Foreclosure Defense: New Weapon for Commercial Mortgagors?

January 27, 2014

A recent case allows a commercial mortgagor to defend against, and even to claim damages from, the lender, for (a) breaching an implied covenant of good faith and fair dealing, and (b) statutory unfair and deceptive trade practices. Burcam Capital. [1]

Most commercial mortgages and deeds of trust contain pages of specific remedies for the mortgagee, and negate any implied obligations of the mortgagee. The case law generally has allowed the mortgagee to enforce those remedies to the letter; i.e. the cases generally do not impose, upon the mortgagee, any duty to negotiate a loan modification or otherwise to mitigate the mortgagee’s damages.

Virginia is a good example. In Fulton Bank [2], which addresses a separate suit challenging a previously completed non-judicial foreclosure, the U.S. District Court for Virginia held that (a) there is no implied covenant of good faith and fair dealing outside of the UCC; and (b) even if such a covenant did exist, it cannot be asserted in a separate cause of action.

In Monton [3], an earlier case in the Norfolk Division of that same Court, the Court cited the express covenants, of the subject deed of trust, as justification for substantially negating both any implied covenant of good faith and fair dealing and any duty on the part of the mortgagee to mitigate its damages:

“2. State Law Claimsa. Breach of Contract Arising from the Implied Covenant of Good Faith and Fair Dealing Plaintiffs assert that Defendants violated the implied covenant of good faith and fair dealing under the Promissory Note by failing to properly consider Plaintiffs for loan modification pursuant to the “public policy of the United States” as “enacted [under] 12 U.S.C. § 5219(a)(1).” Amend. Compl. ¶¶ 5-13, ECF No. 17.

The United States Court [20] of Appeals for the Fourth Circuit has recognized that contracts governed by Virginia law generally contain an implied covenant of good faith and fair dealing. Va. Vermiculite, Ltd. v. W.R. Grace & Co., 156 F.3d 535, 541-42 (4th Cir. 1998); see SunTrust Mortg., Inc. v. United Guar. Residential Ins. Co. of North Carolina, 806 F. Supp. 2d 872, 893-95 (E.D. Va. 2011) (examining at length how state and federal courts in Virginia have acknowledged an implied duty of good faith and fair dealing in contractual relationships, and finding no reason to differentiate between contracts falling under the Uniform Commercial Code (“U.C.C.”) and the common law); Charles E. Brauer Co. v. NationsBank of Va., N.A., 251 Va. 28, 33, 466 S.E.2d 382 (1996) (indicating that under Virginia law, breach of the U.C.C.’s implied covenant of good faith and fair dealing gives rise to a cause of action for breach of contract). However, it is well-established that “when parties to a contract create valid and binding rights, an implied covenant of good faith and fair dealing is inapplicable to those rights.” Ward’s Equip. v. New Holland N. Am., 254 Va. 379, 385, 493 S.E.2d 516 (1997) (emphasis added). As explained by the Fourth Circuit, “although [21] the duty of good faith [under Virginia law] does not prevent a party from exercising its explicit contractual rights, a party may not exercise contractual discretion in bad faith, even when such discretion is vested solely in that party.” Vermiculite, 156 F.3d at 542 (emphasis added).

Therefore, the implied covenant of good faith and fair dealing is “simply a recognition of conditions inherent in expressed promises.” Eastern Shore Mkts., 213 F.3d at 184. To that end, the covenant does not compel a party to take affirmative action not otherwise required under the contract, does not establish independent duties not otherwise agreed upon by the parties, and cannot be invoked to undercut a party’s express contractual rights. De Vera v. Bank of Am., N.A., No. 2:12cv17, 2012 U.S. Dist. LEXIS 87840, 2012 WL 2400627, at *3 (E.D. Va. June 25, 2012).

Here, Plaintiffs argue that Defendants breached the implied covenant of good faith and fair dealing by failing to postpone foreclosure until an underwriter could evaluate Plaintiffs’ application(s) for loan modification. However, the undisputed evidence demonstrates that Plaintiffs failed to satisfy their contractual obligations under the Promissory Note and the DOT. As a result [22] of such failure, ASC had the express contractual right to accelerate payment and foreclose on the property. Plaintiffs have failed to point to any “discretion” under the Promissory Note or the DOT that Defendants exercised in bad faith. Similarly, neither the Promissory Note nor the DOT created an express duty on ASC to facilitate loan modification in the event Plaintiffs fell into arrears on their obligation to make timely payments. See Stanley’s Cafeteria Inc. v. Abramson, 226 Va. 68, 73, 306 S.E.2d 870 (1983) (quoting Warren v. Goodrich, 133 Va. 366, 389, 112 S.E. 687 (1922)) (holding that an agreement to modify a contract must be proven by “‘clear, unequivocal and convincing evidence, direct or implied’”). Moreover, the Substitute Trustee could not have breached any implied duty allegedly owed pursuant to the Promissory Note or the DOT because the Trustee was not a contractual party thereto.

Plaintiffs’ breach of contract claim arising from the implied covenant of good faith and fair dealing therefore fails because, without evidence of ASC exercising contractual discretion in bad faith, the Promissory Note and the DOT expressly provided ASC the right to accelerate payment of the loan and ultimately foreclose [23] on the property. Therefore, Plaintiffs’ first claim is dismissed for failure to state a claim on which relief can be granted.

b. Duty to Mitigate Damages
Plaintiffs assert that Defendants breached the duty to mitigate damages by failing to properly review Plaintiffs for loan modification. Amend. Compl. ¶¶ 14-16, ECF No. 17. The Virginia Supreme Court has “long recognized the obligation of an injured party to mitigate damages.” Forbes v. Rapp, 269 Va. 374, 380, 611 S.E.2d 592 (2005). However, an assertion that an injured party has failed to mitigate damages is an affirmative defense. See, e.g., R.K. Chevrolet, Inc. v. Bank of the Commonwealth, 256 Va. 74, 77, 501 S.E.2d 769 (1998); Marefield Meadows, Inc. v. Lorenz, 245 Va. 255, 266, 427 S.E.2d 363, 9 Va. Law Rep. 974 (1993). The injured party’s common law duty to mitigate damages requires the injured party to “‘exercise reasonable care and diligence to avoid loss or to minimize or lessen the resulting damage.’” Lawrence, 226 Va. at 412 (quoting Haywood v. Massie, 188 Va. 176, 182, 49 S.E.2d 281 (1948)). Although failure to exercise reasonable care and diligence may be a reason for reducing damages, it does not bar all recovery. 8 Id.

Here, Plaintiffs argue that because foreclosure is a damage remedy stemming from the Plaintiffs’ breach of the Promissory Note and DOT, then as a matter of law, Defendants have a duty to mitigate damages by considering an application for loan modification. However, a proper understanding of an allegation that a party breached its duty to mitigate damages and should be precluded from obtaining additional damages as a result, reveals the lack of force behind Plaintiffs attempt to affirmatively state a claim against Defendants under such defensive remedy. Notably, Plaintiffs’ attempt to impose on Defendants a noncontractual duty regarding loan modification finds no support in the common law, and any duty to mitigate that [25] Defendants may have cannot act to trump their express contractual right to foreclose once Plaintiffs fell into arrears. In other words, the common law duty to mitigate damages is not a categorical prohibition on foreclosure, rather, the duty simply requires reasonableness under the circumstances.

Plaintiffs’ attempt to state an affirmative cause of action for breach of the duty to mitigate damages is nothing more than an attempt to couch a HAMP violation–which provides no private right of action–under a different name. Jones, 2012 U.S. Dist. LEXIS 15203, 2012 WL 405053, at *6 n.8. Although loan modification and foreclosure may each have been options for ASC, the common law duty Plaintiffs seek to invoke does not eviscerate ASC’s express contractual right to opt to initiate foreclosure proceedings. Consequently, Plaintiffs’ claim for breach of the duty to mitigate damages is dismissed.”

Unfortunately, in Burcam Capital, the Court did not explain how the mortgagor could prove a violation of the implied covenant of good faith and fair dealing given (a) its holding that the mortgagor “does not act improperly when it enforces its rights, such as initiating a foreclosure”; and (b) the express covenants the subject of deeds of trust likely contain specific provisions to the contrary. Moreover, most consumer protection statutes do not protect commercial mortgagors. Whether long-standing commercial mortgage practices will be found to be unfair and deceptive trade practices, particularly in relation to a commercial mortgagee, is far from certain.


[1] Burcam Capital II, LLC v. U.S. Bank Nat’l Ass’n (In re Burcam Capital II, LLC, 2013 Bankr. LEXIS 4108, 2013 WL 5487815 (Bankr. E.D.N.C., Raleigh Div., 2013).

[2] Jones v. Fulton Bank, N.A., 2013 U.S. Dist. LEXIS 100779, WL 3788428 (E.D.VA, Richmond Div., 2013).

[3] Monton v. America’s Servicing Co., 2012 U.S. Dist. LEXIS 117259, 2012 WL 3596519 (E.D.VA, Norfolk Div., 2012).