In a recent decision, the New Jersey Superior Court, Appellate
Division, analyzed the enforceability of a counterclaim waiver
provision contained in commercial loan documents. In Investors
Savings Bank v. Waldo Jersey City, LLC, A-6201-09, _____ N.J.
Super. _____ (App. Div. 2011), the court held that enforcement of
such a provision in a collection action is contrary to New
Jersey's court rules and policy in favor of judicial
efficiency. This decision, however, does not significantly impinge
upon lenders' rights - it merely permits a borrower to bring a
lender liability claim as a counterclaim in a collection action,
rather than in a separate action.
Investors involved a collection action on a defaulted
multi-million dollar development loan from plaintiff Investors
Savings Bank ("Investors") to defendants Waldo Jersey
City, LLC, and Powerhouse Land Development, LLC
("Defendants"). In July 2006, Investors issued a
commitment letter agreeing to provide Defendants with a loan in
excess of $30 million. Defendants' counterclaim alleged
Investors understood that, if the loan was not fully funded,
Defendants could not complete the project.
In September 2007, the parties entered into the loan agreement.
Between the execution of the commitment and the closing, the
residential real estate market in Jersey City (where the property
was located) declined, as did Investors' appraisal of the
property, from $25 million to $16.7 million. By the time the loan
closed, Defendants had incurred $1 million in costs on the
assumption Investors would fully fund the loan. Defendants alleged
Investors funded less than $8.3 million at closing and then decided
to stop funding the loan. Investors subsequently declared a default
and commenced both a foreclosure action and the subject collection
action. In the collection case, Defendants counterclaimed, alleging
Investors materially breached the loan agreement by virtue of its
purported failure to fully fund the loan. Investors successfully
moved to dismiss the counterclaim based on a provision in the loan
documents stating that Defendants waived all rights to bring a
counterclaim against the bank. Defendants appealed.
On appeal, Investors relied on New York state court decisions
holding that a counterclaim waiver provision is enforceable, with
certain limited exceptions. Those decisions did not permanently bar
the counterclaims but merely held that they had to be brought in
separate actions. The Appellate Division noted that New York
federal courts reached a different result. This was because
counterclaims are merely permissive under New York state procedure
but are compulsory under the Federal Rules of Civil Procedure. In
Sage Realty Corp. v. Insurance Co. of North America, 34
F.3d 124, 126, 129 (2d Cir. 1994), the Second Circuit Court of
Appeals noted that, if it were to uphold the waiver provision there
and require the counterclaim to be brought in a separate action,
the later action would be barred by the federal compulsory
counterclaim rule. This would be contrary to the parties'
intent to merely defer the counterclaim. The Second Circuit deemed
the waiver provision unenforceable.
The Appellate Division found the Second Circuit's analysis in
Sage Realty compelling, given the similarities between the
federal rules and New Jersey's state court rules, which require
a defendant to bring "counterclaims arising from the same
operative facts or transaction" as the plaintiff's claim,
or have such counterclaims permanently barred. The court went on to
note that the essence of New Jersey's civil practice rules is
the promotion of efficiency and fairness and the reduction of cost
and delay. Enforcement of the counterclaim waiver provision would
merely lead to "the filing of yet another lawsuit," which
"sensible case management" would require to be
consolidated with Investors' suit. Thus, the Appellate Division
found, the waiver served no purpose and convoluted the proceedings.
As such, it was contrary to public policy and
unenforceable.1
The court also noted that, given the circumstances, it would refuse
to apply the waiver provision, even if it was enforceable. The New
York cases Investors relied on carved out an exception for, among
other things, counterclaims for fraud. The court found that
Defendants' counterclaim, alleging Investors failed to fund the
loan as promised, was similar to the fraud claims permissible under
New York's rule: it was inherently intertwined with the
lender's claim alleging a loan default. 2
While the decision in Investors limits a lender's
right to enforce a counterclaim waiver provision, the court
recognized that, ultimately, its decision had little practical
impact and merely bolstered New Jersey's policy in favor of
efficient case management.
Footnotes
1. The court did note that the waiver provision might be intended as a means of enforcing New Jersey's court rules regarding foreclosure, which permit only "germane" counterclaims. The court did not opine on whether the waiver provision would be enforceable in Investors' foreclosure action, but did note that it "might be sensibly applied" there.
2. The trial court had also, in dismissing the counterclaim, relied on a provision in the loan documents requiring Defendants to indemnify Investors for any loss Investors incurred resulting from the loan transaction. The court's logic was that, even if Investors was liable to Defendants, Defendants would have to indemnify Investors for that liability, canceling any recovery. The Appellate Division noted this was improper, as indemnity agreements can only be based on liability incurred to a third party. Additionally, the consideration for the indemnity provision was Investors' funding of the loan, which Defendants' counterclaim alleged did not fully occur. That allegation had to be taken as true for the purpose of Investors' motion to dismiss. The Appellate Division found the trial court could not have relied on the indemnity provision to grant Investors' motion.
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