Senior Lender Did Not Have Special Duty to Subordinated Junior Lender

On September 9, 2019, Justice Emerson of the Suffolk County Commercial Division issued a decision in Saltini v. North Sea Dev. LLC, 2019 NY Slip Op. 51456(U), holding that a senior lender did not have a special duty to a subordinated lender, explaining:

In support of the ninth cause of action for breach of fiduciary duty, the plaintiff contends that, relying on promises by the Lender, he gave up a position of security and control over the project to become a mezzanine lender with no vote and no control whatsoever. The plaintiff contends that his reliance required the Lender to do whatever he would have done to supervise and manage the project so that the homes were completed properly, in a workmanlike manner, within budget, and on time. The plaintiff contends that both he and the Lender knew that, absent the Lender's performance of these duties, there would not be sufficient funds from the sale of the homes to pay both the Lender and himself. The plaintiff contends that this created a fiduciary duty, which the Lender breached.

A contractual subordination agreement is simply a contractual arrangement whereby one creditor agrees to subordinate its claim against a debtor in favor of the claim of another. Under New York law, when a contractual subordination agreement is unambiguous, the parties' rights are governed exclusively by that agreement and the words of that agreement are given their plain, ordinary, and usual meaning. The Intercreditor Agreement, which is the only contractual agreement between the plaintiff and the Lender, provides, "Mezzanine Lender agrees that Senior Lender owes no fiduciary duty to Mezzanine Lender in connection with the administration of the Senior Loan and the Senior Loan Documents and Mezzanine Lender agrees not to assert any such claim." Acceptance of the plaintiff's version of the transaction would require the improper consideration of parol evidence, contradicting the clear terms of the Intercreditor Agreement, which contains a merger clause, precluding any extrinsic proof to add or vary its terms.

In any event, it is well settled that parties engaged in an arms' length business transaction are not fiduciaries, especially when, as here, they are sophisticated business people who were represented by counsel. Moreover, the plaintiff's version of the transaction imputes to the Lender duties to supervise and manage the project that are not found in the record. The documentary evidence establishes that the Lender's obligation was merely to provide financing. Other defendants, specifically North Sea and the Coast defendants, were responsible for construction of the homes.

Affording the complaint a liberal construction, accepting the facts alleged therein as true, and granting the plaintiff the benefit of every possible favorable inference, the complaint fails to allege special circumstances that could have transformed the business relationship between the plaintiff and the Lender into a fiduciary relationship, such as control by one party of the other for the good of the other or creation of an agency relationship. The plaintiff, an experienced architect, was not under the control of the Lender. That he was under financial pressure and had to give up certain things in order to obtain financing for the project does not create a fiduciary relationship. Accordingly, the ninth cause of action is dismissed.

The plaintiff contends that the Lender breached the duty of good faith and fair dealing implicit in all contracts. The plaintiff contends that the Lender furthered its own economic interest by making modifications to the Senior Loan, such as increasing the release price, thereby making it impossible for him to be repaid from the sale of the homes.

Courts have generally been reluctant to find a breach of the implied covenant of good faith when doing so reads so much into the contract that it creates a new term or when alleged misconduct is expressly allowed by the contract. The Intercreditor Agreement clearly provides that the Mezzanine Loan is subordinate to the Senior Loan and all of the terms, covenants, conditions, rights and remedies contained in the Senior Loan Documents, and no amendments or modifications to the Senior Loan Documents or waivers of any provisions thereof shall affect the subordination thereof. The court cannot employ the covenant of good faith and fair dealing to impose on the parties obligations that are inconsistent with the express terms of the Intercreditor Agreement. Unless a subordinated creditor can show some inequitable conduct which harmed the junior creditor, such as a subsequent fraudulent transfer or preference, the subordination agreement will be enforced, even if the senior creditor uses its bargaining position to improve the status of its existing claims.

Affording the complaint a liberal construction, accepting the facts alleged therein as true, and granting the plaintiff the benefit of every possible favorable inference, the plaintiff has failed to show that the Lender engaged in inequitable conduct that harmed him. The modifications to the Senior Loan were made after the Property LLCs defaulted to provide the Lender with additional security. While the Lender initially increased the release price to $6,000,000, it subsequently reduced it to $5,000,000. Moreover, the properties have not been sold yet, and two of the three are currently listed for sale at prices well above the reserve amount. The plaintiff's contention that the Lender's actions have made it impossible for him to be repaid are entirely speculative.Accordingly, the court finds that the plaintiff has failed to state a cause of action for breach of the covenant of good faith and fair dealing.

(Internal quotations and citations omitted).

Litigating contract disputes is a large part of our practice. Even parties that have no relationship to New York often choose to have their contracts interpreted under New York law because--with a few exceptions--an unambiguous contract between sophisticated business people will be enforced based solely on the terms of the contract. Contact Schlam Stone & Dolan partner John Lundin at jlundin@schlamstone.com if you or a client have questions regarding a contract dispute.