Unconscionability: Substantive and Procedural – Illinois Case Snapshot

The Case: Rosenbach v. NorStates Bank, 2014 IL App (2d) 131162-U

Facts Summary: Plaintiff LLC member who guaranteed commercial real estate loan sues the lender after lender makes (allegedly) unauthorized loan advances, declares a default against the LLC and seizes over $200,000 of the plaintiff’s personal funds that were pledged to induce the loan to the LLC.  Plaintiff’s claims are for breach of contract and a declaratory judgment action seeking ruling that the commercial guaranty is unconscionable under Illinois law.

Procedural History: Lender moves to dismiss on dual bases that (1) plaintiff’s injury is derivative of injury to the LLC borrower; and (2) commercial guaranty is not procedurally or substantively unconscionable.  Trial court grants motion and plaintiff appeals.

Result: Trial court’s dismissal upheld.  Lender wins, plaintiff LLC member/guarantor loses.

Operative Rules:

To defeat a guaranty claim, a guarantor must establish he suffered a direct injury as a result of a lender’s breach; as opposed to injury that is derivative of the injury suffered by the borrower.  So, if a corporate borrower is damaged due to a lender’s breach, the borrowing entity has a right to sue; not a constituent (individual) member of that borrower (e.g. an officer, shareholder, employee, etc.);

Illinois’ declaratory judgment statute allows a court to make binding declarations of rights in cases where the parties’ dispute has crystallized and they have reached an impasse.  The “dec action” plaintiff must show (1) a tangible legal interest in the subject of the suit; (2) a defendant with an opposing interest to plaintiff’s; and (3) an actual controversy between the parties. 735 ILCS 5/2-701(a);

Illinois recognizes (a) procedural unconscionability; and (b) substantive unconscionability.  The former means there is unfairness during the contract formation stage that deprives one of the parties of freedom of choice.  The latter (substantive unconscionability) looks to the terms of a contract and whether they are so one-sided that they oppress or unfairly burden an innocent party and show an imbalance in obligations among the contracting parties.

Procedural unconscionability factors include whether each party had a chance to understand the terms of the contract, whether key terms were hidden amid “a maze of fine print” and any other circumstances surrounding contract formation.

¶¶ 20-28, 31-35

Application:

Plaintiff’s claimed injuries in the breach of guaranty count were purely derivative of the LLC borrower’s.  The extent of plaintiff’s liability to the lender defendant was tied directly to the borrowing entity’s liability to the lender defendant.  There were no facts pled that showed plaintiff would have any different (in nature or amount) liability to defendant than the underlying corporate borrower.

The court held that loss of a guarantor’s investment is a derivative injury, not a direct one.  As a result, plaintiff’s claims were defeated since he failed to plead a direct (as opposed to flow-through) injury as the result of any lender conduct.

The plaintiff’s unconscionability arguments also failed.  The plaintiff only made conclusory allegations that the guaranty was a pre-printed document, drafted by the lender who had a superior bargaining stance compared to the plaintiff.  These blanket allegations weren’t enough though to show a defect during the formation and execution of the guaranty.

The court also held that even if the guaranty was procedurally unconscionable, the plaintiff would still have to show sustantive unconscionability – that the guaranty terms were inordinately one-sided in favor of the lender (and against the plaintiff) that no court could fairly enforce the guaranty.

Here, the court allowed that the guaranty definitely did favor the lender and the lender was probably in a stronger contracting position than the plaintiff.  Still, the terms weren’t so one-sided that the court should abstain from enforcing them.  In rejecting the plaintiff’s substantive unconscionability argument, the court also cited the fact that the guaranty terms weren’t hidden or hard to understand or any unfair surprise.

Afterwords:

Individual guarantor of a corporate borrower must show separate and distinct injury from the corporate borrower to have standing to sue a lender for breach;

A sophisticated borrower will likely need to show both procedural (formation defects) and substantive unconscionability (unfair or one-sided contract terms) to free himself from a contract he willingly signed.

Illinois Credit Agreements Act and the Unclean Hands Defense – No Writing = Difficulty Defeating Breach of Guaranty Claim

handsAmerican Chartered Bank v. Cameron. 2014 IL App (1st) 132231-U, an unpublished First District case, glaringly illustrates the difficulty of defeating a lender’s breach of guaranty claim when the defenses are based on the lender’s oral promises.  The case also sheds light on the nature of the borrower-lender relationship and the contours of the unclean hands defense in the context of a breach of contract action.

The defendant guaranteed a commercial loan made to a business that defendant invested in. After the borrower defaulted, the plaintiff sued the corporate borrower and guarantor defendant and won summary judgment of nearly $150K. The guarantor appealed arguing the guaranty wasn’t enforceable.

Held: summary judgment for the bank affirmed. Defendant’s defenses are defeated by the Illinois Credit Agreements Act 815 ILCs 160/1, et seq. (ICAA) and the express language of the guaranty.

Reasons:

The Court rejected the guarantor’s defense based on the clear guaranty language that specified the bank didn’t have to first proceed against the loan collateral (the bank could immediately go after the guarantor).  The guaranty also had a non-reliance clause: the guarantor waived his reliance on verbal statements by the bank’s agents.

The ICAA also trumped the defenses.  The ICAA prevents a debtor (here, the guarantor) from suing or defending a suit under a “credit agreement” unless it’s in writing and signed by both creditor and debtor” 815 ILCS 160/2.

The ICAA defines a “credit agreement” as an agreement to lend money, extend credit or to delay or forbear repayment of money that is not for consumer (personal, family or household) purposes and that doesn’t involve credit cards. 815 ILCS 160/1(1).  ICAA Section 3(3) negates any claims based on a creditor’s promise to modify, amend or forbear from enforcing a credit agreement.  815 ILCS 160/3

Illinois courts construe the ICAA broadly and describe it as a strengthened Statute of Frauds (740 ILCS 80/0.01 et seq.) that bars all actions at all related to a credit agreement.  The ICAA case law makes clear that the statute prevents a borrower from alleging he relied on any oral statements of a lender.

Here, the guarantor’s claim that the bank agent made verbal misstatements to induce the execution of the guaranty was clearly governed and defeated by the ICAA.  The court also found the ICAA negated the defendant’s argument that the bank officer orally modified the guaranty terms.(¶¶ 33-35).

The defendant’s “unclean hands” defense also failed.  This defense, which posits that a litigant can’t take advantage of his own wrongful conduct, was premised on the claim that the bank breached a fiduciary duty to inform the defendant of the bank’s intention to enforce the guaranty if there was a loan default.  The Court rejected this defense for two reasons: first, the lender-borrower relationship is not a fiduciary one as a matter of law.  Additionally, unclean hands defense only applies in equity cases: it doesn’t affect legal (actions at law) claims. (¶¶ 38-40)

The other argument raised and rejected by the guarantor was that since he successfully opened a confessed judgment in favor of the bank, this was tantamount to a summary judgment-defeating fact question claimed that since the trial court found that he satisfied the standard for opening a confessed judgment under Rule 276, this was tantamount to a summary judgment-defeating fact question.

Afterwords:

Cameron illustrates the expansive applicability of the ICAA and how that statute will bar almost all claims and defenses related to a promise to lend money.  The case also clarifies that the unclean hands defense will only apply in an equitable case (e.g. an injunction, declaratory judgment suit, etc.); not in a garden-variety breach of contract claim for money damages.  Procedurally, the case’s lesson is that opening a confessed judgment involves different evidentiary standards than does showing a fact question sufficient to defeat a summary judgment motion.

 

 

Integration Clauses and the Implied Duty of Good Faith and Fair Dealing – An Illinois Case Note

In JPMorgan Chase Bank, N.A. v. East-West Logistics, LLC, 2014 IL App (1st) 121111, the Illinois First District affirmed summary judgment for the plaintiff bank in its lawsuit for breach of a commercial guaranty.  In doing so, the Court re-emphasized the key rules governing affirmative defenses, the nature of a guarantor’s liability in Illinois and the content of a proper summary judgment affidavit.  Part I of this post examines the Court’s salient holdings on the court’s Section 2-615 dismissal of the defendant’s affirmative defenses.  Part II will focus on the Court’s dismissal of the guarantor’s fraud counterclaims and the Court’s discussion of summary judgment affidavits.

Facts:

The guarantor (Defendant is the guarantor’s estate) signed a continuing guaranty in 2003 in which he guaranteed over $1M of a logistics company’s loan debt to plaintiff.  The guaranty provided that the plaintiff could proceed directly against the guarantor without first suing the principal debtor.

Plaintiff sued after the loan matured and the guarantor filed multiple affirmative defenses and counterclaims.  After the guarantor died, his Estate substituted in as defendant and prosecuted the defenses and counterclaims on the guarantor’s behalf.  The trial court struck all defenses and counterclaims and granted summary judgment for the bank in an amount exceeding $2M.  The court also denied the Estate’s motion to strike two of the lender’s summary judgment affidavits.  The Estate appealed

Held: affirmed:

Q: Why?!

A: The Court rejected the Estate’s affirmative defenses that the guaranty was extinguished.  The Estate’s affirmative defenses were deficient under Illinois fact-pleading rules.  In Illinois, an affirmative defense must allege facts with the same degree of specificity required to establish a cause of action.  An affirmative defense should not be stricken where well-pleaded facts raise the possibility that the party asserting the defense will prevail.

Illinois treats a guaranty like any other contract: the same formation and interpretation rules apply.  And while a guaranty is construed in favor of the guarantor (since he’s promising to answer for another’s debt), this rule only applies where there is ambiguity or doubt about a guaranty’s meaning.  Where the guaranty’s terms are clear, the terms should be enforced as written; with no need for outside evidence to interpret  the guaranty’s meaning.  A guarantor will be discharged where a creditor takes  action without the guarantor’s consent that either varies the terms of the underlying obligation or materially increases the guarantor’s risk. (¶¶ 32-33).

Application:

The Estate claimed that the guaranty was erases because the plaintiff increased the late guarantor’s liability by continuing to lend money to the corporate debtor knowing that it was in fiscal distress.  The Court disagreed and noted that the guaranty was “unconditional” and “unlimited” and the plaintiff was within its rights to continue lending monies to the corporate borrower without telling the guarantor.  The guarantor also waived any notice of the corporation’s default.  Illinois allows contractual waivers where they are clear and unambiguous.  (¶¶ 35-36).

The Court also upheld the trial court striking the Estate’s breach of duty of good faith and fair dealing and integration clause  defenses.  Good faith and fair dealing is implied in every contract, including guaranties.  A creditor has a good-faith obligation to inform the guarantor of any facts that will materially increase the guarantor’s risk beyond that which he intended to assume.  But parties are still entitled to enforce a contract t the letter and the implied covenant of good faith and fair dealing can’t overrule the express terms of a written contract.

Here, the  duty of good faith and fair dealing didn’t alter the clear and expansive guaranty language.  The guaranty required  the decedent/guarantor to actively monitor the corporate debtor’s financial state.  As a result, the bank’s continued loans to the struggling corporate borrower without informing the guarantor didn’t violate the duty of good faith and fair dealing. (¶¶47-52).

The Court also rejected the Estate’s claim that an integration clause in the underlying loan agreement (between the bank and the corporation) terminated the deceased’s guaranty obligations.  An integration clause  manifests the parties’ intent to protect against misinterpretations of a contract that might arise from extrinsic evidence.  It bars from consideration any evidence outside of the contract that tries to explain a certain term’s meaning. 

Here, since the deceased wasn’t party to the underlying loan contract (it was between the  bank and a corporation), he couldn’t rely on that contract’s integration clause to affect his guaranty obligations.  As a result, the loan agreement integration clause didn’t impact the guarantor’s obligations.  (¶¶ 59-63).

Conclusion: East-West Logistics presents a thorough summary of Illinois’ pleading rules for affirmative defenses and the substantive law on written guaranty construction and enforcement.  Even though a guarantor is a proverbial “favorite” of the law, a guaranty will still be enforced as written – no matter how seemingly  harsh the terms are.  The case reaffirms the proposition that a breach of implied duty of good faith defense can’t override clear, countervailing language in a written contract.  It’s also post-worthy for its discussion of the purpose and scope of integration clauses in written contracts.