2nd Circuit Rules That Lender Did Not Unlawfully Demand Accrued Interest and Fees After a Default

Commercial Lending Bulletin
A recent decision from the U.S. Court of Appeals for the Second Circuit highlights the extent to which courts will enforce loan documents in accordance with their terms rather than imposing uncertain standards of fairness, equity, or good faith. In Gaia House Mezz LLC, et al. v. State Street Bank and Trust Co., the Circuit Court ruled that equitable remedies cannot be used to challenge the actions of a lender that acted within its rights under the loan documents.
In December 2006, Gaia House Mezz LLC entered into a loan agreement with Lehman Brothers to finance the construction of a residential building. After Lehman Brothers’ bankruptcy in September 2008, State Street assumed Gaia’s loan. After a number of defaults and loan modifications, State Street notified Gaia that it would not waive the collection of accrued interest due under the loan agreement.
In July 2011, Gaia refinanced the State Street loan with another lender. Under protest, Gaia also paid approximately $4.5 million in accrued interest and $370,000 in professional fees.   Gaia then filed a lawsuit against State Street, alleging it was entitled to a return of the accrued interest and professional fees because State Street failed to give notice of default or of its intent to collect the accrued interest and therefore State Street modified the loan documents through its actions.   Following a bench trial, the lower court found that principals of equity required State Street to return the accrued interest and professional fees paid by Gaia.
On appeal, however, the appellate Court found there was no question that Gaia defaulted under the loan and State Street was entitled to demand the accrued interest and professional fees from Gaia under the terms of the loan agreement. The only question before the court was whether equitable considerations should be imposed instead of the express terms of the loan documents.   The Second Circuit found that State Street's actions did not give rise to a claim of equitable estoppel, which prevents one party from being harmed by another party’s voluntary actions or inaction. The covenant of good faith and fair dealing cannot be used "to imply an obligation inconsistent with the other terms of a contractual relationship," and equity need not intervene to prevent "contracted-for financial consequence[s]" under a loan agreement.
Although the Court found that Gaia failed to prove that an equitable remedy was warranted, this case illustrates that a court may impose equitable principles when a party’s actions are inconsistent with a written agreement and further demonstrates the importance for a lender to act consistently with the terms of the loan documents, especially after the occurrence of an event of default under the loan.  
This case is cited as Gaia House Mezz LLC et al.,  v. State Street Bank and Trust Co., No. 12-2481-cv, 2013 WL 2500579 (2d Cir. 06/12/13).
Michael Smith is a commercial lending attorney at Lerch, Early & Brewer in Bethesda, Maryland who structures, negotiates, documents, conducts due diligence in and closes commercial lending transactions. For more information, contact Michael at (301) 657-0166 or

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