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For many years, the parties who oppose banks in litigation have considered their best strategy to be getting in front of a California jury, and most lenders have tended to recognize that risk.  In today’s financial crisis environment, those concerns are clearly all the more appropriate, as public sentiment seems to have developed a very distinct anti-lender bias, and our recent trial experience in the voir dire process of selecting jurors confirms that in full. 

In the past, the lenders who have recognized this risk have sought to address it with a wide variety of waivers in their loan agreements and guaranties.  But recent experience indicates that many waivers are not wholly reliable, at least the way they have been drafted.  It thus seems time for lenders to review their waivers and to upgrade them for enhanced protection.

There are, of course, many kinds of waivers in loan instruments and this article will very briefly discuss two of them: (1) jury trial waivers (and corresponding arbitration clauses); and (2) bad conduct waivers (both past and forward looking).

Jury Trial Waivers and Arbitration Clauses

California’s Supreme Court has made it clear that a predispute waiver of a borrower’s or a guarantor’s right to a jury trial is not enforceable.  Grafton Partners v. Superior Court (2005) 36 Cal.4th 944.  Moreover, Courts have repeatedly turned back efforts to contractually reengineer the arbitration process, such as by providing that a lender’s appellate rights are preserved.  Gravillis v. Coldwell Banker Residential Brokerage Company (2010) 182 Cal. App. 4th 503.

 

But all is not necessarily lost for lenders, since a similar result can be obtained with a well drafted arbitration clause.  To be effective, arbitration clauses have to be mutual (Jeff Pokorny, et al v. Quixtar, Inc., et al., 10CD 05 4839) and they do have to provide both procedural and substantive due process rights such as discovery.  See, e.g., Armendariz v. Foundation Health Psychcare Services, Inc. (2000) 24 Cal. 4th 83, 90-91.

Many lenders are nervous about arbitration because there is no appeal even if there is a plain error of law.  They are also concerned that arbitrators have been known to “split the baby” so that a sympathetic borrower or a guarantor can come away from the process with a recovery which might seem excessive to a lender who believes it has done no wrong.  But arbitration also has many advantages, including the ability to screen and select the arbitrator, something mostly lacking in the conventional Court system, and it is often a faster process.  As an alternative, the parties may also select a judicial reference process, essentially a private trial by a retired judge but where the traditional rules regarding evidence admissibility and rights of appeal are respected.  Cal. Civ. Proc. Code §§638 et seq.  The latter vehicle may also preserve the lender’s right to apply for a Right to Attach Order, along with the advantage of not having to face a jury.

Many arbitration clauses, however, fail to consider several risks within the arbitration process.  For example, if the clause recites (as many do) that the American Arbitration Association is the service provider, there is an automatic default to a panel of three arbitrators, and that can complicate the entire process as well as render it much more expensive.  Attention should also be given to a pre-selected venue for the arbitration, possible limitations on expensive discovery, and even an established procedure for the choice of an arbitrator.

Alleged Misconduct Waivers

Misconduct waivers are generally divided in two groups: waivers of future misconduct and waivers of past misconduct.  The law treats them differently, especially as to lenders. 

California and most other states allow waivers in a guaranty that permit the lender to modify the underlying obligation without exonerating the guarantor.  But in California, loan agreements or guaranties which attempt to release a lender from future fraud are not enforceable.  Civ. Code Section 1668.  Further, there is significant legal authority to the effect that contract documents containing waivers of the right to complain about conduct even short of fraud, such as gross negligence, are not enforceable where public policy is concerned.  Tunkl v. Regents of University of California (1963) 60 Cal.2d 92, 94.  Since strong legal arguments exist that the business of lending to the public does involve public policy principles, lenders would seem to be well advised to consider such waivers as perhaps desirable but not necessarily reliable.

Past conduct waivers are treated differently.  Here, even past fraud can be waived through a recitation of what is called a Civ. Code Section 1542 (the right to contend that unknown claims are not released can be expressly waived).  This is true even if the borrower or guarantor did not know of the misconduct, although if the lender engaged in active concealment then the lender might be estopped or prevented from enforcing the waiver by application of equitable principles.
Questions arise also as to whether a mere reference in the guaranty to a waiver in the corresponding loan agreement is adequate to bind the guarantor.  The prudent lender will take the extra step to make sure that the waivers are contained within the four corners of the guaranty as well.

Conclusion

Juries have very wide discretion in establishing rough justice, and so if the borrower or guarantor’s plight is sympathetic enough, or if the lender’s conduct is troublesome enough, then even contractual waivers are vulnerable.  Though some lenders seem to favor the Court system for purposes of getting Right to Attach Orders, the risk is that an individual who is a litigation opponent will start off with a distinct advantage at trial. 

In some ways, many of the same things can be said as well for arbitrators since they are not bound by rules of law or evidence, and since their determinations are non-appealable.  But their decisions tend to be more reasoned and less subject to sympathy considerations, so a thorough review of waiver language contained in loan instruments and guaranties is advisable.  There is no substitute for a careful analysis of the kinds of risks a lender is likely to face, and for identifying ways to minimize those risks through an expeditious and economical dispute resolution process that is well engineered in contract documentation.

For further information, please contact William H.G. Norman, chair of Cooper, White & Cooper LLP’s Financial Crisis Group.

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