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.
Choice of Law and Venue
Choice of law and venue provisions are the legal equivalent of choosing your battlefield. A favorable choice of law provision (like New York) can ensure that the lender does not run afoul of, for example, usury statutes, or prevent the borrower or guarantor from taking advantage of onerous state-law provisions. Similarly, a venue provision can ensure that disputes are litigated in a forum that is convenient for your organization.
State substantive law can be outcome-determinative.
In California, for example, guarantors sued for a deficiency may avoid liability by arguing that they are not “true guarantors.” Under California law, a person is not a true guarantor if that person is already personally liable for the underlying loan apart from any additional personal guaranty. Talbott v. Hustwit, 78 Cal. Rptr. 3d 703, 706 (Cal. Ct. App. 2008). This situation might arise, for instance, in the case of a loan to a partnership where the general partners themselves are personally liable for the partnership’s debts regardless of whether they sign any additional personal guaranty.Id. In such a situation, California law provides that “where a principal obligor purports to take on additional liability as a guarantor, nothing is added to the primary obligation.” Id.
While California Courts have held that there is no “true guarantor” problem when the loan is made to an entity whose principals are shielded from personal liability by a corporate structure, id. at 706-707, there is no reason to allow for this argument in a transaction having connections to jurisdictions other than California. So, even if your guarantors are California residents (or the bank is), if you can choose the law of some other state, do so.
Try to maintain the home-court advantage.
Related to choice of law, but different, is venue. A venue provision identifies the location in which disputes arising out the transaction can be tried. There are two things to remember about venue provisions: (1) they can be mandatory or permissive; and (2) they should be consistent across documents.
A mandatory venue provision reads like this:
Any dispute arising under or in connection with this Agreement or related to any matter which is the subject of the Agreement shall be subject to the exclusive jurisdiction of the state and/or federal courts located in Dallas County, Texas.
Under this provision, any suit arising out of the loan transaction must take place in courts located in Dallas County. By contrast, these are permissive venue provisions:
Any dispute arising under or in connection with this Agreement shall come within the jurisdiction of the state and/or federal courts located within Dallas County, Texas.
Any dispute arising under or in connection with this Agreement may be brought in he state and/or federal courts located within Dallas County, Texas.
Under these provisions, litigation can take place in any court of competent jurisdiction, and one such jurisdiction is courts located in Dallas County. If your client wants the option of filing suit elsewhere, you need a permissive venue clause. But if your client only wants to litigate in one place (i.e., his backyard), you need a mandatory clause.
The other thing to keep in mind is that all loan transaction documents should choose the same venue. Be sure to read the note, the security instrument and the guaranty. Do all three have the same venue? If not, choose one. Please.
Choice of law and venue are powerful provisions that can make a real difference in both the cost and outcome of litigation. So don’t default to what you’ve always done. Give some real thought to what law is best for your organization and what courts you want applying it.
Merger and Integration Clauses
It is fairly common for a defendant sued on a debt to assert, long after the money’s been spent, that he was defrauded into entering the transaction. Such “fraud in the inducement” claims are very difficult to have dismissed on summary judgment, because allegations of fraud are generally accepted to raise issues of fact. One of the most fact-intensive elements of a fraudulent inducement claim is whether the defrauded party actually relied on the other party’s representations in entering the contract, and whether such reliance was reasonable. A merger clause that negates reliance, may bring the lender one step closer to defeating this argument.
Can a merger clause beat allegations of fraud in the inducement? Maybe.
A merger clause is a contractual provision to the effect that the written terms of the contract may not be varied by prior agreements because all such agreements have been merged into the written document. IKON Office Solutions, Inc. v. Elfert, 125 S.W.3d 113, 125 n.6 (Tex. App.—Houston [14th Dist.] 2003, pet. denied). Most merger clauses look something like this:
All understandings, representations and agreements heretofore had with respect to this Guaranty are merged into this Guaranty which alone fully and completely expresses the agreement of Guarantor and Lender.
Such a clause is insufficient to beat a fraudulent inducement claim. Dallas Farm Mach. Co. v. Reaves, 307 S.W.2d 233, 239 (Tex. 1957). But the Texas Supreme Court has held that under certain circumstances fraudulent inducement can be avoided by a merger clause that expressly indicates an intention to negate reliance and/or preclude fraudulent inducement claims.
In Schlumberger Tech. Corp. v. Swanson, 959 S.W.2d 171, 177 (Tex. 1997), the Texas Supreme Court held that the following merger clause, which was contained in a post-dispute release agreement, sufficiently negated reliance so as to preclude a claim that the settlement was induced by fraud:
[E]ach of us expressly warrants and represents and does hereby state . . . and represent . . . that no promise or agreement which is not herein expressed has been made to him or her in executing this release, and that none of us is relying upon any statement or representation of any agent of the parties being released hereby. Each of us is relying on his or her own judgment and each has been represented by Hubert Johnson as legal counsel in this matter. The aforesaid legal counsel has read and explained to each of us the entire contents of this Release in Full, as well as the legal consequences of this Release . . .
In doing so, the Court held that disclaimers of reliance are binding when the circumstances surrounding formation of an agreement support the notion that the parties intended to release all further disputes between the parties. Id. at 179-80. That may not be the case in a pre-dispute merger clause because fraud vitiates the entire contract, including the disclaimer of reliance, but there is no reason to deprive yourself of this potential argument if language disclaiming reliance can be negotiated into the contract. You can be sure that without it, a claim of fraud in the inducement is going to have to be either settled or tried.
The courts have not ruled on whether a disclaimer of reliance in a pre-dispute merger clause will cut off a claim of fraud in the inducement, but it is worth trying. And in every post-dispute settlement agreement or forbearance agreement, disclaimer of reliance is an absolute necessity.
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