Opinion ID: 775220
Heading Depth: 3
Heading Rank: 2

Heading: Material Breach of the Guaranty Agreement

Text: 27 First Tennessee next argues that the district court erred by finding that it had materially breached its guaranty agreement with the SBA. In particular, the bank contends that its failure to review the documents that Telware presented to Beogradska Banka did not constitute a material breach, contrary to the district court's conclusion. First Tennessee also argues that its failure to act after Beogradska Banka's initial dishonor of the letter of credit did not cause the SBA's loss or increase the risk of such a loss. Consequently, First Tennessee insists that its own action (or inaction) was immaterial to Telware's default. Finally, in connection with its materiality argument, First Tennessee contends that the district court erred by allowing Peter Iorlano, the SBA's expert witness, to testify at trial. The bank argues that Iorlano lacked the qualifications to offer valid expert testimony, and that his testimony was not based upon technically valid reasoning. As a means of analysis, we first will address the bank's arguments regarding the admissibility of Iorlano's testimony. After resolving that issue, we will determine whether the record supports a finding that First Tennessee breached its agreement with the SBA and, if so, whether that breach was material. 28
29 In determining that First Tennessee did not act consistent with prudent banking standards, the district court relied largely upon the testimony of Iorlano, who the court found to be qualified as an expert witness. This court reviews a district court's decision to admit expert testimony for an abuse of discretion. Gen. Elec. Co. v. Joiner, 522 U.S. 136 (1997); Morales v. Am. Honda Motor Co., Inc., 151 F.3d 500, 515 (6th Cir. 1998). Upon review, we find no abuse of discretion in the district court's decision to allow Iorlano's testimony. 30 Federal Rule of Evidence 702 sets forth the requirements for the admissibility of expert testimony. At the time of the district court's ruling, Rule 702 provided: 31 If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise. 12 32 In the present case, First Tennessee does not suggest that Iorlano offered scientific expert testimony, and we find nothing in the record to support such a conclusion. Rather, Iorlano's testimony falls under the technical or other specialized knowledge component of Rule 702. In essence, Iorlano opined at trial that First Tennessee imprudently took itself out of the loop by allowing Telware to handle the dispute with Beogradska Banka. As noted, supra, Iorlano identified various problems associated with a lender such as First Tennessee allowing its client to negotiate a letter of credit and document dispute on its behalf. Iorlano also identified several steps that First Tennessee could have taken in an attempt to persuade Beogradska Banka to honor the letter of credit. Finally, Iorlano testified that such steps might have made a difference in the present case. 33 After reviewing the record, we agree that the foregoing testimony assisted the district court in determining whether First Tennessee had acted as a prudent lender with respect to the Telware loan. We also find no abuse of discretion in the district court's determination that Iorlano was qualified to offer his opinion on the foregoing issue, by virtue of his specialized knowledge, skill, experience, training, or education. Iorlano testified that he began his banking career in 1950, examining letters of credit and related documents. He later joined the international office of a different bank, eventually supervising employees who provided various letter of credit services. Later, Iorlano served as the manager of an entire letter of credit department, and then as a vice president in charge of a letter of credit department and a payment and receipt department. Before taking an early retirement, Iorlano joined the Union Bank of California as a vice president and head of its large international department. In that capacity, he supervised up to forty employees from various departments, performing letter of credit import and export functions, document collection, and loan servicing, which handled the refinancing of letters of credit and bankers' acceptance. Iorlano also testified that his banking career exposed him to all aspects of an international banking transaction. In his capacity as the manager of a letter of credit department, he became familiar with how banks in First Tennessee's position handled letter of credit financing transactions. 34 After hearing the foregoing testimony concerning Iorlano's qualifications, the district court stated: 35 I think he has specialized knowledge that will assist the trier of fact in understanding the evidence, and any weaknesses in his background will go to the weight to be accorded to his opinion. 36 [Plaintiff's counsel] is free to examine him in that regard. 37 This gentleman has managed letter of credit departments and worked in letter of credit departments in a number of large banks. He is certainly familiar with the process of honoring and dishonoring letters of credit and of banks' approaches on those. 38 I think he has sufficient specialized knowledge to be helpful in understanding this process. That doesn't mean I will necessarily believe everything he tells me. He is qualified to render an opinion. 39 We find no error, much less an abuse of discretion, in the district court's assessment of Iorlano's qualifications as an expert witness. As it did in the trial court, First Tennessee insists on appeal that Iorlano lacked expertise with respect to the issue of whether it managed its relationship with one of its borrowers with due care and prudent bank knowledge. According to the bank, Iorlano possessed absolutely no experience in lender-borrower relationships and, therefore, was unqualified to offer an opinion about whether First Tennessee had followed prudent banking practices with respect to servicing the Telware loan. In our view, however, First Tennessee takes an unduly narrow approach to defining the central issue at trial. This litigation concerns not only First Tennessee's traditional lender-borrower relationship with Telware, but also the scope of its obligation to monitor Telware's transaction with Beogradska Banka, and its obligation (and ability) to intercede on Telware's behalf, particularly after discovering that the Yugoslavian bank had dishonored the letter of credit and had rejected Telware's documentation. Based upon Iorlano's testimony, we find no abuse of discretion in the district court's determination that he possessed the requisite expertise to offer his opinion about these issues. Iorlano's testimony was both relevant and sufficiently reliable to support the district court's ruling. Finally, to the extent that Iorlano may have lacked familiarity with some aspects of banking relationships, the district court correctly reasoned that such unfamiliarity merely affected the weight and credibility of his testimony, not its admissibility. Morales, 151 F.3d at 516 (reasoning that the jury was free to give [an expert's] testimony as much credence as it felt the testimony deserved, particularly in light of Defendant's cross-examination exposing [his] lack of familiarity with the given topics); see also Davis v. Combustion Eng'g, Inc., 742 F.2d 916, 919 (6th Cir. 1984) (Rule 702 should be broadly interpreted on the basis of whether the use of expert testimony will assist the trier of fact. The fact that a proffered expert may be unfamiliar with pertinent statutory definitions or standards is not grounds for disqualification. Such lack of familiarity affects the witness' credibility, not his qualifications to testify.). 40 Finally, First Tennessee suggests that Iorlano's testimony was not based upon technically valid reasoning or methodology, even if he was qualified to offer such testimony. We find this argument to be unpersuasive. In support of its assertion, the bank draws from the Supreme Court's decision in Daubert v. Merrell Dow Pharm., Inc., 509 U.S. 579 (1993) and its progeny. In Daubert, the majority recognized that the federal courts fulfill an important gatekeeping function, guaranteeing that evidence is both relevant and reliable. Id. at 589. The Daubert Court then suggested a non-exclusive list of factors for courts to consider when deciding whether proposed scientific expert testimony is sufficiently reliable. Such factors include: (1) whether a theory or technique . . . can be and has been tested; (2) whether the theory or technique has been subjected to peer review or publication; (3) the known or potential rate of error; and (4) general acceptance. Id. at 593-94. Although Daubert specifically dealt with scientific evidence, we have recognized that the gatekeeper analogy 'is applicable to all expert testimony offered under Rule 702.' United States v. Thomas, 74 F.3d 676, 681 (6th Cir.), cert. denied, 517 U.S. 1162 (1996), abrogated on other grounds by Gen. Elec. Co. v. Joiner, 522 U.S. 136 (1997), quoting Berry v. City of Detroit, 25 F.3d 1342, 1350 (6th Cir. 1994), cert. denied, 513 U.S. 1111 (1995); Cook v. American S.S. Co., 53 F.3d 733, 738 (6th Cir. 1995) (noting that a duty comparable to Daubert's gatekeeping function is imposed upon a trial court when the subject of the proposed opinion testimony is not 'scientific' knowledge, but 'technical, or other specialized knowledge'), abrogated on other grounds by Joiner, 522 U.S. 136. 41 In Berry, 25 F.3d at 1350-51, this court adopted the aforementioned four Daubert factors as an analytical framework when assessing the reliability of proposed non-scientific expert testimony. Utilizing those same factors (i.e., testing of the expert's theory, peer review and publication, rate of error, and general acceptance) in the present case, First Tennessee contends that the SBA failed to demonstrate that technically valid reasoning and methodology supported Iorlano's opinions. Therefore, the bank asserts that his so-called expert testimony was not proven to be reliable. 42 We cannot agree. Contrary to First Tennessee's argument, the fact that Iorlano's opinions may not have been subjected to the crucible of peer review, or that their validity has not been confirmed through empirical analysis, does not render them unreliable and inadmissible. In United States v. Jones, 107 F.3d 1147, 1158 (6th Cir.), cert. denied, 521 U.S. 1127 (1997), this court recognized that the four specific factors utilized in Daubert may be of limited utility in the context of non-scientific expert testimony. We noted that [i]f [the Daubert] framework were to be extended to outside the scientific realm, many types of relevant and reliable expert testimony--that derived substantially from practical experience--would be excluded. Such a result truly would turn Daubert, a case intended to relax the admissibility requirements for expert scientific evidence, on its head. Id. at 1158. Indeed, even the Berry court itself recognized that [t]he distinction between scientific and non-scientific expert testimony is a critical one[,] and that Daubert is only of limited help in assessing technical or experiential expertise. Berry, 25 F.3d at 1349. Consequently, in Jones we declined the appellant's invitation to apply the factors outlined in Daubert to testimony involving a non-scientific field. Jones, 107 F.3d at 1158. 43 Following our ruling in Jones, the Supreme Court clarified the applicability of the so-called Daubert factors to non-scientific evidence in Kumho Tire Co., Ltd. v. Carmichael, 526 U.S. 137(1999). In Kumho, the Court reaffirmed Daubert's central holding that a trial judge's gatekeeper function applies to all expert testimony, regardless of whether such testimony is based upon scientific, technical, or other specialized knowledge. Id. at 141, 147-49. With respect to the individual factors enumerated in Daubert, the Kumho Court held that trial courts may consider such factors when assessing the reliability of all types of expert testimony. Id. at 149-52. The Court stressed, however, that Daubert's list of specific factors neither necessarily nor exclusively applies to all experts or in every case. Id. at 141. In some cases (even cases involving non-scientific expert testimony), the factors may be pertinent, while in other cases the relevant reliability concerns may focus upon personal knowledge or experience. Id. at 150. [W]hether Daubert 's specific factors are, or are not, reasonable measures of reliability in a particular case is a matter that the law grants the trial judge broad latitude to determine. Id. at 153. 44 After reviewing Iorlano's trial testimony, we cannot say that the district court abused its discretion by allowing him to testify as an expert witness. In reaching this conclusion, we find the Daubert reliability factors unhelpful in the present case, which involves expert testimony derived largely from Iorlano's own practical experiences throughout forty years in the banking industry. Opinions formed in such a manner do not easily lend themselves to scholarly review or to traditional scientific evaluation. 13 Consequently, we find no merit in First Tennessee's argument that Iorlano's testimony lacked sufficient indicia of reliability, and therefore was inadmissible, under the guidelines established by Daubert. The fundamental objective when considering the admissibility of expert testimony is to ensure the reliability and relevancy of that testimony. Id. at 152. As set forth above, the district court possessed an adequate basis for concluding that Iorlano's testimony was both reliable and relevant. Accordingly, we find no abuse of discretion in the district court's decision to admit his testimony. 45
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).