Beware the Boilerplate: Issue Four (Re: Constructing Loan Language)
A loan is only as good as its documents. This series reviews the potential implications that may go unnoticed in boilerplate language and the importance of customizing standard language in loan documents from one transaction to the next.
Multiple Contracts with Similar (But Not Identical) Clauses
In most commercial loan transactions, there will be multiple documents—for example, a note, a deed of trust and a guaranty. Many times, each of these documents contains provisions intended to have a uniform effect. These are often the boilerplate clauses copied and pasted from one deal to another, but they have critical importance in the context of litigation. They contain, for example, provisions about venue, choice-of-law, waiver of jury trial and merger/integration. As a general rule, contracts executed contemporaneously will be construed together. Jim Walter Homes, Inc. v. Schuenemann, 668 S.W.2d 324, 327 (Tex. 1984).
Creating ambiguity from three unambiguous documents.
A litigator faced with an unfavorable contract provision will often try to argue that it means something less burdensome to his client. One way to do so is to parse the language between contemporaneously executed documents, trying to ascribe meaning to relatively minor differences in the text. Take, for example, the following jury waiver provisions taken from the note, deed of trust and guaranty in a single transaction:
Note Jury Waiver
BORROWER . . . HEREBY WAIVE[S], TO THE FULLEST EXTENT PERMITTED BY LAW, THE RIGHT TO TRIAL BY JURY, IN ANY ACTION, PROCEEDING OR COUNTERCLAIM, WHETHER IN CONTRACT OR TORT OR OTHERWISE, RELATING DIRECTLY OR INDIRECTLY TO THE LOAN EVIDENCED BY THIS NOTE, THE APPLICATION FOR THE LOAN EVIDENCED BY THIS NOTE, THIS NOTE, THE SECURITY INSTRUMENT AND THE OTHER LOAN DOCUMENTS OR ANY ACTS OR OMISSIONS OF LENDER, ITS OFFICERS, EMPLOYEES DIRECTORS OR AGENTS IN CONNECTION HEREWITH.
Deed of Trust Jury Waiver
EACH OF BORROWER AND LENDER WAIVES TRIAL BY JURY IN ANY ACTION OR PROCEEDING BROUGHT BY EITHER PARTY HERETO AGAINST THE OTHER OR IN ANY COUNTERCLAIM ASSERTED BY LENDER AGAINST BORROWER, OR IN ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS SECURITY INSTRUMENT, THE NOTE, ANY OF THE OTHER LOAN DOCUMENTS OR THE DEBT.
Guaranty Jury Waiver
EACH OF GUARANTOR . . . HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY, AND AFTER AN OPPORTUNITY TO CONSULT WITH LEGAL COUNSEL, WAIVES ANY AND ALL RIGHTS TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING IN CONNECTION WITH THIS GUARANTY, THE GUARANTEED PRINCIPAL, ALL MATTERS CONTEMPLATED HEREBY AND ALL DOCUMENTS EXECUTED IN CONNECTION HEREWITH.
In this case, counsel for the guarantors argued that his clients had a right to jury trial on their counterclaims for fraud, because the waiver of jury trial in the guaranty made no specific reference to counterclaims, while the waivers in the note and the deed of trust did. In addition, he argued that the lack of “fullest extent allowed by law” language in the guaranty meant the waiver was intended to be limited. Obviously, the bank’s intention was for each document to waive the right to jury trial as to all claims in any way related to the transaction to the fullest extent allowed by law. Since the intention is the same across all documents, to the extent practicable, the language should be too.
After motions, briefs and an evidentiary hearing, the lender prevailed. The jury waiver was found to be enforceable and applicable to the guarantors’ counterclaims, and the defendants’ jury demand was stricken. Nevertheless, the lender incurred the costs of responding to the motion, preparing for hearing and arguing in court—costs that could have been lessened or avoided entirely had the documents been consistent.
Even if each document in a transaction is well-drafted in and of itself, it must also appear well-drafted when read with all the others. So put those boilerplate provisions side-by-side and make them consistent across all your deal documents. It will be time well spent.
Not Boilerplate, But Still Beware: Overcomplicating
The purpose of a contract is to set out the intention of the parties. Sometimes, though, it seems that drafters go out of their way to make that intent as unclear as possible. In the context of a dispute, this is a big problem because a finding that the contract is ambiguous increases litigation cost significantly. With an ambiguous contract, parol evidence is admissible—which means it is fair game in discovery (the costliest phase of most cases) and at trial. In addition, with an ambiguous contract it’s the jury, not the judge, who decides what it means. So say what you mean and try to avoid these traps.
Requiring cross-referencing when you can easily define a term.
Yes, contracts executed together will be construed together. And, yes, it is easier to refer to terms defined in another document rather than repeat the definition. But if it is possible to simplify the document by saying what you mean, and the undefined term is part of a waiver or other litigation-critical provision, do so.
Consider this case:
- A Guaranty contained a choice of law provision calling for application of the laws of the jurisdiction in which the “Land” is located.
- The Guaranty did not define “Land,” but it did define “Property” as “the real property described in the Security Instrument.”
- The Guaranty also noted that undefined capitalized terms have the meanings ascribed to them in the Security Instrument.
- The Security Instrument defined “Land” as the land described on Exhibit A, which was the real property description of the land securing the loan. So “Land” and “Property” meant the same thing, with only “Property” defined in the Guaranty, but “Land” used to define the applicable law.
In response to a motion for summary judgment, the guarantors claimed the choice of law provision was ambiguous because the term “Land” was not defined in the Guaranty itself and presumably there was some reason to use “Land” instead of “Property” in the choice of law provision. This argument could have been avoided by either
(a) using the term that was defined in the Guaranty;
(b) using only one defined term for the real property described in the Security Instrument; or
(c) just saying Texas law applied.
Option (c) would have been the best in this case, because the guarantors also alleged they had been duped into agreeing to Texas law. Although the property was located in Texas, both the guarantors and the lender were based in California. The Guarantors claimed that it never occurred to them that the law of the jurisdiction where the property was located would control the Guaranty.
Although this is an issue the lender would be very likely to win at trial, the court in this case found there was a fact issue that precluded summary judgment (remember, fraud almost always guarantees you won’t win on a motion). So in a case where all the essential facts establishing liability were uncontested, the lender still could not obtain a ruling on liability in advance of trial.
Failing to define the critical term.
The example above showed how using two terms to define the same thing complicates a case. The mirror-image problem is when a contract uses an undefined term in a critical place, which calls into question whether a defined term controls. Here’s an example:
- A guarantor agrees to pay the “Guaranteed Principal” in the event of a default.
- “Guaranteed Principal” is defined as the principal sum evidenced by the Note, plus interest and all other sums that may or shall become due and payable under the terms of the Note or the other Loan Documents, including but not limited to prepayment premiums, expenses and attorneys fees.
- The guaranty further provides that the guarantor’s obligation is “limited to 50% of the principal balance of the Note.
In this circumstance, what is due? Is it 50% of the Guaranteed Principal, or is it 50% of the outstanding principal balance (i.e., not including interest, fees, prepayment premiums, etc.)? For that matter, is the Guaranteed Principal the same as the amount due under the Note or something else? In this case, the lender meant for the guaranty to be of all amounts due under the note, which includes collection costs, interest, prepayment premiums, etc. This contract uses three terms to describe the same exact thing— only now a defense lawyer can argue that each term is intended to have a distinct meaning, and that the amount his client is liable for is the smallest amount.
Choose one set of defined terms and stick with it. And if a contract calls for a complex calculation, include an example as an addendum to the agreement.
Read the rest of the series: