Frustrated by a Builder’s Insolvency Following the Financial Crisis? People’s Nat’l Bank v. Mark S. Mehlman Realty, Inc., 2013 WL 3971037 (Mo. Ct. App., E.D.)

Here we have a puzzling discussion of the defense of frustration of purpose.  A lender makes a $3.1 million loan, expecting the loan proceeds will be used to purchase lots for sale to a specific builder, who subsequently became insolvent, it appears.  The question involves a deficiency of $1.2 million following a foreclosure sale (the lender being the winning bidder).  The borrower’s brief claims:

In response, Appellants have asserted the doctrine of commercial frustration as an affirmative defense to Respondent Bank’s claim for deficiency judgment, because the parties agreed that the continued existence of a third party home builder was essential to Appellants’ performance of the Loan Agreement, and its failure has destroyed the purpose and object of the contract..

Even if the borrower’s performance of the loan agreement were frustrated, the lender would be entitled to recovery of the principal amount in restitution.  E.g., Far West Federal Bank, S.B. v. Director, Office of Thrift Supervision, 787 F.Supp. 952 (D. Or. 1992) (citing Restatement (First) of Restitution § 150 (1937)), aff’d, 119 F.3d 1358 (9th Cir. 1997). The borrower’s brief does not mention restitution at all (not particularly informative in this regard), so it is not clear from the brief whether this is a quibble about recovery of some part of accrued interest.

But, should the defense be available in any case?  One would think not ….

More after the break …

One of the better-known modern cases involving the principle of frustration of purpose is Lloyd v. Murphy, 153 P.2d 47 (Cal. 1944).  A change in governmental regulations, restricting the sale of vehicles, adversely affected the value of leased premises.  The landlord waived various use restrictions.  The court affirms the trial court judgment, finding the defense not available.  The court notes, inter alia:

The courts have required a promisor seeking to excuse himself from performance of his obligations to prove that the risk of the frustrating event was not reasonably foreseeable and that the value of counterperformance is totally or nearly totally destroyed, for frustration is no defense if it was foreseeable or controllable by the promisor, or if counterperformance remains valuable.

The court notes this requirement is not met:

The sale of automobiles was not made impossible or illegal but merely restricted and if governmental regulation does not entirely prohibit the business to be carried on in the leased premises but only limits or restricts it, thereby making it less profitable and more difficult to continue, the lease is not terminated or the lessee excused from further performance.

Missouri authority has similar requirements:

The doctrine of commercial frustration grew out of demands of the commercial world to excuse performance under contracts in cases of extreme hardship. Kassebaum, 42 S.W.3d at 699. Under the doctrine of commercial frustration, if the occurrence of an event, not foreseen by the parties and not caused by or under the control of either party, destroys or nearly destroys the value of the performance or the object or purpose of the contract, then the parties are excused from further performance.

Adbar, L.C. v. New Beginnings C-Star, 103 S.W.3d 799 (Mo.App. E.D. 2003) (a case the brief cites for this purpose).

And again, also in authority the brief cites:

Sound public policy, while requiring that the doctrine be limited in its application so as to preserve the certainty of contract requires the law to be flexible and equitable in situations where unexpected contingencies operate to make performance valueless and the allocation of contractual risks capricious or fortuitous.

Howard v. Nicholson, 556 S.W.2d 477 (Mo. App. 1977).

The court in Howard allows the defense against a claim by a contractor seeking lost profits for the client’s alleged breach of a contract for construction of a bridal salon:

In this case the proposed building could have been built. But in view of the findings by the trial court that the building had been specifically designed for use as a bridal salon by Honey’s and for the sale of bridal fashions and accessories and that it was not suited for other uses, the value of the building as such was destroyed by the supervening circumstance of the bankruptcy of Honey’s, the proposed tenant.

So, what’s the difference between Howard and People’s Nat’l Bank?  Unless the original loan required the borrower to sell lots to the now-insolvent builder and the lender was not willing to waive that requirement (recalling Lloyd references the lessor’s release of limits on use), we are simply in the circumstance that the preferred contracting partner of the borrower is no longer able to perform.  And that some other arrangement merely will be less renumerative is, of course, not a basis for the defense of frustration of purpose.

For those interested, a contemporaneous discussion of the ability to assert a claim of frustration of purpose against the lender under Missouri law is provided in BancorpSouth Bank v. Hazelwood Logistics Ctr., LLC, 706 F.3d 888 (8th Cir. 2013).