Lenders Beware: North Carolina Business Court Recognizes New Duty to Negotiate in Good Faith

In a case involving workout discussions between a lender and borrower, the North Carolina Business Court recognized on June 9, 2015, for the first time under North Carolina law, a borrower’s claim for a breach of a duty to negotiate in good faith when the lender went “dark” towards the end of advanced workout negotiations. While that case, RREF BB Acquisitions, LLC v. MAS Properties, L.L.C., is not binding precedent, Business Court opinions are nevertheless closely followed and are viewed as “highly persuasive” by other courts. This recent decision is significant for lenders because it opens the door to new potential liability under certain circumstances, but it also raises some interesting (and important) questions: When and how can a lender end negotiations with a borrower without increasing its potential exposure? How does a court measure the damages for a breach of this duty? How does a lender defend its position that it was negotiating in good faith? The court has not answered those questions yet, but we offer suggestions to help avoid a claim that the lender has violated a duty to negotiate in good faith.

Factual Background

The RREF BB Acquisitions case arose from two short-term commercial real estate loans that BB&T made to MAS Properties totaling over $5 million. For nearly 20 years, the parties almost annually renewed or modified the loans. In February 2012, BB&T decided not to renew the loans because MAS Properties had been sued by another bank for $70 million due on other loans and gave MAS Properties written notice of the non-renewal before the March 2012 maturity date.

After the loans matured, the parties entered into negotiations to restructure the loans. BB&T sent MAS Properties a proposed forbearance agreement—which MAS Properties never signed—and a reservation of rights letter. In July 2012, during the parties’ negotiations, BB&T began foreclosure proceedings. At the same time it was engaged in workout discussions, BB&T began marketing the loans for sale without informing MAS Properties.

BB&T and MAS Properties continued their negotiations. In late October 2012, the parties met and agreed on most material terms for restructuring the loans, a meeting promptly followed by BB&T’s transmittal of a term sheet to MAS Properties containing fairly typical disclaimers that it did “not constitute any kind of commitment or undertaking” by BB&T, was “intended solely to facilitate discussions” and was “subject to [BB&T’s] internal approval process.” Nearly three weeks later, MAS Properties submitted a revised term sheet to BB&T proposing, among other things, to remove one of the two guarantors from the loans.

The day after MAS Properties sent its revised term sheet, BB&T stopped all workout discussions with MAS Properties based on its internal policy to do so when a loan was “up for sale.” BB&T never responded to MAS Properties’ revised term sheet. Instead, BB&T soon thereafter sold the loans to RREF BB Acquisitions, LLC and informed MAS Properties about the sale.

The Business Court’s Decision

When RREF sued MAS Properties to collect the loans, MAS Properties filed a third-party complaint against BB&T. MAS Properties claimed, among other things, that BB&T had breached a duty to negotiate in good faith by (1) ending negotiations on the proposed restructuring and (2) failing to tell MAS Properties that its late October 2012 term sheet was a last and best offer and, had it done so, it would have accepted it rather than countering it. MAS Properties argued that even if the parties had not reached a binding restructuring agreement, they had agreed on all terms necessary to reach a binding agreement so they had a duty to negotiate in good faith to finalize the agreement. MAS Properties conceded that no court had previously recognized this claim under North Carolina law.

The viability of the duty to negotiate in good faith claim came before the Business Court on BB&T’s summary judgment motion. In denying that motion, the Business Court concluded, “on the unique facts” presented, that MAS Properties’ claim “may be viable.” Essentially, the Business Court held that the parties’ negotiations were sufficiently advanced to potentially create a duty for BB&T to continue negotiating in good faith and BB&T’s failure to respond to MAS Properties’ counter term sheet could have breached that duty. The Business Court also noted the trend in other states towards recognizing this type of claim. BB&T will not be able to appeal the decision until after trial, so it may be some time before North Carolina’s appellate courts confront the issue in this case. Of course, the case may settle, so the Business Court decision may not be challenged until it is raised in another case.

Takeaways

While lenders can debate the merits of the RREF BB Acquisitions decision and claim that the unique facts there limit its significance and impact (or that unusual facts make bad law), lenders should think about a few strategies to avoid creating a duty to continue negotiating in good faith or breaching that duty:

• Require a borrower to execute a pre-negotiation agreement giving the parties the right to terminate negotiations at any time for any reason, without notice, and stating that no agreement exists on any single term until agreement exists on all terms;
• Don’t “go dark” in negotiations; rather, respond to any proposals or counter-proposals, even if simply rejecting the proposal, and make clear the negotiations have ended; and
• At the end of any negotiating session or meeting, if appropriate, expressly state that while progress may have been made, other terms still need to be negotiated so the parties do not have an agreement.