The Arizona Supreme Court’s opinion in Wells Fargo Bank v. Arizona Laborers, Teamsters and Cement Masons Local No. 395 Pension Trust Fund, 201 Ariz. 474 (2002), and its progeny have substantially impacted commercial litigation by expanding the implied covenant of good faith and fair dealing (“implied covenant”). In contrast to a written, agreed upon term, Arizona law implies this covenant in every contract.

However, rather than eviscerating parties’ right to negotiate and enter into contracts on express terms, as some naysayers originally prophesied, its largest impact may be more economic than substantive.

Implied covenant claims are exceedingly prevalent in commercial litigation. Indeed, they are present more often than not. Due to the expansion of the implied covenant in Wells Fargo and its progeny, these claims are less likely to be resolved by early motions—resulting in longer, and often more expensive litigation. Without question, this result has only fanned the popularity of these claims.

Wells Fargo arose from a Tri-party Agreement between the Mercado Developers (a partnership headed by Arizona’s former Governor, J. Fife Symington, III) (“Symington”), First Interstate Bank (Wells Fargo’s predecessor) (the “Bank”), and various union pension funds (the “Funds”). The Bank agreed to provide temporary construction financing if Symington was able to secure permanent financing from another lender. The Funds agreed to be that lender.

The Funds took out the Bank’s construction loan and Symington eventually defaulted on the permanent loan. The Funds ultimately claimed, among other things, that the Bank breached the implied covenant by failing to disclose Symington’s deteriorating financial condition to the Funds.

Although the Bank was not expressly required to make such disclosures to the Funds, the Supreme Court found that a jury might reasonably conclude that the Bank’s actions were inconsistent with the Funds’ “justified expectations” under the Tri-party Agreement.

As a result of Wells Fargo and its progeny, a party may breach the implied covenant without actually breaching an express term of the contract. Courts must make a factual determination whether a party acted in a manner inconsistent with the other party’s reasonable or justified expectations. However, these factual questions typically require the parties to undertake costly and time consuming discovery, and make it very challenging for either party to prevail on an implied covenant claim in the early stages of litigation. Therefore, the unintended consequence of the Wells Fargo decision is often longer, more costly litigation.

Landmark Litigation Article Arizona Business Magazine September-October 2011

http://dioguardiflynn.com/wp-content/uploads/2011/09/Moolenaar_2011906.pdf

While Arizona does have an anti-deficiency statute which prohibits lenders from pursuing some borrowers personally for the balance due on a note after a foreclosure sale, its protection is generally limited to purchase money mortgages on residential property of two and one-half acres or less. Purchase money mortgages are those given to secure the payment of the balance of the purchase price or to secure a loan to pay all or part of the purchase price.

Although the anti-deficiency statute may at first appear fairly mundane, for many homeowners, investors or trusts, its application is anything but. Common issues that require careful consideration and analysis include: (1) the impact of equity lines of credit; (2) personal guarantees; (3) the potential for cross-defaults under other loans; (4) whether the property is a “dwelling” under the statute; (5) whether the lender has waived any right to a deficiency; and (6) the amount of the deficiency. The analysis of whether a borrower has potential liability for a deficiency (and to what extent) often requires careful review of the loan and security documents, as well as the borrower’s actions following the execution of the note and security instrument. Although there are many sources that purport to provide this information, a comprehensive analysis should be conducted by an attorney experienced with these matters.

The attorneys at Dioguardi Flynn LLP have extensive experience in litigating a wide array of civil/commercial litigation matters in the State and Federal Courts of Arizona and throughout the country. They have gained substantial experience over the years addressing the needs of their Internet-based clients as well, including claims involving the Digital Millennium Copyright Act (“DMCA”). Please contact John at 480-951-8803 (jflynn@dioguardiflynn.com) or Peter at 480-951-8806 (pmoolenaar@dioguardiflynn.com) if you would like to discuss obtaining legal advice and representation.

[Download a copy of the Court's Decision]

MERS was created in 1997 to obviate the need to record changes to mortgages stemming from the subsequent transfers of their corresponding Notes. Although MERS does not own or service the mortgages it registers, it is typically listed in the mortgage as a nominee for the actual owner.

Although the majority of the challenges to MERS (which have been largely unsuccessful) involve the proprietary of its role vis-a-vis the borrower or homeowner, there may be some question as to the legitimacy of its registration vis-a-vis a subsequent bona fide purchaser or encumbrance holder for value.

All states have recording acts governing the recordation of documents concerning the title to real estate. These acts are designed to protect subsequent bona fide purchases of an interest in land from unrecorded claims. They generally have no application to the validity of a deed between the grantor and grantee.

There are three types of recording acts: Race, Notice and Race-Notice. In a Race statute, whoever wins the race to record first prevails over anyone who has not recorded or subsequently records. In a Notice statute, a subsequent purchaser wins if he or she has no notice of a prior claim when he or she acquires the interest in the property. Race-Notice statutes protect subsequent purchasers who take their interest without notice of the prior claim and win the race to record.

Given that the vast majority of states have either a Notice or Race-Notice statute, the question is whether security instruments listing MERS as a nominee provide sufficient “notice” to subsequent purchasers. The recorded mortgage typically will not identify the current owner of the mortgage, nor will there be subsequent recorded documents identifying the owner. Therefore, it is not possible for a subsequent purchaser to discern from the records whom is asserting a prior claim to the property. Further, should the subsequent purchaser contact MERS, he or she will typically only be informed of the entity that is servicing the mortgage. This may not necessarily be the same entity that owns the mortgage.

Should subsequent purchasers or encumbrance holders for value begin to challenge MERS, Courts will likely be asked to determine the level of “notice” required. Is notice of an asserted interest in property, without notice of the person or entity asserting the claim, sufficient?

Feature in the Arizona Attorney Magazine, June 2009