Opinion ID: 775220
Heading Depth: 4
Heading Rank: 2

Heading: Materiality of First Tennessee's Conduct

Text: 46 In a final argument, First Tennessee insists that it did not materially breach its loan guaranty agreement with the SBA. The district court reached a contrary conclusion, however, holding that First Tennessee had failed to act in a prudent manner and, therefore, had breached the loan guaranty agreement, by (1) failing to review any of Telware's documentation, and (2) failing to take any action after Beogradska Banka's initial dishonor of the letter of credit. The district court deemed the foregoing breaches to be material, and it found the SBA under no obligation to repurchase the defaulted Telware loan. 47 In order to assess the correctness of the district court's ruling, we first must identify the nature of the bank's obligations under the terms of its guaranty agreement with the SBA. Those obligations emanate from two sources: (1) the parties' loan guaranty agreement itself; and (2) the Telware loan authorization issued by the SBA. The loan guaranty obligated First Tennessee to close and disburse all SBA-guaranteed loans in accordance with the terms and conditions of the applicable loan authorization, and to take all actions, consistent with prudent closing practices, necessary to protect the interests of the SBA. 14 The guaranty agreement also obligated First Tennessee to follow the loan servicing standards employed by prudent lenders generally, and it incorporated, by reference, the SBA's rules and regulations. One of those regulations, 13 C.F.R. 120.202-5, releases the SBA from liability on a loan guaranty unless the lender has substantially complied with all of the provisions of the SBA's regulations and the loan guaranty agreement. 15 Section 120.202-5 also releases the SBA from liability if the lender fails to service its loan in a prudent manner, such that a substantial loss on the loan may result. In addition, the SBA has promulgated standard operating procedures (SOPs) which address its obligation to repurchase a guaranteed loan and have the force and effect of law. First Nat'l Bank of Lexington, Tenn. v. Sanders, 946 F.2d 1185 (6th Cir. 1991); First Nat'l Bank of Louisa, Ky. v. United States, 6 Cl. Ct. 241 (1984). One such regulation, SOP 50-50-3, sets forth the circumstances under which the SBA may refuse to honor a guaranty: 48 The basic prerequisites for denial of liability are failure on the part of the participant to close/disburse substantially in compliance with the Authorization or servicing in a substantially negligent manner, either of which may result in a substantial loss on the loan. The combination of a substantial failure by participant which results, or may result, in a substantial loss is necessary before a denial can be sustained. 49 Finally, with respect to export revolving lines of credit (ERLC), such as the Telware loan at issue, SOP 50-10-2 provides: It is anticipated that the lender's commercial loan officer will work with its international department (or with the international division of its correspondent) in the implementation of an ERLC. The complexities of export finance warrant the services of banking experts in this field. 50 After reviewing the foregoing regulations, the district court determined that First Tennessee had materially breached its loan guaranty agreement with the SBA. In reaching this conclusion, the court reasoned that Beogradska Banka was the initial cause of Telware's default, given its unjustified dishonor of the letter of credit. The court also found that First Tennessee's inaction following the Yugoslavian bank's rejection of Telware's documents may have, but likely did not, further cause the loss. Nevertheless, the district court interpreted the guaranty agreement, 13 C.F.R. 120.202-5, and SOP 50-50-3 as relieving the SBA from liability if First Tennessee's conduct may have resulted in a substantial loss. Although the lower court found no evidence suggesting that First Tennessee could have forced Beogradska Banka to honor the letter of credit, it determined that additional prudent action may well have helped. Specifically, the court reasoned that First Tennessee had imprudently increased the SBA's risk of loss when it failed to review Telware's documents, and when it failed to take any action whatsoever following Beogradska Banka's initial dishonor of those documents. 51 We find no error in the district court's conclusion. As noted above, the loan guaranty agreement required First Tennessee to act, consistent with prudent banking practices, to protect the interests of the SBA. The agreement also required the bank's conduct with respect to SBA-guaranteed loans to conform with that of prudent lenders generally. Notably, 13 C.F.R. 120.202-5 releases the SBA from its guaranty obligation if imprudent loan servicing may have resulted in a substantial loss on a loan. Similarly, SOP 50-50-3 provides that substantially negligent loan servicing by a lender bank will release the SBA from its guaranty obligation if such servicing may have resulted in a substantial loss. 52 The foregoing rules and regulations support the district court's determination that the SBA was released from its guaranty obligation if First Tennessee's actions may have resulted in a substantial loss on the Telware loan. Indeed, the text of SOP 50-50-3 and 13 C.F.R. 120.202-5 expressly states that actions by a lender which may result in a substantial loss will justify the SBA's refusal to honor its guaranty agreement. 16 In short, we find nothing in the parties' agreement or the applicable regulations which would suggest that proof of actual loss, attributable to First Tennessee's poor servicing of the Telware loan, was required in order to release the SBA from its guaranty obligation. 53 Our interpretation of SOP 50-50-3 and 13 C.F.R. 120.202-5 is consistent with the conclusion reached by the Tenth Circuit Court of Appeals in Valley Nat'l Bank v. Abdnor, 918 F.2d 128 (10th Cir. 1990). In that case, the court read the aforementioned regulations and policy statements as releasing the SBA from its guaranty agreement, upon the failure of a lending bank to service its loan in a prudent manner, if a substantial loss on the loan may have resulted. In so ruling, the court reasoned: 54 . . . The Bank contends that the loss on the loan would have resulted even if it had serviced the loan in the manner found wanting by the trial court. According to plaintiff, the Bank could not have prevented the ultimate loss on the loan by performing the various acts cited by the trial court, because the only reasons for the failure of Eagle Limousin were Miller's dishonesty and the inherent risk in this experimental venture. 55 This defense must fail for several reasons. First, the language relied upon by the Bank states that the SBA will be excused of liability if the negligent conduct may result in a substantial loss on the loan. 13 C.F.R. 120.202-5(a) (emphasis added). In addition, S.O.P. 50-50-3 76(a) emphasizes that an actual loss is not necessary, stating that [t]he combination of a substantial failure by participant which results, or may result, in a substantial loss is a predicate to an SBA denial of liability. Thus, the trial court's interpretation of the terms of the agreement on this issue is supported by the regulations forming a part of the agreement. Under the SBA regulations and policy statements relied upon by the parties, it is sufficient if the lender's actions are of such a nature that they may be expected to result in a substantial loss on the loan. 56 Id. at 132-33. 57 In response to the foregoing analysis, First Tennessee cites E. Ill. Trust & Sav. Bank v. Sanders, 826 F.2d 615 (7th Cir. 1987), for the proposition that the SBA may refuse to honor a guaranty agreement only when a lender's imprudent conduct actually results in a substantial loss. In Sanders, the court read SOP 50-50-3 56 as outlining two prerequisites to repudiating a guaranty: a substantial failure of compliance and a resulting substantial loss on the loan. Id. at 617. Notably, however, the Seventh Circuit's analysis concerned SOP 50-50-3 56, which has not been cited by First Tennessee in the present case. Our analysis herein is confined to SOP 50-50-3 76(a). Under that regulation, it is not necessary for a loss on an SBA-backed loan to be traceable, with certainty, to First Tennessee's negligent servicing. Valley Nat'l Bank, 918 F.2d at 132-33. Insofar as First Tennessee seeks to apply the Seventh Circuit's ruling to SOP 50-50-3 76(a), which relieves the SBA from its obligation if the lender's actions may have caused a substantial loss, we find Sanders to be in direct conflict with the express language of the regulation. Therefore, we decline to read SOP 50-50-3 76(a) as requiring proof that First Tennessee's deficient loan servicing actually resulted in a substantial loss to the SBA. 58 First Tennessee next argues that the record does not support a finding that its administration of the Telware loan was substantially negligent, as required by SOP 50-50-3 76(a). Rather, the bank argues, only in hindsight, could the choices made by First Tennessee be questioned in light of the unjustified refusal by Beogradska Banka to honor the letter of credit. We find this argument to be unpersuasive. Asking whether a lender was substantially negligent, or whether it substantially complied with a loan guaranty agreement, is simply another way of asking whether the lender materially breached the agreement. Cf. Heritage Bank & Trust Co., 906 F.2d at 300-01. 17 59 In the present case, the district court determined that First Tennessee had materially breached the loan guaranty agreement by (1) failing to review Telware's documents, and (2) failing to intervene after Beogradska Banka's dishonor of the letter of credit. Once again, we find no error in the district court's conclusion. First Tennessee insists that its failure to review the documents could not have constituted a material breach of the guaranty agreement, given the parties' stipulation that those documents were accurate and should have been honored by the Yugoslavian bank. Although this argument possesses some appeal, the bulk of the district court's analysis focused upon the second material breach, namely First Tennessee's inaction after Beogradska Banka had dishonored Telware's documents and the letter of credit. Specifically, the district court reasoned that First Tennessee could and should have taken further actions, following the initial dishonor of the letter of credit to protect its interests and the interests of the SBA, but it did not. The court concluded that such actions may have persuaded Beogradska Banka to honor the letter of credit. 60 The district court's finding that First Tennessee's post-dishonor inaction constituted a material breach of the guaranty agreement must be affirmed unless such a finding is clearly erroneous. Valley Nat'l Bank, 918 F.2d at 130. In light of the testimony presented at trial, we find no clear error in the district court's ruling. As noted above, Bauman testified that his only action, upon discovering Beogradska Banka's rejection of the documents and the letter of credit, was to speak with Fatima Telware, who assured him that she personally would handle the problem. Even after Beogradska Banka dishonored the letter of credit a second time, Bauman took no action whatsoever. Notably, Bauman did not approach First Tennessee's international department, despite his awareness that Allan Good, a manager of the department, was familiar with important people at Beogradska Banka. Likewise, neither Bauman nor anyone else at First Tennessee notified the SBA about the document rejection. Good also testified that a claimed discrepancy in documentation [h]appens all the time, and that there may have been a time or two when First Tennessee had insisted forcefully that no such discrepancy existed, and a foreign bank had accepted its interpretation, thereby resolving the dispute. Likewise, First Tennessee expert witness James E. Byrne agreed that from time to time one bank can dispute a perceived discrepancy and obtain payment on a letter of credit. Finally, SBA expert Peter Iorlano recalled times when a paying bank initially had claimed a document discrepancy, but then had honored a letter of credit, after a strenuous objection by the document-presenting bank. Additionally, Iorlano explained a bank such as First Tennessee could have spoken with higher-level individuals at the foreign bank in order to obtain document approval. He also mentioned other options at First Tennessee's disposal, including: (1) having a vice-president of the document-presenting bank communicate personally with contacts at the foreign bank, or elsewhere in the foreign country; (2) pressuring representatives of Beogradska Banka who were located in the United States: or (3) presenting the dispute to an international banking organization for its review and assistance. 61 In light of the foregoing testimony, we find no clear error in the district court's conclusion that First Tennessee breached its loan guaranty agreement by failing to intervene after Beogradska Banka's rejection of Telware's documentation and letter of credit. We also agree that the bank's breach was material, because various actions by First Tennessee may have persuaded Beogradska Banka to honor the letter of credit, and because the bank's failure to initiate such actions violated key terms of the guaranty agreement and the rules and regulations incorporated therein by reference. 18 Cf. Heritage Bank & Trust Co., 906 F.2d at 301-02 (reasoning that a bank's non-compliance with SBA regulations constitutes a material breach of a loan guaranty agreement); Pittsburgh Nat'l Bank, 898 F.2d at 338 (recognizing that a lender's failure to service an SBA-backed loan in a commercially prudent manner may constitute a material breach of a guaranty agreement); Citizens Marine Nat'l Bank v. United States Dept. of Commerce, 854 F.2d 223, 228 (7th Cir. 1988) (reasoning that the failure to use care and diligence in the administration of an Economic Development Administration loan constitutes a material breach of the bank's guaranty agreement with the agency), cert. denied, 489 U.S. 1053 (1999).