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Impairment Of Collateral Defense Denied

If your financial institution is seeking to collect a business debt from a guarantor that is asserting an “impairment of collateral” defense, the recent decision by the Northern District of Indiana in LEAF Funding v. Brogan, 2009 US Dist. LEXIS 65203 (N.D. Ind. 2009) (Leaf.pdf) should help you understand the defense and help you convince the guarantor that the defense may not apply. 

The situation.  Plaintiff LEAF, equipment lessor (lender), sued defendant Brogan, equipment lessee, for breach of a medical equipment lease.  Dines, also a named defendant, was the guarantor of the lease.  Brogan had defaulted on the lease for a failure to make payments.  LEAF had been unable to repossess the equipment, as allowed under the lease, because Brogan’s landlord had changed the locks to Brogan’s plant.  And a court order arising out of a separate state court lawsuit froze all of Brogan’s assets, which order contributed to LEAF’s inability to repossess the equipment.

The argument.  Dines’ only contention in response to LEAF’s motion for summary judgment was that LEAF impaired the collateral (the equipment) when LEAF “failed to take timely possession of and to promptly liquidate the leased property after Dines made two phone calls to LEAF requesting that LEAF make arrangements to come and retrieve the Equipment.”  Dines sought to be discharged from liability.

The defense, generally.  LEAF identified several Indiana points of law applicable to the defense:

 The guarantor’s liability [could be] discharged if the facts establish that the creditor’s conduct unjustifiably impaired the collateral securing the debt.

 The guarantor has the burden of proving the impairment (damage/loss of value), and impairment to the collateral is a necessary element of the defense.

 When a creditor releases or negligently fails to protect security put in his possession by the principal debtor, the surety is released to the extent of the value of the security so impaired.

Indiana case law focuses on the conduct of the creditor.  The creditor (the plaintiff) must have acted improperly and caused harm to the collateral.  Absent a reduction in value of the collateral attributable to the creditor, the defense will not apply.  The Court also cited to the UCC at Ind. Code § 26-1-3.1-605(g), which says that impairing value of an interest in collateral includes:

 (1)  failure to obtain or maintain perfection or recordation of the interest
 in collateral;
 (2)  release of collateral without substitution of collateral of equal value;
 (3)  failure to perform a duty to preserve the value of collateral owed,
 under IC 26-1-9.1 or other law to a debtor or surety or other person
 secondarily liable; or
 (4)  failure to comply with applicable law in disposing of collateral.

No discharge.  While some Indiana cases suggest that the guarantor’s debt can be fully discharged upon proof of the defense, in actuality Indiana law provides that the guarantor will only be released “to the extent of the value of the security so impaired.”  Indiana favors a “pro tanto [for so much] approach that measures the amount of the impairment at the time of default” as opposed to allowing for a complete discharge of any liability.

Not applicable in LEAF.  After taking inventory of Indiana’s rules and policies applicable to the impairment of collateral defense, the Court in LEAF concluded that the defense should fail and that Dines remained jointly and severally liable to LEAF for the damages resulting from Brogan’s breach.  The inaccessibility of the collateral was not the result of actions taken or caused by LEAF, which was unable to repossess the equipment due to circumstances outside of its control.  Moreover, the lease specifically provided that Brogan had an obligation to deliver the equipment to LEAF upon default.  LEAF had no duty to retrieve the equipment at Brogan’s request.  Finally, none of the UCC § 605(g) elements were present in LEAF

Guarantors in lien enforcement cases may try to duck or delay collection efforts by asserting the impairment of collateral defense when, in my view, the defense should only apply in very limited circumstances in which the plaintiff/lender/creditor has actually caused harm to the collateral while the collateral was in its possession or control. 

Investors Not Protected By FDCPA

In my November 16, 2006 post “Worried About The Fair Debt Collection Practices Act?” I explained that the Fair Debt Collection Practices Act (“FDCPA”) generally does not apply to commercial foreclosures or the collection of business debts.  The recent decision by the Indiana Court of Appeals in Baird v. ASA Collections, 2009 Ind. App. LEXIS 961 (Ind. Ct. App. 2009) (.pdf) supports this conclusion. 

HOA dues.  Plaintiff ASA Collections filed a lawsuit against defendant Baird to recover past-due homeowner’s association fees and dues.  Baird filed a counterclaim against ASA based upon alleged FDCPA violations.  The issue was whether the FDCPA applied to the case.  Since the FDCPA regulates “consumer debts,” which are defined at 15 U.S.C. § 1692(a)(5) as obligations “primarily for personal, family, or household purposes,” one might expect homeowner’s association dues to fall under the FDCPA.  Indeed in Newman v. Boehm, 119 F.3d 477 (7th Cir. 1997), the Seventh Circuit held that the plaintiff’s delinquent condominium dues and assessments constituted “consumer debts” under the FDCPA. 

Investor.  Baird was distinguishable from Newman, however.  Baird had purchased six vacant lots at a tax sale for investment purposes.  Baird sold the lots to purchasers who wanted access to recreational facilities on the property.  Baird never built on the lots, and she did not reside in any structure in the development.  Instead, she bought the properties and sold them to various owners once the land was developed.  Thus Baird’s FDCPA counterclaim failed as a matter of law:

The evidence demonstrated that Baird may be characterized as an investor rather than a consumer in the transaction, and she has failed to show that the dues and fees that were assessed involved a “consumer debt” within the meaning of the FDCPA.

Only consumer debts.  Baird provides additional comfort for lenders and their counsel involved in Indiana commercial foreclosure litigation.  In general, the regulations and pitfalls of the FDCPA should not apply to the collection of an investment-related debt - even if the underlying nature of the debt seems to be personal in nature.  The FDCPA is designed to protect consumers, not investors.

Seventh Circuit Remands Prepayment Premiums Case For Trial

I previously blogged about yield maintenance provisions, also known as prepayment premium clauses, on 1-25-07 and 2-2-07.  My prior posts addressed whether Indiana law permitted lenders to pursue yield maintenance remedies and the rules that may apply.  Then, on 9-11-08, I discussed BKCAP, LLC v. CAPTEC, a decision from the Northern District of Indiana that tacitly recognized the validity of prepayment premiums/yield maintenance provisions.   

Reversed.  On 7-13-09, the Seventh Circuit issued its opinion in the appeal of the BKCAP case.  Here’s the cite:  BKCAP, LLC v. CAPTEC, 2009 U.S. App. LEXIS 15369 (7th Cir. 2009, amended Aug. 5, 2009).  The decision reversed the District Court’s holding and remanded the case “for a trial on the question of the parties’ intended meaning of the prepayment premium.”  Click here to review the opinion.

The lesson of the latest BKCAP opinion is that the contract language should be simple and clear.  Note Judge Tinder’s opening remarks:

This case demonstrates that even experienced, sophisticated business entities can encounter difficulty when drafting carefully negotiated loan documents.  Since July 2007, the plaintiffs and the defendant have been at loggerheads over the meaning of just a handful of lines out of several hundred in their five-page, single-spaced Note.  Unfortunately, this appeal cannot bring their stalemate to an end, and more litigation lies ahead. 

Judge Tinder ultimately concluded that “the meaning of the prepayment premium is a question of fact that requires an examination of relevant extrinsic evidence.”  Since trials translate to further delays and expense for lenders, as a practical matter Judge Tinder’s holding is a bad result.  For more on how the Seventh Circuit reached its conclusion and how a court might analyze the meaning of a yield maintenance provision/prepayment clause, please review the opinion. 

Still fine.  Despite the remand, the Seventh Circuit did not in any way, shape or form question the validity of yield maintenance fees.  As such, it would appear that my prior conclusions remain true as they related to Indiana’s view of the legitimacy of prepayment premiums under certain circumstances.