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April 20, 2014

Beware the Boilerplate: Evolving Terms

Times change, and so does the English language. Nowhere is this more prevalent than in the use of industry jargon and terms of art. If you’ve been using the same form of contract for years, chances are the contract contains terms that do not mean today precisely what they meant when the original form was drafted. But it is the meaning of words at the time of contracting that controls—even if the term’s meaning has changed over time.

“[T]he circumstances to be considered are not the parties’ statements of what they intended the contract to mean, but circumstances known to the parties at the time they entered into the contract, such as what the industry considered to be the norm or reasonable and prudent.”

KMI Continental Offshore Prod. Co. v. ACF Petroleum Co., 746 S.W.2d 238, 241 (Tex. App. Houston [1st Dist.] 1987, writ denied).

An example of industry change: Insurance

When a contract uses industry terms that are outdated, enforcing the contract becomes more complicated, because it opens the possibility of a disconnect between what the term meant at the time of execution, and what the parties actually intended.

Take, for example, insurance requirements. Insurance for property damage comes in two forms—special form insurance and named peril insurance. Special form insurance at one time was referred to as “all-risk insurance,” which is a bit of a misnomer because special form insurance covers all property damage except losses expressly excluded. The problem is that what is considered standard special form coverage changes over time. Prior to September 11, 2001, special form or “all-risk” insurance covered property damage caused by terrorists. After that day, standard insurance practice was to exclude losses caused by terrorism. Let’s say a borrower had an “all-risk” or special form policy covering the period January 1, 2001 through December 31, 2001 (which thus covered terrorist acts). That borrower signs a loan document on November 15, 2001, that requires it to maintain all-risk insurance. Is a post-9/11 all-risk policy (that excludes terrorism coverage) sufficient? What if the loan documents required the borrower to have coverage equivalent to what it had at the time the loan was entered? Must it separately insure against terrorist acts in both cases, only one, or neither?

An example of legal change: Securitization Requirements

Industry terms can also change through court cases, so it is important to be up on the case law in your practice area. In the securitization context, several cases have been fought over the meaning of the term “Loan File.” Lenders typically do not include underwriting information among the documents delivered to the Custodian, and would contend that a “Loan File” in a securitization excludes underwriting information. But at least one Servicer has argued—successfully—that such information is part of the Loan File and must be delivered under the mortgage loan purchase agreement. If your client does not want to deliver underwriting documents for pooled loans, that term must be specific—reliance on your client’s concept of the term “Loan File” is perilous.

A similar disconnect between the intention of lender and borrower on the one hand and the interpretation of the trustee/servicer on the other arose in the case of Wells Fargo Bank, NA v. Cherryland Mall L.P., No. 304682 (Mich. App. Dec. 27, 2011). TheCherryland case addressed the meaning of the term “single purpose entity (SPE)” in CMBS transactions. Standard practice for CMBS loans is to require the borrower to create and maintain SPE status. Failure to maintain SPE status can—and in this case did—trigger full recourse obligations for the borrower and the guarantor. The contractual provisions relating to the SPE requirement in Cherryland were titled “Single Purpose Entity/Separateness” and listed several items, including that the borrower “is and will remain solvent . . . .” As happened with many commercial real estate ventures in the last few years, the property underperformed and cash flows were insufficient to pay debts as they became due. Wells Fargo argued that this insolvency meant that the borrower had not maintained its SPE status, and thus the loan became full recourse. The trial court agreed.

This ruling created panic in the CMBS industry because it essentially made every payment default in a CMBS deal a full-recourse event. The reaction was so strong that the Michigan state legislature passed a law limiting recovery for default of a CMBS loan to the real estate securing it, and applied the law retroactively to un-do the Cherrylanddecision. The defendants appealed the judgment against them all the way to Michigan’s highest court, providing Wells Fargo the opportunity to challenge the constitutionality of the law’s retroactive application.

On September 26, 2012, the Michigan Supreme Court remanded the case back to the court of appeals to address the effect of the law on its prior decision. But you can be sure this will not be the end of the fight. I’m predicting at least one more trip to the Michigan Supreme Court before this is through.

The Cherryland case presents a classic situation where industry players all think they agree about what a term means (in that case, “SPE”), and so do not carefully examine the language in their agreements to be sure it reflects that shared understanding. When this happens, a clever lawyer has an opening to argue for a contrary meaning. That is costly for the client, even if the client wins in the end.

Lawyers are not soothsayers, and no drafter can anticipate every change. The idea is to keep in mind that terms do change, and may have changed since the last time you dusted off that old contract.

Bottom line

If a term is material to your organization, before you simply copy and paste, be sure that the words used present a current and accurate description for the industry and law as of the day of signing. Otherwise, you may find yourself in court repeating Inigo Montoya’s famous line from The Princess Bride: “You keep using that word. I do not think it means what you think it means.”

© 2014 Andrews Kurth LLP

About the Author

Linda R. Stahl, Commercial Litigation Attorney, Andrews Kurth, Law Firm
Partner

Linda Stahl is a litigation partner practicing complex commercial litigation, a member of the firm’s Pro Bono Committee and the Pro Bono Coordinator for the Dallas Office.

Linda handles a wide variety of complex commercial disputes, including intellectual property matters, oil and gas related litigation, fiduciary duty claims and enforcement of financial instruments.

The clients Linda represents include financial institutions, energy producers and internet companies. Through her successful representation of loan sellers, servicers and trustees of commercial...

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