My recent post on Donald Trump’s legal arguments in defense of his failure to pay off a contruction loan on the Chicago Trump Tower project has spawned a number of inquiries. Many have asked specifically about the theory that the “world financial crisis” could constitute a valid defense to Trump’s performance of a contractual obligation. Folks want to know the chances that this theory could ultimately be adopted by a court, and whether it could have a wider application beyond the construction loan context.
Those interested in the issue should read a recent federal opinion called Hoosier Energy Rural Electric Cooperative, Inc. v. John Hancock Life Insurance Co., 2008 WL 5068649 (S.D. Ind. Nov. 25, 2008). The background is somewhat complex but essentially involves the owner of an electrical generating plant in Indiana, Hoosier Energy, which in 2002 entered into a complex lease-back arrangement over some of its assets with an insurance company, John Hancock, aimed at creating a tax shelter for John Hancock. As part of the deal, Hoosier Energy was required to obtain what amounted to a line of credit from Ambac, a financial institution called a “swap provider.”
Until 2008, Hoosier Energy made all of its scheduled payments under the agreement. Then, global financial crisis ensued, and the credit rating of Hoosier Energy’s swap provider sunk like a stone. Hooiser Energy was unable to find another swap provider with a suitable credit rating who could be substituted in a timely manner. John Hancock declared Hoosier Energy to be in default and demanded a large termination payment, shortly after which Hoosier Energy filed suit, requesting a protective injunction.
Here’s where it gets interesting. Like Donald Trump, Hooiser Energy argued that the extraordinary freeze in global credit markets at least partially excused it from performing under the contract as an instance of “commercial impracticability,” mitigating the default declared by John Hancock. And the court agreed:
The crisis certainly was not anticipated in 2002, when the deal between Hoosier Energy, Ambac, and John Hancock was being finalized. Retrospect will not assist John Hancock here, nor will an assertion that it was Hoosier Energy’s responsibility to prepare for and guard against any imaginable commercial calamity . . . . Hoosier Energy has come forward with evidence indicating that the obstacles it faced were not specific to Ambac but were the product of the credit crisis that effectively but temporarily froze the market for comparable credit products at any price. Those effects were not anticipated and could not have been guarded against.
That’s strong language and, to my knowledge, the first judicial pronouncement that the economic events of 2008 were so extraordinary as to excuse performance under a pre-existing contract.
How could this newly articulated doctrine be more broadly applied? One possibility rests with the large number of individuals who signed preconstruction real estate contracts several years ago, with the intention of obtaining mortgage financing once the project was finished. Now that many of those projects have been or will soon be competed, those buyers are unable to close because, owing to the global credit crunch, banks will no longer extend mortgage financing for certain new real estate construction at 2004 or 2005 prices.
While many of these purchase contracts were drafted with clauses stating that they were not contingent upon the buyer qualifying for a mortgage, it could be argued, on the basis of the reasoning set forth in Hoosier Energy, that the deals were signed under both parties’ reasonable assumption that financing would actually be available from somewhere once construction was completed. To quote the Southern District of Indiana in Hoosier Energy, “The crisis was not anticipated by the most senior economists in the country.” If that is true, why should the defense of commercial impracticability, based on the lack of accessible credit, be any less available to the individual real estate buyer seeking to mitigate the effect of a pre-existing contract then it would be to an electrical generating plant operator dealing at arms length with a multibillion dollar insurer? (To some degree, the question overlaps the analysis of whether “bailout” principles should apply equally to financial institutions and individual homeowners, both of whom are victims of their own inability to foresee the mortgage crisis).
We may very well get some clarity from the courts on these issues in 2009. In the meantime, we will no doubt see lawsuits filed and defended on these theories, with lawyers pushing the reasoning on both sides.
This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.
Mr. Beck has a law degree from Harvard Law School, and practices law in the courts of South Florida. His law firm, Beck & Lee Business Trial Lawyers in Miami, is dedicated to the practice of business and real estate litigation, as well as pursuing the rights and remedies of consumers and investors. A significant portion of Mr. Beck’s practice is devoted to issues arising under purchase contracts for real estate, including condominiums, condo-hotels, single-family homes, and commercial property. He can be reached at 305-789-0072 or firstname.lastname@example.org