Good faith and fair dealing in Lender’s Liability- Research

 By Yasser Latif Hamdani

Principle: A party to a contract breaches the implied covenant of good faith and fair dealing by interfering with or failing to cooperate with the plaintiff in the performance of the contract.

Case: Solfanelli v. Corestates Bank, MA, 203 F. 3d 197

Court: United States Court of Appeals, Third Circuit

Overview: The District Court concluded that Bank’s eleven month delay in selling the stock was commercially unreasonable. This was affirmed by the aforesaid court. It must be noted that in this case the debtor did not even request but rather withheld consent and yet the court ordered that the Bank’s delay was unreasonable.

Facts: The facts as far as they are relevant to our case here are that the plaintiff kept shares at collateral for debt. Unlike our case, the Bank sought the plaintiff’s consent to sell shares which was withheld. Yet the court ruled that the bank’s duty to conduct commercially reasonable sale was not waivable. 

Excerpts from the judgment:

We agree with the District Court that the test to determine "commercial reasonableness" should be whether the sale's every aspect is characterized by: (1) good faith, (2) avoidance of loss, and (3) an effective realization. United States v. Willis, 593 F.2d 247, 259 (6th Cir.1979). We also agree with the District Court that, in liquidating the collateral, the creditor acts as the debtor's fiduciary and has a corresponding good faith duty to maximize the proceeds of the collateral's sale. United States ex rel. Small Bus. Admin. v. Chatlin's Dep't Store, 506 F.Supp. 108, 111 (E.D.Pa.1980).

Here, the Solfanellis question the commercial reasonableness of the sale, and the burden falls to Meridian to show the sales' commercial reasonableness under the "totality of the circumstances." Savoy v. Beneficial Consumer Discount, 503 Pa. 74, 77, 468 A.2d 465 (1983). We find that Meridian has not met this burden. Meridian justifies its failure to sell the stock upon (1) Mr. Solfanelli's refusal to consent to the sale of the stock by Meridian, and (2) the terms of the parties' Stipulation and Security Agreement. Moreover, Meridian insists, as the Bankruptcy Court held, that Mr. Solfanelli's failure to demand a sale of the stock precludes any claim based upon the untimeliness of the sale.

When Meridian sought Mr. Solfanelli's agreement to sell the shares in early 1991, he declined to give his consent. Moreover, it is undisputed that Mr. Solfanelli did not at any point demand that the shares be sold. Neither of these facts, however, has the significance that Meridian would attribute to it. First, we note 201*201 that the undisputed record evidence indicates that the Solfanellis made no request that the stock be held at any point between March 1991 and the end of January 1992, from our point of view the crucial period for present purposes. Moreover, even if such a request had been made, it would be only one factor in determining the commercial reasonableness of the sale and would not preclude liability if the totality of the circumstances indicated that the sale was commercially unreasonable.

Ultimately, Meridian's argument regarding the debtor's requests is a red herring. In reality, rather than trying to honor a debtor's request through forbearance, Meridian focused on the risk that the FEB shares' value might fall below the loan balance. After Meridian focused on that, there were repeated days when the stock sold for $16 or $17 a share. Meridian neither engaged a broker, nor put in place a monitoring scheme or strategy for executing on this collateral. At trial, Meridian did not offer any credible explanation for retaining the stock for eleven months after filing the certificate of default, while the stock continued to deteriorate. While plaintiff's expert, a bank president, testified that Meridian did not act in a commercially reasonable manner in holding the stock, Meridian's expert declined to give an opinion on the matter, one way or the other. It is evident to us that Meridian was derelict in its responsibility to move ahead in good faith and to realize as much as possible for the Solfanellis' benefit.

Nor can we accept the proposition that a demand for a sale of the collateral is a prerequisite in these circumstances for a claim based on a commercially unreasonable delay. FDIC v. Caliendo, 802 F.Supp. 575 (D.N.H.1992), which the Bankruptcy Court relied upon for that proposition, is inapposite here. We agree with the District Court's analysis regarding Caliendo. In that case, the District Court for the District of New Hampshire found that where a loan was over-collateralized, clearly not the status in the present case, the secured creditor has a duty to preserve the value of the collateral, pursuant to U.C.C. § 9-207(1), only if the debtor requests that the collateral be redeemed. The Court in Caliendo did not address the creditor's duty under § 9-504 to dispose of collateral in a commercially reasonable manner. The Solfanellis have not argued that Meridian had a duty to preserve the value of the FEB stock, and thus we agree with the District Court that Caliendo does not bear on this case. Even if § 9-207 were applicable, however, we think it clear that Meridian cannot be relieved of its obligation under § 9-504 to dispose of the collateral in a commercially reasonable manner, irrespective of a debtor's instruction to sell or to hold.

Case: United States v. Willis, 593 F. 2d 247

Court: United States Court of Appeals, Sixth Circuit.

Overview:

Facts:  Facts revolve around commercially unreasonable sale of collateral and are not directly analogous to our situation.

Excerpts from the judgment:

Involved here is a uniform provision which imposes upon a creditor a duty of good faith in disposing of collateral entrusted to it. Its apparent purpose is to protect debtors from unnecessary loss upon sales of the collateral by their creditors following foreclosure.^[9] Adoption of state law as the federal 254*254 rule of decision in these circumstances does not appear to unduly burden the Government; all it need do is exercise good faith in the disposition of collateral entrusted to it. This much we would hope it would do even without the rule and appears to be no more than a fair requirement in any case.

This Court cannot and will not sanction the kind of economic waste and financial hardship the Government's interpretation of this language has the potential of bringing about. The guaranty agreement executed by defendants clearly conferred broad power and discretion upon the SBA to deal with the collateral upon Opticron's default. However, it is our belief that the discretion conferred was never intended to be boundless, and that the powers conferred carry with them a duty to exercise them in a good faith attempt to maximize the proceeds of sale.

Case: Savoy v. BENEFICIAL CONS. DISCOUNT CO., 468 A. 2d 465

Court:  Supreme Court of Pennsylvania.

Overview/Facts:  Plaintiff had acquired a loan from the Defendant and had secured it through her Cadillac. The Defendant sold the Cadillac for a value much lower than it was worth. The Court held the sale unreasonable commercially.

Excerpts from the Judgment:

 When a private sale of repossessed collateral has been made, and the debtor raises the question of the commercial reasonableness of that sale, the great weight of authority holds that the burden of proof on this issue is shifted to the secured party seeking a deficiency judgment to show that, under the totality of circumstances, the disposition of collateral was commercially reasonable. United States v. Willis, 593 F.2d 247, 258 (6th Cir.1979); 59 A.L.R.3d, Reasonableness of Disposition of Collateral, § 4, pp. 378-380 (1974); 69 Am. Jur.2d, Secured Transactions, § 623, pp. 530-531 (1973).

Case: Reid v. Key Bank of Southern Maine, Inc., 821 F. 2d 9

Court: United States Court of Appeals, First Circuit.

Overview:  Plaintiff argued that the Bank violated an implied covenant of good faith contained in the March loan agreement between plaintiffs and the Bank. The Jury at the District Court ruled in the Plaintiff’s favour and on appeal the US Court of Appeals, First Circuit, affirmed it.

Facts:  Plaintiff approached Bank to obtain financing for the establishment of a painting business. Bank granted Plaintiff a series of loans which Plaintiff used for the operation of his business, Pro Paint and Decorating. Plaintiff and Bank entered into a $25,000 commercial credit agreement. The agreement was variously explained at trial as a "line of credit" and an "incomplete loan." Plaintiff’s contractor sent the bank a cheque for Plaintiff’s work. It was made out to Bank and to Pro Paint pursuant to an agreement between Bank and Plaintiff whereby Plaintiff assigned his accounts receivable to Bank as security for the March loan. Bank credited $2,500 to the account of Pro Paint and applied the remaining $4,007.90 to offset part of the outstanding balance on Plaintiff's March loan. Plaintiff claimed that Bank undertook this action without his authorization. Plaintiff claimed that another check was also inappropriately handled by Bank. He testified that on June 8, 1979, he gave the Bank a check for an amount somewhere between eleven and fifteen thousand dollars. Plaintiff contended that this check represented the proceeds for work he performed at Brunswick Naval Air Station. He alleged that Bank converted the check and used it to offset part of the balance on the March loan. On September 20, 1979, Plaintiff received a past-due notice on the March loan. The notice requested payment of $694.84 in interest and stated that the payment had been due on September 5, 1979. Plaintiff testified that this was the first notice he had received concerning the March loan. On November 5, 1979, the Bank repossessed Plaintiff’s personal automobile and one of his vans. Plaintiff’s business collapsed and he lost his four vehicles and his home. On November 7, 1979, the Plaintiff filed a Chapter 13 bankruptcy proceeding which was converted to a Chapter 11 proceeding in January, 1980. The Plaintiff brought a seventeen-count action in United States District Court for the District of Maine against the Bank. Jury trial found in favour of the Plaintiff on the issue of breach of an implied covenant of good faith.  Both parties however appealed the decision. The Bank appealed against the judgment on implied covenant of good faith and the Plaintiffs appealed on the judgment on breach of fiduciary duty.

Excerpts from the judgment:

Plaintiffs' recovery in contract was based on the theory that when Depositors, in May 1979, and thereafter, shut off Reid's credit and took steps to realize upon its collateral, it violated an implied covenant of good faith contained in the March loan agreement between plaintiffs and Depositors. The district court took as self-evident the proposition that Maine contract law required good faith performance. See generally Burton, Breach of Contract and the Common Law Duty to Perform in Good Faith, 94 Harv.L.Rev. 369 (1980). The Uniform Commercial Code, as adopted by Maine, states: "Every contract or duty within this Title imposes an obligation of good faith in its performance or enforcement." 4 Me.Rev.Stat.Ann. tit. 11, § 1-203 (1964). That this obligation carries with it a cause of action seems clear from another provision of the Code: "Any right or obligation declared by this Title is enforceable by action unless the provision declaring it specifies a different and limited effect." Id. at § 1-106(2). See also Restatement (Second) of Contracts § 205 (1979).

We have examined the judge's original instructions as well as his subsequent clarification of those instructions to determine the precise nature of the test submitted to the jury. In regard to the contract claim, the judge initially formulated two standards. First, he stated that the contract, as a whole, was subject to a "covenant of good faith and fair dealing." Second, with specific reference to the claim that Depositors inappropriately disposed of Reid's collateral, he stated that the bank had a duty to act in a "commercially reasonable manner." In setting the latter standard, he cited Article 9 of the U.C.C. See 5 Me.Rev.Stat.Ann. tit. 11, §§ 9-501-504. He then twice defined "good faith" in terms indicating a purely subjective standard. He concluded the instruction, however, by reformulating the "good faith" test as including an objective standard of reasonableness.

The jury later requested that the judge clarify these instructions. In his new instructions, the judge clearly formulated a subjective standard for good faith:

Now good faith is defined as honesty in fact.

15*15 One acts with good faith, in general, when one acts honestly.

Good faith means that one acts without any improper motivation. One acts with the truth and not for some ulterior motive that is unconnected with the substance of the agreement in question when one is acting with good faith. The judge again referred to the "commercially reasonable" standard only in connection with Article 9 violations. We find, therefore, that the judge ultimately instructed the jury to decide the issue of good faith under the subjective standard. "Honesty in fact" is required under all interpretations of the duty of good faith under section 1-203. Thus, even if we agreed with defendant that the Maine courts would limit an objective standard for good faith to Article 2 cases, we would not find a fatal error in the judge's instructions here.^[2]

Case: Sutherland v. Barclays American/Mortgage Corp., 53 Cal. App. 4th 299, 314, 61 Cal. Rptr. 2d 614 (1997)

Court: Court of Appeals of California, Second District, Division One.

Facts:  Plaintiff owned a condominium that sustained severe damage in an earthquake. Plaintiff contacted her mortgage company, explained what had happened, and stated that she had to move out of the damaged unit and rent another residence. The mortgage company agreed to put a "stop" on her account for three months, during which time she did not have to make any payments. Plaintiff thought that, at the end of the three-month period, her mortgage payments would resume in the regular amounts, thereby extending the life of the mortgage by three months. A week before the end of the "stop" period, the mortgage company informed Plaintiff that her next scheduled payment had to include not only the regular monthly amount but also the sum of the three months' payments not made during the "stop" period. Plaintiff could not afford that sizable a payment, so she sent the mortgage company a check for one month only. The mortgage company returned the check as an improper partial payment and declared her in default. She filed an action against the Mortgage Company. The trial court found – in summary judgment- in favour of the Mortgage Company. She appealed in the aforesaid court. The aforesaid court reversed the judgment.

Excerpts from the judgment:

 “Even if we ignore the circumstances surrounding the parties' oral agreement, we cannot conclude that an agreement to "stop" a loan account for three months means that, as a matter of law, the excused payments will all be due in the fourth month. A mortgagee's statement that it will temporarily "stop" an account does not indicate with reasonable certainty when the excused payments have to be made. Such a statement is ambiguous and should arguably be construed in favor of the borrower. (See Civ. Code, § 1654.) Moreover, to the extent the parties' competing interpretations of the "stop" payment agreement are equally plausible, the agreement should be interpreted in favor of the borrower, since it was for her benefit that the agreement was made.”

“In these circumstances, we cannot say that, as a matter of law, Sutherland was obligated to continue making regular monthly payments after May 1994. Surely, Barclays would have returned them. The law did not require Sutherland to engage in futile or useless acts. (See Civ. Code, § 3532.) Having returned Sutherland's May 1994 payment, informed her that such "partial" payments would not be accepted, and declared her in default on May 12, 1994, Barclays can hardly maintain that Sutherland should have been making regular payments after the three-month "stop" period. Accordingly, Barclays was not entitled to judgment on the causes of action for declaratory relief and breach of contract.”