I. INTRODUCTION

            On December 9, 1987, the 9th Circuit Court affirmed an $18.5 million judgment against a bank for breaching a dinner-table oral loan commitment to lend $10 million to finance the down payment on a purchase of an undervalued eleven-acre lot in Los Angeles.[1] The banking industry cried "foul" and lobbied to change the results legislatively.[2]

            This paper will assess the current status of the lender liability in oral loan commitments in California. It will start with discussing the case which started the uproar, analyse the banking-industry-sponsored amendment to the statute of frauds, and end with a discussion on the current trends of the law under various theories relating to oral loan commitments.

 

II. ORAL LOAN CONTRACTS

a. In General

            In general, a promise to loan money needs not be in writing. If an oral promise is sufficiently definite in its terms and supported by consideration, it will constitute a binding contract to make a loan.[3] Although the statutes of frauds in most jurisdictions do not require that an oral agreement to loan money or provide financing be in writing[4], the California legislature recently amended its statute of frauds to require a writing in certain cases.

            Historically, the provision of the statute of frauds requiring a writing in the sale of real property or of "an interest therein", was viewed in California as rendering unenforceable an oral commitment to lend money secured by a deed of trust.[5]

 

      b. Landes Construction Co., Inc. v. Royal Bank of Canada

      1. The Case

            In Landes Construction Co., Inc. v. Royal Bank of Canada, 833 F.2d 1365 (9th Cir. 1987), a one-man corporate buyer owned by Mr. Landes and the sellers reached a "tentative purchase agreement" to buy eleven acres located on the prestigious 5700 block of Wilshire Boulevard in Los Angeles, California. The total purchase price was $50 million. The buyer would execute a $40 million note secured by a purchase deed of trust on the subject property in favor of the sellers and seek other sources to finance the $10 million balance. In effect, the buyer would acquire an interest in the property without any cash down.

            Although the case is silent as to whether or not the purchase deed of trust contained any subordination clause to a construction loan, the facts that the buyer did not have enough money for the $10 million down payment and submitted an application for only $22.5 million which was not enough to pay off the $40 million purchase trust deed, lead to a conclusion that such subordination clause was included in the purchase deed of trust. Moreover, a typical seller-financing on a land purchased for a development usually contained such clause to give a new construction lender a priority on the assumption that the new construction added a value to the land.

            As Mr. Landes acknowledged to the sellers that neither he nor his company had sufficient resources and would bring in a partner to help arrange the financing, the sellers wanted assurances that the buyer could obtain financing for the down payment. The partner contacted a bank through a vice-president and another officer.[6]

            After the bank's real estate specialist accompanied the partner to meet with Mr. Landes and the sellers, Mr. Landes, the partner and the vice-president met again in San Francisco. At a dinner, the vice-president told Mr. Landes: "We are going to lend you $10 million for this project". The next day, the vice-president assured the sellers' representative that the bank would provide the financing. The sellers' representative and the buyer then signed a purchase agreement with the $10 million down payment payable $1 million initially, $2 million in 30 days, and $7 million in another 50 days. If the $7 million final payment was not timely made, the $3 million payable in the first 30 days would be treated as a consideration for an option on the property and would be forfeited to the sellers.[7]

            Four days later, the partner met with the vice-president to negotitate the terms of the $10 million loan. The buyer would pay an interest at a rate of "prime plus two", a loan fee of $3 million after the close of the purchase, and Mr. Landes and his partner would personally guarantee the loan.[8]

            The bank advanced the first $3 million on schedule against the established line of credit of the partner's one-man corporation. It provided some of the financing of another development project which was owned by the buyer and the partner and which the vice-president had previously participated in the approval[9] in the same manner until the paperwork for the project's own credit was completed.[10]

            A little less than two months later, the vice-president prepared an application for a $22.5 million loan: $7 million for the final payment and the balance for the development, interest and fees. The bank however, rejected the application about a month later, five days before the $7 million was due. When the $7 million final payment was not timely made, the $3 million previously paid was forfeited per the terms of the purchase agreement.[11]

 

      2. The Holding

            The court wrote that although "[a]n oral agreement to lend money with which to purchase real property clearly falls outside California's statute of frauds", "[a]n oral agreement to grant a lien against real property as security for a debt is within the statute."[12] It added that "California case law ... holds that when promises not within the statute of frauds are coupled with one that is, the former are enforceable if they are divisible and separable."[13] The court held that the buyer's promise to pay interest and loan fees and principal is separable from its promise to convey a deed of trust as security to the bank.[14] Thus, the bank's oral commitment to finance the down payment was not within the statute of frauds and enforceable.

            Two alternative measures of damages were presented at trial: an expected loss profit with a present value at trial of $79.6 million, and a market value at the expected purchase closing date of $29-40 million more than the agreed purchase price. The trial court allowed a general verdict against the bank for $18 million.[15] The 9th Circuit Court held that even assuming that the trial court improperly admitted the evidence of the loss profit as being too speculative, it merely committed a harmless error because the verdict was much less than either of the two theories and the bank did not timely request a special verdict.[16]

 

      3. Criticism by Commentators

            Robert E. Freitas and W. Douglas Kari of the California Continuing Education of the Bar wrote that "The reasoning in Landes is suspect; it is highly doubtful that anyone familiar with real estate lending would regard the lender's agreement to loan money for the purchase of property as separable from the borrower's agreement to secure the loan against that property." R. Freitas & W. Kari, Selected Issues in Lender Liability at 23 (Cal. C.E.B. April/June 1990).

            Although the C.E.B. commentators may be correct in a typical lender's agreement to finance the balance of a purchase price after the buyer puts a cash down payment, they would not be as correct under the facts of Landes.

            In Landes Construction Co., Inc., the financing at issue was for the down payment itself, not for the balance of the purchase price as in a typical transaction. The seller would finance $40 million of the $50 million purchase price in the form of a note secured by the subject property. The buyer would obtain the $10 million balance from other financing source.

            Although the facts did not clearly indicate, the sellers would unlikely subordinate their interest in their $40 million purchase money trust deed to the $10 million trust deed without any added value to the property from the development because Cal. Code of Civ. Pro. §580(b) would bar them from recovering any deficiency judgment in case the buyer defaults on the note and places them in a worse situation than if they had not sold the property. For the same reasons, the bank would unlikely allow a priority of the sellers' trust deed of $40 million, an 80% of the purchase price, over its $10 million trust deed because its action probably would constitute an unsafe and unsound practice under the banking laws. A logical conclusion would be that the buyer agreed to give the bank a security for the bank's $10 million in the form of a trust deed on the property after the construction was completed or at some point after the purchase was closed such as after the $22.5 million loan application which the vice-president prepared, was approved.

            Assuming, arguendo, that the buyer agreed to give the bank a security in the form of a trust deed on the property upon the close of the purchase, the personal guaranty by the buyer's sole shareholder, Mr. Landes, and his partner, would make the personal guaranty an instrument separate and apart from the deed of trust. As any note, the $10 million note may be secured by more than a property or instrument. It may be viewed as being secured both by a deed of trust on the property and by the personal guaranty of Mr. Landes and his partner. Although the buyer's oral agreement to grant a lien against the property as a security for the $10 million loan was within the statute of frauds, the bank's oral agreement to lend money on the signatures of Mr. Landes and his partner in the form of a personal guaranty to buy a real property was not within the statute of frauds. Moreover, the buyer was not technically the personal guarantors who were Mr. Landes and his partner. If the buyer defaults on the $10 million note, the bank may either enforce the trust deed to foreclose non-judicially on the property or judicially against the buyer, or use the personal guaranty to sue Mr. Landes and his partner personally. Even if one were to accept that Mr. Landes and his partner were only secondarily liable under the personal guaranty in case the bank could not collect from the sale proceeds of the property, the trust deed signed by the buyer and the personal guaranty signed by Mr. Landes and his partner are two separate instruments.

            In brief, Landes Construction Co., Inc. was not as "highly doubtful". "The lender's agreement to loan money for the purchase of property" and "the borrower's agreement to secure the loan against that property" in the trust deed may not be "separable" as the C.E.B. commentators wrote, but both of them constituted only one of the two instruments involved, and are "separable" from those in the personal guaranty.

 

      4. A Recent California Case Dealing With Oral Loan Commitment

            In a recent California case, the California Court of Appeals of the First District recognized the existence of oral loan commitments in California but held that the alleged loan commitment in the case was not enforceable for lack of the essential terms. Kruse v Bank of America, 202 Cal. App. 3d 38, 248 Cal. Rptr. 217 (Cal. App. 1 Dist 1988), cert. denied, 109 S.Ct. 869 (1989).

            In Kruse, the borrower borrowed from the bank and relent it to a supplier-widow after the bank denied her any loan and a sheriff's sale was scheduled to liquidate her properties to satisfy two judgments. About three years later, the bank insisted that the borrower have a controlling interest in the supplier's company as a condition to the continued financing of the supplier's dehydrating plant. The supplier reluctantly transferred a majority of her stock to the borrower for $180 with the expectation that the stock would be returned to her once the bank funded the long-term loan enabling her company to repay the borrower.

            Two months later, the borrower exhausted his $650,000 annual operating line of credit and obtained the bank's approval for an additonal $445,000 credit. The bank officer who regularly worked with the borrower, told him that something would be "worked out" at the end of the year. The borrower optimistically anticipated long-term financing which would permit him to consolidate several debts under a favorable repayment schedule even though he know that the bank officer lacked the authority to approve a loan of such size.

            A month later, the bank officer's regional office supervisor with the bank officer visited the construction site and reportedly stated that "we're going to be able to help [you]". The borrower assumed that the statement indicated that the loan would be approved. After approximately four months, the bank officer realized that the regional credit office would not approve the loan and so informed the borrower. The supplier sued. The borrower and his son cross-claimed that the bank wrongfully induced him to borrow heavily to finance the supplier's company and reneged on its promise to provide long-term financing once they were hopelessly overextended. The trial court awarded $12.75 million to the borrower and $4.5 million to his son in compensatory damages based on special verdicts finding fraud and bad faith denial of contract and $20 million in punitive damages.

            The California Court of Appeals reversed on the grounds that the alleged oral commitments to fund were not enforceable for lack of the essential terms and the borrowers' hopeful expectations that the bank would ultimately give long-term loan did not constitute the justifiable reliance necessary to establish fraud by the bank in inducing them to undertake short-term borrowings without disclosing the possible likelihood that their request for long-term financing would be denied.

 

c. Cal. Civ. Code §1624(g)

            At least partly in response to Landes Construction Co., Inc., the banking industry lobbied successfuly for an amendment to the California statute of frauds.

 

      1. The Amendment

            Shortly before the California Senate Bill S.B. No. 2492 was passed, Paragraph (g) was added to the Cal. Civ. Code §1624 part of the bill.[17] It was approved by the Governor on September 25, 1988, and chaptered by the Secretary of State the next day.[18] The amendment became effective on January 1, 1990,[19] and reads:

 

      A contract, promise, undertaking, or commitment to loan money or to grant or extend credit in an amount greater than one hundred thousand dollars ($100,000), not primarily for personal, family, or household purposes, made by a person engaged in the business of lending or arranging for the lending of money or extending credit. For purposes of this section, a contract, promise, undertaking, or commitment to loan money secured solely by residential property consisting of one to four dwelling units shall be deemed to be for personal, family, or household purposes. This section does not apply to leases subject to Division 10 (commencing with Section 10101) of the Commercial Code.[20]

            In short, the amendment would require a writing to enforce any contract, promise, or commitment to loan money or to grant or extend credit of more than $100,000, not primarly for personal, family, or household purposes and made by a person engaged in the business of lending or arranging for the lending of money or extending credit, unless "some note or memorandum" are in writing and subcribed to by the lender or its agent, or the financing is in the form of a lease of personal property.[21]

 

      2. The Meaning of "to grant or extend credit"

            The second sentence of Cal. Civ. Code §1624(g) deems a "contract, promise, undertaking, or commitment to loan money" secured solely by one- to four-unit residential property to be for "personal, family, or household purposes".

            It is not clear from the text of the code why the term "or to grant or extend credit" after "commitment to loan money" was not included as in the first sentence. The California Legislation review of the Pacific Law Journal did not even address the exclusion.[22]

            A reading would be to exclude the granting or extension of any unsecured loan for such purpose. If the intent was to exclude only the extension but not the initial financing of such loan, the reason for excluding the word "to grant" from the second sentence but not from the first sentence seems illogical.

            A more logical interpretation would probably be to read the amendment in conjunction with the title of the original Senate Bill S.B. 2789 authored by Senator Maddy[23], rather than with the final Senate Bill S.B. 2492 sponsored by Senator Beverly[24] who merely incorporated S.B. 2789 into his bill shortly before its passage as a "double joining amendment".[25] The terms "LOANS AND CREDIT" in the title of S.B. 2789 suggest that the amendment addresses two separate concerns: "loans" and "credit". The first sentence should thus encompass both "a contract, promise, undertaking, or commitment to loan money" in the sense that the money would pass from the promisee to the promisor or one who the promisor designates, and "[a] contract, promise, undertaking, or commitment" "to grant or extend credit" in the sense that the promisee merely give the promisor a credit toward a purchase and no money would change hands.[26] By the same reasoning, the words "to grant or extend credit" would not be appropriate in the second sentence because "a contract, promise, undertaking, or commitment to loan money" secured by a real property involves the passage of money, not merely a credit. However, using the same reasoning, this exclusion of the words "to grant or extend credit" would appear to exclude a line of credit secured by a real property at least until such time as the money is advanced to the borrower.

            If this later interpretation is accepted, then an argument could be made that only an extension of a credit is within Cal. Civ. Code §1624(g), not an extension of "a contract, promise, undertaking or commitment to loan money". However, this argument would be misleading because such later extension does not involve the passage of money but merely an extension of credit in that it extends the terms of the loan to the borrower, thus making the use of the word "or extend" between "to loan" and "money" in the first sentence redundant. A law professor who is experienced with legislation suggested that the draftsmen frequently used the two words  where one would have done nicely and intended no distinction at all between "grant" and "extend" or even between "loan" and "credit".[27]

 

      3. Summary Table of the Effects of Cal. Civ. Code §1624(g)

      Primarily for       Lender

      P/F/H Purp*        in Busn of Lending   Loan Amt             Writing Req

      Yes                       Yes                               Any                        No. See, Landes.

      Yes                       No                                Any                        No. See, Landes.

      No                         No                                Any                        No. See, Landes.

      No                         Yes                               $100K or less       No. See, Landes.

      No                         Yes                               Over $100K         Yes. Civ. Code §1624(g).

     

*    P/F/H Purp: Personal, family, or household purposes.

*    A "contract, promise or undertaking to loan money" secured by up to 4-unit residential property and a lease financing of personal property are specifically excluded from the coverage of the statute of frauds.[28]

 

      4. Exceptions Apply

            All exceptions which are applicable to contracts subject to other provisions of the statutes of frauds, apply to the new amendment Cal. Civ. Code §1624(g).[29] For instances, the statute of frauds had no application to an executed agreement[30], estoppel, fraud, misrepresentations, or waiver. See, Part III below.

 

d. Proofs for Oral Promises

      1. Preponderance of the Evidence

            The standard of proof for an oral promise is by a preponderance of the evidence. Barrett v. Bank of America, N.T. and S.A., 183 Cal. App. 3d 1362, 229 Cal. Rptr. 16, 21 (Cal. App. 4 Dist. 1986), review denied (1986).

            In Barrett, the court reversed the trial court holding which required the borrowers-principal shareholders of a financially troubled corporation, to prove by a clear and convincing evidences the bank's loan officer oral promise that the bank would release the borrowers from their personal guaranty of the corporation's $253,000 SBA loan within six months after the corporation merged with a stronger company which would be solely responsible for such loan. The court stated that the burden of proof for oral modification of a written contract is a preponderence of the evidence. Id., Cal. Rptr. at 21.

 

      2. Statute of Limitation

            Most statutes of limitation distinguish between oral and written contracts.

            In James De Nicholas Associates, Inc. v Heritage Construction Corporation, 5 Cal. App. 3d 421, 85 Cal. Rptr. 233 (Cal. App. 2 Dist. 1970), rehg. denied (1970), hearing denied (1970), the partial payment by the borrower subsequent to oral agreement with the lender did not constitute acceptance of the terms of the agreement, as contained in the written confirmation prepared by the lender, so as to bring the agreement within the four-year statute of limitation applicable to written instruments, but served only to extend two-year statute of limitation applicable to oral contracts, making it run from the date of such last payment.

 

      3. Modification of Oral Contracts

            While a written contract which would be enforceable if unwritten, may be modified by parol, a contract which required by law to be in writing, may not be modified by parol. Boyd v. Big Three Ranch Co., 22 Cal. App. 108, 133 P. 623 (1913).

 

      4. Parol Evidence

            Bucknell, Jr., Goodwin & Stoddard, Jr. wrote: "In California, at least, the parol evidence rule has been so undermined that oral evidence concerning a long agreement or contract will almost always be admissible. See, e.g., Trident Center v. Connecticut Gen. Life Ins. Co., 874 F.2d 564 (9th Cir. 1988)."[31]

            However, in Price v. Wells Fargo Bank, 261 Cal. Rptr. 735, 746-47 (Cal. App. 1 Dist. 1989), the court held that the parol evidence rule precluded proof of the alleged promissory fraud in the procurement of a mobile home loan when the note bore apparent marks of an integrated agreement and the bank's alleged oral promise that it would beat the terms of another bank constituted "contemporaneous oral agreement" contradicting the terms of the written agreement.

 

      5. Claims in Complaint

            In general, claims of oral agreement and exceptions to the statute of frauds must be raised in the complaint or answer.

            In Price v. Wells Fargo Bank, 261 Cal. Rptr. 735, 742 (Cal. App. 1 Dist. 1989), the court held that the equitable doctrines of estoppel, waiver, negligent misrepresentation and constructive fraud, which may bar unfair tactics in the enforcement of agreements, must be raised in the complaint.

     

6. Other Cases Relating to Proofs and Contracts Theories

            An oral loan agreement is not unenforceable because the parties intended that it would be subsequently reduced to writing. J. A. Folger and Company v. Williamson, 276 P.2d 645 (Cal. App. 1 Dist. 1954).

            If "a course of conduct, including various oral representations, created a reasonable expectation", the "cause of action is more property described as one for breach of an implied-in-fact contract", not one for breach of contract absent any explicit words by the parties agreed. Foley v. Interractive Data, 47 Cal. 3d 654, 211 Cal. Rptr. 211, 221 (Cal. 1988).

 

III. OTHER THEORIES

            The California statute of frauds does not render the oral loan commitment invalid but merely unenforceable in the absence of the required writing.[32] As the legislature did not indicate any intention to insulate the lender from the common-law remedies which traditionally have been applied to prevent the statute of frauds from becoming an instrument of injustice,[33] the enforcement of an oral loan commitment, or damages for its breach, may be subject to the exceptions otherwise applicable to contracts subject to the statute of frauds.[34] A cause of action for a breach of an oral loan commitment which was rendered unenforceable because of the statute of frauds, may thus still be maintained under the theories of an implied covenant of goood faith and fair dealing, promissory estoppel, waiver, fraud, or misrepresentation.

           

a. Implied Covenant of Good Faith and Fair Dealing

            The implied covenant of good faith and fair dealing is founded on the emerging common law of contract, tort, and provisions of the Uniform Commercial Code.[35]

 

1. The Uniform Commercial Code Provisions

            Section 1-203 of the Uniform Commercial Code provides that every contract or duty subject to the Code imposes "an obligation of good faith in its performance or enforcement." Section 1-201 (19) defines good faith as "honesty in fact in the conduct or transaction converned." Section 1-208 limits a lender's discretionary acceleration of a term obligation by allowing acceleration only where the lender has a "good faith" belief that its position has been impaired. Courts are divided as to whether the breach of the covenant created by the Uniform Commercial Code creates a separate cause of action in tort.[36]

 

2. The Old Wallis Factors

            In Seaman's Direct Buying Service v. Standard Oil Co., 36 Cal. 3d 752, 769, 206 Cal. Rptr. 354, 362 (Cal. 1984), the California Supreme Court first recognized tort liability based on a bad faith denial of a contract in relationships other than insurer-insured relationship because of their similarity. It described the tortious conduct as "seeking to avoid all liability on a meritorious contract claim by adopting a 'stonewall' position ('see you in court') without probable cause and with no belief in the existence of a defense."[37]

            Citing Seaman's, a California court of appeal in Wallis v. Superior Court[38] listed characteristics of the "sepecial relationship" required for tort recovery in cases other than insurance:

 

(1) the contract must be such that the parties are in inherently unequal bargaining positions; (2) the motivation for entering the contract must be a non-profit motivation, i.e., to secure peace of mind, security, future protection; (3) ordinary contract damages are not adequate because (a) they do not require the party in the superior position to account for its actions, and (b) they do not make the inferior party 'whole'; (4) one party is especially vulnerable because of the type of harm it may suffer and of necessity places trust in the other party to perform; and (5) the other party is aware of this vulnerability.[39]

            Other courts have used these so-called "Wallis factors" to determine the special relationship for a tortious breach of the covenant until the California Supreme Court's decision in Foley v. Interractive Data, 47 Cal. 3d 654, 211 Cal. Rptr. 211 (Cal. 1988).[40]

 

3. Foley v. Interractive Data

i. The Case

            In Foley v. Interractive Data, an employee who had been working for his employer, Chase Manhattan Bank, for almost 7 years, was fired after he reported to his former supervisor and vice president that his new supervisor was currently under investigation by the Federal Bureau of Investigation for embezzlement from his former employer, Bank of America. The employee alleged that his employer's officers had made repeated oral assurances of job security as long as his performance remained adequate. The California Supreme Court held that the employee had sufficiently alleged a breach of an "implied-in-fact" contract which was not barred by the provision of the statute of frauds which requires "[a]n agreement that by its terms is not to be performed within a year from the making thereof" to be in writing. It cited White Lighting Co. v Wolfson, 68 Cal. 2d 336, 343, 66 Cal. Rptr. 697, 438 P.2d 345 (1968), which held that the statute of frauds "applies only to those contracts which, by their terms, cannot possibly be performed within one year."

            The court however, went on to hold that California does not recognize a tort damage for bad faith discharge of employee in violation of implied covenant of good faith and fair dealing. It reasoned that such tort existed in the insurance context because of the special relationship between the insurance company and the insured. While an insured can not turn to the market place to find another insurer willing to insure a loss already occurred, a wrongfully terminated employee can (and must to mitigate the damages) make reasonable efforts to seek alternative employment. An insured does not seek commercial advantages but merely protection from potential specified economic harm. Unlike the "quasi-public" insurance company, the employer does not similarly "sell" protection to its employees and is not providing a public service. Finally, although the insurer's and the insured's interest are financially at odds, the employer's economic benefit is to retain good employees.

            Thus, although the California Supreme Court in Foley left a very little room for a tortious breach of implied covenant of good faith and fair dealing in other than an insurance context, it still leaves open the issue in a lender-borrower context. See, Mitsui Manufacturers Bank v. Superior Court ex rel. The Squidco Corporation of America, Inc. et al, 212 Cal. App. 3d 726, 260 Cal. Rptr. 793, 795 (Cal. App. 4 Dist. 1989).

 

ii. Applying the Foley's Special Relationship Test

            A law review commentator stated that "[a]fter Foley, ... the initial inquiry is whether the tort can exist in a particular relationship, not whether the tort is found given certain facts.[41] It further argued that in comparing the lender-borrower to the insurer-insured relationships, the argument for the tort in the lender liability cases is stronger than in the Foley employment termination case.[42]

            Like the insured who can not turn to the market place to find another insurer willing to insure a loss already occurred, and unlike the wrongfully terminated employee who can make reasonable effects to seek alternative employment, the borrower whose loan agreement was breached by the lender, rarely has time to apply for another loan. In most instances, the lender would have run a credit check on the borrower. Even if the credit report does not show that the loan has been turned down, it would indicate that the lender has run a credit check. This alone would put a red flag on the borrower, causing the new prospective lender to scrutinize the borrower's loan application to it more strictly, and usually would result in the rejection of the application. The borrower may have to resort to bankruptcy.

            An argument could be made that like the insurer which takes the premium from a large group of insureds and "sell" the protection to them, the lender takes deposits from the public and lends them to the borrowers. In a sense, the lender like the insurer, performs a "quasi-public" service.

            Finally, although an employer saves money by performing a contract, a lender save money by breaching a contract and re-lend the prospective loan at a higher rate to a new borrower like the insurer which saves money by breaching a contract.

            In summary, applying the Foley's Special Relationship test probably would lead to a conclusion that a special relationship exists in the lender-borrower relationship similar to the insurer-insured relationship. Thus, the Foley court should allow a lender liability for a tortious breach of implied covenant of good faith and fair dealing.

 

4. Bank Cases

            A breach of implied covenant of good faith and fair dealing occurred when a bank claimed a non-existent one-year statute of limitation as a defense to avoid reimbursing a customer for a $4,000 check which the bank paid on unauthorized signatures, 11 days after the California Supreme Court clearly applied a three-year statute of limitation in such situation. Commercial Cotton Co. v. United California Bank, 163 Cal. App. 3d 511, 209 Cal. Rptr. 551 (1985). However, no such breach occurred when a bank took a "hard line" in repayment negotiations after the borrower defaulted because the bank had no affirmative duty of moderation in the enforcement of its legal rights. Price v. Wells Fargo Bank, 213 Cal. App. 3d 465, 261 Cal. Rptr. 735, 739 (Cal. App. 1 Dist. 1989).

            In a 9th Circuit case, 999 v. C.I.T. Corp., 776 F.2d 866 (9th Cir. 1985), the court affirmed a trial court's judgment of $925,000 (remittur from a $1.9 million jury verdict) for compensatory damages caused by the lender's refusal to honor a financing commitment. The lender sent a letter asking the borrower to deposit $25,000 with C.I.T. and to submit a loan application. Upon request by the borrower, the lender outlined in handwriting the terms of the proposed financing and signed the letter. When C.I.T. later sought to add a provision for a $25,000 per month prepayment penalty, the borrower demanded the return of its deposit. C.I.T. refused. The borrower was not able to obtain other financing before its creditors filed for its involuntary bankruptcy. The damages were based on the borrower's lost business opportunities upon the theories of breach of contract and breach of an implied covenant of good faith and fair dealing.

            In a post-Foley case, Mitsui Manufacturers Bank v. Superior Court ex rel. The Squidco Corporation of America, Inc. et al, 212 Cal. App. 3d 726, 260 Cal. Rptr. 793, 797 (Cal. App. 4 Dist. 1989),  the California Court of Appeals of the 4th District wrote that "the plain fact is [that tort liability for the breach of the covenant of good faith and fair dealing in ordinary arms-length commercial transaction between parties of equal bargaining strength] never existed." It held that "[w]hile Foley may leave this question, albeit narrowly, it is clear from the court's failure to find sufficiently insurance-like characteristics to justify permitting tort actions against employers who discharge employees in bad faith, that it would not permit such an action in an ordinary commercial context where a lender refuses to honor an oral commitment to extent or 'roll over' short-term loans."[43]

 

b. Promissory Estoppel

            An oral promise within the statute of frauds may be enforced under the theory of a promissory estoppel.

            The required elements for a promissory estoppel in California as set forth in Thompson v. Internat. Alliance of Stage Employes are: "(1) a promise clear and unambiguous in its terms; (2) reliance by the party to whom the promise is made; (3) his reliance must be both reasonable and foreseeable; and (4) the party asserting the estoppel must be injured by his reliance. Laks v. Coast Federal Savings & Loan Association, 60 Cal. App. 3d 885, 131 Cal. Rptr. 836, 839 (Cal. App. 2 Dist. 1976), reh'g denied (1976), hearing denied (1976).

            In Laks, the court held that the bank's letter addressed to the borrower stating the loan amount with a maximum loan-to-value ratio, the interest rate, the loan fee, and the loan period, did not constitute sufficiently "clear and unambiguous" terms for a promissory estoppel because it did not state any payment amount.

            In an older case, Morrison v. Home Savings & Loan Association, 175 Cal. 2d 765, 346 P.2d 917 (Cal. 1960), after making an appraisal of the property at the request of the seller, the lender made an oral commitment to the seller to lend $24,500 to a buyer. In reliance on such promise, the seller authorized the agent to sell the property and inform prospective buyers of the loan commitment. When the seller secured a buyer and requested the lender for the funding, the lender notified the seller that it would only advance $23,000 at a maximum 6.6% interest rate for 17 years and require the buyer to obtain an extended coverage insurance policy. The seller accepted. Relying on such oral loan promise, the seller contracted to buy a new house. The lender later confirmed in writing the loan promise. However, approximately a week later, the lender notified the seller for the first time that it would not advance the $23,000 without an "all physical loss" insurance policy. As such type of policy was not available, the sale was not consummated. Citing Drennan v. Star Paving Co., a California Supreme Court case, the Court of Appeals of the 2nd District held that the lender was bound by its commitment on the theory of promissory estoppel.

     

c. Waiver

            As stated earlier, the Code does not render the oral loan commitment invalid but merely unenforceable. Thus, the lender can waive the requirement of a written memorandum by the borrower, and would be bound by a written commitment even though it has not been signed by the borrower.[44]

 

d. Fraud

            A promisor who does not intent to perform at the time she/he makes the oral promise, commits a promissory fraud. Such promise is enforceable despite the statute of frauds.[45]

            The elements of fraud are: "(1) a material and false representation of fact, opinion, intention or law; (2) made with knowledge of its falsity or without any basis for positively asserting it to be true; (3) made with the intention that it should be acted upon by the other party; (4) the other party acted in reliance on such misrepresentations; and (5) the other party suffered injury in so relying. Restatement of Torts (Second) §525.[46]

 

e. Breach of Fiduciary Duty/Constructive Fraud

            As a general rule, a lender is not a fiduciary of its borrower, its borrower's creditors or its borrower's shareholders.[47]

            In Price v. Wells Fargo Bank, 213 Cal. App. 3d 465, 261 Cal. Rptr. 735, 739-741 (Cal. App. 1 Dist. 1989), the court held that bank has a traditional debtor-creditor relationship toward its loan customer, not a "quasi-fiduciary" relationship.

             Under certain circumstances however, a lending relationship may create a fiduciary duty on the part of the lender.[48]

            In Barrett v. Bank of America, N.T. and S.A., 183 Cal. App. 3d 1362, 229 Cal. Rptr. 16, 21 (1986), almost immediately after the funding of the loans, the bank notified its corporate borrower that the corporation was in "technical default" because it was not within the financial ratios required by the loan documents. A bank loan officer told the principal shareholders-guarantors of the corporation that the bank would release them from their personal guaranty of the corporation's loans within six months after the corporation merged with a stronger company which would be solely responsible for such loan. After several months of negotiations, a merger was completed. However, the new company ultimately defaulted on the loan and filed for bankruptcy. When the bank refused to release from their guaranty, the guarantors sued the bank on various theories including constructive fraud. The court reversed a judgment for the bank and held that the trial court failed to properly instruct the jury on the the theory of constructive fraud, and noted:

     

      "Constructive fraud exists in cases in which conduct, although not actually fraudulent, ought to be so treated - ..., having all the consequences and all legal effects of actual frauds." ... Constructive fraud usually arises from a breach of duty where a relation of trust and confidence exists ... Confidential and fiduciary relations are in law, synonymous and may be said to exist whenever trust and confidence is reposed by one in another."

            In Commercial Cotton Co. v. United California Bank, 163 Cal. App. 3d 511, 209 Cal. Rptr. 551 (1985), the court allowed tort remedies based on a breach of a bank-depositor relationship because the bank claim a non-existent one-year statute of limitation as a defense to avoid reimbursing a customer for a $4,000 check which the bank paid on unauthorized signatures, 11 days after the California Supreme Court clearly applied a three-year statute of limitation in such situation. It affirmed the award of damages for $4,000 negligence in debiting the account and $100,000 punitive damages. Citing Seamen's, the court noted that the relationship between a bank and its depositor constituted a special relationship characterized by the fiduciary responsibility, adhesion, and certain public interest factors, similar to the facts present in insurance contracts. It explained the special relationship between a borrower and a lender as follows:

 

      A depositor in a non-interest bearing checking account, except for state or federal regulatory oversight, is totally dependent on the banking institution to which it entrusts deposited funds and depends on the bank's honesty and expertise to protect them... The relationship of a bank to a depositor is at least quasi-fiduciary, and depositors reasonably expect a bank not to claim nonexistent legal defenses. Id., at 516, 209 Cal. Rptr. at 554.

 

f. Misrepresentation

            The Restatement (Second) of Torts §527 (1977) provides:

 

      One who fraudulently makes a misrepresentation of fact, opinion, intention or law for the pupose of inducing another to act or to refrain from action in reliance upon it, is subject to liability to the other in deceit for pecuniary loss caused to him by his justifiable reliance upon the misrepresentation.

            A misrepresentation is fraudulent if the maker know or believes that the matter is not as she represents it to be, or if she does not have the confidence in the accuracy of her representation that she states or implies, or if she knows that she does not have the basis for her representation that she states or implies. The Restatement (Second) of Torts §526 (1977).  A representation that the maker knows to be ambiguous is fraudulent if she believes that it will be understood in its false sense, if she is without any belief or expectation as to how it will be understood, or if she acts with reckless indifference as to how it will be understood. The Restatement (Second) of Torts §527, comment a (1977).

            In Sanchez-Corea v. Bank of America, 701 P.2d 826 (Cal. 1985), the court held that the lender was liable for fraudulent misrepresentation where it represented that future financing might be forthcoming only after an assignment of accounts receivable when in fact it had determined not to extend further loans.

 

IV. STATE STATUTES AND ORAL LOAN COMMITMENTS

            Many state and federal laws impose liability on banks in cases where no liability exists under contracts theories. For instances, a bank may not be liable for orally quoting a lower interest rate if the borrower knew of the error and signed a statement which include the correct rate under contract theories but the bank may be liable under state and federal laws relating to advertising.

            In Chern v. Bank of America, 15 Cal. 3d 866, 127 Cal. Rptr. 110 (Cal. 1976), the California Supreme Court remanded the case to allow the borrower to show that a bank's practice of orally quoting an annual interest rate based on a 360-day year constituted a false and misleading advertisement under Cal. Bus. & Prof. Code §17500 even though the borrower understood and signed the Truth in Lending Statement showing the correct rate based on a 365-day year. However, the court affirmed the summary judgment against the borrower on the contract theory because the borrower had prior knowledge of the correct interest rate as evidenced by her pointing out the error to the bank before signing the statement. Although the fact that the borrower only sought 36 cents damage individually and $100,000 for the class in addition to punitive damages was not specifically considered by the court, they are noteworthy.

 

V. ORAL LOAN COMMITMENTS WITH A FAILED BANK

            In general, when the Federal Insurance Corporation (F.D.I.C.) becomes the receiver of a failed bank, under the basic constract law of assignments, it steps into the shoes of the bank.[49] It succeeds to the bank's contract rights and becomes subject to most defenses that the debtors have against the bank except for certain oral agreements.

            The Federal Deposit Insurance Act of 1950, §2(13)(e), 64 Stat. 889, as amended, 12 U.S.C. §1823(e), provides:

 

      "No agreement which tends to diminish or defeat the interest of the Corporation in any asset acquired by it under this section or section 1821 of this title, either as security for a loan or by purchase or as receiver of any insured depository institution, shall be valid against the Corporation unless such agreement (1) is in writing, (2) was executed by the depository institution and any perons claiming an adverse interest thereunder, including the obligor, contemporaneously with the acquisition of the asset by the depository institution, (3) was approved by the board of directors of the depository institution or its loan committee, which approval shall be reflected in the minutes of said board or committee, and (4) has been, continuously, from the time of its execution, an official record of the depository institution."[50]

            In Langley v. Federal Deposit Ins. Corp., 108 S.Ct. 396 (1987), the borrowers executed a note, a collateral mortgage, and personal guarantees to borrow $450,000 from a bank to purchase land in Pointe Coupee Parish, Louisiana. The note was renewed several times. When the borrowers failed to make the first installment due on the last renewal of the $468,124.41 note, the bank sued in a state court. The borrowers removed the suit to the federal court where it was consolidated with a suit by them against the bank and others for more than $5 million. They alleged that the note was procured by the bank's misrepresentations that the land consisted of 1,628.4 acres including 400 mineral acres without any mineral leases, when in fact it consisted of only 1,522 acres including 75 acres with mineral leases. However, such allegations did not appear in the documents executed by the borrowers, in the bank's records, or in the minutes of the bank's board of directors or loan committee.[51]

            Approximately two years after the filing of the suit, the F.D.I.C. conducted an examination of the bank and discovered the substance of the suit including the borrowers' allegations of the bank's misrepresentations. About a month later, the Commissioner of FInancial Institutions for the State of Louisiana closed the bank because of its unsound condition and appointed the F.D.I.C. as receiver.[52]

            The United States Supreme Court wrote that a purpose of §1823(e) is "to allow federal and state bank examiners to rely on a bank's records in evaluating the worth of the bank's assets with great speed, usually overnight, in deciding whether to liquidate a failed bank or to finance the purchase of its assets (and assumption of its liabilities) by another bank". Another purpose is "implicit in the requirement that the 'agreement' not merely be on file in the bank's records at the time of an examination, but also have been executed and become a bank record 'contemporaneously' with the making of the note and have been approved by officially recorded action of the bank's board or loan committee."[53] Such requirement was in part to prevent fraudulent insertion of new terms, with the collusion of bank employees, when a bank appears headed for failure.[54]

            The Court held that although "fraud in the factum-that is, the sort of fraud that procures a party's signature to an instrument without knowledge of its true nature or contents" "would take the instrument out of §1823(e), because it would render the instrument entirely void", "neither fraud in the inducement nor knowledge by the FDIC is relevant to the section's application". The allleged misrepresentation about the acreage and mineral interests constituted only fraud in the inducement which merely rendered the note voidable but not void.[55] The bank may thus transfer to the F.D.I.C. voidable title, enough to constitute "title or interest" in the note. Although the Court incompletely wrote that "An agreement is an agreement whether or not the FDIC knows of it; and a voidable interest is transferable whether or not the transferee knows of the misrepresentation or fraud that produces the voidability,"[56] it added many sentences later that the F.D.I.C.'s knowledge is relevant only "if it existed at the very moment the agreement was concluded" because of the statutory requirements that any agreement be approved by the bank's board or loan committee and filed "contemporaneously" in the bank's records.[57] As the F.D.I.C.'s holder in due course rights apply to all agreements of the bank, not just negotiable instruments, and its knowledge has no relevance except at the conclusion of such agreements, a textbook author termed the F.D.I.C.'s status as "super holder in due course".[58]

            In brief, the F.D.I.C. may recover on a note against the borrowers who raised as a defense or claimed the failing bank's oral misrepresentations even if the F.D.I.C. knew of such alleged oral misrepresentations by reading the borrowers' pleadings during an examination before it took over the failing bank.

            Thus, whatever oral loan commitments the borrowers may have with a failed bank, they would not be valid except in the unlikely case that the F.D.I.C. knew at the time of the commitments.

 

VI. CONCLUSION

            In general, an oral loan commitment is enforceable if it is sufficiently definite in its terms and supported by consideration.

            Although some commentators criticized the reasoning in the Landes case as "highly doubtful" in separating the oral agreement to lend money from the oral agreement to grant a lien against real property, the case on its special facts was not as doubtful. It merely affirmed the general enforceability of oral loan commitment. Unlike a typical loan secured by a real property, the oral loan in question was for the down payment itself and was made on the personal guaranty of two different individuals with an assurance to offer a security on the property owned by a corporation sometimes after the close of the purchase. The new banking-industry-sponsored amendment to the statute of frauds, Cal. Civ. Code §1624(g), modified the effects of the Landes case only to the extent that it requires a writing to enforce any contract, promise, or commitment to loan money or to grant or extend credit of more than $100,000, not primarly for personal, family, or household purposes and made by a person engaged in the business of lending or arranging for the lending of money or extending credit. A contract, promise or undertaking to loan money secured by up to 4-unit residential property and a lease financing of personal property are specifically excluded from the coverage of the amendment. Although a logical interpretation exists, it is not clear why the words "to grant or extent credit" in the first sentence was left out from the second sentence of the amendment.

            As the California statute of frauds does not render an oral loan commitment invalid but merely unenforceable in the absence of the required writing, the enforcement of an oral loan commitment, or damages for its breach, may be subject to the exceptions otherwise applicable to contracts subject to the statute of frauds. A cause of action for a breach of an oral loan commitment which was rendered unenforceable because of the statute of frauds, may still be maintained under many state and federal statutes and the theories of an implied covenant of goood faith and fair dealing, promissory estoppel, waiver, fraud, or misrepresentation.

            The Foley case which denied a tort recovery in a wrongful discharge action, probably would allow such recovery in the lending context because the lender-borrower relationship is similar to the insurer-insured relationship.

            In case of a failed bank however, the F.D.I.C. may reject whatever oral loan commitments the borrowers may have with the bank except in the unlikely case that the F.D.I.C. knew at the time of the commitments.