Construction Law Today : Construction Lawyer & Attorney : Joshua Glazov : Design Build Contracts, Construction Bankruptcy

• Fraudulent Inducement and Misrepresentation

The best known case is

Langley v. FDIC. In the Langley decision, the borrowers (Mr. and Mrs. Langley) borrowed money from a bank to buy land in Louisiana. Later, they sued the bank claiming that some of the bank's representatives misled them about (a) the total acreage of the land and (b) how many of those acres were "mineral acres." Then the bank failed and the FDIC acquired the borrowers' loan. The borrowers tried to use the bank representatives' misrepresentations as a defense against the FDIC's efforts to collect on the loan. But the FDIC responded that those misrepresentations were "agreements" for purposes of the D'Oench, Duhme doctrine and Section 13(e). As "agreements," the misrepresentations must comply with the 4 Requirements. And because they didn't, the borrowers couldn't use the misrepresentations as a defense. The case went all the way to the U.S. Supreme Court. Unfortunately for the borrowers, Justice Antonin Scalia wrote the court's unanimous decision agreeing with the FDIC.
Listen just below to the U.S. Supreme Court oral argument in the Langley case. Take special notice of how the borrowers' lawyer urges the justices to not D'Oench the borrowers. He laments: "the statute's mean, it's tough, it's not fair, it's really not fair!!" But all eight of the justices hearing the case still decide against the borrowers.
Another important and frequently cited case is Adams v. Walker. The borrowers in the Adams decision borrowed money from a Kansas bank to invest in an RV sales company. They also guaranteed some of the RV company's debts to the same bank. The bank's president operated and owned a majority stake in the RV company. He also gave the borrowers various oral assurances about the loan and the prospects for the RV company's success. The bank failed. The FDIC sold the borrower's loan and the guarantees; the buyer then tried to collect on both. The borrowers defended saying that they shouldn't have to pay because the bank's own president misled them into borrowing money and guarantying the RV company's debt. The buyer's response: that all may be true, but it doesn't matter. The bank president's misrepresentations were "agreements." And because those agreements didn't satisfy the 4 Requirements, the borrowers couldn't use them as a defense against the FDIC's or the buyer's collection on the loan or guarantees. Judge Sam A. Crow hearing the case agreed with the buyer.
Completing a quartet of cases on the D'Oenching of fraud and misrepresentation claims and defenses is Adams v. Madison Realty & Development, Inc.. Besides echoing the Langley v. FDIC and Adams v. Walker decisions, the two Adams v. Madison Realty & Development, Inc. decisions also say misrepresentations from a third-party (instead of from a bank representative) are also "agreements" that must comply with the 4 Requirements. The first of is Judge Alfred Wolin's District Court decision from New Jersey. Second is Judge Robert Cowen's 3rd Circuit Court of Appeals decision affirming Judge Wolin's decision.


Loan Commitment Letters
In Fleet Bank of Maine v. Prawer an acquisition and construction loan commitment letter said: "this loan shall be repaid from the sale of the mortgaged property or its refinancing into a residential subdivision loan." But that qualification on the borrower's duty to repay the loan never made it into the promissory note. Nor did the promissory note, or any other loan document, mention that qualification or refer back to the qualification in the commitment letter. After the bank failed, the FDIC sold the loan to Fleet Bank. When Fleet Bank tried to collect on the loan, the borrower tried to avoid paying because, as provided in the commitment letter, the property hadn't yet been sold nor had the original acquisition and construction loans been refinanced. Fleet Bank urged Judge Gene Carter to treat the commitment letter qualifications as an "agreement" subject to D'Oench and Section 13(e) that didn't comply with the 4 Requirements. He did; and so he didn't allow those qualifications to stop Fleet Bank from collecting on the loan.
Breach of Many Duties and Covenants (E.G., Fiduciary Duty, Duty of Care, Good Faith)
Claims and defenses like breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, and negligence get D'Oenched too. Clay v . FDIC is a good example. In the Clay decision Judge Jerry E. Smith from the 5th Court of Appeals D'Oenched loan guarantors' attempts to avoid paying-up on their guarantees. The guarantors said that the FDIC, and a bank that bought the affected loans from the FDIC, carelessly managed the enforcement of, and collection on, the underlying loans. But Judge Smith said that because the FDIC couldn't identify those defenses from looking at the banks official records (i.e., the guarantees), the D'Oench Duhme doctrine and Section 13(e) must deny those defenses.
Withholding Approval of Leases
In RTC v. Sharif-Munir-Davidson a borrower tried to defend against enforcement of a loan secured by an office building. The borrower originally borrowed the money from a bank and gave the bank an assignment of rents and leases as security for the loan. The assignment of leases and rents gave the bank the right to approve each proposed tenant. The borrower defaulted on the loan and the bank sued to foreclose on the office building. Then the bank failed and the Resolution Trust Corporation (the "RTC") took over the lawsuit as the bank's receiver. The borrower defended contending that (a) the bank had unreasonably withheld approval of proposed tenants, and (b) that withholding of approval caused the borrower to default on the loan. So, consequently, the borrower shouldn't have to repaying the full loan.
The RTC responded saying that nothing in the assignment of leases and rents required the bank to be reasonable in deciding whether to approve a tenant. And because that duty was not in the assignment or any other of the loan documents, under the D'Oench, Duhme doctrine and Section 13(e), that defense couldn't apply against the RTC. The 5th Circuit's Judge Irving Loeb Goldberg agreed with the RTC and denied the borrower's defense.

Handwritten and Initialed Changes to Loan Documents
In FDIC v. Gilbert a borrower and their bank hand-wrote changes to the principal amount on a promissory note. Each initialed the change. After the bank failed and the FDIC tried to collect on the promissory note, the borrower tried to avoid the hand-written change. The FDIC responded saying that under the D'Oench, Duhme doctrine and Section 13(e), the hand-written changes should be enforced as written. The 5th Circuit's Judge Thomas Morrow Reavley agreed with the FDIC.





Common Law Setoff
At least one judicial decision, Fleet Bank of Maine v. Steeves, applies D'Oench, Duhme and Section 13(e) to deny a borrower's attempt to setoff a counterclaim against money due under a loan. The borrower had two separate loans from her bank: (a) an equity line of credit loan and (b) a construction loan. None of the loan documents for either loan referenced the other loan. Neither set of loan documents provided that the bank's failure to perform under one loan would excuse the borrower's failure to perform under the other loan.
The construction loan allowed the bank to withhold 10% retainage from each interim loan disbursement during construction. But even though the bank received notice that the contractor was not properly performing construction work, the bank didn't withhold 10% retainage from any loan disbursement to pay the contractor.
The borrower defaulted on the equity line loan and the bank sued her. She asserted a counterclaim alleging that the bank's failure to withhold 10% retainage from each disbursement under the construction loan damaged her. The borrower also wanted to set her counterclaim damages off against what she owed the bank under the equity line loan. While that lawsuit was pending, the bank failed, the FDIC stepped into the lawsuit as the bank's receiver and sold the loans to Fleet Bank.
Fleet Bank responded that the D'Oench, Duhme doctrine and Section 13(e) should prevent the borrower from setting her construction loan counterclaim off against what she owed under the equity line loan. Judge Gene Carter (the same judge from the Fleet Bank v. Prawer decision I mentioned above) once again agreed with Fleet Bank holding that D'Oench and Section 13(e) stop the borrower from setting her construction loan counterclaim off against what she owed Fleet Bank under the equity line loan. He specifically focused on the facts that:
• Neither the equity line loan documents nor the construction loan documents referenced each other. So the failed bank's official records didn't reflect that the bank's default under the construction loan would reduce what the borrower owed under the other loan. Consequently, the borrower didn't satisfy the 4 Requirements' official records requirement.
• The borrower and the failed bank entered into the equity line loan documents and the construction loan documents at different times. So the borrower couldn't satisfy the 4 Requirements' contemporaneous requirement.

The critical things these examples emphasize: when you get assurances affecting your loan from, or guaranty to, a bank, and those assurances don't satisfy each of the 4 Requirements, if the bank fails, expect your assurances to evaporate. When dealing with banks - especially when negotiating "work-outs" - prudent borrowers and guarantors keep the 4 Requirements in mind and work assiduously to ensure each is satisfied. Because after they got a hold of your promissory note or guaranty, the FDIC's going to have the 4 Requirements on their minds hoping that you satisfied 3 or fewer. So will those who buy loans from the FDIC. And that's a good segue to the next post....