Jeffrey B. Steiner and Jason R. Goldstein
Jeffrey B. Steiner and Jason R. Goldstein (Handout)

Loan documents are filled with boilerplate provisions intended to preserve the lender’s return in any applicable loan transaction as net of extraneous costs and expenses that the lender may incur in connection with the loan. In addition to carveout guarantees that address certain losses a lender may suffer by virtue of a borrower party’s particular actions taken in defiance of specific terms of the documents, loan documents also include catch-all provisions imposing liability on a borrower for costs and expenses incurred by the lender that relate to the lender’s ownership of the loan or participation in the loan transaction itself. While our articles frequently focus on market-driven drafting considerations, we focus this month on seemingly basic lender indemnification provisions and how different practitioners and courts may approach such matters.

Certain expenses of a lender in connection with general, ongoing servicing or administrative costs of holding a loan are routinely passed on to the borrower. For example, a lender’s costs, expenses and attorney fees incurred in connection with its review of approvals or modifications requested by a borrower are regularly reimbursed by borrowers without significant objection or negotiation. Some expenses of a lender, however, though associated with an extension of credit, are outside of a borrower’s purview and may cause challenges for a lender attempting to recover such costs. For example, commercial mortgage-backed securities (CMBS) lenders may, without informing the borrower, enter into hedging transactions, including interest rate swaps, that protect against fluctuations in the interest rate markets subsequent to the applicable rate-lock or closing and prior to final securitization.

As a general rule, subject to loan document negotiation, a lender’s direct losses resulting from a borrower’s breach of a contract (i.e., general damages) and indirect losses foreseeable by the parties at the time of entering into the transaction (i.e., consequential damages) are recoverable by the lender from the borrower (not necessarily, a recourse carveout guarantor); unforeseeable damages, on the other hand, are often disallowed by courts absent an express understanding to the contrary. Unless a particular type of loss was specifically described in the loan documents evidencing the transaction, however, borrowers may claim such a loss was not contemplated or foreseeable by either party and cannot be lawfully charged to them. In response, lenders will often point to a general indemnity provision, obligating the borrower to indemnify the lender “from and against any and all claims, losses and liabilities growing out of or resulting from the loan.” In the absence of a specific provision indemnifying the lender for hedging losses (or if such a provision has been deleted following negotiation), courts must determine whether hedging losses should correctly be included as indemnified costs by the borrower under a general indemnity.

Two cases (Gulf Islands Leasing v. Bombardier Capital, 2006 WL 214523 (SDNY 2006) (Gulf Islands) and W2007 Monday 230 Park Mezz Ii v. Landesbank Baden-Wuerttemberg, 2013 NY Slip Op 50031, 38 Misc.3d 1209, 966 N.Y.S.2d 350 (N.Y. Sup. Ct., 2013) (Landesbank)) have sought to offer some clarity on the matter.

Gulf Islands

In the Gulf Islands case, a lender sought reimbursement from a borrower for the cost of unwinding a hedging transaction following a prepayment, which the lender entered into to hedge its fixed rate exposure to the loan. New York law, the court stated, requires that indemnification provisions be strictly construed, and a court “cannot find a duty to indemnify absent manifestation of an unmistakable intention to indemnify.” In its examination of the relevant indemnification provision in the loan agreement, the court noted the document’s failure to mention fees incurred to unwind hedging transactions, and in the loan documents generally, there was no reference to such hedging transactions or costs associated therewith. In addition, the court admitted evidence that the lender had entered into agreements with other borrowers around the same time the loan in question was consummated that had specifically contemplated losses incurred from hedging transactions. Because such provisions were addressed in other agreements with similarly situated borrowers but were absent from the loan documents at issue, the borrower argued successfully that the parties did not intend for the borrower to be liable for the costs of the lender’s hedging transactions. The court found that, because the borrower was never made aware of these costs, through express provisions in the loan documents or otherwise, the lender was not entitled to a recovery of such losses.

‘Landesbank’

In the Landesbank case, the lender generated a payoff letter charging the borrower $4,788,000 (which the borrower paid under protest, and which protest became the matter in dispute in this case) when the borrower sought to prepay a $155 million fixed rate loan. In a summary judgment motion brought by the lender, the court examined a provision in the loan agreement where the borrower was assigned liability “for all of the lender’s costs and expenses, including reasonable attorneys’ fees, incurred by the lender in connection with prepayment of the loan.”

The lender argued that the plain unambiguous language of that provision was sufficient to dismiss the case with prejudice and render the borrower responsible for all costs and expenses incurred related to the loan’s prepayment, whether or not such particular costs had been specifically enumerated in the loan documents. Further, the lender noted that while several similar indemnification provisions in the same loan agreement explicitly limited the indemnified costs and expenses to “out-of-pocket” costs, the section under review had no such limitation. The lack of such language, the lender argued, was evidence that the parties intended that lender’s indemnification be interpreted broadly.

The borrower argued that it could not have reasonably anticipated being liable for the lender’s hedging costs since such costs were part of a separate transaction between the lender and third parties. The court determined that the indemnification provision was not specific or explicit enough in identifying hedging losses as an indemnity obligation and thus rejected the lender’s motion to dismiss borrower’s claim to recover its payment made under protest. Following the court’s dismissal of the motion for summary judgment, the parties settled, leaving open the question of whether the court would have ultimately followed the Gulf Islands decision and found the indemnification provision insufficient to protect the lender.

Conclusion

The foregoing cases demonstrate that lenders cannot rely exclusively on generic catch-all indemnification provisions to recover all of their loan expenses from their borrowers. To the extent that lenders expect to enter into hedging transactions when extending credit, the loan documents should delineate the circumstances when the borrower will be liable for losses arising from unwinding any such transactions, including upon an early prepayment.

A prepayment provision, for example, that states that the borrower “acknowledges that the lender may enter into hedge positions with respect to the interest rate, which hedging transactions would have to be ‘unwound’ if all or any portion of the loan is paid down, and the borrower agrees to indemnify the lender for any losses arising therefrom” would greatly enhance the lender’s ability to recover for losses from a hedging transaction. Absent such specificity, loan documents relying on boilerplate catch-all indemnification provisions may fail to protect a lender’s expected return.

Loan documents are filled with boilerplate provisions intended to preserve the lender’s return in any applicable loan transaction as net of extraneous costs and expenses that the lender may incur in connection with the loan. In addition to carveout guarantees that address certain losses a lender may suffer by virtue of a borrower party’s particular actions taken in defiance of specific terms of the documents, loan documents also include catch-all provisions imposing liability on a borrower for costs and expenses incurred by the lender that relate to the lender’s ownership of the loan or participation in the loan transaction itself. While our articles frequently focus on market-driven drafting considerations, we focus this month on seemingly basic lender indemnification provisions and how different practitioners and courts may approach such matters.

Certain expenses of a lender in connection with general, ongoing servicing or administrative costs of holding a loan are routinely passed on to the borrower. For example, a lender’s costs, expenses and attorney fees incurred in connection with its review of approvals or modifications requested by a borrower are regularly reimbursed by borrowers without significant objection or negotiation. Some expenses of a lender, however, though associated with an extension of credit, are outside of a borrower’s purview and may cause challenges for a lender attempting to recover such costs. For example, commercial mortgage-backed securities (CMBS) lenders may, without informing the borrower, enter into hedging transactions, including interest rate swaps, that protect against fluctuations in the interest rate markets subsequent to the applicable rate-lock or closing and prior to final securitization.

As a general rule, subject to loan document negotiation, a lender’s direct losses resulting from a borrower’s breach of a contract (i.e., general damages) and indirect losses foreseeable by the parties at the time of entering into the transaction (i.e., consequential damages) are recoverable by the lender from the borrower (not necessarily, a recourse carveout guarantor); unforeseeable damages, on the other hand, are often disallowed by courts absent an express understanding to the contrary. Unless a particular type of loss was specifically described in the loan documents evidencing the transaction, however, borrowers may claim such a loss was not contemplated or foreseeable by either party and cannot be lawfully charged to them. In response, lenders will often point to a general indemnity provision, obligating the borrower to indemnify the lender “from and against any and all claims, losses and liabilities growing out of or resulting from the loan.” In the absence of a specific provision indemnifying the lender for hedging losses (or if such a provision has been deleted following negotiation), courts must determine whether hedging losses should correctly be included as indemnified costs by the borrower under a general indemnity.

Two cases (Gulf Islands Leasing v. Bombardier Capital, 2006 WL 214523 (SDNY 2006) (Gulf Islands) and W2007 Monday 230 Park Mezz Ii v. Landesbank Baden-Wuerttemberg, 2013 NY Slip Op 50031 , 38 Misc.3d 1209 , 966 N.Y.S.2d 350 (N.Y. Sup. Ct., 2013) ( Landesbank )) have sought to offer some clarity on the matter.

Gulf Islands

In the Gulf Islands case, a lender sought reimbursement from a borrower for the cost of unwinding a hedging transaction following a prepayment, which the lender entered into to hedge its fixed rate exposure to the loan. New York law, the court stated, requires that indemnification provisions be strictly construed, and a court “cannot find a duty to indemnify absent manifestation of an unmistakable intention to indemnify.” In its examination of the relevant indemnification provision in the loan agreement, the court noted the document’s failure to mention fees incurred to unwind hedging transactions, and in the loan documents generally, there was no reference to such hedging transactions or costs associated therewith. In addition, the court admitted evidence that the lender had entered into agreements with other borrowers around the same time the loan in question was consummated that had specifically contemplated losses incurred from hedging transactions. Because such provisions were addressed in other agreements with similarly situated borrowers but were absent from the loan documents at issue, the borrower argued successfully that the parties did not intend for the borrower to be liable for the costs of the lender’s hedging transactions. The court found that, because the borrower was never made aware of these costs, through express provisions in the loan documents or otherwise, the lender was not entitled to a recovery of such losses.

‘Landesbank’

In the Landesbank case, the lender generated a payoff letter charging the borrower $4,788,000 (which the borrower paid under protest, and which protest became the matter in dispute in this case) when the borrower sought to prepay a $155 million fixed rate loan. In a summary judgment motion brought by the lender, the court examined a provision in the loan agreement where the borrower was assigned liability “for all of the lender’s costs and expenses, including reasonable attorneys’ fees, incurred by the lender in connection with prepayment of the loan.”

The lender argued that the plain unambiguous language of that provision was sufficient to dismiss the case with prejudice and render the borrower responsible for all costs and expenses incurred related to the loan’s prepayment, whether or not such particular costs had been specifically enumerated in the loan documents. Further, the lender noted that while several similar indemnification provisions in the same loan agreement explicitly limited the indemnified costs and expenses to “out-of-pocket” costs, the section under review had no such limitation. The lack of such language, the lender argued, was evidence that the parties intended that lender’s indemnification be interpreted broadly.

The borrower argued that it could not have reasonably anticipated being liable for the lender’s hedging costs since such costs were part of a separate transaction between the lender and third parties. The court determined that the indemnification provision was not specific or explicit enough in identifying hedging losses as an indemnity obligation and thus rejected the lender’s motion to dismiss borrower’s claim to recover its payment made under protest. Following the court’s dismissal of the motion for summary judgment, the parties settled, leaving open the question of whether the court would have ultimately followed the Gulf Islands decision and found the indemnification provision insufficient to protect the lender.

Conclusion

The foregoing cases demonstrate that lenders cannot rely exclusively on generic catch-all indemnification provisions to recover all of their loan expenses from their borrowers. To the extent that lenders expect to enter into hedging transactions when extending credit, the loan documents should delineate the circumstances when the borrower will be liable for losses arising from unwinding any such transactions, including upon an early prepayment.

A prepayment provision, for example, that states that the borrower “acknowledges that the lender may enter into hedge positions with respect to the interest rate, which hedging transactions would have to be ‘unwound’ if all or any portion of the loan is paid down, and the borrower agrees to indemnify the lender for any losses arising therefrom” would greatly enhance the lender’s ability to recover for losses from a hedging transaction. Absent such specificity, loan documents relying on boilerplate catch-all indemnification provisions may fail to protect a lender’s expected return.