January 18, 2012
In This Issue:
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Forum Selection Clauses In Promissory Notes May Be Effective Against Guarantors
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Federal Court Rules That Lender May Assert Negligence Claim Against Another Lender
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Sixth Circuit Affirms Judgment Against Borrower for Prepayment Penalty in Swap Agreement
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Tip of the Month: Be Aware of New Ruling Re Attorneys’ Fees in Judgment Provisions
Forum Selection Clauses In Promissory Notes May Be Effective Against Guarantors
A federal court in Kansas recently held that guarantors who were residents of Arizona, and who absolutely and unconditionally guaranteed the payment of an Arizona company’s debt for the purchase and improvement of real property located in Arizona, could be sued in Kansas and Kansas law could govern. The guarantees stated that the guarantors were subject to all the terms in the promissory note and the note selected Kansas as the forum for disputes.
In 2007, First National Bank of Olathe issued a $9.1 million loan to Dove Valley LLC, evidenced by a promissory note. Among other things, the note was secured by guaranties from 11 individuals (all of whom resided in Arizona) and one corporation, which was based in Arizona. Sunflower Bank, among others, entered into a Loan Participation Agreement with First National and purchased a 55% participation interest in the loan.
In 2010, a few years after the loan was executed, Dove Valley LLC defaulted. The parties engaged in negotiations which resulted in a renewed loan for $9,117,999 with Sunflower assuming First National’s position as lead lender. The parties executed new loan documents, including guaranty agreements, to that effect.
In 2011, after Dove Valley LLC again defaulted, Sunflower accelerated the loan and filed suit seeking enforce the 2010 guaranty agreements. The guarantors filed motions to dismiss, arguing that Kansas did not have personal jurisdiction over them “and that for reasons of convenience, the court should transfer the action to the United States District court for the District of Arizona.” The court denied the guarantors’ motions to dismiss.
The court first looked at the choice of law provision found in the signed guaranties. The provision stated that: “This Guaranty is governed by the laws of Kansas, the United States of America, and to the extent required, by the laws of the jurisdiction where the Property is located, except to the extent such state laws are preempted by federal law.” The court noted that it found no circumstances that required the application of Arizona law, as Arizona law did not compel a contrary result. The court stated that the guaranties required the application of Kansas law to reflect the parties’ effective and voluntary choice.
The guarantors contended that because the Kansas forum selection clause was found only in the note, and not the guaranties, keeping the lawsuit in Kansas was not justified. The court held that the guarantors were subject to the provision in the note selecting Kansas as the forum. The court explained that the guaranties expressly directed the guarantors “to abide by the terms of the [n]ote” because the under the guaranties, the guarantors absolutely and unconditionally guaranteed the payment and performance of the “Debt”—which term was expressly defined in the guaranties to include the note.
The guarantors further argued that when they executed the guaranties, they did not intend to subject themselves to jurisdiction in Kansas. The court did not find this argument persuasive and explained that, “an agreement to litigate in a specific forum cannot be later thwarted by the expediency of asserting a contrary subjective intention” or by “an alleged failure to subjectively understand the import of the agreement.” The court further held the enforcement of the forum selection clause was reasonable, stating that while the guarantors “may indeed suffer some inconvenience by defending this action in Kansas, such a result by itself does not authorize ignoring the agreement of the parties.”
Furthermore, the court held that even if the note did not contain a Kansas forum selection clause, the action could be maintained in Kansas. The action could be maintained in Kansas because the minimum contacts requirement of due process clause of the Fourteenth Amendment—“that a non-resident defendant had sufficient contacts with Kansas to reasonably anticipate being hauled into court here”—was satisfied when the guarantors “purposefully engaged in commercial activities with Kansas financial institutions” and Sunflower’s alleged damages arose from these activities. As examples of these contacts, the court cited numerous emails, phone calls and letters with Sunflower in Kansas. The court stated that “a reasonably prudent guarantor would have understood that by executing the 2007 and 2010 [guaranties]—which explicitly identify the lender as a Kansas bank, with a Kansas address, creating an agreement that is subject to Kansas law, and which explicitly or by incorporation included a provision for exclusive Kansas jurisdiction – the guarantor was subjecting himself or herself to jurisdiction in Kansas.”
The court’s decision was not affected by the guarantors’ course of dealings with the Scottsdale, Arizona office. The court held that the localized course of dealings could not alter the express terms of the guaranties “which provide that the guarantors were formally and explicitly agreeing that they were undertaking their obligations in order to induce a Kansas bank to extend credit.” Additionally, the lenders never waived their right to expect performance in Kansas, and reminded the guarantors to send communications to Kansas.
This case is cited as Sunflower Bank, N.A. v. Lund, 2011 WL 4526780 (D. Kan. 9/28/11).
Federal Court Rules That Lender May Assert Negligence Claim Against Another Lender
A U.S. District Court in Texas has ruled that under Texas law, an existing lender may assert a negligence claim against new lender in connection with failed payoff of the existing lender debt.
In September 2007, Sambrano Corporation obtained a $4 million secured line of credit from Compass Bank. A portion of the proceeds of the Compass line of credit were to be used to refinance Sambrano’s existing line of credit with City Bank. However, rather than remit payment directly to City Bank, Compass advanced the full amount of the line of credit directly to Sambrano, which, unbeknownst to Compass, did not repay the City Bank line of credit.
In January of 2008, Compass and City Bank initially discovered that both credit facilities remained open and fully funded. After failing to recover its line of credit from Sambrano, City Bank filed a lawsuit against Compass, asserting, among other claims, that Compass acted negligently by directly advancing to Sambrano the proceeds of the Compass line of credit, instead of sending payment directly to City Bank to pay off its line of credit.
In order to maintain a claim for negligence, a plaintiff generally must establish, among other elements, that the defendant owed a duty of care to the plaintiff. Arguing that it had no duty to ensure the loan proceeds were used to repay City Bank, Compass moved to dismiss the negligence claim. Despite the fact that Compass did not have a direct relationship with City Bank, contractual or otherwise, the District Court refused to dismiss the negligence claim.
In its complaint, City Bank alleged that Compass was aware (a) of the existing City Bank line of credit, (b) that the proceeds of the new Compass line of credit were to be used to repay the existing City Bank line of credit facility, (c) that the most appropriate and secure way to ensure such repayment was for Compass to remit payment directly to City Bank, and (d) that having both lines of credit open and fully drawn at the same time posed a risk to City Bank and Sambrano’s other creditors.
The District Court stated that Texas law provides an exception to the general rule that a lender owes no duty to someone with whom it has no lending or other relationship. In particular, the District Court stated that under Texas law, a lender may owe a third party a duty of care in relation to the conduct of the lender’s customer if the lender:
- Knows the identity of the third party,
- Is aware of a potential harm to a third party, and
- Has a way to avoid that harm.
Reasoning that City Bank’s allegations, if true, would give rise to a duty of care under Texas law, the District Court denied Compass’ motion to dismiss City Bank’s claim for negligence.
This decision is an excellent reminder to lenders: when refinancing an existing loan it is always the best practice to remit payment directly to the existing lender or a title company in escrow.
This case is cited as City Bank v. Compass Bank, 2010 U.S. Dist. LEXIS 66260 (W.D. Tex. July 2, 2010).
Sixth Circuit Affirms Judgment Against Borrower for Prepayment Penalty in Swap Agreement
In a recent matter in Tennessee, a court determined that while a Loan Agreement and a Swap agreement may be construed as part s of the same transaction, each agreement provides for distinct and separate obligations.
Many lenders now use Swap Agreements to provide fixed rate repayment alternatives to borrowers on variable rate loans. Under most loans utilizing swaps, while there may not be a prepayment fee charged under the note, the swap agreement normally provides for the possibility of termination fees in the event the loan is paid off and the swap is terminated. So long as the lender properly documents the loan transaction and swap transaction to provide for these fees, it should be able to enforce its rights to collect the early termination fees.
On March 12, 2002, BKB Properties, LLC and SunTrust Bank entered into a commercial loan agreement and a derivative interest-rate swap agreement. SunTrust agreed to provide $6.96 million to finance BKB’s construction project for improvements on a property in Tennessee.
The Loan Agreement provided that the term of the loan was for 20 years and that the loan could be paid in full, at any time, without penalty. BKB was to pay a variable interest rate on the loan. During negotiations, BKB expressed an interest in obtaining a fixed-rate loan, and SunTrust advised that this could be achieved through a Swap Agreement. Under a Swap Agreement, one party makes periodic interest payments to the other party at a fixed-rate on an agreed upon amount, often referred to as the notional amount, and the counter-party makes periodic interest payments at a variable rate on the same notional amount. The Swap Agreement provided BKB with a fixed rate of 8.08% of the notional amount for a 10 year term. Additionally, the Swap Agreement incorporated a termination fee in the event of early termination. Both the Loan Agreement and the Swap Agreements were secured by a deed of trust on the property.
In 2004, BKB informed SunTrust that it wanted to refinance the loan. SunTrust informed BKB that it would be required to pay a substantial penalty in order to terminate the Swap Agreement. As a result, BKB did not refinance the loan.
In March 2007, BKB informed SunTrust that it was going to prepay the Loan Agreement in full, and terminate the Swap Agreement. SunTrust refused to cancel the Swap Agreement or remove its lien from the property, unless BKB paid the swap termination fee. SunTrust stated that the Swap Agreement provided for unambiguous language that there would be a termination fee applied to BKB in the event of early termination.
In April 2008, BKB filed suit against SunTrust for breach of contract and libel of title, in Tennessee state court. In May 2008, SunTrust removed the case to Tennessee federal district court, based upon diversity jurisdiction, and moved to dismiss BKB’s claims.
The district court agreed with BKB’s contentions that the Loan Agreement and the Swap Agreement should be construed as parts of the same transaction. However, the district court held that each agreement provides for distinct and separate obligations. The Loan Agreement provides that BKB must repay the note, and the Swap Agreement provides for a separate obligation to make payments. Nowhere in the agreements does it provide that the Swap Agreement would be cancelled if the note was prepaid. Therefore, the obligations under the Swap Agreement remained.
Additionally, the district court held that, even in the event that the note was paid in full, SunTrust had a right to retain its lien on the property until the Swap Agreement was fulfilled. Therefore, the district court held in favor of SunTrust, with regard to the libel of title claim.
BKB appealed the decision to the Court of Appeals. The Court of Appeals affirmed the district court’s decision, stating that the Loan Agreement and the Swap Agreement created “two separate financial obligations.” One could be prepaid without penalty, and one could not. Additionally, the Court of Appeals stated that BKB was “a sophisticated commercial entity” that willingly entered into a contract with unambiguous terms.
This case is cited as BKB Properties, LLC v. SunTrust Bank, 2011 WL 2711156 (C.A. 6 (Tenn.)).
Tip of the Month: Be Aware of New Ruling Re Attorneys’ Fees in Judgment Provisions
On September 30, 2011, Maryland’s highest court ruled that if awarding attorneys’ fees equal to a percentage of the outstanding principal balance of a loan causes an inequitable result, courts should not enter a judgment for such amount notwithstanding the terms of any loan agreement the parties may have entered into.
The court reasoned that the attorneys’ fee provision is intended to make the lender whole, rather than to result in a windfall; therefore, the amount of the judgment entered should not exceed the current and possibly anticipated legal fees incurred due to the default.
The court would not enter a judgment for the calculated attorneys’ fees even where the lender agreed to collect from the borrower only its actual attorneys’ fees incurred.
The court also raised the technical legal issue of “merger” as a reason for possibly denying the recovery of post-judgment attorneys’ fees. Based on this decision, we are revising our attorneys’ fees provision in our Maryland loan documents, but for now we are continuing to have percentage calculated attorneys’ fees in our confession of judgment provisions.
