Lender Limits Liability for Breach of Loan Agreement
California Civil Code section 1668 states: “All contracts which have for their object, directly or indirectly, to exempt any one from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.”
This prevents contracting parties from insulating themselves from liability for intentional tortious conduct. But does it leave the door open to limiting liability for normal negligence or breach of contract?
A case recently filed by California’s Second Appellate District — CIP Jardinette Holding, LLC v. RCMF 2018-FL2 Marathon Street, LLC — addresses the issue. While the CIP opinion is unpublished and therefore cannot be cited as binding precedent, it still provides a useful guidepost.
Facts: loan agreement limits lender’s liability to torts; lender declares default and forecloses
The borrower — CIP Jardinette Holding, LLC (“CIP”) — was formed to renovate an apartment building in Hollywood, California. Robert Clippinger was CIP’s manager. Other investors, including Ratel Investments, LP and Ratel Hollywood, LP (“Ratel”), participated in the venture by contributing $3.9 million.
CIP entered into an agreement with ReadyCap Commercial LLC (“ReadyCap”) on a $8,815,000 loan for the project, documented by a loan agreement. The loan was secured by a deed of trust on the property. Clippinger signed a guaranty.
The loan agreement contained a warranty that Clippinger would remain as the manager in control of CIP. The loan agreement also contained a provision limiting the lender’s liability for any loss sustained by CIP unless “such loss was solely caused by the fraud, gross negligence or willful misconduct of Lender[.]”
Disputes arose between Ratel and Clippinger shortly after the loan closed. Ratel believed Clippinger was diverting and misappropriating funds, causing the project to stall. Ratel initiated the process of removing Clippinger as CIP’s manager, and notified ReadyCap of same.
ReadyCap warned Ratel that it could not unilaterally remove and replace Clippinger as CIP’s manager and removal without ReadyCap’s consent would constitute a default under the loan agreement. Ratel moved forward with Clippinger’s removal anyway.
The dispute between Ratel and Clippinger went to arbitration, but the proceedings stalled out and were ultimately dismissed when arbitration fees went unpaid.
Meanwhile, ReadyCap issued a notice of default giving CIP 30 days to cure by obtaining consent for Clippinger’s removal, entering an agreement with a new manager, and providing a new guaranty for the loan. CIP did not cure. ReadyCap withheld loan advances based on the uncured default. Ultimately, ReadyCap transferred the loan to a different entity (RCMF 2018-FL2 Marathon Street, LLC), which foreclosed on the property.
The lender sued CIP, and CIP filed a cross-claim alleging breach of contract.
Trial court: summary judgment granted for lender; borrower showed no evidence of tortious conduct
The lender moved for summary judgment against CIP’s cross-claim for breach of contract based largely on the contractual clause limiting liability. The trial court granted the motion.
The court found that the contractual limitation of liability clause was enforceable because both parties “are sophisticated actors with bargaining parity who engaged in arms-length negotiations over the terms of the agreement.” The court also found that the lender’s conduct was commercially reasonable.
Court of Appeal: affirmed; the contractual limitation of liability was enforceable and decisive
The Court of Appeal affirmed.
The court agreed that the contractual limitation of liability was valid and enforceable: “Parties may agree to limit liability for breach of contract.” The court acknowledged that Civil Code section 1668 prohibits contracts from exempting parties for liability from their fraud, willful injury to others, or violations of law, but “a contract exempting from liability for ordinary negligence is valid where no public interest is involved and no statute expressly prohibits it.”
The court noted that CIP asserted “a cause of action for breach of contract. They do not claim misrepresentation or other type of fraud.”
CIP attempted to argue that the lender’s interpretation of the loan agreement constituted “willful misconduct.” But the court disagreed: “Willful or wanton misconduct is intentional wrongful conduct, done either with a knowledge that serious injury to another will probably result, or with a wanton and reckless disregard of the possible results.” And “gross negligence” is “a lack of care” indicating “a passive and indifferent attitude toward results[.]” The court held that CIP offered “no evidence” that the lender was grossly negligent, let alone engaged in intentional misconduct.
At most, CIP only showed that it disagreed with the lender’s interpretation of the default provisions in the loan agreement. The court concluded: “parties cannot proceed in tort for what are essentially breaches of contract. … Erroneous or not, [the lender’s] reading of the contract does not rise to the level of ‘willful misconduct.'”
Lesson
The unpublished CIP opinion provides a useful reminder that parties to a contract can include provisions limiting liability in the event of future disagreements. Civil Code section 1668 prevents parties from eliminating liability for fraud, willful injury to others, or violations of law, but allows limiting liability for ordinary negligence or breach.