & Transfer Inc. (“County 20”). Nelson had a long history of borrowing from Wells Fargo, a history that dated back almost two decades and encompassed millions of dollars. The bank offered Nelson two different financing options. The first option was a conventional promissory note secured by a mortgage against the warehouse building with interest at 6.4%. The second option, which would allow Nelson to obtain a fixed interest rate at 6.1%, was offered pursuant to a swap agreement. This required Nelson to enter into an International Swap Dealers Association (“ISDA”) Master Agreement.
A swap agreement is an exchange of one cash flow for another. In this instance, Nelson would pay the bank a “fixed rate multiplied by the notional amount of the interest rate swap transaction.” The “notional amount” was a fictional amount that equaled the amount in the linked promissory note, $2.45 million. Wells Fargo would pay Nelson a variable rate of interest multiplied by the same notional amount. With this arrangement, each time a payment was made the party that owed more interest paid the difference to the other party.
Nelson chose the swap option, and on behalf of County 20, entered into both a promissory note and ISDA Master Agreement. After Wells Fargo advanced the loan proceeds, Nelson approached Wells Fargo and asked it to substitute the collateral and another one of his companies—Precision Equipment Manufacturing of North America, Inc.—as borrower. Wells Fargo made the switch, and a new promissory note and ISDA were executed with Nelson signing as co-borrower.
At this point, the parties’ accounts of the facts diverge. In December 2008, Nelson contacted a new loan officer at Wells Fargo and claimed he told the bank officer that he wanted to re-transfer the promissory note from Precision to County 20. Nelson stated that the bank agreed. Nelson also contended that the bank officer told him that the loan documents could not be completed before the end of the year, so on the last day of December, Nelson obtained an unsecured bridge loan from another bank and paid off the outstanding balance on Precision’s note. Wells Fargo stated that even though Nelson paid off the note, the swap agreement still required monthly payments. In January, the borrower indicated he was advised that new lending requirements enacted at Wells Fargo precluded the bank from entering into a new note with County 20 at the same rate of interest. Nelson stated he offered to pay the higher rate, but Wells Fargo failed to prepare the loan documents. Wells Fargo maintained that no promise was made, no definite terms were discussed and it believed Nelson would obtain financing elsewhere.
Ultimately, Nelson ceased making payments under the swap agreement and filed suit against Wells Fargo, alleging six causes of action and demanding a jury trial. Wells Fargo filed a motion to strike the demand for a jury trial.
Wells Fargo argued that Nelson, on behalf of himself and Precision, knowingly and voluntarily waived the right to a jury trial by signing the ISDA Master Agreement and Schedule. The Schedule contained the following provision: “(G) WAIVER OF JURY TRIAL. EACH PARTY HEREBY IRREVOCABLY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY TRIAL OR LITIGATION ARISING OUT OF OR IN CONNECTION WITH ANY TRANSACTION OR THIS AGREEMENT.” Nelson contended that he did not know he was waiving his right to a jury trial.
The Court found that the burden of proving that the waiver was knowing and voluntary was on the party seeking to enforce it. Looking at several factors, the Court denied Wells Fargo’s motion to strike the jury demand. Some of the factors the Court considered were the fact that Nelson was not represented by an attorney, that Wells Fargo never informed Nelson of the jury waiver provision, and that the loan officer admitted “that he was challenged to understand the terms and conditions of the ISDA agreement.”
The Court noted that “even if Nelson was aware of the jury waiver provision, it is unlikely that he was aware of the legal consequences of such a waiver.” In further explaining its ruling it stated that “the jury waiver provision is, in essence, a ‘take-it-or-leave-it’ adhesion provision of the contract inserted into a 27-page complex financing agreement with no discussion as to the consequences….This was a complex derivative financing agreement that neither the Wells Fargo loan officers directly involved with the transaction understood nor did the customer (Nelson) have a clear understanding of. To suggest that there was a knowing and voluntary waiver of a jury trial is not supported by the evidence in the record.”
This case is cited as County 20 Storage & Transfer Inc., et al. v. Wells Fargo Bank, NA, 2011 WL 826349 (D.N.D. 03/03/11).
California High Court Rules That Lender Can Exclude Convicted Felon From Real Estate Deal
The California Court of Appeals recently ruled that a lender had legitimate business reasons to exclude a director from a company investment because the director was a convicted felon.
Ronald Semler was a member of ARI Overland, LLC. ARI applied for a mezzanine loan from General Electric Capital Corporation. GE Capital approved the loan and became an “equity investor” by making an investment in ARI. However, GE Capital also notified ARI that Semler could not be a party to the investment because he had been convicted of felonies in 1988. ARI excluded Semler as a member and did not allow him to invest in the company.
Semler filed a lawsuit alleging a violation of the California Unruh Civil Rights Act by GE Capital for discriminating against him because he was a convicted felon. The trial court ruled that Semler’s lawsuit was barred by the two-year statute of limitations for personal injuries and dismissed his lawsuit. Semler appealed. The Court of Appeals stated it did not need to investigate the question of whether the two-year statute of limitations barred his claim because it could resolve the underlying case by determining whether the Act applied to Semler.
The California Unruh Civil Rights Act mandates that all persons “are entitled to the full and equal accommodations” and are “free and equal, and no matter what their race, color, religion, ancestry, or national origin are entitled to the full and equal accommodations . . . in all business establishments of every kind whatsoever.” California courts have ruled that the Act may also protect personal characteristics other than those listed. For example, other cases have extended the Act to protect families with children from housing discrimination.
The question before the Court of Appeals in this case was whether a convicted felon is such a characteristic protected by the Act. While the Act’s enumerated characteristics are not morally objectionable, the court said, “Being a felon, however, denotes quite the opposite.” Individuals who fall within the Act’s listed categories generally are not restricted by other laws with respect to their rights and privileges. However, the court found that a felon does forfeit many rights and freedoms enjoyed by non-felons, such as disqualification from jury service and inaccessibility to firearms. The court also pointed out that felons are not protected by large bodies of law to protect classes of persons who have historically received adverse treatment, such as racial minorities and women. “In sum, there is no support in the language or history of the Unruh Act for Semler’s contention that being a felon is within its scope.”
The court also found that Semler’s criminal convictions raised legitimate questions about his honesty and trustworthiness, which were valid concerns in judging his creditworthiness. Accordingly, GE Capital had a legitimate interest in ensuring the creditworthiness of its borrowers and the court ruled that a person’s criminal history, as it relates to character and judgment, “bears a legitimate and manifest relationship to the extension of credit.”
Finally, the court determined that it was not equipped to substitute the lender’s judgment of creditworthiness of its borrowers, and that the potential consequences of allowing Semler’s claim to be tried in a court of law would improperly involve the courts in second-guessing the lending institution’s expertise in determining loan and investment criteria.
This case is cited as Semler v. General Electric Capital Corp., No. B221103, 2011 WL 2569286 (Cal. App. 2 Dist. 06/29/11).
Lerch Early Welcomes Creditors' Rights and Bankruptcy Attorneys
Lerch, Early & Brewer is pleased to announce the addition of Jeffrey M. Sherman and John E. Tsikerdanos as attorneys in the firm’s Creditors' Rights and Bankruptcy practice.
Jeff Sherman is a principal at Lerch Early who will chair the Creditor's Rights & Bankruptcy practice group. Jeff has represented creditors and debtors throughout the nation for more than 30 years. He received his Bachelor of Arts magna cum laude from City University of New York, Queens College and his Juris Doctor from The George Washington University Law School. Prior to joining Lerch Early, he was a principal at Jackson & Campbell in Washington, DC. Jeff is admitted to practice in the District of Columbia, Virginia, New Jersey and many courts across the United States.
John Tsikerdanos is an associate at the firm. John assists debtors and creditors with all matters regarding the bankruptcy courts in Maryland and the District of Columbia. John received his Bachelor of Science, cum laude, from West Virginia University and his Juris Doctor from West Virginia University College of Law. Prior to joining Lerch Early he was an associate at Jackson & Campbell.
Jeff and John are supported by paralegal Erin Moyer.
