A New York federal district court recently ruled that the defense of “temporary commercial impracticability” is not available under New York law to guarantors of a loan. The ruling allowed a lender to recover under a loan guaranty where the defendants argued that performance was temporarily impracticable as a result of the ongoing financial crisis. Walden Fed. Sav. & Loan v. Slaine, No. 09 Civ. 1042 (DLC), NYLJ 1202490025504, at *1 (S.D.N.Y. April 5, 2011). The decision followed the reasoning of a Seventh Circuit decision which discussed the unavailability of the temporary commercial impracticability defense under New York law.  

Background

Walden Federal Savings & Loan Association (“Walden”) made several loans to Oxford Landing, LLC totaling approximately $2.9 million. These loans were made in 2005 and subsequently refinanced in 2007 and 2008 with a maturity date of June 1, 2009. Charles Slaine, Daniel Slaine and the Slane Company, Ltd. (“defendants”) guaranteed repayment of the notes. Oxford Landing allegedly defaulted on the notes in August 2008 by failing to make payments due. Walden filed the instant proceeding against the guarantors to recover on the guarantees. In response, the defendants asserted a defense of temporary commercial impracticability. Specifically, the defendants argued that performance on the guaranty was impossible as a result of the ongoing financial crisis. Walden moved for summary judgment.  

The Holding

In ruling for the lender on summary judgment, the court found that the defense of temporary commercial impracticability is not available under New York law. The court based its decision on the Seventh Circuit’s analysis in Hoosier Energy Coop., Inc. v. John Hancock Life Ins. Co., 582 F.3d 721 (7th Cir. 2009), which reached the same conclusion. The Walden court concluded that “New York courts refuse to excuse performance where difficulty is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy.”

The court rejected the defendants’ contention that New York trial court’s decision in Twin Holdings of Delaware LLC v. CW Capital, LLC, CW, 906 N.Y.S.2d 784 (Nassau Co. 2010), had allowed this defense. The court noted that this reliance was unavailing because the court in Twin Holdings “dismissed [the] cause of action seeking a declaration that the plaintiffs were ‘temporarily excused’ from performance of a loan agreement because of the financial crisis.” The Walden court stated “[i]n sum, New York courts do not recognize the defense of temporary commercial impracticability.”  

The Hoosier Energy Decision

The Walden court relied almost exclusively on the Seventh Circuit’s decision in Hoosier to support its conclusion that temporary commercial impracticability is unavailable in New York. In that case, the court examined a lease-back between Hoosier and John Hancock. To guard against the possibility that Hoosier may become insolvent and be unable to perform under the lease-back, Hoosier provided John Hancock with security in the form of a credit default swap and surety bond. Under this agreement, Ambac Assurance Corp. and several other entities agreed to pay John Hancock nearly $120 million upon the occurrence of defined events.  

Ambac’s credit rating subsequently fell below a defined threshold level and John Hancock demanded that Hoosier find a replacement. Hoosier could not find a suitable replacement for Ambac within the time provided by John Hancock, and called on Ambac to perform on the agreement. Hoosier filed suit before Ambac could perform, and the district court granted a temporary restraining order and preliminary injunction, finding that New York law allows temporary commercial impracticability.

On appeal, the Hoosier court focused its examination of the district court’s holding on whether Hoosier had a “plausible theory on the merits . . . to justify exposing John Hancock to financial risks until the district court can decide the merits.” The court rejected Hoosier’s first argument, accepted by the district court, that the transaction was an abusive tax shelter. The court rejected this argument because “[w]hether or not the contract lawfully transfers tax benefits, there is nothing wrong with, or illegal about, the contract itself; only the claim of tax benefits from the contract would be problematic.” Next, the court found that, even though New York does not recognize temporary commercial impracticability, Hoosier may have a plausible argument for impossibility. In contrast with temporary commercial impracticability, an impossibility defense requires a showing that “the new event ‘could not have been foreseen or guarded against’ in the contract.” The court began its analysis by noting that New York law “takes a very dim view of ‘impossibility’ defenses and has never suggested that, when an impossibility defense is unavailable, a ‘temporary commercial impracticability’ defense might serve instead.” While temporary impracticability was unavailable, the court found that the language of the contract left open whether Hoosier had a duty or simply the option to replace Ambac in the transaction. The court concluded that if Hoosier had a duty and could not find any replacement for Ambac then performance of the obligation may have been impossible at that time.

The Seventh Circuit upheld the injunction but went to lengths to note that the district court emphasized that the order was temporary. The court stated “we are confident that the court will not allow ‘temporary’ to drag out in the direction of permanence.” The court made this statement in light of the fact that the longer the injunction continues the more the equities of the situation balance in favor of John Hancock.  

Conclusion  

The Walden and Hoosier decisions reaffirm that the defense of temporary commercial impracticability is not available in New York. While the defense of impossibility is available, it presents a much higher burden, and New York courts have shown reluctance to conclude such burden has been satisfied. Defense counsel need to be keenly aware of the difference between temporary commercial impracticability and impossibility, and plead their defense to satisfy the elements of an impossibility defense.