WILLIAM J. HAYNES, JR., District Judge.
Before the Court is Plaintiff's motion (filed March 31, 2006; Docket Entry No. 17) for judgment in its favor on the administrative record and its memorandum (filed March 31, 2006; Docket Entry No. 18) in support; the defendant's motion (filed March 31, 2006; Docket Entry No. 16) for judgment in its favor on the administrative record and its memorandum (filed March 31, 2006; Docket Entry No. 19) in support; and the plaintiff's response (filed April 17, 2006; Docket Entry No. 23) in opposition to the defendant's motion. The Court also has before it the plaintiff's motion (filed March 31, 2006; Docket Entry No. 20) for a hearing and oral argument and the defendant's response (filed April 4, 2006; Docket Entry No. 22) in opposition.
Plaintiff, First Tennessee Bank National Association, filed this action under the Administrative Procedure Act, 5 U.S.C.
With the administrative record and the briefs of the parties, the Court concludes that oral argument is not necessary in this case, and Plaintiff's motion (Docket Entry No. 20) for oral argument is denied.
For the reasons set forth below, the Court shall affirm in part and deny in part the findings of the Secretary's decision. Plaintiff shall be awarded $359,373.84 on its Loss Claim.
I. REVIEW OF THE RECORD
Plaintiff, First Tennessee Bank National Association, ("FTB"), is a banking institution with offices in Nashville, Tennessee. FTB is the successor in interest to Peoples and Union Bank, ("PUB"), a bank formerly organized and existing under Tennessee law, with offices and place of business in Pulaski, Giles County Tennessee. PUB was a wholly-owned subsidiary of FTB.
On March 24, 1998, Magna Metal Finishing, Inc., ("MMF"), located in Pulaski, Tennessee, applied to PUB for a guaranteed loan through the United States Department of Agriculture Rural Development Business and Industry loan program in the amount of $1,300,000. Docket Entry No. 11, Certified transcript, Volume II at 920.
MMF's loan application reflected that, as of February 28, 1998, it had fixed assets of $671,820 (including equipment valued at $437,592), liabilities in the amount of $261,457, and tangible balance sheet equity of $508,655 (61.08%). Id. at 921. The application projected that after loan closing MMF would have assets of $1,933,028, liabilities in the amount of $1,464,373, and tangible balance sheet equity of $528,655 (20.19%). The application reflects that MMF was to contribute $59,800 for fees and $29,584 for debt restructuring for a total contribution amount of $89,384. On March 27, 1998, PUB certified the loan application. Id. at 920. During March and April 1998, and prior to the loan closing, MMF leased equipment from Leasing Technology, Inc., ("LTI"), for $335,000. Id. at 921; Vol. I at 151, 190-91, 263.
On May 14, 1998, the Rural Business-Cooperative Service, an agency under the USDA and also known as Rural Development, approved the guaranteed loan application. Id. On May 22, 1998, the RBCS issued its Conditional Commitment for Guarantee to PUB, specifying that the funds from the B & I loan were to be used for machinery and equipment (approximately $1,252,500) and debt refinancing (approximately $47,500). Id. The Conditional Commitment also stated, in pertinent part, that:
Id., Vol. I at 10-13; Vol. II at 921.
Although MMF had earlier leased equipment from LTI, in a letter dated, June 9, 1998, PUB'S counsel stated that they had examined the appropriate lien searches relating to MMF's property and that there were no liens on record, as of that date, with respect to the property of the Borrower. Id., Vol. I at 151, 192-94. This letter reads, in part, "Borrower is the absolute owner of all property given to secure the repayment of the loan, free and clear of all liens, encumbrances, and security interests." Id. at 194. On June 9, 1998, PUB certified that MMF owned all of its equipment free and clear of all liens and encumbrances and security interests and accepted the conditions of the Conditional Commitment for Guarantee, signing the Lender's Agreement and closing the loan. Id.; Vol. II at 921. Thus, PUB agreed to use the loan for the purposes authorized in 7 C.F.R. § 4279, in accordance with the provisions of the Conditional Commitment for Guarantee. Id.
On June 16, 1998, PUB submitted a settlement statement to RBCS showing the following loan disbursements:
Total Settlement charges $ 84,727 Disbursement to Others: First Peoples Bank $ 91,741 Citizens First Bank $ 144,498 Oak Ridge Tool-Engineering Inc. $ 44,451 Ganton Technologies Inc. $ 7,000 Kenneth W. Altum $ 54,140 Ontario LTD $ 20,000 Dr. Sood $ 109,000 Leasing Technology $ 369,000 Vendors to be paid $ 254,506 Reserve Account-Peoples and Union Bank $ 80,000 Disbursements to borrower $ 40,935
__________ Total Disbursements $1,300,000
Id. at 922.
On July 1, 1998, MMF entered into a $65,000 lease with Ganton Technologies. Id. at 581, 790. On July 8, 1998, LTI informed Magna Metal that the lease on the equipment had been completed, that MMF's account was terminated and that LTI released its interest in the equipment. Id. at 702-04. Albert Nother, a partner in MMF, stated that there was some early payoff penalties attached to the LTI loans that were not anticipated. Id., Vol. I at 197. According to Nother, all of the unexpected expenses and penalties put a strain on MMF's finances. Id. at 198.
On August 26, 1998, RBCS issued an eighty percent (80%) Loan Note Guarantee of $1,300,000. Id., Vol. II at 922. The Loan Note Guarantee stated:
Id., Vol. I at 16.
According to James Pope, a loan packager
According to Vijay Jethanandani, MMF'S head partner, several problems led to MMF's downfall. Id., Vol. I at 199. In his view, MMF did not borrow sufficient funds at the beginning and had to pay unexpected fees associated with the interim loans. Both Jethanandani and Nother cited Breed Technologies' bankruptcy and Chrysler pulling a contract from the Huntsville, Alabama, plant as contributors to MMF's downfall. Id. at 198-99.
In April 2001, PUB merged with First Farmers and Merchants Bank of Columbia, Tennessee. Id., Vol. II at 922. MMF's loan was endorsed over to FTB. On April 17, 2001, RBCS approved FTB as the substitute lender for the MMF loan. FTB liquidated the loan, and on November 1, 2001, filed a final loss claim with RBCS for $1,086,873.84. Id.
On December 31, 2001, RBCS requested the USDA Office of Inspector General to investigate the MMF loan. On May 20, 2003, the OIG issued its report on the loan that revealed the following:
Id. at 922-23.
In an interview conducted by the OIG, Dan Beasley, RBCS's director, stated that any interim loans obtained by MMF should have been discussed and approved by the USDA. Id., Vol. I at 155, 158. RBCS cannot recall a guaranteed loan once it has been issued. Id. at 158. Usually, if there is a known violation and the borrower is behind on the loan payments, the RBCS will claim the loan is in default and force the lender to consider alternatives such as foreclosure and liquidation prior to bankruptcy. Id. Beasley further stated that if interim loans were to have been used to purchase equipment, the "USDA most likely would have approved them." However, there was no record in the files that the USDA was ever made aware of such loans. Id.
On June 17, 2003, RBCS denied the plaintiff's final loss claim, finding that the loan application submitted to RBCS had serious misrepresentations that would have made the business ineligible for the B & I loan program had RBCS been made aware of the true facts and because the lender allowed the borrower to use the loan proceeds for unauthorized purposes. Id.; Vol. II at 923.
On October 31, 2003, Suzanne Beavers, a rural business specialist with the USDA Rural Development in Lawrenceburg, Tennessee, reviews loan applications from the loan origination through the servicing on the business loans. Id. at 549-50. MMF's loan was the first loan she processed, and she was still learning at the time. Id. at 613. According to Beavers, initially there had not been any issues raised by September and October of 1999 regarding the use of loan proceeds to pay the refinance debt of MMF. Id. at 570. In 1998 and 1999, Beavers had two loans where the proceeds exceeded the 50 percent (50%) maximum allowed to be used to refinance debt, and as a result, the national office requested her office to send a letter to the lenders to determine the reason for going over 50 percent (50%). Id.; 536, 903. Beavers further testified that the USDA was not always that strict in enforcing its restriction against allowing more than fifty percent (50%) of loan proceeds to be used to refinance debt and that by October 1999, both the USDA and PUB were aware that more than fifty percent (50%) of the MMF loan went to pay refinance debt. Id. at 570-72.
When asked if the USDA would have pulled the loan note guarantee or threaten not to honor it upon learning of the refinancing in October 1999, Beavers answered no and stated that at that point the USDA could not have done anything except not pay off under the guarantee. Id. at 572. According to Beavers, if MMF had informed them at the time of the loan that it needed to use the loan proceeds to pay bridge loans for new equipment, the USDA would have waived any objection to the use of the proceeds for such a purpose. Id. at 572, 559. However, Beavers had never experienced a borrower telling her that it was using USDA funds to satisfy bridge loans and then asking her to modify the commitment to allow it to do so. Id. at 559. Nor had Beavers known of such a situation ever happening in general; although, she could have given her approval for refinancing if she had been requested to do so. Id. Lastly, Beavers agreed that if the lender had a first priority security interest over the equipment then the USDA's argument regarding the refinancing as a basis for denying the loss claim would be negated. Id. at 573.
On April 28, 2004, RBCS recalculated MMF's tangible balance sheet equity at eleven percent (11%) based on the following
After a hearing and submission of documentary evidence, the NAD hearing officer determined that RBCS did not err in denying the FTB's final loss claim for the MMF loan. The NAD hearing officer determined that the plaintiff's predecessor allowed MMF to use loan proceeds for unauthorized purposes in violation of the Conditional Commitment for Guarantee, that MMF misrepresented its financial position to meet the minimum twenty percent (20%) tangible balance sheet equity and that the plaintiff was responsible for the actions and omissions of its predecessor. Id.
On July 9, 2004, FTB filed a Request for Director Review of the NAD hearing officer's decision. Id. at 955-71. On October 12, 2004, the Deputy Director of the USDA/NAD issued its Director Review Determination upholding the NAD hearing officer's determination, and by extension, the USDA's original adverse decision to deny the plaintiff's Loan Loss Claim in full. Id. at 917-33. In his opinion, the Deputy Director stated that, as a lender, PUB had the primary responsibility for the successful delivery of the B & I loan program and rejected FTB's attempt to shift the responsibility for the loss to RBCS. Id. at 924. This opinion reads, in pertinent part:
The Deputy Director did, however, vacate the portion of the NAD hearing officer's decision on the calculation of the tangible balance sheet equity requirement. Id. at 931-32. The NAD hearing officer had found the tangible balance sheet equity to have been eleven percent (11%) or less than the twenty percent (20%) minimum equity needed for loan approval and the issuance of the Loan Note Guarantee. Id., Vol. I at 280-81. In its appeal to the Deputy Director, FTB argued that the
In his opinion, the Deputy Director addressed this valuation issue:
(Docket Entry No. 11, Certified transcript, Volume II at 932). The Deputy Director concluded:
Id. at 932.
In its appeal to this Court, FTB contends that the Court should overturn the USDA's decision because it is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; in excess of the USDA's statutory authority or limitations; and unsupported by substantial evidence. FTB's specific contentions are that:
Plaintiff's motion (Docket Entry No. 17) for judgment on the record at 2-5.
II. STANDARD OF REVIEW
A final determination by the National Appeals Division is reviewable by a United States district court of competent jurisdiction under the provisions of the Administrative Procedures Act. 7 U.S.C. § 6998. Under 5 U.S.C. § 706 of the APA, a "reviewing court shall decide all relevant questions of law, interpret constitutional and statutory provisions, and determine the meaning or applicability of the terms of an agency action." In making its determination, the reviewing court shall ...
"A reviewing court reviews an agency's reasoning to determine whether it is `arbitrary and capricious,' or, if bound up with a record-based factual conclusion, to determine whether it is supported by `substantial evidence.'" Dickinson v. Zurko, 527 U.S. 150, 164, 119 S.Ct. 1816, 144 L.Ed.2d 143 (1999). The "arbitrary and capricious" standard of review "is narrow and a court is not to substitute its judgment for that of the agency. Nevertheless, the agency must examine the relevant data and articulate a satisfactory explanation for its action including a `rational connection between the facts found and the choice made.'" Motor Vehicle Mfrs. Ass'n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43, 103 S.Ct. 2856, 77 L.Ed.2d 443 (1983) (citation omitted); Michigan Bell Telephone Co. v. MCIMetro Access Transmission Servs., 323 F.3d 348, 355 (6th Cir.2003) ("The arbitrary and capricious standard is the most deferential standard of judicial review of agency action, upholding those outcomes supported by a reasoned explanation, based upon the evidence in the record as a whole.").
In reviewing the agency's explanation, the reviewing court must consider whether the agency's decision "was based on a consideration of the relevant factors and whether there has been a clear error of judgment." Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 416, 91 S.Ct. 814, 28 L.Ed.2d 136 (1971); Kroger Co. v. Regional Airport Auth., 286 F.3d 382, 389 (6th Cir.2002) ("Under the arbitrary or capricious standard, the party challenging the agency's action must `show that the action had no rational basis or that it involved a clear and prejudicial violation of applicable statutes or regulations.'") (citation omitted).
An agency decision would normally be considered arbitrary and capricious if its decision was based on factors that Congress did not intend it to consider; if the agency entirely failed to consider an important aspect of the problem; or if the agency offered an explanation for its decision that ran counter to the evidence before the agency or was so implausible that it could not be ascribed to a difference in view or the product of agency expertise. Motor Vehicle Mfrs. Ass'n, 463 U.S. at 43, 103 S.Ct. 2856. A reviewing court, in an attempt to remedy any such deficiencies, should not supply a reason for the agency's action in which the agency itself did not give. Id. A court will "`uphold a decision of less than ideal clarity if the agency's path may reasonably be discerned.'" Id. (citation omitted); Kroger, 286 F.3d at 389 ("The arbitrary or capricious standard is the least demanding review of an administrative action. If there is any evidence to support the agency's decision, the agency's determination is not arbitrary or capricious."). "In reviewing agency action under the `arbitrary and capricious' standard, the court should focus its review on `the administrative record already in existence, not some new record made initially in the reviewing court.' Thus, the review should be `based on the full administrative record that was before the [agency] at the time [it] made [its] decision.'" Davidson v. U.S. Dept. of Energy, 838 F.2d 850, 855 (6th Cir.1988) (citations omitted) (emphasis removed).
The Supreme Court "has described the APA court/agency `substantial evidence' standard as requiring a court to ask whether a `reasonable mind might accept' a particular evidentiary record as `adequate to support a conclusion.'" Dickinson, 527 U.S. at 162, 119 S.Ct. 1816
"These two provisions of 5 U.S.C. § 706(2) are part of six which are `separate standards....' [T]hough an agency's finding may be supported by substantial evidence... it may nonetheless reflect arbitrary and capricious action." Bowman Transp., Inc. v. Arkansas-Best Freight Sys., Inc., 419 U.S. 281, 284, 95 S.Ct. 438, 42 L.Ed.2d 447 (1974) (citations and footnote omitted). In Association of Data Processing Service Organizations, Inc. v. Board of Governors, 745 F.2d 677 (D.C.Cir.1984), then Judge Scalia, writing for the Court, explained:
Id. at 683-84 (emphasis in original) (citations and footnote omitted).
III. CONCLUSIONS OF LAW
The regulations governing the making and servicing of B & I loans guaranteed by the RBCS are found at Part 4279, Subparts A and B, and Part 4287, Subpart B, of Title 7 of the Code of Federal Regulations. Section 4279.1(b) provides, "It is the responsibility of the lender to ascertain that all requirements for making, securing, servicing, and collecting the loan are complied with." The lender is responsible for servicing the entire loan, 7 C.F.R. § 4287.101(b), and "for taking all servicing actions that a prudent lender would perform in servicing its own portfolio of loans that are not guaranteed." 7 C.F.R. § 4287.107. Section 4279.30(a)(1) states that the lender's primary responsibility is the successful delivery of the B & I loan program. Any lender obtaining or requesting a B & I loan guarantee is responsible for, inter alia, processing applications for guaranteed loans, developing and maintaining adequately documented loan files, recommending only loan proposals that are eligible and financially feasible, obtaining valid evidence of debt and collateral in accordance with sound lending practices, distributing loan funds, servicing and liquidating guaranteed loans in a prudent manner, following Agency regulations, and obtaining Agency approvals or concurrence as required. Id. The lender is also responsible for conducting loan closings. Id., § 4279.30(d).
The lender is further primarily responsible for determining credit quality of the borrower, including adequacy of equity. New businesses are required to maintain a minimum of twenty percent (20%) tangible balance sheet equity at the time the Loan Note Guarantee is issued. 7 C.F.R. § 4279.131(d). Section 4279.161(b) (16) requires the lender to certify that "it has completed a comprehensive analysis of the proposal, the applicant is eligible, the loan is for authorized purposes, and there is reasonable assurance of repayment ability based on the borrower's history, projections and equity, and the collateral to be obtained." With respect to interim financing, § 4279.113(r)
The Conditional Commitment is the Agency's notice to the lender that the loan guarantee it has requested is approved subject to the completion of all conditions and requirements set forth by the Agency. Id., § 4279.2; 4279.173(a). The Loan Note Guarantee will not be issued until the lender certifies, inter alia, that no major changes have been made in the lender's loan conditions and requirements since the issuance of the Conditional Commitment, unless such changes have been approved by the Agency. Id., 4279.181(a). "The Loan Note Guarantee is unenforceable by the lender to the extent any loss is occasioned
Section 4279.72(a) provides in pertinent part:
Id. Negligent servicing is defined as:
Id., § 4279.2.
"It is well settled that `[a] government agency's regulations that have been published in the Code of Federal Regulations have the force and effect of law.'" First Tennessee Bank Nat. Ass'n v. Barreto, 268 F.3d 319, 329 (6th Cir.2001) (internal quotes and citations omitted). Moreover, the parties' incorporation of the regulations by reference in the guaranty agreement governs their relationship. Id. at 331.
The Secretary asserts that the issue here stems from PUB's uncritical acceptance of MMF's materially misleading original loan application and PUB's subsequent blind and reckless disbursement of loan proceeds. In the Secretary's view, PUB failed to make and service the loan as a prudent lender should. The Secretary contends that MMF's loan application showed that it had $497,629 in fixed assets, which it falsely claimed to own free and clear of all liens. In fact if PUB had conducted a routine Uniform Commercial Code-1 search, PUB would have discovered financial statements from March 11 and April 20, 1998, revealing two liens held by LTI on MMF's equipment in the amount of $335,000. The Secretary argues that PUB's failure to assure that the collateral was unencumbered was a material breach under the Conditional Commitment and the fact that a security interest in the equipment may have been obtained sometime after closing is inconsequential.
PUB certified that the B & I loan was to be used for the purchase of new equipment and to refinance $47,500 in debt. However, the Secretary asserts that MMP improperly used loan proceeds in excess of $710,000 to pay off the bridge loans used to purchase or lease the equipment from LTI, which was contrary to the stated purpose of the loan as presented to the USDA. In the Secretary's view the use of loan proceeds constituted a material breach of the loan application's terms; therefore, PUB did not substantially comply with its obligations under USDA regulations, which require that no adverse changes occur between the time the USDA issued the Conditional Commitment and the time it issued the Loan Note Guarantee
Lastly, the Secretary contends that it did not contest the guarantee as an obligation of the United States but instead it denied FTB's loan loss claim based on PUB'S negligent servicing of the loan. The Secretary contends that PUB was in a better position to prevent the loss and would have done so if it had not been negligent in performing its duties as a prudent lender. Further, the Secretary insists that PUB knowingly allowed MMF to use the loan proceeds for purposes other than those approved of in the loan application or Conditional Commitment. The Secretary argues that FTB, as successor in interest, assumed all of PUB'S original liabilities and is, thus, responsible for PUB's negligent servicing of the loan.
FTB's thirteen contentions set forth in its motion, see (Docket Entry No. 17) for judgment on the record at 2-5, are elaborated upon and condensed into ten headings of contention in its memorandum (Docket Entry No. 18) of law. The Court will address each contention in turn.
A. SUBSTANTIAL COMPLIANCE
FTB asserts that although the record shows that MMF used bridge or interim loans to acquire new equipment anticipated by the B & I loan, those bridge loans were subsequently satisfied out of the proceeds at the loan closing and PUB obtained the collateral intended and required by the USDA, including a first priority security interest on the new equipment acquired. Therefore, FTB contends that this constituted substantial compliance. In support of its contention, FTB relies on Eastern Illinois Trust & Savings Bank v. Sanders, 826 F.2d 615 (7th Cir. 1987).
In Sanders, the plaintiff sued the Small Business Administration for the SBA's refusal to honor its agreement to purchase from the plaintiff 90% of three SBA-guaranteed loans that had lapsed into default. 826 F.2d at 615. SBA regulations placed a cap on the interest rate that a participating bank could charge for a guaranteed loan, and the guaranty agreement, executed by the plaintiff bank and the SBA and incorporated in each of the four loans made to the plaintiff, prohibited the plaintiff from charging any fees or commissions in connection with the loan, unless it was paid for actual services rendered. Id. at 616. SBA regulations required that any fees or commissions accepted as payment for services rendered had to be disclosed to the SBA. Id. In each of the four loans, the plaintiff made a secondary loan to the borrower, which it did not disclose to the SBA and resulted in interest payments higher than those prescribed by the guaranty agreement. The issue in Sanders was, despite the fact that the side loans violated the terms of the guaranty agreement, whether the plaintiff's conduct in connection with the four loans constituted substantial compliance with SBA requirements so that the SBA was required to honor its guaranty obligations. Id. The Seventh Circuit affirmed the lower courts's finding that the lender did not materially breach the guaranty agreement.
This Court finds that the plaintiff's reliance on Sanders in support of its argument for substantial compliance is misplaced. In Sanders a specific provision of the regulations, 13 C.F.R. § 120.202-5, dealt with the SBA being able to refuse to
FTB previously presented the same argument regarding the issue of substantial compliance, and it was rejected by the Agency. In its Post Hearing Responsive Statement, the USDA cited Barreto, 268 F.3d 319, as being the most relevant to the case at bar. (Docket Entry No. 11, Certified transcript, Volume II at 905). In Barreto the plaintiff filed suit against the SBA to fulfill its obligation under the guaranty agreement to repurchase a defaulted loan. The Sixth Circuit specifically refused to follow Sanders finding that the SBA standard operating procedure at issue in that case was different from the one at issue before the Court in Barreto. 268 F.3d at 338; Volume II at 906. The Court found that the lender materially breached its loan guaranty agreement because the lender failed to act in a prudent manner by failing to review documents submitted by the borrower to obtain payment on a letter of credit. Also, upon learning from the borrower that the letter of credit had been dishonored, the lender relied solely on the borrower to obtain payment from the foreign bank issuing the letter instead of referring the matter to the lender's international banking department or taking any other steps to assist the borrower, even after payment on the letter of credit was denied a second time. Id. at 338-340. The Court held that the lender had the burden of making a threshold showing that it had serviced the guaranteed loan in a commercially reasonable manner and affirmed the finding that the lender was substantially negligent in servicing the loan so as to relieve the SBA of its obligation to repurchase the loan. Id. at 330, 336-40; Volume II at 906.
Here in FTB's appeal to the Deputy Director, he found the following:
(Docket Entry No. 11, Certified transcript, Volume II at 925).
In sum, FTB's position on substantial compliance is unsupported by the relevant statutes and regulations and case authority. The Court concludes that the USDA's decision on this issue is neither arbitrary nor capricious nor an abuse of discretion, or otherwise not in accordance with law or unsupported by substantial evidence. The Secretary's decision on this issue is within the USDA's statutory authority or limitations. Accordingly, this contention lacks merit.
B. IMPROPER BURDEN OF PROOF UNDER AUTHORITY CITED BY USDA
FTB contends that the USDA relied upon improper legal authority, which applied stricter standards and imposed a higher burden of proof under SBA regulations that are specifically distinguishable from USDA regulations and caselaw interpreting them. As a result, FTB asserts that the Secretary required proof of precise compliance by PUB with the Conditional Commitment rather than the "substantial compliance" standard. FTB contends that the USDA erroneously relied on Barreto to assert a greater burden of proof than that required by 7 C.F.R. § 11.8(e).
In Brunswick Bank, the lender sued for reimbursement under the terms of a guaranty given by the Farmers Home Administration. 707 F.2d at 1356. The FmHA refused to honor the guaranty because of the lender's negligence in servicing the loan. Id. at 1357. The Lender's Agreement provided that the obligation of guaranty
Despite allocating the burden of proof to the government, the Court found that the bank negligently serviced the loan. Id. at 1361. The Court noted that the loan servicing responsibility of the bank extended to all pre-default actions. Id. at 1362. Specifically, the bank failed to confirm that proper hazard insurance was obtained, the bank was negligent in monitoring the use of loan funds and the bank was negligent in overseeing the modernization of borrower's plant. Id. The Court concluded that the evidence clearly indicated that the bank disregarded many of its most basic servicing obligations. Id. at 1363.
Here, the Deputy Director found the plaintiff's argument on this issue to be conclusory and a summation of its earlier argument. Certified transcript (Docket Entry No. 11) Volume II at 932. He reiterated that PUB failed to comply with the B & I loan regulations that required it properly to make, secure, and service the loan, as it would reasonably do in servicing its own loan portfolio.
The Court finds the Agency's decision to be well taken for the reasons stated in the previous section dealing with substantial compliance.
C. USDA'S AWARENESS OF THE INTERIM LOANS & REFINANCING
FTB disputes the USDA's assertion that it was unaware of the refinancing of the interim loans before it issued its Loan Note Guarantee and that it would not have issued the loan had it known. FTB contends that the USDA representatives were timely advised of the interim refinancing on or about the date of the loan closing in June 1998, or otherwise fully informed within days after closing by delivery of the loan settlement statement showing the disbursement of funds. Further, the USDA had this information in its possession for over two months before issuing the loan Note Guarantee. FTB contends that because the USDA could have refused to execute the Loan Note Guarantee for failure to comply with conditions and requirements approved for the loan, the USDA cannot now assert that it would not have issued its Loan Guarantee "but for" its lack of knowledge of the refinancing. To support this contention, FTB relies on the testimony of Beavers to establish the USDA's policy of waiving the restriction against debt refinancing and to discredit Beasley's self-serving statements.
The Deputy Director did not find Beavers' testimony to refute clearly the USDA's statement that it would not have issued the loan had it had knowledge of the refinancing as presented by the plaintiff. Id. at 926. The Deputy Director stated:
The Court agrees with the reasoning articulated by the Deputy Director. The record does not support FTB's contention that the USDA definitively knew about the bridge loans prior to closing. The Conditional Commitment provided that only $47,500 of the funds from the B & I loan were to be used toward debt refinancing. PUB did not seek a waiver from RBCS. The lender has the ultimate responsibility to make sure that all the requirements with making, securing and servicing the loan are complied. 7 C.F.R, §§ 4279.1(b); 4279.30(a), (d); and 4279.181.
Accordingly, FTB's contention is without merit.
D. WAIVER AND ESTOPPEL
FTB next contends that the USDA was aware that funds were used to refinance the bridge loans, but failed to advise PUB of any problem with the loan closing and allow PUB to take action to satisfy the USDA. Moreover, FTB cites the USDA's lack of action such as refusing to issue or object to the Loan Note Guarantee. As a result, FTB asserts it was not on notice or otherwise advised of any contest or issues involving the validity or enforceability of the Loan Note Guarantee. Therefore, the USDA's actions or failure to act constitutes either waiver and/or estoppel.
The plaintiff cites to Colorado State Bank of Walsh v. United States, 18 Cl.Ct. 611, 632 (U.S. Claims Ct.1989) as providing the elements needed to estop the United States in an appropriate case from denying the existence of a contractual agreement. These elements are:
Id. FTB asserts that the USDA's position is that although it had information in its possession that indicated that verbatim compliance with the Conditional Commitment had not been achieved, it could issue the Loan Note Guarantee and allow the plaintiff to undertake collection of the loan. However, the USDA would then hold in reserve the defense that because PUB did not precisely comply with the requirements, the loan should not have been made and therefore it does not have to honor the Loan Note Guarantee.
The Deputy Director concluded that there was neither anything in the regulations nor did the plaintiff cite a specific regulation or law supporting its assertion that the RBCS failed to comply with its regulations. (Docket Entry No. 11, Certified
In reaching his conclusion that lenders are responsible for compliance with the applicable regulations, the Deputy Director relied on 7 C.F.R. §§ 4279.1(b) and -.30(a)(1), (d). Section 4279.1(b) provides that the lender has the responsibility to ascertain that all requirements for making, securing, servicing and collecting the loan. Section 4279.30(a)(1) states that the lender has the primary responsibility of the successful delivery of the B & I loan program, including processing applications for guaranteed loans, developing and maintaining adequately documented loan files, recommending only loan proposals that are eligible and financially feasible, obtaining valid evidence of debt and collateral in accordance with sound lending practices, distributing loan funds, servicing and liquidating guaranteed loans in a prudent manner, following Agency regulations, and obtaining Agency approvals or concurrence as required. According to § 4279.30(d), the lender is responsible for conducting loan closings.
The Deputy Director noted that there are specific regulations governing the conditions under which the RBCS will grant a waiver of regulatory requirements but that PUB did not avail itself of these regulations. For instance, § 4279.173(b) provides that "[i]f certain conditions of the conditional Commitment cannot be met, the lender and applicant may propose alternate conditions." Further, he stated that it was undisputed that PUB did not seek any type of waiver and that it is purely speculative for the plaintiff to assert what the RBCS would have done had it sought a waiver.
Lastly, the Deputy Director concluded that estoppel does not lie against the federal government where a federal employee engaged in some affirmative action upon which the plaintiff relied. See Office of Personnel Mgmt. v. Richmond, 496 U.S. 414, 419-24, 110 S.Ct. 2465, 110 L.Ed.2d 387 (1990) (recognizing that the Court's position has historically been for equitable estoppel not to lie against the federal government as it lies against private litigants and while not closing the possibility of applying it against the government under certain circumstances, the Court decided to "leave for another day whether an estoppel claim could ever succeed against the Government."); Federal Crop Ins. Corporation v. Merrill, 332 U.S. 380, 68 S.Ct. 1, 92 L.Ed. 10 (1947); see also Colorado State Bank of Walsh, 18 Cl.Ct. at 632 ("It is well established that estoppel cannot be applied against the Government on account of unauthorized statements or acts of an officer or employee who is without authority.").
The Court agrees with the above rationale. Accordingly, FTB's contentions on these issues are without merit.
E. USDA POSITION ON MMF'S EQUITY REQUIREMENT
FTB next asserts that the essence of the USDA's rationale for denying its loan loss claim was that MMF allegedly misrepresented its ownership of the existing equipment valued at $497,000 and that if MMF did not own that equipment, it could not have met the equity requirement. FTB contends that the USDA's calculation was erroneous and that MMF had met the equity requirement at all times. In FTB's view, despite the Deputy Director's vacating the 20% tangible balance sheet equity requirement as a basis
The Court disagrees. MMF misrepresented that it owned the equipment unencumbered and did not advise the RBCS of the interim financing in contravention of the agreement. As stated previously, FTB's contention that the RBCS would have waived any objection to the interim financing is mere conjecture. The responsibility lay in the lender's hands to protect itself by apprising the RBCS of the interim financing, thereby establishing a record on which it could rely for support. This, PUB failed to do. The Court concludes that the Deputy Director's decision is not shown to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; in excess of the USDA's statutory authority or limitations; or unsupported by substantial evidence. Accordingly, this claim fails.
F. NO MISREPRESENTATION OF OWNERSHIP OF ASSETS
FTB next contends that the USDA has consistently failed to recognize that MMF's transaction with LTI was not a true sale and lease of equipment, but rather was a secured transaction perfected by an UCC-1 financing statement. For this contention, FTB cites that (1) MMF owned equipment valued at $497,000 and unencumbered at the end of 1997 and as late as February 28, 1998, and although it entered into a transaction termed a "sale-leaseback" with LTI, the equipment never left MMF's possession; (2) MMF acquired new and additional equipment with the proceeds of this loan transaction; and (3) all such equipment was released when the loan was paid off out of the B & I loan closing. FTB contends that despite the use of the term "lease" in the transactions with LTI, these were, in reality, secured transactions whereby a security interest was granted in the equipment owned by MMF. According to FTB, MMF's assets were not depleted and the same assets became collateral for the B & I loan along with the additional new equipment MMF acquired with the money from LTI. FTB also contends that no loss was occasioned by this transaction, and even if it constituted a misrepresentation by MMF, it was not a material misrepresentation.
The Court disagrees with the plaintiff's assessment. Regardless of the terminology employed to describe the transaction between MMF and LTI, the Deputy Director made clear that part of the reason for denying FTB's claim was that MMF misrepresented that it held assets free and clear of any liens. Financial statements revealed that LTI held two liens on MMF's equipment in the amount of $335,000. Therefore, MMF did not have clear title to the fixed assets as represented in the agreement. Accordingly, the plaintiff's contention on this issue is without merit.
G. GUARANTEE INCONTESTABLE
In accordance with 7 U.S.C. § 1928(b), the Loan Note Guarantee provides that any USDA guaranty "is incontestable except for fraud or misrepresentation of which Lender or any Holder has actual knowledge at the time it became such Lender or Holder or which Lender or any Holder participates in or condones." (Docket Entry No. 11, Certified transcript,
H. NEGLIGENT SERVICING OR NEGLIGENT MISREPRESENTATION
Under the terms of the Loan Note Guarantee and 7 C.F.R. § 4279.72(a),
Certified transcript (Docket Entry No. 11) Volume I at 16. FTB contends that the term "negligent servicing" does not apply to the lender's alleged failure to discover the details of the transactions between LTI and MMF and the failure to report such information to the USDA.
To determine what constitutes "negligent servicing," FTB submits the Court should look first to 7 U.S.C. § 1981f for guidance. Section 1981f states that the Secretary "shall, to the extent practicable, use underwriting forms, standards, practices, and terminology similar to the forms, standards, practices, and terminology used by lenders in the private sector." FTB contends that in its common usage, "servicing" connotes action with regard to a loan after it has been closed and put on the lender's books. The plaintiff, however, has not adduced any authority to establish that the standard practice and usage of "servicing" is in regard to a loan after it has closed.
In support of its contention, FTB cites Brunswick Bank, 707 F.2d 1355, where the Court stated, "The loan servicing responsibility of the bank extended not only to debt liquidation, but also to all pre-default actions that were `necessary after loan closing to collect the indebtedness and to protect the security and security rights.'" Id. at 1362 (citation omitted). However, FTB's reliance on this one statement must be considered in context. In Brunswick Bank, the negligent actions of the bank directly resulted in the loss and occurred after the loan had closed. Therefore, the Court's statement was in reference to the time in which the negligence took place and not a general rule. Further, absent other evidence or legal authority to establish this common usage or understanding of this term, this Court cannot conclude that the Agency's actions were arbitrary, capricious, an abuse of discretion, and otherwise not in accordance with law, and is not supported by substantial evidence as the plaintiff submits. Accordingly, this claim is without merit.
I. NO MATERIAL BREACH OF THE GUARANTEE TERMS
FTB next contends that the guarantor cannot escape its loan guarantee obligation despite violations of the terms of the guaranteed loan documents by the lender, where the violations (including failure to advise the government of additional loans) did not constitute a material breach of the guarantee contract allowing nonperformance by the guarantor. In support the plaintiff relies on Sanders, 826 F.2d 615.
In Sanders it was undisputed that the lender violated the loan agreement when it charged side loans to borrowers, which enabled the lender to charge borrowers higher interest rates than the guaranty agreements permitted. However, the lower court found that this violation was not so material as to release the SBA from its obligation to honor the guaranties or so material as to require the lender to disgorge the guaranty funds it already received. Eastern Illinois Trust & Savings Bank v. Sanders, 631 F.Supp. 1393, 1395, 1398 (N.D.Ill.1986). In its decision, the district court noted that a contractual relationship between a government agency and a private party is qualitatively different than between two private parties. It stated:
Id. at 1395-96.
The court then articulated four factors which should be considered in determining whether a breach is material. They are:
Id. at 1396.
The court found that the side loans did not operate to defeat the bargained-for objective of the parties, which was providing capital to small businesses on reasonable terms, and the breach did not cause disproportionate prejudice to the SBA because the side loans neither diminished the initial flow of funds to the borrower, nor did they negatively impact the borrower's
Here, FTB asserts that the interim financing and transactions with LTI neither interfered with the objectives of providing B & I loans nor did it cause disproportionate financial prejudice to the USDA because PUB obtained all of the collateral that was required of it. The plaintiff further asserts that the interim financing was consistent with the USDA's practice and policy to waive the refinancing requirements and according to Ms. Beavers, the USDA's representative, that if the lender had a first priority security interest on the collateral the refinancing could not then be a basis for denial of the loss claim. Finally, the plaintiff asserts that if the interim financing is used as the basis to allow the USDA to deny the Loss Claim at this point, especially after the substitute lender has come in with no notice of any problems, it would result in the accrual of an unreasonable and unfair advantage to the USDA.
The Court disagrees. Although FTB asserts that the USDA did not experience any financial hardship, as noted by the district court in Sanders, a breach of trust is considered serious even if it is not characterized as financial, where the breach has the potential to impact negatively on the overall success of important governmental programs. See id. at 1395-96. Also, the result in Sanders is inapplicable to the facts in this case because in Sanders the SOP, which set forth the standards used by the SBA in determining whether to deny a loan guaranty, contemplated a substantial failure of compliance by the lender. Id. at 1396. FTB's claim regarding substantial compliance was previously discussed and discounted by this Court. Moreover, the particular clause in the guaranty agreement in Sanders did not provide for the possibility of denial unlike other clauses in the agreement.
Further, FTB's assertion that it was the USDA's practice and policy to waive refinancing requirements is not supported by the record. Moreover, FTB's characterization of Beavers as being "the USDA's representative" appears from the record to be exaggerated, and the record does not support that she had authority to bind or establish USDA policy. FTB's last assertion is irrelevant with respect to FTB being a substitute lender because as a substitute lender the new lender steps in place of the original lender's shoes and assumes all original loan requirements, including the original lender's liabilities and servicing responsibilities. 7 C.F.R. § 4287.135(a)(1)(iii).
Accordingly, the Court finds that the violations were a material breach of the loan guarantee.
J. EXTENT OF LOSS OCCASIONED BY ALLEGEDLY NEGLIGENT CONDUCT
The "Conditions of Guarantee" of the Loan Note Guarantee provides, in relevant
FTB cites the phrase, "to the extent any loss is occasioned by . . . negligent servicing," as limiting the USDA's ability to deny its loss claim to the amount the USDA can show was actually caused by the allegedly negligent conduct. FTB asserts that there is no proof that any loss in any amount was caused by the lender's conduct. According to FTB, neither the hearing officer nor the Deputy Director made any discernable findings on the extent of loss occasioned by negligent servicing except to conclude that all of the loss was occasioned by it because the USDA would not have made the loan "but for" the alleged negligent servicing.
The Deputy Director's decision does not directly address this specific contention made by the plaintiff; therefore, the Court will examine the hearing officer's ruling. The hearing officer stated, in part:
Id., Vol. II at 901. The hearing officer concluded:
Id. (emphasis in original).
FTB contends that if the financing costs of the interim loans caused a $65,000 loss, then that amount is the extent of loss occasioned by that conduct and the Loan Note Guarantee is unenforceable to that extent, and the Loan Note Guarantee remains enforceable as to the remainder of the loan loss claim. FTB further contends, without admitting such determination is correct, that even if the refinancing of the interim loans were an unauthorized use of loan funds, the proof shows that the loss could only have approximately amounted to $662,500 ($710,000 in refinanced interim loans less $47,500 authorized refinancing), while the loan loss claim was in excess of $1,000,000. Therefore, under the USDA's and the hearing officer's reasoning, FTB argues that $337,500 is owed on its claim.
The Court finds this argument persuasive. The hearing officer emphasized that "any losses" would be unenforceable where the loan funds are used for purposes not "specifically approved" by the USDA in its Conditional Commitment for Guarantee. Impliedly, any loss would be unenforceable as long as loan funds were used for purposes not specifically approved. However, that statement relates back to the sentence immediately preceding it, which states, "The Loan Note Guarantee will be unenforceable by the Lender to the extent any loss is occasioned by . . . negligent servicing . . . ." Thus, the lender cannot enforce the Loan Note Guarantee to the extent that such loss was caused by negligent servicing.
The hearing officer noted that MMF incurred approximately $65,000 in unexpected fees in the form of pre-payment penalties. The hearing officer opined that the pre-payment fees contributed to the downfall of the business. However, in reaching this conclusion the hearing officer neglected to take into account the fact that MMF was current on it payments until it lost its contracts with Chrysler and Breed Technologies and Ganton Industries made cutbacks from Magna Metal's Pulaski plant. From the record, more than the $65,000 in pre-payment fees contributed to MMF's downfall.
To be sure, MMF improperly used loan proceeds in excess of $710,000 to pay off the bridge loans used to purchase or lease the equipment from LTI, which was contrary to the stated purpose of the loan as presented to the USDA. PUB certified that the B & I loan was to be used for the purchase of new equipment and to refinance $47,500 in debt, and its failure to assure that the collateral was unencumbered and that loan proceeds went to its stated purpose instead of paying off bridge loans constituted negligent servicing. This breach was material. However, the question remains whether the entire loss was occasioned by the negligent servicing.
In his opinion, the Deputy Director stated:
(Docket Entry No. 11, Certified transcript, Volume II at 927).
Ultimately, PUB did in fact obtain a first priority security interest in the purchased equipment shortly after the closing of the loan, albeit not as contemplated by the terms of the Conditional Commitment. Moreover, Beasley stated that if interim loans were to have been used to purchase equipment, the USDA most likely would have approved them. Id., Vol. I at 158. If the use of the interim loans had been approved, MMF would have still lost its two biggest contracts and ostensibly filed for bankruptcy as a result. The hearing officer and Deputy Director appear to ignore these facts and instead place the entire amount of the loss on FTB because PUB and MMF did not abide by the specific terms of the agreement and that "but for" the negligent servicing by the lender the Agency allegedly would not have made the loan. By this reasoning, the Agency could deny the loss claim years later if MMF were to go bankrupt for whatever reasons. Accordingly, the Court finds that on this issue the Agency's decision to deny the entire loan loss claim is arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law; in excess of the USDA's statutory authority or limitations; and unsupported by substantial evidence.
The terms of the agreement and regulations stipulate that the loss must be caused by the negligent servicing. Based on the record, the financing costs of the interim loans caused a $65,000 loss. Further, the proof shows that $710,000 of the loan proceeds went towards unauthorized purposes, namely the interim loans. This amount is reduced by $47,500 because that amount was authorized to be used for refinancing. Therefore, the total amount attributable to the negligent servicing is $727,500. The loan loss claim filed by FTB was for $1,086,873.84. Accordingly, the Court shall award FTB $359,373.84 on its loan loss claim.
Based on the reasons stated above, the Court finds in favor of the Plaintiff, First Tennessee Bank National Association and shall award it $359,373.84 on its Loss Claim.
7 C.F.R. § 4279.101(b).
Id. at 18.