PAYTON WELLS UPDATE: STATUS QUO

Here's a brief update to my January 28/February 1 post on the demise of the Payton Wells auto dealerships, which appear to be in foreclosure.  Anderson's Herald Bulletin reports today that the city's Wells dealership and service department remain frozen in time since January 25, when borrower Wells locked its doors in response to lender Regions Bank's foreclosure suit.  Somewhat amazingly, customers' cars are still in service bays on the property.  It's been over thirty days.  I have no first-hand knowledge of the case and have not read any court filings (they're not on line).  Still, I'm a little surprised by the inaction, although my colleague Chris Jacobson, who has been involved in auto dealership foreclosures, tells me this kind of lock down is not unusual.  The appointment of a receiver, under Indiana Code 32-30-5, to run all or a part of the business usually is not a viable option in dealership cases.  I'll be on the lookout for media updates.

3-2-07 Update:  The Indianapolis Business Journal, in two small pieces, is reporting that customers have taken their complaints up with the Indiana AG's office:  1 and 2.  Still, nobody from Wells or Regions is talking.

ALLEGED GUARANTORS NEED NOT PROVE A NEGATIVE

In my January 16 post, The Commercial Lender's 8-Item Care Package for its Foreclosure Attorney, I recommend (as item number one) that all applicable loan documents be provided to outside counsel.  This would include any guaranty that was a part of the loan transaction.  As most of you reading this blog know, it is not uncommon for some business loans to have a personal guaranty, which specifically requires an individual to guarantee the financial obligations undertaken by the business.  In other words, the guarantor becomes secondarily liable for the business debt and, as such, will invariably be named as a defendant in the foreclosure suit.   

Although it may seem obvious, the plaintiff lender has the burden of proving the existence of the guaranty.  Without such evidence, a claim against a guarantor will fail, which is exactly what happened in a February 16, 2007 ruling by United States Magistrate Judge Andrew P. Rodovich for the Northern District of Indiana in Case No. 2:97 cv 276, United Consumers Club, Inc. et. al. v. Mark Bledsoe, et. al., 2007 U.S. Dist. LEXIS 11489.  Although the case involved the breach of a franchise agreement, not a promissory note, the holding applies with equal vigor to lenders:

If [plaintiff] is to maintain a claim based upon the execution of a written instrument, their initial burden of providing evidence of the document's existence cannot be shifted by requiring [defendants/alleged guarantors] to prove its non-existence....  [T]here is no evidence before the court that [defendants/alleged guarantors] signed a personal guaranty.  Accordingly, summary judgment is proper in favor of [defendants] on [plaintiff's] claim for breach of the personal guaranty.

The opinion does not specify whether someone lost the guaranty or whether there never was a guaranty in the first place.  The obvious point is - if as a lender you want to sue on a guaranty, you need to produce the written instrument, preferably to your attorney before suit is even filed.  Simply alleging a guaranty existed won't cut it - alleged guarantors are not required to prove a negative in order to prevail.

NOTICES OF DEFAULT: WHO SHOULD SEND THE LETTER?

Loan documents often require the commercial lending institution to provide written notice (a letter) to the borrower before initiating foreclosure or lien enforcement proceedings.  Some of our clients have wondered whether, in Indiana, the default letter can come from outside counsel.  In my view, an effective notice can come from counsel.  But, if the borrower has its own lawyer, the letter probably should come directly from the lender.

Is notice required?  To my knowledge, there is no common law rule or statutory requirement that the borrower receive notice and an opportunity to cure.  (The UCC, Article 9.1, has a notice provision in Part 6 “Default,” but the notice requirements apply only to the disposition of collateral after default.)  Indeed there are loan documents that do not contain notice provisions, in which case the lender can immediately file suit upon default.  On the other hand, if there is a notice clause, basic contract law dictates that notice be sent.  Usually, notice to the borrower must come from the lender and must be sent to a specific person at a specific address.  The best way to ensure effective notice is to do exactly what the parties agreed to do in the written contract(s).

Problem #1 – effective notice.  The common question is whether outside counsel can send the letter on the lender’s behalf.  Sometimes it makes practical sense for outside counsel to do so, and I believe this is the routine practice for many Indiana lawyers.  Default notice letters sent by outside counsel raise two potential problems, however.  The first relates to the effectiveness of the letter.  A literal reading of most loan documents state that notice must come from the lender, not from a lawyer on the lender’s behalf.  A creative advocate for the defaulting party may argue such notice is invalid.  To my knowledge, there is no Indiana case speaking to this specific question.  But I think most if not all judges would conclude that notice from outside counsel is effective because the lawyer is a representative of the lender.  More importantly, the borrower got the letter.  Who sent the letter, it seems to me, is a distinction without a difference.

Problem #2 – ethics.  The second and perhaps greater problem, at least for the lender’s attorney, surrounds the ethics of writing to the client of another attorney.  The issue is governed by the Indiana Supreme Court’s Rules of Professional Conduct, which regulate the practices of Indiana attorneys.  Rule 4.2 “Communication with person represented by counsel” states:

  In representing a client, a lawyer shall not communicate about the
  subject of the representation with a person the lawyer knows to be
  represented by another lawyer in the matter, unless the lawyer has
  the consent of the other lawyer or is authorized by law or a court order.

The purpose of Rule 4.2 relates to protections against “overreaching by other lawyers” . . . “interference by those lawyers with the client-lawyer relationship” . . . and “the uncounseled disclosure of information relating to the representation.”  (See, Official Comments).  Assuming the default notice letter is a standard, straight forward and to-the-point communication, the spirit of the rule, in my view, is not being violated.  This is particularly true if lender’s counsel “carbon copies” the borrower’s attorney on the letter, so that the borrower’s attorney has actual knowledge that the letter has been sent and can counsel his or her client accordingly.  Having said that, it’s my understanding that some Indiana lawyers disapprove of this practice and assert it is an ethical violation.  I concede there is a decent argument the practice technically violates Rule 4.2. 

Safety first.  Despite what I understand to be a relatively common practice, the more prudent approach is for default letters to come from the lender, not lender’s counsel, unless the borrower is unrepresented.  This technique will avoid conflict with the opposing party that could result in ill-will, which in turn could hamper settlement discussions or, more importantly, drive up legal fees associated with a fight.  Keep in mind that the letter still can be drafted by outside counsel.  It just needs to be signed in-house and on the lender’s stationery.  I therefore recommend that, in Indiana, commercial lending institutions declaring a default should (1) follow the explicit notice instructions in the operative loan documents and (2) have any required default letter come from the lender, not outside counsel, in the event the borrower is represented by an attorney. 

YIELD MAINTENANCE FEES, PART II: APPLYING INDIANA LAW

This is the second of a two-part article dealing with yield maintenance fees in the context of Indiana commercial foreclosure law.  In Part I, posted under the Court Commentary category, I summarized the only three Indiana cases on point.  I’ll now apply that case law and, given the rules, explore some of the decisions commercial lenders may face.

The rules.  The law from the Seventh Circuit and the Indiana Court of Appeals is definitive as to a few issues.  The general rule is that reasonable prepayment provisions are enforceable.  Thus yield maintenance fees (a/k/a prepayment premiums) can be recovered.  But there is an exception if a lender accelerates the debt (forecloses).  In that instance, the lender waives its claim to yield maintenance fees.  In other words, an election to accelerate generally is an exclusive remedy that will preclude the recovery of yield maintenance fees. 

Payoff vs. acceleration.  Assuming a reasonable yield maintenance fee provision is in the note, a pure payoff by the borrower (an election to prepay the note) generally will permit the assessment of reasonable yield maintenance fees designed primarily to compensate the lender for its lost interest.  On the other hand, a pure foreclosure by the lender (an election to accelerate the note payments) probably will defeat a claim for such fees.  When lenders hire my firm to foreclose on loan collateral, therefore, we advise that it will be difficult to recover yield maintenance fees.  Usually, the lender’s only remedy will be what is articulated in the default/acceleration clause of the note, typically the recovery of the unpaid principal balance, accrued interest, late fees and litigation expenses.  Of course, not all cases are the same, and there are exceptions to every rule.  As a foreclosing lender, don’t give up on yield maintenance fees until you or your lawyer fully evaluate the issue.

The junior lender’s dilemma.  Recently, a lender hired my firm to protect its interests, many but not all of which were subordinate to a senior lender’s.  Although our junior lender client was getting paid, the senior lender was not.  So, our client got dragged into the senior lender’s foreclosure case.  Our note had a yield maintenance provision.  Of course the client wanted yield maintenance fees as part of its damages.  But, for several reasons, our client’s best interests dictated acceleration and foreclosure, which weakened our argument for those fees.  The client understood and relented on its claim.

Decisions like these can be difficult for junior lenders involved in a foreclosure.  Typically, the junior lender could choose to declare a default (triggered by the default on the senior debt), accelerate the debt, file a cross-claim against the borrower and reduce its claims to a judgment, as we did in our recent case.  There are advantages to this approach, including the creation of a judgment lien.  This option, however, almost certainly will result in a waiver of yield maintenance fees.  On the other hand, the junior lender could elect to simply answer the complaint, protect its collateral position (priority) in the litigation and await a payoff request when the collateral is disposed of.  This scenario likely will result in a recovery of, or a strong argument for, yield maintenance fees.  In the final analysis, decisions depend upon an almost infinite number of factors, and there is no case law applicable to every situation.  The key is for junior lenders to remain mindful of the general rules and make strategic decisions accordingly. 

Demand a calculation.  As a competing lender, beware of other lenders improperly building in yield maintenance fees to their judgment amounts.  Borrowers and their counsel may not aggressively police the damages claimed by lenders, or they may not know the law.  As a party to a foreclosure case, it’s in a lien holder’s best interests to force the plaintiff, and all competing lien holders for that matter, to provide a calculation, based upon admissible evidence, of the nature and extent of the claimed debt.  This is particularly true for junior lenders because the amount of a junior lender’s recovery, if any, will increase as the senior lender’s recovery decreases.  If a competing lender is not entitled to yield maintenance fees, a timely objection to the claim should be made.   

Uncharted waters.  Bear in mind that there has been no Indiana case on the topic of yield maintenance fees for over fifteen years, and there are gaps in the law.  So creative contract drafting may net positive results.  In the commercial setting, courts are disinclined to rewrite contracts and generally will lean toward enforcing what the parties clearly and unambiguously agreed to.  For instance, although it may not be a common contract term, it’s conceivable that reasonable yield maintenance fees built into an acceleration clause (to be paid upon foreclosure) could be upheld by an Indiana court.  “Reasonable” means, among other things, that the fees are tied to interest formulas in the note or based on present value calculations.  Arbitrary or purely penal computations are far less likely to be enforced.  As always, I will be keeping an eye out for any new Indiana case law on this issue and will log new posts accordingly.