Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

With all  the foreclosures going on these days, sooner or later one of these cases is bound to affect a tenant leasing all or a portion of the premises being foreclosed.  So what happens to a tenant in these situations?

The answers depends upon factors such as

• what the lease says, i.e. does it say that it is subordinate to any mortgage
• whether it was the lease or mortgage whcih was executed first
• whether it was the lease or the mortgage which was recorded first
• whether the tenant is joined as a party defandant to the foreclosure

So let's start with what the lease says.  Nearly all commercial leases in Ohio are likely to say that the lease is subordinate to any existing or subsequent mortgage financing by the owner of the real property.  In the unlikely event that a commercial lease does not have this provision, the tenant's lease will generally ride thorough the foreclosure if it was executed before the mortgage or at least recorded before the mortgage.  If the mortgage was executed before the lease, then it will depend on whether the tenant is named as a party defendant to the foreclosure and what rights of the tenant are at issue.

The BIG issue is what happens if a lease is executed after the mortgage, but the tenant is not made a party defendant to the foreclosure.  In Ohio, the definitive case is New York Life Ins. Co. v. Simplex Products Corp., 135 Ohio St. 501, 21 N.E. 2d. 585 (Stark Cty. C.P., 1939).  That case said that since there was no privity between the tenant and the purchaser at Sheriff's sale and the tenant's interest came from the property owner's interest which was auctioned, the lease was terminated - regardless whether the tenant was made a party to the foreclosure. 

However, as is often the case, the facts of the Simplex case left the door open for creative lawyering because it involved a foreclosure sale purchaser interested in enforcing a lease of a tenant not named in the foreclosure.    In Davis v. Boyajuan, 229 N.E.2d 116 (C.P. 1967), the Stark County Common Pleas Court took the out and held that if the purchaser wanted to evict the tenant.  the lease remained in force with respect to a tenant not made a party to the foreclosure.  Consequently, if the tenant was not named as a party to the foreclosure but was in compliance with its obligations under the lease, the purchaser at a foreclosure sale could not kick the tenant out.  But see Prudential  Ins. Co. of America v. Bull Market, Inc., 420 N.E.2d 140 (C.P. Montgomery Cty. 1979)  ("[T]his court concludes that the Supreme Court  [of Ohio] did in fact announce in Simplex. that this state follows the minority rule to this effect that foreclosure terminates a lease of the mortgagor  for lack of priority between the lesee and the mortgagor.")

So these are mere Common Pleas Couty decisions - isn't there anything more authoritative?  More recently, the Ohio Court of Appeals for the Eighth Appellate District in Cuyahoga County has weighed in.  In Victoria Mortgage Corp. v, Williams, 1996 WL 200160,  involving a foreclosure sale purchaser attempting to evict a tenant with an oral lease who was not joined as a party to the foreclosure, the Court succinctly explained the majority rule not followed by Ohio:

The rule in a majority of jurisdictions regarding the survival of a lessor's rights when the lessee is not joined in a foreclosure action is that the lessee does not lose his or her right to possession  or quiet enjoyment.   A judicial sale is treated as a reversion which is subject to the lease, and the purchaser  acquires the rights and duties of the mortgagor thereby becoming the new lesser.

However, because Ohio follows the minority rule, the Court ultimately found that the lease was junior to the mortgage and was extinguished at sheriff's sale.

But what if the lease contains attornment provisions, as is common?  These provisions essentially say that the tenant will recognize any purchaser as stepping into the shoes of the seller/lessor, at least so far as it comes to continuing to pay rent.  In Brandon/Wiant Company v. Teamor, 125 Ohio App.3d 442, 708 N.E.2d 1024 (1998), the Eighth Appellate District Court of Appeals  in Cuyahoga County held that the lease as a contract was clear and unambiguous in stating that the tenant had agreed to accept subsequent purcahsers of the property as lessor.  While the case involved a lessor trying to collect rent from the tenant, in dicta, the Court noted:

[The tenant]  certainly has a right to enforce the obligations owed him bythe lessor against [the purchaser at foreclosure].  The lease is in full effect against both parties to the agreement.

The Fifth Appellate District Court of Appeals out of Muskingham County has consideted the foreclosure purchaser wishing to terminate a lease situation.  In First Federal Savings and Loan Association of Zanesville v. Rig Oil Company, Inc., 1983 WL 7013, the Court acknowledged Simplex, but found the reasoning in Davis persausive.  The Court said:

there is a significant difference between a nonjoined party being given the benefit that miight accrue from nonjoinder and denying him rights not litigated as a result of non-'joinder.  

Clear as mud, right?  So let''s try some general guidelines...

>>>>> IF YOU ARE A COMMERCIAL TENANT WANTING TO BE SURE YOU ARE PROTECTED AGAINST THE FORECLOSURE OF THE PROPERTY OWNED BY THE LANDLORD...

Consider obtaining a SNDA Agreement, short for Subordination, Non-Disturbance, and Attornment Agreement.  These agreements provide more certainty for commercial tenants when the landlord is in default, but the tenant is not and wishes to remain in place.  For more on how this works, vist the Ohio Real Estate Advisor Blog's post "Don't Forget the 'ND' and the 'A' in 'SNDA's'". 

>>>>> IF YOU ARE A LENDER AND/OR SUCCESSFUL PURCHASER AT FORECLOSURE SALE WHO WANTS TO PROTECT THE STREAM OF INCOME OF RENTS FROM TENANTS FOLLOWI NG FORECLOSURE SALE...

Check the lease for attornment language.  If none, and perhaps even if there is, best to have tenant named as party defendant.

IF YOU ARE A LENDER AND/OR SUCCESSFUL PURCHASER AT FORECLOSURE SALE WHO WANTS TO BE ABLE TO HAVE EXCLUSIVE POSSESSION OF THE PROPERTY  FOLLOWING FORECLOSURE SALE.....

If you are in Stark County, definitely include tenants as defendants if there is going to be a desire to evict them following foreclosure.  If you are in Cuyahoga County, don't worry too much  about it.  Elsewhere in Ohio, it just depends on your judge, although to be safe, tenants should probably be included as defendants.  Of course, if the lease contains subordination language, you may be O.K regardless  on contractual grounds.

And of course, sometimes, there may just be too many tenants to make notification and addition as party defendants practical.  There's also the additional wrinkle that in some counties - Lucas Countywhich includes Toledo comes to mind - local rules actually require teants be notified. 

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One of the questions I get asked a lot by my bank and creditor clients is "how long?"  How long til we can get the property back?  And those on the unfortunate receiving end of a foreclosure have the same sort of question - how long til I have to move out? - for different reasons.  Of course the answer is that it depends on so many different things and varies considerably from one county to the nextand one case to the next.  But that's not really the sort of answer anyone can run a bank on or make personal decisions with.  So here are some slightly more specific FAQ  

     1.     How long can I stay in my home if it is in foreclosure? 

If your residence is in foreclosure, it still belongs to you until the time it is sold at sheriff's sale and a confirmation entry is entered by the Court.  So, in plain language, the house is still yours until it is sold at sheriff's sale.  At that time, title to the property passes to the successful purcahser at the Sherriff's sale.  However, it will typically be at least a few more weeks (maybe even two or three months) as a practical matter before the confirmation entry is entered by the Court and the successful purchaser at the sheriff's sale receives the deed.  Because foreclosures are taking so long, in "real life", we are probably talking a year or more.

Double-edged sword is that you ARE still the owner as far as taking care of property......  Soooo,,. if you were thinking about just walking away from the whole mess because you're so far underwater equity-wise, it may not be quite that simple.  For a brief summary of the consequenses ogf this approach, visit Connie Carr's post entitled Mortgage Debt: The Consequences of Walking Away over at the Ohio Real Estate Blog.

     2.      How long will the foreclosure take? 

Talk about impossible questions to answer!  I like to start with the absolute MINIMUMS as far as time periods required if everything went exactly perfectly and there were absolutely positively no delays whatsoever.   Here's what has to happen to at least get to the point of getting a Decree in Foreclosure.  

• Defendants must actually be "served" with the foreclosure Complaint, i.e. they must either actually receive a copy of the Complaint or be deemed served through "publication by service" which means that it's been advertised in those tiny print LEGAL NOTICES part of a local newspaper.  Figure probably a week or two if no problems arise.
• Once "served", under Ohio law, a defendant has twenty-eight (28) days to respond to the Complaint.  So, OK, figure another month here.
• If the defendant does not respond after being served, the plaintiff lender can seek a "default" judgment.  To do this, the plaintiff lender must file a Motion for Default with the Court and wait for the Court to enter the Default Judgment.  This is obviously a HUGE wild card.  Some judges may enter judgment right away while others may just let things sit on their desk for months.  And there's really not all that much the plaintiff lender can do to move things along.  Let's just pencil in a couple of months here as being a not unreasonable period of time for this to happen, but with the understanding that this might well be much longer.
• If, on the other hand, a defendant does respond by filing an Answer to the foreclosure Complaint or there are other complications, the plaintiff lender will need to file a Motion for Summary Judgment.  A Motion for Summary Judgment is similar to a Motion for Default Judgment, but will need to address any arguments brought up by any defendants.  In addition, an Affidavit by an officer of the plaintiff lender will probably also be included setting forth the amount owed and explaining other relevant facts.  Once the Motion for Summary Judgment is filed, defendants have fourteen (14) days to respond and customarily, the plaintiff lender will have an additional seven (7) days to file a responsive Reply.  Here again, it's up to the judge as to when a decree in foreclosure will be entered and there really isn't that much a lender can do to hurry things up.  So, OK, figure 2-6 months here (although I will tell you that I currently have at least one case in which the Motion for Summary Judgment has been pending for more than a year)    

So, to recap, to get from the point the foreclosure Complaint is filed to actually having a judgment Decree in Foreclosure, it's going to be AT LEAST 3 1/2 months or so, and THAT IS SUPER OPTIMISTIC!!!  More likely, you are really looking at six to seven months or more and even that assumes that everything goes perfectly.  My anecdotal expereince is whether commercial or residential, a year or more is NOT an unusual amount of time for a foreclosure to take right now just to get to judgment, even if there is no spirited defense.

     3.     So the case FINALLY has reached that Judgment Decree in Foreclosure stage!  NOW how long til it finally gets auctioned at Sheriff's sale? 

Short answer: one heckuva lot longer than you might expect.  Again, I like to go with what i know to be the MINIMUM periods of time required and work out from there.  Here's what has to happen at this point:

• First off, under Ohio law, the property MUST be appraised by appraisers working for sheriff's office.  This is because, under Ohio law, the opening bid  at sheriff's sale for the proerty MUST be at least TWO-THIRDS of this appraised value.  How long this takes will depend A LOT on what county the case is in.  However, in general, let's figure about a month here.        
• Once the appraisal is done, the Sheriff's Office must set the date on which the property will be offered for sale.  This is where, as a practical matter, things really SLOOOW down.  As a practical matter, this is taking MONTHS right now.  By way of example, Franklin County currently already has sheriff's sales already scheduled through March.  In other words, right now, this step is taking 3 months or more.
• Once the sale date is set, it must be advertised for at least three consecutive weeks.  If there is a silver lining anywhere, it's here where the advertising can take place during the waiting period between the time the sale is set and when it actually occurs.  Also, unlike some surrounding states such as indiana, typically most Ohio counties have sales on a weekly basis.    
• If the sale is cancelled for any reason,even if it was something like a blizzard, the property must be readvertised.  There is no such thing as "postponing" a shriff's sale without the necessity of having to readvertise the property.  However, a new appraisal is not required.

So, to recap here, we're probably talking 3-4 months AT BEST!!!!

    4.     The Sheriff's sale has happened!!!! When do I get $$$?  When do I get the property??? 

OK, here the "good news" is that in Ohio - unlike certain other states -- the "equity of redemption" ends when the hammer falls at sheriff's sale and the Confirmation Entry gets entered by the Court.   The exact process will probably vary from one county to the next.  (On its website, the Franklin County, Ohio Sheriff's Office has helpfully posted an overall summary of its procedures following sale as well as an even  more specific  "What You need to Know as a Potential Third-Party Purchaser"  For other counties, visit the Buckeye State Sheriffs' Association website.)  In general, here's the process: 

• Once the sheriff's sale is over, the confirmation entry is to be submitted within 30 days after the sale,
• Once the Order of Confirmation has been entered, the plaintiff's attorney is to submit the deed to the Sheriff's Office within seven (7) days thereafter
• The successful bidder generally has thirty (30) days following entry of the Order of Confirmation to pay the purchase price to the Sheriff's office, although the precise amount of time will be set forth in the Order of Sale.
• The Sheriff is supposed to record the deed within fourteen (14) days of payment, but that doesn't always happen.  Once the deed is recorded, it will be sent to the successful bidder. 
• The proceeds will be distributed as described in the order of Confirmation after the purchase price has been paid in.

So you're looking at another two or three months here.

     5.     Can I get control of the property sooner by getting a receiver appointed and how long will that take?

Yes, maybe. Appointment of receiver generally only makes sense in the context of commercial properties.  Most  commercial mortgages provide for the appointment of a receiver and especially if there are defaults other than  nonpayment, appointment of a receiver should not be especially difficult.  It is possible in certain cases to obtain appointment  of a receiver on an expedited basis, but the timing and the identity of the individual appointed is still a matter of discretion with the court.  Once the receiver is appointed, the receiver can collect the rents,  handle maintenance issues, and interface with tenants.  However, in non-emergency situations, it is sometimes difficult to obtain a quick hearing date on the Motion to appoint a receiver.  

    6.     What about a "deed in lieu"?  Can that speed things up?

Yes, it can.  However, a "deed in lieu" in which the borrower conveys the property over to the lender, usually in exchange for a release or limitation of liability, only really works if (A) the borrower wants to to do this; and (B) there are no other liens on the property.  If those two criteria are met, a deed in lieu (DIL in the biz) can happen very quickly, perhaps even in a month or less.    

     7.     So the bottom line is.....?

Any way you look at it, foreclosure in Ohio is a long process for either residential or commercial property.  Think at least a year before the property is auctioned at Sheriff's sale and another couple of months before it's finalluy done.  In a commercial foreclosure, getting a receiver appointed early in the case can make the long wait far more palatable to the foreclosing lender as it gives the lender control over the income being produced by the property.

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Are we there yet?  Anyone who has ever been involved in a transactional deal of any complexity has udoubtedly at least thought, if not uttered, this well worn phrase in frustration as yet another obstacle arises to the successful completion of the contemplated transaction.   

Even sophisticated clients are sometimes frustrated by how long it seems to take lawyers to "close" and complete a transaction.  Clients with less experience can become positively apoletic about the fact that it takes more than a week or so for the lawyers to declare the deal done and finished.  Frankly, as one of the lawyers at the center of these trabsactions, I too am occasionally surprised how long it can take in certain situations to successfully complete the transactions.

So why does it take so long, and perhaps more importantly, how can everyone in the deal know how close we are to being able to answer yes to the perennial question "are we there yet?  One of the best tools to understand both what's involved in getting a particular transaction completed AND, on a real time basis what's left to do is a CLOSING LIST.  Every transactional attorney uses some variation of a Closing List to keep track of which tasks and items have been completed, which are still in process, and which issues and tasks still need to be addressed. 

A Closing List for a loan transaction  (Click here and  here  and here for examples) necessarily differs somewhat from a Closing list for a purchase/sale of a business or other transaction (click here and here for examples), both share the same basic elements and utility.  When I do my Closing List, I always start by putting the contact information for all the parties and their attorneys and other important agents and representatives at the top of the first page.  This way I'm never searching for a phone number or e-mail at a crucial point in negotiations.  

The rest of the Closing List is generally in the format of a table.  My tables have visible grid  lines so I can easily see each discrete item or task.  I usually have five columns: 

• Item Number (for quick reference and efficient organization of various folders pertaining to the deal)
• Name of Item or Task (for obvious reasons)
• Responsibility (i.e. which party is primarily responsible for preparing the documentation or completing the task) 
• Status (entries in this column are constantly changing as progress occurs)
• Comment (for additional useful information such as actual or potential obstacles to be resolved, other contact people, etc,)  

Because every deal is different, most closing lists are organic instruments which begin with certain basic items and tasks common to that sort of particular transaction and then initally grow longer as the unique aspects of the deal at hand become fleshed out.  Like other transactional attorneys, building out the Closing List helps me organize what needs to be done and the order in which tasks and items should be attacked.

I usually wait to give clients a copy of the Closing List until I am fairly certain it is a reasonably complete reflection of what will be entailed to make the contemplated transaction a reality in a manner that properly protects my client.  After circulating the intial Closing List, I try to provide updated revised Closing Lists on a regular basis which show where progress has been made and where we may have run into a roadblock or detour that may delay completion of the transaction. 

My hope and intention is that sharing these updated Closing Lists will allow clients to have as close to the same understanding as I do about "where we are" as far as getting the deal done and why we're not there yet.   Thus, if your attorney gives you something of this nature, don't just put it aside and assume it has no purpose relevant to you.  It's your best guide to what's been done so far to bring the deal to fruition and what still remians to make it a reality.   

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When I hear the word "indulgences", my mind immediately goes to something "sinful" and well, probably fun.  In this case, however, I'm talking about  that ubiquitous provision found in loan documents designed to allow lenders to continue to hold borrowers and gurantors liabile notwithstanding the lender's failure or inability to abide by the letter of the loan documents or to exercise all or some subset of its rights upon default in a manner saitsfactory (usually with the benefit of 20-20 hindsight) to the borrower and/or gurantor.  Does this stuff really worK?   

Suppose you have this deliquent borrower -  let's call him "B"  -- on a promissory note (though it could be any obligation) and collateral not worth enough to pay you off in full.  But then you also have this guarantor -- let's call him "G".  Somewhere along the line one of your folks messed up in that "commercial reasonable sale" thing that's supposed to happen when you repossess and liquidate collateral.  Or maybe you let a financial covenant default here and there pass for the time being.  Or perhaps you just extended the maturity date or went interest only for B for a while.  Question is whether you're still OK because you can hold G - who does have assets - liable for the obligation.

Most, if not all, bankers and their counsel would say "yes" because both the UCC and our loan docs say we can.  Which is why  Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) -- now on appeal to the Sixth Circuit and the subject of my last post -- is an important case to watch. 

In a nutshell, the Bank had allowed advances to the Borrower to fund draws on letters of credit in excess of a  "maximum amount" specified in the loan documents and the Bank was pursuing one of the guarantors,  Bank took cognovit judgment and guarantor sought relief from judgment   Federal district court held that the indulgence clause was not sufficient to preclude relief from judgment.

Initially, as a lender-oriented attorney, the case concerned me. It seemed to suggest that lenders permitting any sort of modification -- other than the most vanilla extension of time sort --would now be accepting a substantially greater risk that such forbearance would relieve any guarantor not explicitly consenting from liability. In addition, the manner in which it brushed aside the waivers contained in the “indulgence” clause as inapplicable sent a cold shiver down my spine.   And the logic of the ruling would be applicable not just to cognovit notes, but really any sort of obligation.  So, taken as a whole, if upheld by the Sixth Circuit, the decision seemed likely to convince many lenders that it simply was not in their best interests to work with delinquent borrowers.

As I've thought about it more, however, I've begun to think this decision makes more sense and is less alarming than I had first surmised.  The decision in fact makes an important distinction between the nature and extent of the obligation intended by the parties to be guaranteed on the one hand and mistakes and errors made by the lender in enforcing the guaranty on the other.  In this particular case, the guaranty was never intended to be unlimited - there was a clearly stated unambiguous cap on the amount of credit to be extended to the borrower at particular times.  In continuing to permit advances to fund letter of credit draws, the Bank exceeded this previously agreed limitation on the amount for which the guarantor had accepted responsibility for seeing was paid.

When read closely, the language itself – and certainly the concept originally underlying inclusion of such a clause – is about the consequences of the Bank’s inaction or failure to take appropriate steps to ensure the obligation guaranteed could be satisfied from sources other than the guarantor. When viewed from this perspective, the decision leaves largely intact a lender’s ability to rely on indulgence clauses with respect to events and actions occurring during the course of a workout situation.  It is only a lender’s decision to continue extending credit to the borrower beyond an explicitly agreed–upon point that becomes a problem.

Granted, the ruling is still worrisome.  In asset-based lending, a lender may unknowingly extend credit beyond the “availability” permitted pursuant to a borrowing base calculation formula.  And in the Wallace case, the Bank was obligated to honor letters of credit previously issued and really did not have the ability to refuse to make further advances.

What also makes things a bit problematic for me in this case is that the “cap” in question was only for a very short, almost temporary, period of time and was substantially less than it was at other times.  Had the events occurred but a couple of months earlier or later, the cap would not have come into play.

For me, the take-away lessons for now from this case are:

•  If at all possible, obtain guarantor consent to any modifications or waivers at the time the modifications are made or waivers given.  I already do this anyway, but now it will be even more important.
•  If a lender wants the guaranty to truly be unlimited and/or cover over-advances, the guaranty should say so very explicitly.
• Problems arising due to lack of perfection, release of collateral or other obligors, or other events and circumstances connected with an aspect of the lending relationship that do not pertain to the amount advanced are probably still within the protection of indulgence clauses.   

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How would Peanuts’ Linus manage without his trusty security blanket? Depending on the result, the Sixth Circuit reaches in a recently appealed cognovit judgment case, financial institutions such as banks and others relying on cognovit notes, and perhaps ordinary promissory notes as well, may well have to face a similar question.

Every guaranty I’ve seen has some variation of what is sometimes called an “indulgence” clause. These provisions essentially say that a guaranty remains in effect even if the Bank waives a default by the primary obligor or errs in its collection efforts. Now a federal district court, applying Ohio law, has snatched this security blanket away, saying that such a clause does not allow the lender to ignore the credit terms of a loan with impunity. 

In Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) (Case No.09CV408, Carr, J.), decided August 19, 2009, the defendant guarantor alleged he had a meritorious defense justifying vacation of the cognovit judgment taken against him. His argument was that because the Bank made a “material alteration” to the terms of his guaranty by continuing to allow advances even though the amount outstanding exceeded the prescribed “maximum amount”, his guaranty obligation was rendered invalid. 

The Bank has now appealed the case to the Sixth Circuit (Case No. 09-4172).  If upheld, the decision may have far reaching consequences beyond cognovit notes.  The district court decision suggests that the ONLY modification to an obligation that a lender may comfortably do is an extension of time unless the guarantor agrees.  It could also be taken as meaning that even if the guarntor consents, such modifications would release the guarantor of all liability

Factual Background

The underlying fact scenario is a common one. In August 2007, a company known as Bellepointe entered into a First Amended and Restated Loan and Security Agreement “Loan Agreement”) with the Bank. The Loan Agreement governed three separate obligations – a term note, a line of credit, and a “Guidance Line” involving draws on letters of credit. Michael Wallace (“Wallace”), the father of the company’s owner, executed a guaranty of Bellepointe’s indebtedness to the Bank; the son also executed a guaranty, but the case pertains only to the father’s guaranty.

The guaranty excluded any liability for the term loan indebtedness and also capped the maximum amount of liability with respect to the Line of Credit. The crux of the case focused on the proper interpretation of certain language found in the Loan Agreement and the Guidance Line cognovit note, to wit: 

Notwithstanding anything to the contrary contained herein, the maximum amount available under the Guidance Line shall be as follows:

from the date hereof through and including 11/30/07 - $865,000

12/1/07 through and including 12/31/07 - $250,000

1/1/08 and thereafter - $550,000      

These provisions obviously required a substantial reduction in the amount outstanding as of December 1, 2007. It is not altogether uncommon for lines of credit to require a substantial reduction in the amount outstanding at least once a year. 

Procedural History

Procedurally, the case is a bit complicated. Apparently there was some discussion back and forth between Wallace and the Bank concerning his liability prior to any lawsuit being filed. When those talks broke down, Wallace filed a declaratory judgment action in the Southern District of Ohio federal district court against the Bank on February 11, 2009. Two days later, the Bank took a cognovit judgment against Wallace in Lucas County Common Pleas Court. The Bank said it had no knowledge of the declaratory judgment action when it took the cognovit judgment. 

Wallace promptly removed the state court cognovit judgment action to federal district court for the Northern District of Ohio, apparently on diversity grounds that he was a resident of Florida, and sought relief from judgment. After the Northern District federal court granted the motion to vacate the cognovit judgment, the Bank appealed to the Sixth Circuit where the case is now pending. It appears likely that the Southern District declaratory judgment action will be consolidated with the pending Northern District cognovit action.

The Decision 

Wallace alleged that the Bank continued to make advances on the Guidance Line in December 2007 even though Bellepointe had failed to reduce the amount outstanding as required.  Consequently, he contended that the Bank’s actions caused a “material alteration” in the nature of his guaranty obligation, thereby relieving him of liability under his guaranty. The Bank did not dispute that the advannces exceeded the "maximum amount."  However,it countered by pointing out that its loan documents had one of those “indulgence clauses” which stated:

Guarantor hereby promises that if one or more of the Obligations are not paid promptly when due, he will pay the Obligations to Bank, irrespective of any action or lack of action on the Bank's part in connection with the acquisition, perfection, possession, enforcement or disposition of any or all Obligations....   Guarantor agrees that no extension of time, whether one or more, nor any other indulgence granted to [sic] Bank by [sic] Debtor, or to any other gurantor, or any of them, and no omission or delay on Bank's part in exercising the right against, or in taking any action to collect from or pursue Bank's remedies against Debtor or any other guarantor, or any of them, will release, discharge or modify the duties of guarantor hereunder.

In addition, the Bank insisted that it was obligated to pay the draws on outstanding letters of credit in any event and that the definition of “advances” used in the line of credit differed from the definition of “maximum amount available” for precisely this reason. It also argued that the “indulgence” provisions in Wallace’s guaranty allowed it to ignore Bellepointe’s default in any event.  

So what happened? The federal district court agreed that the provisions of the loan documents did allow the Bank to continue making advances in December 2007. However, the court also noted that “Wallace’s burden is only to allege a meritorious defense, not to prove that he will prevail.” It went on to say:

Even if Wallace had initially failed to allege sufficient facts to support his defense, he has subsequently submitted an affidavit describing the above referenced facts, Wallace alleged sufficient facts for this court to evaluate whether his defense is meritorious.

And the reason? The Court cited Toland v. Key Bank of Wyoming, 847 P.2d 540 (1993) and Frost National Bank v. Burge, 29 S.W.3d 580 (Tex. App. 2000) for the proposition that “’indulgence’ is limited to extensions of time for payment and contract terms permitting indulgences do not waive suretyship defenses.” That’s it!  Really isn’t any further analysis or discussion. 

What IS interesting and informative are the briefs of the parties filed in the federal distriuct court case.  Leaving out exhibits, but including affidavits,here they are:

• Wallace's Motion to Vacate
• Bank's Responsive Memo in Opposition
• Wallace's Reply
• Bank's Sur-reply

Now I think the district court got this wrong and I’d really have appreciated a little further analysis of the pertinent provisions in the loan documents so I could fully understand the Court’s reasoning.  However, I also think the Sixth Circuit proceedings will be rather interesting to follow in the months ahead for lender attorneys everywhere. I’ll share my thoughts about the decision in more detail in my next post. 

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As a footnote to my last couple (click here and here) of posts about the Ohio foreclosure process, I thought it would be worthwhile to link to this recent post on "Evicting the Blameless Tenant"  by Mark Edwards of the Concurring Opinions blog which, especially for a legal blog post, has drawn substantial vociferous comments.  (Hat tip to the Tough Times for Lenders blog for their aptly titled "The Very Dark Side: Evicting tenants from foreclosed apartments" for drawing my attention to this post and pointing up the dichotomy between the lender/servicer view of apartment investment real estate as "project collateral" and the owner/investor (and certainly the tenant) perspective of an "apartment community").

This extremely well written post  poses the question of who as between a lender and a tenant should bear the risk of foreclosure.  It begins:

One of the most pernicious effects of the mortgage crisis has been the eviction of blameless tenants. Leases are usually terminated by foreclosure. Tenants who have never missed a rent payment, and who have no idea that their landlord has not been applying rent payments to their mortgage obligations, suddenly face eviction -- often with no notice.

 

It is difficult to overstate the trauma of the eviction. Tenants are not only turned out into the streets. Often their personal property is put on the curb or thrown into dumpsters. They don't just lose their homes -- they can lose everything they own. Passing rainstorms or scavengers can turn a lifetime's worth of work into nothing. Children in particular can be traumitized by seeing parents rendered powerless, by losing their possessions, and by the fear of the unknown. Violence is a constant threat.

While it is hard not to be moved by these words, it remains difficult for me to be believe that lenders routinely make the effort to boot out truly "blameless" tenants.   Although I can certainly conceive of situations in which tenants have dutifully paid their rent to an unscrupulous landlord who has filed to make mortgage payments, thus resulting in a foreclosure. it remains difficult for me to believe that the truly "blameless" tenant, whether residential or commercial, is all that frequently in danger of being thrown out on the street without warning.  For one thing, at least in Ohio, they would need to be named as defendants in the foreclosure for their rights to be definitively cut off.  

If the tenant is willing and able to continue paying rent at something close to a market rate, I just can't imagine that any purchaser in their right mind would want to disturb such a scenario.  In my experience, low vacancy properties with paying tenants are precisely the sort of commercial real estate valued most highly.  Why?  Because it's a turnkey operation and all the new owner has to do is notify the tenant(s) of a new address to which rent checks should be sent.  Why would any rational purchaser want to dump perfectly good tenants in favor of having to expend resources of time and money to go out and find others?

What I suspect is more likely the case is a situation in which the tenant has perhaps been a bit lax in consistently making timely rent payments - perhaps not so much deliquent that the property owner would be inclined to go to the trouble to get the tenant out, but enough to adversely affect the value of the property as a commercial investment.  In this scenario, it is not the "pure as the driven snow"  tenant we all feel for that we are really talking about.  

And now we are really back to the central issue in the larger foreclosure crisis - what to do about people who can no longer afford to remain in their homes and whether it matters whether we think they are at fault for allowing themselves to be in this situation.  Edwards (correctly in my view) recognizes that '[f]or the bank, the risk is that it is saddled with the responsibility of property management, and that it might be more difficult to sell the property".  He goes on to contend that the relative harm to the tenant of possible eviction and loss of personal property is higher and that

the absolute harm to society in general is greater [than the harm to the lender] when blameless tenants are evicted because of foreclosure, because eviction of blameless tenants has significant negative externalities for neighborhoods and cities. 

A number of the comments to the post (which are themselves interesting to read) seem to elicit an unusual amount of passion. and appear preccupied with allocating the moral supeiority high ground between the lender and tenant.  One more cogent comment by Nate Oman made the most sense to me and reflects my own questions as I read the post:

I am curious as to the underlying economics of these foreclosures. I can understand why the banks don't want to go into the property management business, but I don't see why avoiding that business requires evicting the tenants. Why can't the banks simply sell the properties along with the leases, which if the tenants really are blameless are a valuable income stream after all?

 

It seems to me that there are two possible issues. First, banks can't sell occupied property. Second, the leases lock in rental rates that no longer pay for the landlord. Niether of these seem intuitively plausible to me. The first possiblity is certainly belied by the routine sale of occupied commercial real estate. The second seems odd to me as well. If rent was somehow tied to the land lord's costs, then we would expect leases written at the height of the bubble to actually have very attractive terms given the current real estate market.

 

In short, I am confused as to exactly why this is happening. I suspect that there is some important part of the story that we are missing, and I'd like to understand what it is before signing off on any particular policy response.

While I certainly agree that commercial foreclosures could result in "collateral damage" to those actually living in the foreclosed property and that the"human element" of displaced residents raises issues that need to be addressed, I see these as social issues to be dealt with in a larger context.   Simply saying that because the lender has deeper pockets, it should have to deal with the problem (and in essence maintain the status quo of allowing continued occupancy of an apartment complex without regard to whether market rate rate is being paid by the third-party tenant)  seems too superficial (and frankly unfair) a solution to the issue. 

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Teri Rasmussen has helped guide clients in making legally informed business decisions for more than twenty years.  Her pragmatic strategic thinking has enabled her to provide strong practical counsel and advice to businesses and their owners facing a variety of challenges and legal concerns. 

As an attorney with more than twenty-five years, Teri focuses her practice on business, corporate, commercial, and real estate law.    She concentrates her own practice on matters such as creditors' rights, business insolvency and bankruptcy, workouts and turnarounds, loan structuring, negotiation, and documentation, and commercial litigation.  She also assists clients with business acquisitions, mergers, and sales; business formation; debt and equity financing; contract review and negotiation; relations among business owners; real estate purchase and leasing; and other general business, commercial, corporate and real estate law issues.

To learn more about what Teri can do for clients in these areas, visit this summary of Practice Areas, or read About This Blog and My Approach to Lawyering.  You might also be interested in reading her post on this blog about Why Every Client Should Want an Attorney Who Blawgs.

Teri received her J.D. legal degree cum laude from the University of Michigan Law School where she was a member of the University of Michigan Journal of Law Reform Editorial Board, as well as serving as a research assistant to Prof. James J. White, a well recognized authority on the Uniform Commercial Code.  She is admitted to practice before the courts of all Ohio state and federal courts (including bankruptcy court), as well as before the United States Sixth Circuit Court of Appeals. 

Throughout her career, Teri has been actively engaged in the leadership of numerous professional and business organizations.  She is a Past Chair of the Columbus Bar Association Financial Institutions Committee and of the Ohio State Bar Association Banking, Commercial, and Bankruptcy Law Committee.  Currently Teri has been appointed to the membership of the Ohio State Bar Association Legal Ethics and Professional Conduct Committee.  She was also a cofounder of Women for Economic and Leadership Development (WELD) and served on its Board of Directors for many years.

Teri has also made strong contributions through her involvement in various other civic and community organizations.  She is an alumna of Leadership Columbus’s FOCUS Columbus program and of Leadership Dublin.  In addition, Teri is a Past President of the Columbus Chapter of Executive Women’s Golf Association and served on the Board of Governors for Leatherlips Yacht Club for several years.  She has also served on the Board of Directors for CATCO (aka Contemporary American Theatre Company) while it transitioned to Equity status and for the Central Ohio Chapter of the American Leukemia Society.

 To learn more about Teri, visit her bio on the website of Rasmussen Law Office or

Rasmussen Law Office offers representation to businesses, professionals, and individuals in many areas of law, including

• business, corporate,and commercial matters
• creditors' rights
• real estate
• general civil and appellate litigation

The Rasmussen Law Office serves business, professional, and individual clients in Central Ohio - including Bexley, Clintonville, Dublin, Gahanna, German Village, Grandview, Grove City, Hilliard, New Albany, Powell, Upper Arlington, Victorian Village, Westerville, and Worthington -, as well as throughout the Stats of Ohio.

This blog is not intended as legal advice as every situation differs and you should consult an attorney about your particular legal concern. This blog (as well as any comments to posts on this blog) is not an offer to represent you nor is it intended to form an attorney-client relationship.

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