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Relationships Gone Wrong

The magazine’s legal eagle delves into the dust-up between Union Bank and Car Mart. It’s a must-read for dealers considering bank assistance for an operating expense.

April 2013, F&I and Showroom - Feature

by Tom Hudson

You like your banker. He likes you. That makes for a nice relationship when you need a few extra shekels for inventory, a new computer system or some other operating expense. You take the nice banker to lunch. He talks to you about your kids, compliments your business acumen and then has you sign a few documents. Then you part with check in hand. A nice, friendly relationship, isn’t it? That is, until it isn’t.

See, everything was great until you discovered, to your chagrin, that those documents weren’t exactly what you thought they were. And there is nobody to blame. No deception was involved. Your banker is not a charlatan.

Between 2005 and 2010, Car Mart Auto Group Inc. obtained several loans from such a banker — The Union Bank Co. The dealer signed four “cognovits” demand notes with the bank. In 2010, Union Bank accelerated the loans and sued Car Mart on the notes. Car Mart confessed judgment. The trial court entered judgment on the notes and appointed a receiver to run Car Mart’s day-to-day operations.

Months later, Car Mart countersued Union Bank for allegedly breaching its duty to act in good faith by improperly accelerating the loans without a good faith belief that “the prospect of repayment was impaired.” Car Mart also claimed that Union Bank exercised total domination over Car Mart’s auto sales business and, through its misuse of that control, caused the business to become insolvent.

Union Bank moved for summary judgment. The trial court granted that motion and dismissed Car Mart’s counterclaims. Car Mart appealed.

The Court of Appeals of Ohio held that the trial court was correct for several reasons in dismissing Car Mart’s first claim against Union Bank for breach of good faith. First, the Uniform Commercial Code (UCC) commentary states that a lender’s authority to accelerate at will only where it deems the borrower unable to repay does not apply to “demand instruments,” or “obligations whose very nature permits call at any time with or without reason,” as was the case here.

Second, Ohio courts have repeatedly held that a lender does not act in bad faith when it decides to enforce its contractual rights. Here, Union Bank simply exercised its contractual right to accelerate the notes.

Third, the UCC commentary makes clear that a lender’s duty to act in good faith does not give rise to an independent cause of action. Thus, even had Union Bank breached its duty to act in good faith, the appellate court held that Car Mart could not sue Union Bank for it.

The appellate court then held that the trial court was correct in dismissing Car Mart’s second claim brought under the “instrumentality theory,” which states that a lender may be held liable for the borrower’s wrongdoing when the lender exerts such a degree of control over the borrower that the borrower becomes a mere business conduit for the lender.

The doctrine is meant to be a means to enable a plaintiff to bring its cause of action against the “alter-ego” corporation. The appellate court found that the theory does not create an independent cause of action against that party. As such, the appellate court affirmed the trial court’s entry of summary judgment for Union Bank.

There were two dangerous yet transparent provisions in the document that this dealer signed. First, the loans were payable by the borrower whenever the lender demanded payment. That’s what a demand note is. No default by the buyer or action by the lender is a necessary predicate for the demand. The lender can simply wake up one morning on the wrong side of the bed, decide that today would be a good day to get paid, and demand payment from the borrower. And the borrower must pay.

The second provision is a “cognovit” or “confessed judgment” clause. A cognovit clause essentially permits the lender to go to court and have a judgment entered against the borrower. Although it’s possible to have a judgment entered in this manner vacated, it can be very hard to do.

You have to wonder if this dealer actually read the documents containing these provisions and knew what they meant. Or you have to wonder whether, heaven forbid, he engaged a lawyer to tell him the legal effect of these onerous provisions. I’m betting he did not.

Thomas B. Hudson is a partner in the law firm of Hudson Cook LLP and the author of several widely read compliance manuals available at CounselorLibrary.com. ©Counselor Library.com 2012, all rights reserved. Based on an article from Spot Delivery. Single print publication rights only, to Bobit Business Media. HC# 4825-9463-1442 (04/13).

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