Enforcement of Acceleration Provisions and the Rhetoric of Good Faith

R. Wilson Freyermuth* I. INTRODUCTION Today, virtually all mortgages contain acceleration clauses permitting the mortgagee to accelerate the mortgage indebtedness upon default by the mortgagor as defined in the mortgage loan documentation. Section 8.1 of the new Restatement (Third) of Property: Mortgages [hereinafter Mortgages Restatement] endorses the view that these mortgage acceleration provisions are generally enforceable after default in accordance with their terms.2 Following default and acceleration, the mortgagor may prevent foreclosure only by redeeming the property from the mortgage debt, i.e., "only by paying or tendering to the mortgagee the full accelerated mortgage obligation."3 Section 8.1(d)(3), however, places certain constraints upon the mortgagee's right to accelerate, permitting the mortgagor to reinstate (after curing any existing defaults) if "the mortgagee has engaged in fraud, bad faith, or other conduct making acceleration unconscionable."4 This standard has a significant judicial pedigree in mortgage law decisions, but its use of the elusive term "bad faith"-a term often understood in the context of its more honorable twin, "good faith"-creates the potential for uncertainty in the evaluation of disputes over the enforcement of acceleration provisions. The rhetoric of good faith has played a significant role in judicial opinions addressing challenges to creditor decisions to exercise acceleration clauses following the occurrence of a default by the borrower. Most of these challenges involve a claim by the borrower either that the lender's security or prospects for repayment are not threatened (i.e., that the default poses no actual harm to the lender meriting acceleration of the debt) or that the lender's decision is pretextual or comes as an unfair surprise. For example, consider the following hypothetical: Randolph runs a small plumbing supply business, financed via a $750,000 revolving line of credit (bearing an interest rate of 10%) from Local Bank. Local Bank holds a perfected security interest in all of Randolph's inventory, accounts, and intangibles as well as a recorded mortgage upon Randolph's business premises. Under the terms of the loan documents, Randolph must provide audited financial statements to Local Bank each year by January 14. Under the terms of the loan documents, failure by Randolph to perform any obligation (whether monetary or nonmonetary) constitutes a default and entitles Local Bank to demand immediate payment of the entire outstanding balance of the line of credit. Now consider the following scenarios, each involving a variation on the foregoing hypothetical. Example One (Borrower Insolvency). As of January 15, 1998 (one day late), Randolph has not provided the audited financial statements. Citing Randolph's failure to provide the financial statements on a timely basis, Local Bank demands immediate repayment of the entire credit line. Had Randolph provided the financial statements, they would have shown him to be insolvent. Example Two (Bank's Mistaken Perception of Insecurity). On January 20, 1998 (six days late), Randolph provides Local Bank with audited financial statements. The statements demonstrate that Randolph has a net worth exceeding the outstanding balance of the credit line, and operating cash flows that are more than sufficient to cover monthly amortization of that outstanding balance. Furthermore, the financial statements indicate that the value of Local Bank's collateral exceeds $1 million. Nevertheless, Smith (the Local Bank loan officer responsible for Randolph's loan) is concerned by rumors that Home Depot will open a new superstore in the area. Smith believes that a new Home Depot would erode Randolph's customer base and render his operations unprofitable. In reality, however, Home Depot has decided not to open a new store in the area; the rumors are the wishful thinking of a local real estate developer. …