Enforceability of Attorneys’ Fees Provisions in Nonrecourse Loans

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 Lenders should be especially careful when drafting attorneys’ fees provisions in commercial loan documents that contain nonrecourse provisions with specific carveouts. For example, in Aozora Bank, Ltd. v. 1333 North California Boulevard, 119 Cal. App. 4th 1291 (2004), the jury at the trial court level had found the defendant borrower liable for approximately $395,000 in compensatory damages and $8,333,333 in punitive damages. But the trial court remitted the amount of punitive damages to $1.6 million. The appellate court upheld the remittur of punitive damages and the order for new trial on the amount of punitive damages only. At the second trial, in which the jury awarded no punitive damages to the bank, the bank moved for an award for the attorneys’ fees it incurred in the case, in the amount of approximately $1,434,000. The trial court approved this request by the bank, which included a 1.5 multiplier for "the complex and cutting edge nature of the issues litigated." The borrower then appealed this ruling to the appellate court.

 The appellate court reversed the trial court's determination that the bank was entitled to attorneys’ fees under the contractual language in the loan documents. The court first noted that attorneys’ fees are not generally available to prevailing parties in tort actions, citing applicable California statutes and case law. Turning to the contractual language, the court rejected the bank's argument that the borrower was liable under the general attorneys’ fee provisions contained in the note and mortgage. According to the court, if the carveouts did not expressly include liability for attorneys' fees, they would only be recoverable from the real estate collateral. The applicable nonrecourse carveout in the note and deed of trust stated that, "nor shall such limitation of liability apply if and to the extent that [Borrower/Trustor] …. commits fraud, material representation or waste."

 The appellate court seized on this language to find the following reasons to reject the trial court's determination that it was broad enough to make the borrower partnership liable for attorneys’ fees: (1) the carveout did not specifically refer to attorneys’ fees, and would not be implied because attorneys’ fees generally are not awarded in tort actions; (2) given the importance of this issue in connection with the enforcement of nonrecourse carveouts, "it is unlikely that the carve-out would be silent on attorneys’ fees if they were intended to be included," Id. at *7, and (3) because the carveout only applied "if and to the extent" that waste was committed, this undercut the bank's argument that the carveout entirely negated the nonrecourse aspect of the agreement when waste is committed. The court summarized by stating that, "the most reasonable reading of the agreement is that the waste carve-out does not implicitly include attorneys’ fees for prosecuting a waste action. As a consequence, recovery of these fees from the Partnership is barred by the nonrecourse provisions of the note and deed of trust." Id. at *8.

The appellate court also dismissed the bank's argument that if it were precluded from obtaining attorneys’ fees, it would "void the general purpose" of the general attorneys' fees provisions in the note and mortgage but the borrower would be able to invoke the attorneys’ fees clause against the lender, thus violating the California statutory provision that makes attorneys’ fees clauses reciprocal. The court noted that the because the partnership borrower was not the prevailing party in the case, it need not decide the issue of reciprocity, and that the bank still could benefit from the attorneys’ fees provisions of the note and deed of trust even though the loan was nonrecourse, because it could recover such fees from the mortgage security and add them to the amount required to reinstate the loan or add them to the amount of a credit bid at a foreclosure sale.

The bank lender easily could have prevailed in Aozora Bank case -- and picked up another $1,434,000 -- if it had merely inserted the "magic words" in the carveout language of the nonrecourse provision. The appellate court even set forth the "roadmap" to follow in a footnote, including the following suggested language stating that a carveout provision should cover "all loss, cost (including [reasonable] attorneys' fees and expenses), expense, claim, liability or damage incurred by Mortgagee as a result of waste of the Mortgaged Premises, which [materially] reduces the value of the Premises."

A modification agreement should expressly provide that all rights under the original mortgage are preserved, and specifically provide in the modification agreement for the right to collect attorneys' fees even if the original loan documents contain an attorneys’ fees provision. Otherwise, if the lender sues based on a breach of provisions in the modification agreement and it doesn't contain a specific right to attorneys' fees, the lender may not get them. See Wheeling Trust & Savings v. Citizens National Bank, 142 Ill.App.3d 333 (1986), in which the borrower brought an action against the bank lender for a declaratory judgment that language in the Extension Agreement executed by the parties, which provided an interest rate of 6% over prime, but 5% over prime if no default in note and payments timely made, was an unenforceable penalty. The court held that the interest-rate provision was not a penalty before maturity, but also held that the bank was not entitled to attorneys’ fees. The mortgage contained a covenant that the borrower would pay for any expenses and attorneys’ fees incurred by the bank in "any action or proceeding to protect its security or in which it was made a defendant by reason of its mortgage." The bank argued that the language referred to "any proceeding," not just proceedings enforcing its security. The Extension Agreement specifically referenced the original mortgage and provided that it secured the Extension Agreement. The court noted that the action was brought in connection with the interest rate provided for in the Extension Agreement, which was a document separate from the mortgage, and made no provision for payment of attorneys' fees.

Jack Murray
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