Ambiguity from Multiple Writings–F.A.L. Investments, LLC v. Hawthorne Bank

F.A.L. Investments, LLC v. Hawthorne Bank, 2014 WL 1663767 (Mo. Ct. App., W.D., Apr. 1, 2014), presents a number of interesting issues concerning interpretation of a contractual relationship memorialized in multiple writings.

The facts are not stated succinctly in the brief. And what I would like to see, in order to make my own assessment of the merits, a verbatim, unedited extract of from the operative agreements, is not reproduced in one place. So, understanding the brief would require moving back-and-forth between the brief and other documents. And the arrangements are messy, involving obligations owed by an entity, and LLC, and its members in their individual capacities. So, I do not envy the judges.

In essence, the appellant’s brief seems to reference the following basic circumstances:

  • Existing loans extended by the bank were refinanced by the bank.
  • During that refinancing, what had been unrelated personal debts of one of the members of an LLC (one Samson) were secured by a deed of trust on LLC-owned property (other obligations also being secured under that deed of trust).
  • The deed of trust appears to be a form that was not negotiated.
  • The loan agreement has some oblique provision in it, described on page 10 of the brief, as follows:

“Upon the sale of any portion or all of the 179 property,” proceeds were to be divided as follows:

a. agreed expenses and taxes were payable to Green [a borrower];

b. the Borrowers’ Obligations of $1.781 Million were payable to Hawthorne; and

c. “any remaining proceeds” were to be divided equally between Hawthorne and the Greens, with Hawthorn’s share applied “to the Samson Obligations”.

  • The real property is sold to an affiliate at a price the bank thinks inadequate.
  • The borrower claims that, under the loan agreement, the Bank, after other debt is paid, is limited to getting half the proceeds for purposes of satisfying the Samson Obligations. The Bank claims it is not; the sale of the property triggers a separate due-on-sale provision in the deed of trust, entitling the Bank to additional rights.

One can see that the brief here just provides snippets in quotes. To analyze this, I want to see the entire, unedited language.

The case illustrates that the memorialization of an agreement in multiple writings can create ambiguities, because the separate parts may not fit well together. I recently wrote about this problem in an article styled, Side Letters, Incorporation by Reference and Construction of Contractual Relationships Memorialized in Multiple Writings, 64 BAYLOR LAW REVIEW 651 (2012), which can be downloaded for free at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2254388.

I would think a form deed of trust unlikely to address satisfactorily the arrangements to provide collateral securing multiple obligations, only some of which are intended to be with recourse to the borrower.

More after the break …

Interpreting Ambiguous Provisions

The first step in determining whether the Bank is entitled to more than half the proceeds (after the other obligations are paid) is to determine whether the agreements, collectively, are ambiguous. Here’s how one Missouri court articulates the test for whether a contract is ambiguous:

Contract ambiguity is measured by a “reasonable person” standard, that is, ambiguity exists if reasonable people may fairly and honestly differ in the reading of the terms because the terms are susceptible of more than one meaning. Bydalek v. Brines, 29 S.W.3d 848, 854 (Mo.App.2000).

Yerington v. La-Z-Boy, Inc., 124 S.W.3d 517 (Mo. Ct. App. 2004). Getting snippets of contract provisions does not enhance one’s ability to ascertain contractual meaning with certainty.

In my experience, one of the best ways to begin examining issues of contract interpretation, including determining whether an agreement is ambiguous, is to attempt to identify the evident business deal the parties intended to create. That approach is consistent with the following discussion from a Delaware case:

Despite the existence of separate parts, a contract is to be considered as a whole and its meaning gathered from the entire context, and not from particular words, phrases or clauses, or from detached or isolated portions of the contract.  In order to determine the meaning of each part, the entire agreement must be considered.  Thus, a “meaning which arises from a particular portion of an agreement cannot control the meaning of the entire agreement where such inference runs counter to the agreement’s overall scheme or plan.”

American General Corp. v. Continental Airlines Corp., 1988 WL 7393, at *4 (Del. Ch. Jan. 26, 1988). So, the search for the basic contours of the business deal is the way to implement what the American General opinion references as the “entire context” of the contract.

One gets the sense that some courts find it easier simply to engage in the linguistic exercise of construction of snippets of provisions. So, the laudable approach expressed in American General is not universal.

In deciding whether the agreement is ambiguous, one needs to assess whether the alternative proffered interpretations are plausible, both in the sense of something persons could have bargained-for and in the sense of whether plausibly memorialized by the words the parties used.

The borrower’s proffered interpretation is a plausible relationship for the parties to have contemplated. After all, it involves causing property to be subject to a deed of trust to secure some entirely unrelated debt. So, it is entirely possible that, as part of working-out the arrangements, it was contemplated that the bank would be limited to recovering one-half of the proceeds of the sale of the realty, after the other (i.e., the related) obligations were discharged.

It also seems to me entirely plausible that the parties would have documented the arrangement in the way they did. That would involve a conceptualization of the deed of trust as merely assuring performance of the duties set forth in some other document (the loan agreement). So, if the obligations under the loan agreement are satisfied, the deed of trust does not give rise to rights to additional principal payments. Does that conceptualization seem anomalous? I think not, particularly where the lender’s typical form of deed of trust was not altered in this regard, notwithstanding the anomalous scope of obligations in the loan agreement.

The Bank’s brief states the following (underlining added to allow reference):

C. The Judgment Does Not Render Paragraph 7 a Nullity

Appellants argue Paragraph 7 establishes what is due Hawthorn upon the occurrence of the sale of FAL’s land. (Appellants’ Brief, p. 30). That is an incorrect statement. It is the Deed of Trust and the due on sale clause which establish what is due upon the sale of FAL’s land. At its option Hawthorn can allow the sale to go forward, leaving the notes intact and apply the sale proceeds per Paragraph 7 or it can exercise its option to accelerate the debt and allow the sale to proceed but only with all of the secured debt paid.

If the due on sale clause is written out of the Deed of Trust as the Appellants argue, the Deed of Trust would have no function. It would become a useless document. The purpose of the Deed of Trust is to provide security for the payment of the obligations set out in the Loan Agreement. The Deed of Trust creates a lien to secure the terms of repayment to which it refers. Tipton v. Holt, 610 S.W.2d 659, 662 (Mo. App. W.D. 1981). Without the due on sale clause, FAL could sell the real estate to any party, for any price, and demand a deed of release even though that sale may not have paid any of the Borrowers’ Obligations must less any of the FAB debt. It should be noted that the parties did not strike the due on sale clause from the Deed of Trust. Both parties negotiated the Loan Agreement represented by counsel (TR 381-382). Paragraph 7 states nothing about a deed of release. To create a conflict between the Loan Agreement and the Deed of Trust, one must read into Paragraph 7 a requirement that Hawthorn provide a deed of release upon any payment tendered by FAL.

D. The Due on Sale Clause and Paragraph 7 Are Each Specific Terms and Deal with Different Subject Matters.

The subject of the due on sale clause is the bank’s option to accelerate the date for payment of the secured debt in the event of sale and the subject of Paragraph 7 is the application of sale proceeds received when the bank elects to accept proceeds less than the amount required to pay off all the secured debt. The due on sale clause deals with a specific subject and is not modified by Paragraph 7. The due on sale clause is not a clause that is “general and broadly inclusive in character.” Appellants cite A & L Holding Company v. Southern Pacific Bank, 34 S.W.3d 415, 419 (Mo. App. 2000) for the proposition that the specific prevails over more general provisions. That rule of construction applies only if there is an ambiguity or inconsistency between the clauses. Id. at 418-419. That case also holds a construction attributing a reasonable meaning to each phrase and clause is preferred to one which leaves some of the provisions without function or sense. Id. at 419. There is no inconsistency between the Deed of Trust and Paragraph 7. The due on sale clause of the Deed of Trust accelerates payment of the debt in the event of a sale, whereas Paragraph 7 allocates sales proceeds when they are received. Each clause or paragraph performs a different function which is not in conflict with the other.

Appellants also make reference to certain unsigned drafts of the Loan Agreement and cite certain clauses from those unsigned documents. (Appellants’ Brief, p. 32-34). Appellants incorrectly assert that every unsigned draft of the Loan Agreement was admitted into evidence by stipulation and cite the trial transcript at pages 369-370. That  transcript reference indicates that the unsigned drafts were admitted only to show the dates of their preparation and who prepared the draft, not for content. The content of the unsigned drafts is not in evidence and any discussion concerning their contents is irrelevant to any issue to be decided in this appeal. Only those portions of documents which were part of the record before the trial court can be considered. Reference to the portions of documents not before the court will be disregarded. Lay v. St. Louis Helicopter Airways, Inc., 869 S.W.2d 173, 174 (Mo. App. E.D. 1993). The only relevant document is the final draft which was executed on May 1, 2009. (Plaintiffs’ Exhibit 1). Furthermore, use of the prior unsigned drafts violates the Merger Doctrine cited by the Appellants on page 51 of their brief.

Appellants further argue that Paragraph 7 divides the notes into two tiers: Those which are unconditionally due and those which are conditionally due. Appellants argue that it is the use of the words “any remaining proceeds” that creates the two tiers. With or without the use of those words, Paragraph 7 would read the same and the order of priority would remain intact with the obligations of subparagraph (4) being paid before the obligations in subparagraphs (5) and (6). Paragraph 7 does not establish a minimum payment obligation which ends at subparagraph (4) with the payment of the Borrower’s Obligations. If that were the case, there would be no point in adding subparagraphs (5) and (6). As stated previously, the terms of Paragraph 7 are subject to the condition created by the due on sale clause in the Deed of Trust. FAL sold the entire property and Hawthorn elected to exercise the due on sale clause and require payment in full of the secured debt.

Appellants argue that the trial court’s finding concerning 20 CSR 1140-6.050, that payment of the FAB Debt is contingent upon the profit received from the sale of the Highway 179 property, is inconsistent with the court’s finding that the due on sale clause allows Hawthorn to accelerate the date of payment of the secured debt. There is no conflict or inconsistency between these findings. In finding the payment of the FAB Debt is contingent upon the profit from the sale of the property, the trial court is merely recognizing that in a non-recourse transaction, such as this, payment of the secured debt is always contingent upon the amount of proceeds received from the sale of the collateral which secures the loan. That contingency is inherent in all such transactions. Black’s Law Dictionary defines a non-recourse note as a note that may be satisfied upon default only by means of the collateral securing the note, not by the debtor’s other assets. Black’s Law Dictionary, 8th Edition, p. 1088 (2004). The FAL/Hawthorn transaction is, as to the FAB Debt, a non-recourse transaction. Paragraph 2 of the Loan Agreement states that Appellants shall have no personal liability for repayment of Samson’s Obligations (the FAB Debt). (Plaintiffs’ Exhibit 1, ¶ 2, A25). But since the land is the only source from which the non-recourse debt is paid, the bank retains their right, through the due on sale clause, to require all outstanding secured debt be paid when the property is sold. Until all secured debt is paid, Hawthorn is not obligated to deliver a deed of release. In discussing the “contingency” in the 20 CSR 1140-6.050 context, the trial court is merely identifying the source of payment of the FAB Debt, and in the context of the due on sale clause, the trial court is discussing the sum that must be paid to Hawthorn for it to have a duty to give a deed of release.

FAL cites Schwartz v. Waterway Gas and Wash Company, 108 S.W.3d 71 (Mo. App. E.D. 2003) and equates the facts in that case to those here. The two cases are not factually similar. In Schwartz, there was not a deed of trust which contained a due on sale clause and there was no debt which could be accelerated upon sale. The contract between Schwartz and Waterway gave Waterway the first $975,000.00 of sale proceeds and gave Schwartz one-half of the proceeds above that amount if the property was sold within 5 years. The court found that Waterway did not receive proceeds above $975,000.00 and therefore did not owe any money to Schwartz. With no secured loan and no deed of trust, Schwartz is nothing like the present case and is therefore irrelevant to the analysis.

The first sentence of the second-quoted paragraph frankly makes no sense. It states:

If the due on sale clause is written out of the Deed of Trust as the Appellants argue, the Deed of Trust would have no function.

The debtor’s claim is not the due-on-sale clause is to be “written out” of the deed of trust. Rather, the claim is that the due-on-sale provisions do not end up causing the creditor to be entitled to more than half the proceeds (after payment of other amounts) to discharge the unrelated debtor’s obligation from the proceeds of the collateral. The deed of trust would, of course, still serve a function as to the scope of the obligations, set forth in the loan agreement, collateralized by the deed of trust.

A reasonable person certainly could think that the parties had intended to go about memoralizing a relationship of the type the borrower references. The Bank’s brief suggests it believes the the agreement is unambiguous–see the language I’ve underlined. If it is not ambiguous, I would think, then, what remains as the unambiguous interpretation is the plausible one proffered by the borrower.

Bad Faith

There is some irony in the Bank’s position. The Bank further claims the sale to an affiliate, at what the Bank claims is a below-market price, is a breach of the obligation to act in good faith. Somewhat ironic when the Bank previously required some unrelated loan be secured as a condition to working-out credit arrangements.

We may have more to say about the claim of bad faith in a subsequent post.