Basic Capital Management, Inc. v. Dynex Commercial, Inc., 2011 WL 12067376 (Tex. Sup. Ct. J. Apr. 1, 2011)
A real estate lender agreed to finance three existing projects by lending money to three separate Single-Asset Bankruptcy Remote Entities (SABREs), owned by certain real estate investments trusts, and to finance $160 million in future ventures of the trusts, with further SABREs to be created as each deal came to fruition. As financial and credit conditions worsened, the lender withdrew its future lending commitments and stopped funding the current commitments. The trusts sued the lender for breach of contract, winning judgments at the trial level. However, the lender successfully non-suited the judgment on the grounds that the trusts lacked standing to recover damages because the current and future lending commitments were with the SABREs, not the trusts, and also that damages for the future commitments were not foreseeable. On appeal, the Texas Supreme Court overruled the non-suit on both grounds, holding that the trusts were third-party beneficiaries and that damages were foreseeable.
Basic Capital Management managed publicly traded real estate investment trusts (REITs) in which it owned stock. Two of these REITs, ART and TCI, are involved in this case. Dynex Commercial, Inc. provided financing for multi-family and commercial real estate investors.
ART and TCI held investment property in single-purpose entities (SPEs), also known as SABREs (single-asset, bankruptcy remote borrowing entities). The purpose of each SABRE was to own a single piece of real estate, so that if one SABRE became insolvent, its problems were separate and remote from the other SABREs, which provided additional security to lenders doing business with the SABREs.
Dynex agreed to loan three TCI-owned SABREs $37 million to acquire and rehabilitate three commercial buildings (one building each) in New Orleans. This loan was conditioned on Basic Capital’s promise to find other deals acceptable to Dynex, similarly structured through as-yet-to-be created SABREs. Dynex required that these SABREs borrow $160 million over the next two years.
The New Orleans agreement was between Dynex and TCI (not a SABRE), and provided that the $37 million would be loaned to the “borrower” for use by three yet-to-be-created SABREs acceptable to Dynex.
The $160 million Commitment was between Basic Capital and Dynex, and it likewise required that each deal be structured through a SABRE, each of which would be created and owned by either ART or TCI.
Dynex partially performed under the agreements, but when market interest rates rose, making the deals unfavorable to Dynex, it refused to loan any more funds either for the New Orleans project or under the Commitment. Basic Capital, TCI and ART sued Dynex for breach of contract, alleging that real estate transactions that would have qualified for financing under the Commitment were financed at higher costs, if at all. The plaintiffs sought damages for interest paid in excess of what would have been paid under the terms of the Commitment, as well as lost profits from investments that could not be financed at all. ART and TCI alleged that they were intended third-party beneficiaries under the Commitment, because their wholly owned SABRE subsidiaries would own the properties and borrow the funds from Dynex. Dynex argued that ART and TCI were not the intended beneficiaries, and they lacked standing to sue for breach of contract.
At trial, the jury found for ART and TCI, but the trial court set aside that verdict. The Court of Appeals upheld the trial court’s judgment notwithstanding the verdict, and Basic Capital, TCI and ART appealed to the Texas Supreme Court.
The court first considered whether ART and TCI could recover for breach of the Commitment, and TCI for breach of the New Orleans deal, as third-party beneficiaries. More generally, could the owners of a SABRE be the beneficiaries under the contract? The court first set forth the well-established law regarding third-party beneficiaries: “The fact that a person might receive an incidental benefit from a contract to which he is not a party does not give that person a right of action to enforce the contract. A third party may recover on a contract made between other parties only if the parties intended to secure some benefit to that third party, and only if the parties entered into the contract directly for the third party’s benefit.” The court went on to state that the intention of the parties was controlling, that the intent to benefit a third party must be clear, and that a court could not create a third-party beneficiary by implication.
The court found the evidence, including the contracts themselves, to be clear. Dynex knew that the purpose of the Commitment was to obtain future financing for ART and TCI (each of which was owned and managed by Basic Capital), and that Basic Capital was never going to be the named borrower. “On the contrary, the Commitment expressly required that the borrowers be SABREs acceptable to Dynex. Nor was Basic to own the SABREs.” The court also pointed out that the SABRE requirement was of great benefit to Dynex, which sought to limit its potential losses in the event any of the projects failed and sought to shield each venture’s collateral from each of the others.
The court found Dynex’s arguments that only a SABRE had standing to sue under the Commitment illogical, because a SABRE would not be created until an investment opportunity presented itself. Without financing, an investment opportunity would not exist, and thus neither would a SABRE. “It would be unreasonable to require ART and TCI to have created SABREs for no business purpose, merely in order that those otherwise inert entities could sue Dynex.”
The court acknowledged that a corporate parent is not automatically a thirdparty beneficiary of its subsidiary’s contract, but here the deal was structured to benefit both the parent and the lender. “If Dynex and Basic did not intend the Commitment to benefit ART and TCI directly, then the Commitment had no purpose whatever.” The court held that ART and TCI were third-party beneficiaries and entitled to recover for breach of the Commitment.
Dynex also argued that TCI was not a third-party beneficiary of the New Orleans projects, because the three promissory notes had been executed by the three TCI-created SABREs, not TCI itself. The court rejected this argument, holding that the notes had been executed pursuant to the New Orleans agreement, which was expressly between Dynex and TCI. As a party to the agreement that provided financing to its wholly owned SABREs, TCI was a third-party beneficiary of the New Orleans agreement.
Foreseeability of Damages Issue
Dynex contended that Basic Capital could not recover lost profits as consequential damages because the loss of profits was not foreseeable. Dynex argued that it had no idea what specific investments Basic Capital would propose, or that alternative financing would not be available. The court agreed with the overarching principle that general knowledge of a prospective borrower’s business does not give a lender reason to foresee the probable results of its refusal to make a loan. “But Dynex cites no authority, and we are aware of none, for the proposition that the consequences of a lender’s breach of a loan commitment are not reasonably foreseeable unless the lender knew, at the time the commitment was made, not only the nature of the borrower’s intended use of the money, but the specific venture in which the borrower intended to engage.”
The court held that it was not necessary for the lender to know the specific venture the borrower had in mind, only the general nature of the intended use. Dynex was in the business of providing financing to commercial real estate developers, and had discussed for months with Basic Capital its intended uses for the financing. “In sum, the evidence establishes that Dynex clearly knew how the Commitment would be used. Indeed, it would be surprising if Dynex had agreed to lend Basic $160 million without such knowledge.” The court held that Dynex knew that if interest rates rose and it pulled its financing, Basic Capital would have to arrange less favorable financing. Thus, the damages were foreseeable.
The Texas Supreme Court reversed and remanded the case for a determination of the actual damages Basic Capital sustained.
Lenders that require prospective borrowers to form multiple SABREs to protect the lender’s security interests should also expect that a court may find that the company standing behind the SABRE (even if not an actual signatory to the loan agreement) will have standing to sue pursuant to the contracts.