Are Loan Documents Enforceable in Wisconsin?

25 September 2013 Publication
Author(s): Emory Ireland Sarah N. Null

Legal News Alert: Finance & Financial Institutions

Three recent decisions call attention to the fundamental issue of the extent to which courts will enforce loan agreements and guaranties in accordance with their terms rather than imposing uncertain standards of fairness, equity, or good faith.

The Second Circuit recently held that equitable remedies cannot be used to challenge the actions of a lender that acted within its rights under a loan agreement. See Gaia House Mezz LLC v. State Street Bank and Trust Co., 12-2481-CV, 2013 WL 2500579 (2d Cir. June 12, 2013). In Gaia House, after a number of defaults and loan modifications, the lender, State Street, notified the borrower, Gaia House, that it would not be waiving accrued interest in accordance with the loan agreement. After Gaia House obtained financing from another lender to pay off its loan to State Street, including the disputed accrued interest and fees, it brought suit alleging that State Street was not entitled to such interest and fees. According to the court, there was no question as to whether Gaia House defaulted on its obligations or whether State Street was entitled to demand the accrued interest under the loan agreement. The only question before the court was whether equitable considerations should be imposed instead of the express terms of the contract. The Second Circuit found that State Street’s actions did not give rise to a claim of equitable estoppel, the covenant of good faith and fair dealing cannot be used “to imply an obligation inconsistent with the other terms of a contractual relationship,” and equity need not intervene to prevent “contracted-for financial consequence[s]” under a loan agreement. The United States Supreme Court and the Seventh Circuit have come to similar conclusions. See US Airways, Inc. v. McCutchen, 133 S.Ct. 1537, 1546-47, 1549-50 (2013) (“A valid contract defines the obligations of the parties as to matters within its scope, displacing to that extent any inquiry into [equitable considerations].” (citation omitted)); Continental Bank, N.A. v. Everett, 964 F.2d 701, 705 (7th Cir. 1992) (“Gap-filling methods such as good faith do not ‘block use of terms that actually appear in the contract’.” (citation omitted)); Market Street Assocs. v. Frey, 941 F.2d 588, 593-94 (7th Cir. 1991) (“[I]t is unlikely that Wisconsin wishes, in the name of good faith, to make every contract signatory his brother’s keeper ...”); Kham & Nate’s Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d 1351, 1357 (7th Cir. 1990) (“When the contract is silent, principles of good faith ... fill the gap. They do not block use of terms that actually appear in the contract.”).

In Park Bank v. Westburg, the Supreme Court of Wisconsin held that a guaranty of payment would be enforced as written with no inquiry into the fairness of such enforcement or whether the lender acted in good faith with respect to the guaranty at issue. 2013 WI 57 (2013). The court noted that, because the guaranties in this case were guaranties of payment rather than of collection, the creditor was under no obligation to seek collection elsewhere before demanding payment from the guarantors. As such, Park Bank only needed to show (a) that payment is due or (b) that any debtor has become the subject of a bankruptcy or insolvency proceeding, both of which Park Bank demonstrated. Since the guarantors’ affirmative defenses did not address either of these two points, the court upheld the circuit court’s grant of summary judgment for Park Bank. Nevertheless, the force of this decision is limited by a procedural issue. The guarantors made several counterclaims based on Park Bank’s dealings with the borrowers, including allegations that Park Bank breached its duty of good faith. The court held that these were derivative claims which could not be brought by guarantors. The result could have been different if the guarantors had complied with the statutory requirements for bringing derivative actions as shareholders.

The final decision, argued before and filed by the Supreme Court of Wisconsin just one day prior to the Park Bank decision, focused on the equities of granting specific performance under a stock repurchase agreement rather than simply enforcing the agreement in accordance with its terms. Beidel v. Sideline Software, Inc., 2013 WI 56 (2013). In Beidel, the court called for the circuit court to evaluate the equities of granting specific performance and the application of the covenant of good faith and fair dealing under an employment-related contract that explicitly provided specific performance as the remedy for a breach, and noted that a claim for specific performance “by definition turns on equitable considerations.” Beidel at P9. The dissent asserted that the court’s decision in Beidel “undermines contract rights in the name of good faith and fair dealing [and] overturns thirty years of precedent.” Beidel at P65. Sideline Software “acted completely in accordance with its contractual rights”, yet the majority looked to equitable considerations that conflict with the express terms of the contract. See Beidel at P69. Similar to the determination of the Second Circuit in Gaia House, the dissent in Beidel asserted that the covenant of good faith and fair dealing cannot be used in opposition to clear contractual language.

So where does that leave the law in Wisconsin? On the one hand, Beidel may signal a willingness to allow issues of good faith to override the express terms of a contract, and Park Bank may have turned on a procedural issue. If so, Beidel represents a dramatic departure from Circuit Court of Appeals decisions in both the Second Circuit and the Seventh Circuit. On the other hand, Beidel may be limited to the employment context, or to cases which involve specific performance or other equitable remedies. Moreover, both the Beidel and the Park Bank decisions were clearly influenced by the facts before the court. Stay tuned for further developments.

This article originally appeared in the September 2013, Vol. No. 32 Issue No. 2 edition of the Business Law Section, State Bar of Wisconsin and is reprinted with permission.

Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this update or would like to discuss the topic further, please contact your Foley attorney or the following:

Emory Ireland
Milwaukee, Wisconsin

Sarah N. Null
Milwaukee, Wisconsin

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