By: Camilla N. Andrews & Amy R. Brownstein 

On January 14, 2013, in Riverisland Cold Storage v. Fresno-Madera Production Credit Assn., 2013 Cal. Lexis 253 (2013) ("Riverisland"), the California Supreme Court overturned Bank of America etc. Assn. v. Pendergrass,4 Cal.2d 258 (1935) ("Pendergrass") which, for nearly 80 years, has limited borrowers' ability to challenge contracts based on alleged oral promises made by a lender that contradict the terms of the loan documents. This change in California law will make it harder for California lenders to quickly dispose of such borrower allegations by demurrer or summary judgment, and is likely to result in increased litigation costs - and longer times to complete liquidation - for California lenders. 

In Riverisland, the borrowers alleged that the lender's vice president had met with them two weeks before a loan modification agreement was signed, and that he represented to them that the lender would extend the loan for two years in exchange for two pieces of additional real property collateral. The borrowers further alleged that when they signed the agreement, which they did not read (although they initialed the pages setting forth the legal descriptions), the lender's vice president assured them that the term of the agreement was two years, and that the two additional pieces of real property were the only additional collateral being taken. In fact, however, the written agreement provided for only three months of forbearance by the lender, and identified eight additional pieces of real property collateral. The borrowers subsequently failed to make payments as agreed, and the lender recorded a notice of default. After the borrowers repaid the loan and the foreclosure proceedings were dismissed, the borrowers filed an action against the lender seeking damages for fraud and negligent misrepresentation. Causes of action included reformation of the restructuring agreement and rescission. 

Under California law, the parol evidence rule (set forth in California Code of Civil Procedure §1856) prohibits the introduction of outside evidence, such as oral statements or earlier writings, to contradict the terms of a final written agreement. The parol evidence rule is subject to exceptions, however, and allows for evidence challenging the validity of an agreement, or evidence to establish fraud. The decision in the Pendergrass case limited the parol evidence rule's fraud exception, requiring that the evidence offered to show fraud relates to fraud in procuring the written agreement and not a promise that was different from the terms of the agreement. 

In Riverisland, the lender filed a motion for summary judgment, seeking to have the case dismissed based upon the Pendergrass rule. The California Supreme Court overruled Pendergrass, finding it to be inconsistent with California law, an "aberration," and a potential shield for fraud. 2013 Cal. LEXIS 253, 25-27. Consequently, borrowers will be able to offer additional evidence, such as oral statements allegedly made by a representative of the lender as to the terms of loan documents, to support allegations of lender fraud.

What are the ramifications for lenders? Quite simply, lenders may be unable to quickly dispose of claims of oral promises differing from the terms of written loan documents through demurrer or summary judgment. Such claims will most likely result in time-consuming and costly litigation, with most cases brought by borrowers expected to include allegations of fraud, and more cases expected to go to trial. 

What actions might a lender take to protect itself? While the facts of Riverisland indicate that the initialing of loan documents will likely not be sufficient to support a lender's defense that borrowers had knowledge of the contents of loan documents, there are a number of protective measures that lenders can take to protect themselves from allegations of fraud.

• Some experts have recommended the inclusion of arbitration or judicial reference clauses in loan documents which, if enforced, would allow the lender to have the dispute heard by an arbitrator or judge rather than a jury that might have more sympathy for a borrower. 

• Experts have also recommended that loan documents be provided to the borrower in advance of closing to allow the borrower time to read the documents, possibly coupled with an acknowledgment that the borrower has been encouraged, and has been provided an opportunity, to have the documents reviewed by its own legal counsel. 

• A lender might require the borrower to re-execute a commitment letter at closing, confirming the pertinent terms of the loan. 

• A lender might obtain an affidavit, to be signed under penalty of perjury, which is read to the parties and signed by them prior to the execution of loan documents, to specifically disclaim reliance upon oral representations and warranties made by the lender. 

• Lenders should ensure that their personnel, including outside brokers and agents, are aware of the state of the law on this issue. All employees and agents who interact with borrowers and other loan parties must understand that misrepresentations to these parties may result in a court determining that the borrower and other loan parties are not bound by the terms of the loan documents. Terms and conditions of a loan or loan documents should never be misrepresented to any borrower party. 

Solutions will vary for each lender and each loan. Please feel free to contact Camilla at (949) 333-4108 or Amy at (215) 542-7070 for additional assistance in addressing this issue. 

candrews@starfieldsmith.com

Starfield & Smith, P.C. | Irvine, CA Office
2955 Main Street, Second Floor | Irvine, CA 92614
(949) 333-4108 

By Jeffrey Feldman   

There comes a time in every lender's portfolio when its workouts are no longer working out, and the only commercially reasonable course of action is to sue the obligors. When a lender participating in the SBA's 7(a) program sees that time approaching, it must work closely with its counsel to ensure that its litigation plans fully comply with the SBA's requirements.

           The first step towards a valid litigation plan is the retention of qualified collections counsel. The SBA requires that the attorney hired by the 7(a) lender have expertise in debt collection and bankruptcy law, be licensed to practice law where the litigation will be conducted, maintain adequate malpractice insurance, and have no conflicts of interest. In addition, the attorney's fees must reasonable for the locality where the litigation is being brought, and his or her billing practices must conform to the SBA's requirements. A lender should confirm these understandings in its written engagement agreement with its counsel.

            The most important threshold issue to be addressed by the lender and its counsel in formulating a litigation strategy on a 7(a) loan is whether it is necessary to submit a litigation plan to the SBA for approval. In general, a written litigation plan must always be prepared and submitted for approval in advance by the SBA unless: (1) the litigation qualifies as "Routine Litigation," or (2) the SBA grants a limited waiver of the need for a litigation plan. "Routine Litigation" is uncontested litigation for which the estimated legal fees do not exceed $10,000 in the aggregate. A limited waiver of the written litigation plan requirement may be granted by the SBA in its discretion upon request if certain extraordinary circumstances exist that warrant granting a temporary waiver.

            The form and content of any litigation plan submitted by a lender and its counsel should follow the template used in the SBA's official form, which is available at www.sba.gov. Every section of the form should be completed in order to avoid delays in its processing. Although the form is completed by counsel, the lender is responsible for providing its counsel with a variety of information and documentation related to its loan that must be included in the plan.

             If the litigation plan involves a bankrupt obligor or a claim against a deceased obligor's estate, the SBA requires that a specific series of steps be taken to protect the SBA's interests. Where applicable, lenders should ensure their proposed litigation plan references and fulfills those requirements. In addition, a lender should also review its litigation plan to ensure that it does not incur legal fees that the SBA either will not pay or has the discretion not to pay. Finally, the lender should also review any proposed pro-rata application of legal fees and recovery between the SBA loan and any other loans.

            When the plan is complete, it should be promptly submitted to the SBA for approval via e-mail to loanresolution@sba.gov. Once received, the SBA will generally approve or deny the litigation plan within 15 business days. If the SBA fails to do so, however, that cannot be deemed an implied consent by the SBA - it must provide its express consent to the lender in writing.

            After the plan is approved, a lender must monitor its litigation to determine whether (a) it has taken any actions that materially deviate from, or were not included in, the original litigation plan, and/or (b) it has incurred any expenses that exceed the estimates in the existing plan by more than 15%. If either has occurred, the lender must submit an amended litigation plan to the SBA for approval prior to taking any further action. Similarly, a lender who has been pursuing Routine Litigation without an approved plan must submit a litigation plan when (a) it incurs legal fees in excess of $10,000 or (b) other changes occur that render its litigation "Non-Routine."

            SBA lenders should select qualified litigation counsel who are experienced with the regulations governing the liquidation of SBA loans to ensure that their pursuit of the obligors' assets does not inadvertently jeopardize their own most valuable asset - the SBA's guarantee.

           For more information regarding litigation plans, please contact Jeff at JFeldman@StarfieldSmith.com or
(215) 542-7070. 

Starfield & Smith, P.C. protects the interests of its lender clients through a staff of experienced attorneys and paralegal loan processors. Their expertise in SBA guaranteed loans encompasses the breadth of the SBA's lending options, including the 7(a), 504, Express and Export Working Capital programs. If you would like to learn more about Starfield and Smith, PC visit their website at http://www.starfieldsmith.com/.

A special thanks to Jeffrey for sharing this article with our members and Camilla Andrews who originally introduced us to this article on the Inside Banking - Lending Group.