The Colorado Credit Agreements

Transcription

1 Reproduced by permission Colorado Bar Association, 36 The Colorado Lawyer 31 (June 2007). All rights reserved. BUSINESS LAW The Colorado Credit Agreements Act and Its Impact on Lenders and Borrowers by Bruce A. Kolbezen and Samuel A. Evig Business Law articles are sponsored by the CBA Business Law Section to apprise members of current substantive law. They focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, nonprofit entities, securities law, and small business entities. This article analyzes case law construing the Colorado Credit Agreements Act (Statute), from its enactment in 1989 through the most recent decision by the Colorado Court of Appeals. This body of case law has uniformly expanded the reach of the Statute. The scope of the Statute demands the attention of institutional lenders, their borrowers, and counsel who represent them. Article Editors: David P. Steigerwald of Sparks Willson Borges Brandt & Johnson, P.C., Colorado Springs (719) , Rob Fogler of Kamlet Shepherd & Reichert LLP, Denver (303) , com; Curt Todd of Lottner Rubin Fishman Brown & Saul, P.C., Denver (303) , (Bankruptcy Law) About the Authors: Bruce A. Kolbezen is a partner at Sherman & Howard L.L.C. He specializes in real estate law and real estate lending, and related commercial law matters (719) , bkolbezen@sah. com. Samuel A. Evig is an associate at Sherman & Howard L.L.C. His practice includes general real estate matters (303) , sevig@sah.com. The Colorado Credit Agreements Act 1 (Statute) provides that neither a lender nor a borrower may rely on the oral representations of the other in the context of credit agreements. The majority of case law under the Statute involves cases where a lender seeks to defeat claims by its borrower based on oral representations of the lender. However, the Statute is bilateral, notwithstanding its lender-oriented legislative history. 2 Consequently, the statutory shield against claims based on oral representations operates to protect borrowers, as well as lenders. The purpose of this article is to provide context for the Statute, to describe the Statute and its reach, to analyze important decisions construing the Statute, and to provide drafting suggestions for practitioners. History of the Statute The Colorado legislature enacted the Statute in 1989, at the end of a financial institution crisis that included rising interest rates, changes to federal tax law, and an overextension of credit, all of which contributed to instability in the lending industry. 3 During this time, borrowers frequently asserted claims and defenses against lending institutions based on undocumented oral representations and promises made by lenders, such as a lawsuit based on an oral promise to extend the term of a loan. 4 As a preemptive measure against potential lawsuits based on oral promises, the Colorado legislature enacted the Statute. The specific intent of the legislature was to curtail suits against lenders based on oral representations made by members of the credit industry. 5 The Statute s Provisions The operative provisions of the Statute preclude any debtor or creditor from filing or maintaining an action or a claim relating to a credit agreement in excess of $25,000 if the credit agreement is not in writing and is not signed by the party against whom enforcement is sought. In addition, and unlike other statutes of frauds, the Statute abrogates common law exceptions to its application based on performance, partial performance, and promissory estoppel. 6 For the Statute to apply to a given situation, there must be: (1) a credit agreement; (2) a debtor; and (3) a creditor.the Statute s definition of these terms is discussed below. Credit Agreement A credit agreement is defined in CRS (1)(a) as: (I) A contract, promise, undertaking, offer, or commitment to lend, borrow, repay, or forebear repayment of money, to otherwise extend or receive cred- The Colorado Lawyer / June 2007 / Vol. 36, No. 6 / 31

2 32 Business Law June it, or to make any other financial accommodation; (II) Any amendment of, cancellation of, waiver of, or substitution for any or all of the terms or provisions of any of the credit agreements defined in subparagraphs (I) and (III) of this paragraph (a); and (III) Any representations and warranties made or omissions in connection with the negotiation, execution, administration, or performance of, or collection of sums due under, any of the credit agreements defined in subparagraphs (I) and (II) of this paragraph (a). In deference to the legislative intent, courts have broadly interpreted the definition of credit agreement. The cases construing the Statute make it clear that oral promises to make loans, oral promises to forebear from foreclosing, and settlement agreements regarding the collection of debts are credit agreements. 7 Actions or Claims Related to Credit Agreements The Colorado Supreme Court case of Univex Int l, Inc. v. Orix Credit Alliance, Inc. 8 illustrates how expansively the Statute has been applied. This case involved a struggling company run by Robert and Mary Rose (Rose), which offered to sell equipment to a rival company, Univex. The equipment was encumbered by a lien in favor of Rose s lender, Orix. The parties verbally agreed that Orix would acquire the equipment from Rose by voluntary repossession, then sell the equipment to Univex and provide financing to Univex for the purchase. The parties never signed any paperwork, but did exchange drafts of documents. Univex delivered a security deposit to Orix. Rose sold the equipment to a third party for the amount outstanding on the loan. Univex subsequently sued Rose and Orix. The Colorado Supreme Court held that the Statute precluded enforcement of the oral agreement by Orix to sell the equipment to Univex, because that purchase and sale agreement was related to Orix s oral credit agreement to provide financing. The Court determined that the oral agreement regarding financing was an unenforceable credit agreement under the Statute. Based on that determination, the Court held that the related agreement for the purchase and sale of the equipment also was unenforceable under the Statute. The Univex case illustrates the broad reach of the Statute. Under the Univex analysis, any commercial transaction that includes even a tangential financing component can be determined, in its entirety, to be related to the credit agreement. If the credit agreement component of the transaction is unenforceable under the Statute, the primary related transaction can be rendered unenforceable, as well. 9 Creditors and Debtors The Statute defines creditor as a financial institution. The Statute defines financial institution as a bank, savings and loan association, savings bank, industrial bank, credit union, or mortgage or finance company. 10 The Statute does not extend to noninstitutional lenders. A debtor under the Statute is a person who or entity that obtains credit or seeks a credit agreement with a creditor or who owes money to a creditor. Although the presence of both a creditor and a debtor is required for the existence of a credit agreement, the application of the Statute is not limited to claims directly between the creditor (lender) and debtor (borrower). The Colorado Supreme Court, in Schoen v. Morris, 11 held that oral representations by one lender (a bank) to another lender (an individual), when the two lenders shared a common borrower, constituted an unenforceable credit agreement under the Statute. In Schoen, the first lender made a loan to the borrower for the construction of a dance hall and saloon.the proceeds of the loan were insufficient to complete construction. The second lender made several bridge loans to the same borrower for payment of construction vendors, allegedly based, in part, on the first lender s oral representations to the second lender that a permanent loan had been approved by the first lender and would be funded in an amount sufficient to repay the bridge loans. The permanent loan was never made, and the borrower filed for bankruptcy protection. The second lender sued the first lender based on the oral representations. The Colorado Supreme Court held that the oral representations made by the first lender to the second lender ( a commitment to lend ) constituted a credit agreement under the Statute. Further, the Court held that the first lender was a creditor ( a financial institution which offers to extend... credit ) and the second lender was a debtor ( a person who... seeks a credit agreement ) under the Statute, despite the absence of a direct lender-borrower relationship between them. Consequently, the claims based on oral representations by the first lender to the second lender regarding the extension of credit to a common borrower were barred by the Statute. As a result of Schoen, all inter-creditor agreements, including tri-party, participation, buy-sell, and subordination agreements, must be in writing and signed to be enforceable. Also, all modifications to such agreements must be in writing and signed to be enforceable. 32 / The Colorado Lawyer / June 2007 / Vol. 36, No. 6

3 2007 Business Law 33 Claims to Which the Statute s Shield Applies Most cases under the Statute involve fact patterns where lenders seek to defeat claims by borrowers based on actual or alleged oral promises to provide credit, modify an existing loan, or forebear from foreclosing or otherwise enforcing a defaulted loan. In such cases, lenders assert the Statute as a shield to protect their interests. However, the operative language of the Statute states that no debtor or creditor may file or maintain an action or a claim relating to a credit agreement. 12 Thus, the statutory shield operates to protect both lenders and borrowers; oral representations and promises by a borrower related to credit agreements are unenforceable by the lender. Premier Farm Credit, PCA v. W-Cattle, LLC, 13 discussed below, involves the use of the Statute as a shield by both the lender and the borrower against the other s claims. Further, the Statute has been found to bar many types of claims.these claims include unjust enrichment, 14 breach of fiduciary duty, outrageous conduct, interference with prospective business advantage, 15 and negligent misrepresentation. 16 The Premier Decision Premier is the most recent case involving the Statute. The facts of Premier are similar to those of many cases involving the Statute the borrower tried to prevent the lender from taking action to collect defaulted loans based on an alleged oral assurance given by the lender. Facts and Background The borrower and the lender had established a relationship in During the initial loan application process, the borrower materially misrepresented its financial position. Unaware of the misrepresentation, the lender provided a $6 million revolving line of credit, secured by pledges of cattle, farm machinery, feed grain, equipment, and crops. The parties documented the loan by signing standard loan documents, which required the borrower to submit monthly borrowing base reports listing cattle inventory, crop inventory, and facts about other assets. Each year during the term of the loan and in reliance on the accuracy of information contained in the monthly borrowing base reports, the lender increased the amount available for disbursement under the line of credit. In 2003, concerns about the actual value of its collateral prompted the lender to include new reporting requirements in the loan agreement and, later, to perform an on-site audit of the collateral. After the on-site audit, which indicated the borrower had been misrepresenting its position, the lender s president met with the borrower to discuss the discrepancy. The borrower claimed to have received assurance from the president that the lending relationship would continue and that loans would not be called due. In reliance on these alleged verbal assurances, the borrower executed deeds of trust on all of its real property as additional security for the existing loan. The parties did not memorialize the alleged promise by the president to forebear from calling the loan due. The next borrowing base report established that the borrower owned cattle worth approximately $11 million less than the most recent report had claimed. The lender filed suit against the borrower for breaches under the loan documents, fraudulent misrepresentation, fraudulent concealment, and conversion of collateral. The lender sought damages, turnover of personal property collateral, an accounting, appointment of a receiver, and foreclosure of the recently granted deeds of trust. Importantly, the lender s fraud claims were based on its allegation that the borrower had misrepresented its financial status in the application process for the original loan in The borrower responded by asserting defenses and counterclaims, including claims of fraud, breach of contract, negligence, breach of fiduciary duty, and by requesting a declaration that the deeds of trust executed in 2003 were void as having been fraudulently induced. The borrower s core allegation was that the lender s president had deceived the borrower by his oral representations that the lender would not call the loan due, thereby inducing the execution of the deeds of trust by the borrower. Trial Court Ruling The trial court held that the borrower could not assert claims, including the claim for rescission of the deeds of trust, because of fraud in the inducement. The court also held that the borrower could not introduce evidence based on the lender s oral promise to forbear repay- The Colorado Lawyer / June 2007 / Vol. 36, No. 6 / 33

4 34 Business Law June ment of money, because the oral promise was an unwritten and unsigned credit agreement and, therefore, unenforceable under the Statute. Similarly, the trial court held the lender could not assert claims or introduce evidence based on the borrower s oral representations made in connection with the negotiation of the lender s commitment to lend money in 1998, because the oral representations were an unenforceable credit agreement under the Statute. Appellate Decision The Colorado Court of Appeals affirmed the decision of the trial court. Particularly, the majority of the Court of Appeals concluded that the phrase action or claim in the Statute is not limited to claims for affirmative recovery, but also is intended to bar the assertion of affirmative defenses to liability based on oral misrepresentations. Consequently, the majority held that the borrower s claim for rescission of the deeds of trust based on the theory of fraudulent inducement were barred by the Statute. 17 The Premier case illustrates two points. First, the Statute precludes claims based on the borrower s alleged fraudulent oral misrepresentations at the outset and during the lending relationship. Second, the Statute defeats a claim to rescind a credit agreement based on fraud in the inducement. Implications for Institutional Lenders, Borrowers, and Counsel Based on Univex, parties to transactions that are related to a credit agreement should exercise caution. A large number of business transactions involve a credit agreement that is not the primary focus of the transaction. Parties involved in the transaction must be aware of the consequences of the Statute s application to their particular transaction and document the transaction accordingly. Under Premier, the Statute will operate to defeat claims for fraud in the inducement based on oral misrepresentations by either a lender or a borrower. However, notwithstanding Premier and the statutory bar, it is important to remember that a lender typically will have recourse under its promissory note against its borrower, as well as recourse under its security documents against the collateral securing the repayment obligation. Consequently, a fraud claim, like that made in Premier by the lender, absent additional punitive damages, would not add to the lender s contractual rights to recovery under its loan documents. 18 On the other hand, the Statute provides the lender with a defense to fraud claims asserted against it by its borrower based on the lender s alleged or real oral misrepresentations. Therefore, on balance, the decision is favorable to lenders. Nonetheless, in light of the holding in Premier, some general revisions to loan documents should be considered. Particularly, in the context of nonrecourse lending, revisions to the fraud and misrepresentation carve-out also should be considered. In addition, lenders may wish to implement certain strategies in anticipation of a borrower s potential bankruptcy. Loan Documentation Revisions To make otherwise unsigned pre-closing due diligence documentation and post-closing loan administration reports enforceable under the Statute, the lender 34 / The Colorado Lawyer / June 2007 / Vol. 36, No. 6

5 2007 Business Law 35 reasonably might require that such documentation and reports be certified on behalf of the borrower. The requirement for the certificate would be included in the loan application form for the borrower. (See Certificate example in accompanying sidebar.) Further, any significant oral representations by the borrower or its representatives made to the lender in the loan application and underwriting process should be reduced to writing and certified, as suggested above, or incorporated in the loan documentation. In addition, general representations concerning the accuracy and completeness of information contained in and related to the loan application and commitment should be included in the loan documentation. (See Representations of Accuracy example in accompanying sidebar.) A default provision corresponding to the general representations would be included in the definition of Events of Default. (See Default example in accompanying sidebar.) Related boilerplate provisions of existing loan documents should be critically reviewed. Particularly, integration provisions, by which prior agreements are merged into the loan documents and thereby superseded, should be removed. Indeed, the operation of the Statute addresses, in significant part, the institutional lender s concerns that gave rise to the inclusion of such integration provisions in loan documentation. A conflicts provision should be substituted for the integration provision. Under the conflicts provision, the terms and conditions of the loan documents would supersede any inconsistent terms and conditions of the loan commitment, but the loan commitment and the reports, certificates, lists, and other instruments, described above, otherwise would survive the execution and delivery of the loan documents. Importantly, the fraud or misrepresentation recourse carve-out in any nonrecourse provisions of the applicable loan documents should be reviewed and revised if necessary. If, as a result of fraud or misrepresentation, the value of the collateral has been significantly overstated, the lender must have personal recourse against the borrower and guarantors. In light of the Premier decision, the fraud or misrepresentation carve-out should be cast as a contractual undertaking by the borrower. (See Fraud or Misrepresentation Carve-Out example in accompanying sidebar.) If obtainable, the lender should include a provision giving the lender full recourse against the borrower and guarantors in the event of fraud or misrepresentation. Bankruptcy Implication and Strategy In bankruptcy court, a creditor seeking a determination that a debt, evidenced by a promissory note, is nondischargeable under 11 U.S.C. 523(a)(2)(A) must prove that: (1) the debtor made representations; (2) at the time of making the representations, the debtor knew they were false; (3) Loan Documentation Revisions: Example Language Certificate The following is an example of a form of certificate that might be required: The undersigned certifies (a) that the undersigned is an [officer/partner/member] of [Borrower] with responsibility for the matters discussed and described herein; (b) that the undersigned has reviewed all information contained herein and certifies that it is accurate and complete, and does not omit any material facts; (c) that it is the intent of the [Borrower] that [Lender] shall rely on all the information contained herein in underwriting, making, and administering the loan from [Lender] to [Borrower]; and (d) that the undersigned has been fully authorized to give this certificate by [Borrower]. Name: Title: Date: Representations of Accuracy The following are examples of such representations with respect to a real estate loan: Representations in Commitment and Otherwise. The representations made in connection with the Commitment, including but not limited to the type of development, income, and expenses of the Real Property, the Leases, and the financial condition and credit of Borrower, are as represented in the Commitment in all respects, except any changes that may have been approved by Lender in writing. In addition to the foregoing, all financial and other information and statements relating to Borrower, any Guarantor, and/or any of the Real Property that has been previously supplied to Lender by Borrower, are true, complete, and correct in all material respects and have been prepared in accordance with generally accepted accounting principles, consistently applied. Complete Information. No representation or warranty of Borrower or any Guarantor contained in any of the Loan Documents or Guarantor Documents; no statement of Borrower or any Guarantor contained in any report, certificate, schedule, list, financial statement, side letter, or other instrument furnished to Lender by or on behalf of Borrower or any Guarantor; and, to the best knowledge of Borrower, no statement of any person or entity other than Borrower or any Guarantor contained in any report, certificate, schedule, list, financial statement, side letter, or other instrument furnished to Lender by or on behalf of Borrower or any Guarantor, contains any untrue statement of a material fact, or omits to state a material fact necessary to make the statements contained therein not misleading in any material respect. Default The following is an example of a default provision with respect to a real estate loan: Misrepresentations. Any representation or warranty made by Borrower or any person(s) or entity(ies) comprising Borrower or any guarantor(s) under the loan application or Loan Documents or any report, certificate, schedule, list, financial statement, side letter, or other instrument furnished to Lender at any time in connection with the loan application, the Loan, or the Loan Documents proves to be untrue or misleading in any material respect. Fraud or Misrepresentation Carve-Out The following is an example of such a carve-out: The Borrower hereby absolutely and unconditionally agrees to pay, indemnify, and hold the Lender harmless from and against any and all damage, loss, liability, cost, and expense, including, without limitation, reasonable attorney fees and costs, plus default interest thereon, which Lender may suffer or which Lender may become subject to, directly or indirectly, arising out of, resulting from, or based on any fraud or misrepresentation by Borrower or by any of Borrower s guarantors to Lender prior to or during the term of the Loan, and irrespective of whether such fraud or misrepresentation is itself actionable under the Colorado Credit Agreements Act, CRS , or otherwise. The Colorado Lawyer / June 2007 / Vol. 36, No. 6 / 35

6 36 Business Law June the debtor made them with intention and purpose of deceiving the creditor; (4) the creditor relied on such representations; and (5) the creditor sustained loss or damage as proximate result of representations having been made. The determination of the dischargeability of a debt in bankruptcy is a matter of federal law. Therefore, the Statute and the Premier case should not have significance with respect to the borrower s bankruptcy and the lender s claim of nondischargeability of its debt based on false pretenses, false representations, or actual fraud under Bankruptcy Code 523(a)(2)(A). Although the doctrine of collateral estoppel, or issue preclusion, does apply in bankruptcy court, an earlier state court determination that a claim for oral fraud is barred by the Statute should not affect a bankruptcy court s subsequent determination regarding the dischargeability of the debt evidenced by a promissory note or a judgment entered thereon. Generally, as long as Premier remains good law, it would not be productive for a creditor to litigate, in state court, a fraud claim against the borrower based on oral misrepresentations relating to a credit agreement. However, in a case where default judgment is likely to be entered in state court, creditor s counsel might consider inclusion of allegations of fraud in the lender s complaint that, on entry of default judgment, could satisfy the factual predicates to nondischargeability. Conclusion The lessons from Colorado state court decisions regarding the Statute are twofold. First, case law confirms that the Statute is expansive and, for the first time, the Statute has been found to preclude claims of fraud in the inducement based on oral misrepresentations. Second, drafting loan documents with care and attention to the details of the particular transaction is critical. Although the facts regarding loan documentation in Premier are sketchy, the case might have turned out differently had either of the parties focused closely on documentation during the loan application and underwriting process and the subsequent loan administration process. The use of standard form loan documents is acceptable for many transactions and usually will have the added effect of lowering transaction costs. However, in transactions of sufficient size or complexity, the inclusion in loan documents of specific representations and warranties and complementary default and indemnification provisions will prove valuable to the lender. Further, in most transactions involving large loan amounts or increased complexity, the marketplace will accept the increase in cost attendant to more thoughtful loan documentation. NOTES 1. CRS See Schoen v. Morris, 15 P.3d 1094, (Colo. 2000), citing Recordings of the House Business Affairs Committee on H.B , 57th General Assembly (Jan. 19, 1989). 3. See Federal Deposit Insurance Corporation Division of Research, History of the Eighties Lessons for the Future (1997), available at ical/history. 4. See Smith v. Hoyer, 697 P.2d 761 (Colo. App. 1984) (damages recovered by borrower based on bank s breach of an oral agreement to extend term of loan). 5. See Schoen, supra note 2 at CRS (2) and (3). 7. See Schoen, supra note 2; Hewitt v. Pitkin County Bank and Trust Co., 931 P.2d 456 (Colo. App. 1995); Pima Financial Serv. Corp. v. Selby, 820 P.2d 1124 (Colo.App. 1991). 8. Univex Int l, Inc. v. Orix Credit Alliance, Inc., 914 P.2d 1355 (Colo. 1996). 9. Id. at 1361.The dissent observed that: [T]he effect of the rule announced by the majority is to render any commercial transaction allegedly containing financing terms a credit agreement in its entirety regardless of the nature or extent to which the agreement addresses financing issues or how incidental such issues might be to the primary transaction. 10.The term bank, which is included in the definition of financial institution, has been construed broadly to mean both state and federally chartered banks and institutions that function like banks by accepting deposits, allowing withdrawal of funds by check or draft, making loans, and accepting security for loans. Premier Farm Credit, PCA v. W-Cattle, LLC, No. 05CA0444 (Colo.App. 2006), cert. denied (April 9, 2007). 11. Schoen, supra note CRS (2). 13. Premier, supra note Lang v. Bank of Durango, 73 P.3d 1121 (Colo.App. 2003). 15. Hewitt, supra note Norwest Bank Lakewood v. GCC Partnership, 886 P.2d 299 (Colo.App. 1994). 17. Id. The Court of Appeals opinion contained a special concurrence by Judge Carparelli. In Judge Carparelli s opinion, the Colorado Credit Agreements Act (Statute) does not defeat a common law defense (such as fraud in the inducement), because the Statute, by its terms, applies only to an action or a claim. Judge Carparelli found that the result reached by the majority nonetheless was correct, because the fraud claims by W-Cattle and the Wisdoms were based on Premier s alleged misrepresentations about its future plans, as opposed to concealment or failure to disclose past or present facts. Although the Colorado Supreme Court denied cross petitions for certiorari in this case, it remains to be seen whether Judge Carparelli s position will be adopted by the Court in the future. 18. In addition, because a lender will have contractual remedies against its borrower under the loan documents, it is questionable whether, under the economic loss rule, a fraud claim, which is a claim in tort, may be asserted by a lender against its borrower. The rationale of the economic loss rule is to separate the law of contracts, under which the duties and obligations of parties are determined by their mutual agreement, from the law of torts, under which duties and obligations are determined by social policy. The operation of the economic loss rule prevents a commercial plaintiff from recovering excessive damages for losses based on tort theories of liability, when contract or commercial law would more accurately calculate the remedy based on the agreement of the parties. See Lawler, Independent Duties and Colorado s Economic Loss Rule Part 1, 35 The Colorado Lawyer 17 (Jan. 2006). 36 / The Colorado Lawyer / June 2007 / Vol. 36, No. 6