In a recent decision, the New Jersey Superior Court, Appellate Division, analyzed the enforceability of a counterclaim waiver provision contained in commercial loan documents. In Investors Savings Bank v. Waldo Jersey City, LLC, A-6201-09, _____ N.J. Super. _____ (App. Div. 2011), the court held that enforcement of such a provision in a collection action is contrary to New Jersey's court rules and policy in favor of judicial efficiency. This decision, however, does not significantly impinge upon lenders' rights - it merely permits a borrower to bring a lender liability claim as a counterclaim in a collection action, rather than in a separate action.
Investors involved a collection action on a defaulted multi-million dollar development loan from plaintiff Investors Savings Bank ("Investors") to defendants Waldo Jersey City, LLC, and Powerhouse Land Development, LLC ("Defendants"). In July 2006, Investors issued a commitment letter agreeing to provide Defendants with a loan in excess of $30 million. Defendants' counterclaim alleged Investors understood that, if the loan was not fully funded, Defendants could not complete the project.
In September 2007, the parties entered into the loan agreement. Between the execution of the commitment and the closing, the residential real estate market in Jersey City (where the property was located) declined, as did Investors' appraisal of the property, from $25 million to $16.7 million. By the time the loan closed, Defendants had incurred $1 million in costs on the assumption Investors would fully fund the loan. Defendants alleged Investors funded less than $8.3 million at closing and then decided to stop funding the loan. Investors subsequently declared a default and commenced both a foreclosure action and the subject collection action. In the collection case, Defendants counterclaimed, alleging Investors materially breached the loan agreement by virtue of its purported failure to fully fund the loan. Investors successfully moved to dismiss the counterclaim based on a provision in the loan documents stating that Defendants waived all rights to bring a counterclaim against the bank. Defendants appealed.
On appeal, Investors relied on New York state court decisions holding that a counterclaim waiver provision is enforceable, with certain limited exceptions. Those decisions did not permanently bar the counterclaims but merely held that they had to be brought in separate actions. The Appellate Division noted that New York federal courts reached a different result. This was because counterclaims are merely permissive under New York state procedure but are compulsory under the Federal Rules of Civil Procedure. In Sage Realty Corp. v. Insurance Co. of North America, 34 F.3d 124, 126, 129 (2d Cir. 1994), the Second Circuit Court of Appeals noted that, if it were to uphold the waiver provision there and require the counterclaim to be brought in a separate action, the later action would be barred by the federal compulsory counterclaim rule. This would be contrary to the parties' intent to merely defer the counterclaim. The Second Circuit deemed the waiver provision unenforceable.
The Appellate Division found the Second Circuit's analysis in Sage Realty compelling, given the similarities between the federal rules and New Jersey's state court rules, which require a defendant to bring "counterclaims arising from the same operative facts or transaction" as the plaintiff's claim, or have such counterclaims permanently barred. The court went on to note that the essence of New Jersey's civil practice rules is the promotion of efficiency and fairness and the reduction of cost and delay. Enforcement of the counterclaim waiver provision would merely lead to "the filing of yet another lawsuit," which "sensible case management" would require to be consolidated with Investors' suit. Thus, the Appellate Division found, the waiver served no purpose and convoluted the proceedings. As such, it was contrary to public policy and unenforceable.1
The court also noted that, given the circumstances, it would refuse to apply the waiver provision, even if it was enforceable. The New York cases Investors relied on carved out an exception for, among other things, counterclaims for fraud. The court found that Defendants' counterclaim, alleging Investors failed to fund the loan as promised, was similar to the fraud claims permissible under New York's rule: it was inherently intertwined with the lender's claim alleging a loan default. 2
While the decision in Investors limits a lender's right to enforce a counterclaim waiver provision, the court recognized that, ultimately, its decision had little practical impact and merely bolstered New Jersey's policy in favor of efficient case management.
1 The court did note that the waiver provision might be intended as a means of enforcing New Jersey's court rules regarding foreclosure, which permit only "germane" counterclaims. The court did not opine on whether the waiver provision would be enforceable in Investors' foreclosure action, but did note that it "might be sensibly applied" there.
2 The trial court had also, in dismissing the counterclaim, relied on a provision in the loan documents requiring Defendants to indemnify Investors for any loss Investors incurred resulting from the loan transaction. The court's logic was that, even if Investors was liable to Defendants, Defendants would have to indemnify Investors for that liability, canceling any recovery. The Appellate Division noted this was improper, as indemnity agreements can only be based on liability incurred to a third party. Additionally, the consideration for the indemnity provision was Investors' funding of the loan, which Defendants' counterclaim alleged did not fully occur. That allegation had to be taken as true for the purpose of Investors' motion to dismiss. The Appellate Division found the trial court could not have relied on the indemnity provision to grant Investors' motion.