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FORCES DELAYING OR DERAILING FORECLOSURE

A Presentation to The American College of Real Estate Lawyers

April 25-28, 1991 Naples, Florida

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TABLE OF CONTENTS

Page

I. INTRODUCTION................................................................................................................... 1

II. GENERAL CHALLENGES TO PRIVATE FORECLOSURE ............................................. 1

A. Constitutionality of Private Trustee Sale -State Action? ................................................. 1

B. Military Service Obstacles ............................................................................................... 2

C. Federal Tax Liens............................................................................................................. 2

D. Custodia Legis - Mortgagor�s Death................................................................................ 3

E. Custodia Legis - Receivership.......................................................................................... 4

F. Bankruptcy ....................................................................................................................... 5

III. ATTACKING FORECLOSURE - BEFORE AND AFTER SALE ....................................... 5

IV. LENDER LIABILITY - INNOVATIVE APPROACHES TO OLD THEORIES ................. 7

A. Control by Lender - Lender Liability�s Cornerstone ....................................................... 9

FORCES DELAYING OR DERAILING FORECLOSURE Randall K. Howard*

I. INTRODUCTION

This paper will focus on myriad forces that delay or derail a foreclosure, with emphasis on trustee sales pursuant to a power of sale contained in a contractual mortgage or deed of trust. Given the breadth of this undertaking, an effort was made to touch many of the bases on this subject, while other contributors to this collective ACREL work have given a comprehensive treatment of specialized foreclosure related problems, such as receivership, bankruptcy, sale procedures and irregularities, junior lienholders, deeds-in-lieu, and subordination issues. Gratuitous tidbits and other well-intentioned suggestions covering private trustee sales in this paper are offered, fully appreciating that differences among state laws may render the offering of limited efficacy in some instances. The scope of this paper will cover some traditional stumbling blocks faced by lienholders and defenses thrown against private trustee sales, but any survey, of course, would be incomplete without a review of the innovative defenses arising from lender liability claims and recent federal environmental legislation and regulations with a focus on �control� issues.

II. GENERAL CHALLENGES TO PRIVATE FORECLOSURE

A. Constitutionality of Private Trustee Sale -State Action?

Those states suffering through the real estate downturn in the mid 1970�s generated significant decisional precedent as desperate borrowers with innovative counsel fought to stem the tide of foreclosures. As other parts of the country experience similar problems, similar arguments may arise.

In view of certain United States Supreme Court decisions knocking down state law remedies that authorized the sale or seizure of a debtor�s assets without prior notice and hearing,1/ do private foreclosure sales violate federal constitutional due process? Thus far, the attacks on state statutes governing trustee sales as being unconstitutional in violation of the Fourteenth Amendment (prohibiting the state from depriving any person of property without procedural due process) have been unsuccessful.2/ On deciding the threshold issue of state involvement, the federal and state courts have upheld various private trustee sale statutes on the basis that such sales do not constitute action that may be attributed to the state. Absent state action, the due process clause of the federal constitution does not apply. 3/

Such holdings recognize the contractual nature of private foreclosure sales where the state has merely restricted the contractual relationship between private parties by setting minimum procedural requirements for the exercise of the power of sale conferred in the deed of trust. The trustee is viewed as conducting the foreclosure sale under the power granted to the trustee by the deed of trust in a private transaction. The trustee is not deemed to be an agent of the state, which merely recognizes the legal effect of private arrangements. Any state involvement (such as county recordation) is deemed an insignificant ministerial act incident to the contractual relationship between private parties. While the United States Supreme Court is yet to directly address this issue, it seems unlikely that the highest court would reach a different

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result, particularly in those states that have amended their statutory restrictions in the mid 1970�s to shore up statutory personal notice requirements for private trustee sales. 4/

Therefore, the courts have held that insufficient state action exists to invoke the protection of the Fourteenth Amendment of the United States Constitution. The character of the state regulation is measured for constitutional purposes in determining if the state has in a meaningful way acted to deprive debtors of their property. It seems to matter little that the statutory regulation is comprehensive and detailed so long as the character of the regulation remains restrictive as opposed to promoting the sale.5/ A number of United States Circuit Courts uniformly have upheld private trustee sale statutes, although one United States District Court in North Carolina in 1975 found the foreclosure statute in violation of the Fourteenth Amendment due process due to the significant discretionary rights granted the government clerk and thus, sufficient state action to declare the statute unconstitutional. 6/

B. Military Service Obstacles

The Soldiers� and Sailors� Civil Relief Act of 19407/, while an ever present concern, is particularly topical in view of the War in the Persian Gulf. Chances have increased that your borrower might be protected by this statute, which could delay a scheduled foreclosure. If a debtor incurs an obligation prior to military service, a creditor is prohibited from conducting a trustee sale during such debtor�s period of military service or within three months thereafter, unless pursuant to a previously granted court order.8/ �Military service� is defined as federal service on �active duty� with the United States Army,9/, United States Navy, the Marine Corps, the Coast Guard and the Public Health Service.10/ A knowing violation of this act is a misdemeanor, punishable by imprisonment not to exceed one year or by a fine not to exceed $1,000.00, or both.11/ Additionally certain benefits are accorded such military personnel including a right to reduction of the interest rate to six percent. As to truth-in-lending disclosure, prudence dictates that upon military discharge and a return to the contract interest rate, a new disclosure statement be given to the debtor.12/

To avoid delays or other undesirable problems, if the lienholder cannot confirm the debtor�s military status, then it would be prudent to contact a location service for this informational.13/ An evidentiary certificate may be secured by a foreclosing lender from each of the respective military services, specifying the borrower�s service branch and the borrower�s compensation. Frequently, prior to resale or as otherwise needed, title companies will require the foreclosing creditor to execute an affidavit stating that the owner foreclosed upon is not in the military service. Common practice is to execute and record this affidavit immediately following the sale as individuals familiar with the borrower may not be available on the resale date.

C. Federal Tax Liens

A trustee sale frequently is postponed due to the existence of federal tax liens filed against the property to be foreclosed. Generally, a trustee sale pursuant to a prior recorded deed of trust will be subject to, and not affect, a federal tax lien which was filed at least thirty days prior to such sale unless notice, in accordance with appropriate regulations, is given to the Internal Revenue Service (�IRS�,) of such foreclosure sale.14/ Internal Revenue Code (�I.R.C,�) § 7425 requires in all foreclosure sales of property in which the United States has or claims a lien or a title derived from enforcement of a lien, that notice of such sales be given to the IRS

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Secretary of his delegate (usually the Chief of the Special Procedures Section) in writing, by registered or certified mail or by personal service, not less than twenty-five days prior to the sale. This twenty-five day notice is a requirement only if the notice of a federal lien or the claim to title by the United States was filed more than thirty days prior to the contemplated trustee sale.

Assuming appropriate notice was given pursuant to section 7425, the IRS retains the right to redeem the property for a period of 120 days following the trustee sale.15/. The redemption price is a sum equal to (i) the actual amount paid by the purchaser at such sale, (ii) the interest on the amount paid at six percent per annum from the date of such sale and (iii) certain necessary expenses.16/ In practice, a title company issuing a post-foreclosure policy will require that the returned postal receipt of the certified or registered mail together with a copy of the notice be furnished to the title company as a condition of policy issuance. Additionally, a title policy issued within 120 days of a foreclosure sale likely will contain an exception making the policy subject to the right of redemption of the United States. For this reason, contracts for resale of foreclosed property are closed infrequently within the redemption period.

The IRS Special Procedures Staff has the authority to negotiate for the removal of the federal tax lien even if the required notice of trustee sale is not timely or properly given.17/ This tax lien may be discharged prior to or following the trustee sale, upon terms negotiated with the IRS Special Procedures Staff.18/ For clarification, a senior and properly filed federal tax lien will not be affected by a junior lien foreclosure. Therefore, failure of the IRS to attempt redemption is of no consequence following a junior lien foreclosure since I.R.C. § 7425 does not apply and a federal tax lien is not extinguished or affected.19/

In practice, the foreclosing lienholder or its counsel may face a timing hiatus in trying to identify federal tax liens which may have been filed thirty days or more prior to the scheduled foreclosure date and providing the IRS Secretary with at least twenty-five days notice of such sale. In some jurisdictions, the title company records may not reflect the most current information on potential federal tax liens by the deadline for sending notice to the IRS. It is good practice to require the title company to provide you with a supplemental oral report with the most recent information their title plant can offer as close to the twenty-five day deadline for notice to the IRS. However, prior to foreclosure, smart practice dictates that you receive written confirmation from the title company as to federal tax liens or better yet, if available, a commitment which might later be converted to policy insurance protection. Should a federal tax lien be discovered after posting as a result of this timing hiatus, the trustee sale should either be rescheduled or if necessary, completed assuming you are successful in negotiations with the IRS for consent to discharge on acceptable terms. A further practice point is that all names or variations on the names of the debtors and owners should be properly searched and duly memorialized in correspondence with the title company.

D. Custodia Legis - Mortgagor’s Death

Whether the power of sale is suspended or revoked on death of the debtor/mortgagor likely will vary from state to state, making generalizations too difficult for our purposes. However, to provide some orientation of the issues you may face in delaying or derailing a foreclosure as a result of the debtor�s death, the following discussion covers a few jurisdictions with which this author has some familiarity.

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In some states, the determinative factor is whether the jurisdiction of the probate court is invoked. That is, if an intestate dependent administration of the debtor�s estate is pending or is opened within a fixed period of time after death, a foreclosure sale conducted without consent of the probate court may either be void or voidable.20/ If the trustee sale is conducted during the pendency of a dependent administration, the trustee sale sometimes is deemed void since the power of sale under the deed of trust is suspended as long as the dependent administration is pending.21/ The lienholder who assumes the risk of a sale during an unadministered estate (and later a dependent administration is initiated) may be liable to the estate administrator who seeks to recover its loss of use damages during the period the lienholder had possession following foreclosure.22/

Although perhaps prohibited from foreclosing the interest of a deceased spouse, there is authority in some community property states that the power of sale under the deed of trust may be exercised to foreclose against the community property interest of the surviving spouse in the property where the debt is joint and several.23/

As to independent administration of a deceased debtor�s estate, private trustee sales generally are effective to pass title.24/ Notice is given to the independent executor the same as would have been given to the debtor had he survived. Deficiencies, if permitted under state law, may be brought against the estate through the independent executor.25/ Conversion from independent to dependent administration typically should not negate the prior existence of a valid power of sale conferred under a deed of trust and should not invalidate the acts of the independent executor while the executor had independent control of the estate.26/ Removal of the personal representative of the estate of a decedent, either as executor or administrator thereof, generally deprives the personal representative of the authority to do anything further with respect to the administration of the estate.27/

Where the debtor does not own an interest in the mortgaged property at the time of death, generally the power of sale is unaffected by death of the debtor.28/

E. Custodia Legis - Receivership

The author�s experience is that debtors seldom resort to voluntary receivership as a means of combating foreclosure. Instead, the debtor prefers the continued possessory advantages afforded by a state court injunction or the bankruptcy automatic stay along with its debtor in possession status. However, divorce or insolvency proceedings, among others, may give rise to involuntary receivership.29/ Generally, the appointment of a receiver will suspend the power of sale under a deed of trust and preclude the foreclosure of property held in custody by that receiver until the sale is authorized by the court in which the receivership has been pending.30/ Similarly, in those jurisdictions enjoying expeditious trustee sales, the perception is that receivership is not often invoked by the lienholder instant to a foreclosure, excepting occasional special receiver appointments to trap collateral rents.31/

Some jurisdictions appear to permit appointment of the receiver pursuant to the contractual receivership clause which create a prima facie, but rebuttable evidentiary showing of entitlement to the appointment of a receiver.32/ For a full discussion of receivership particularly as relates to enforcement of assignment of rents issues, see the companion paper of Dennis B.

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Arnold in this collective ACREL work entitled, �Pre-Foreclosure Management of Real Property and Personal Property Collateral.�

F. Bankruptcy

The automatic stay afforded under section 362 of the Bankruptcy Code is an injunction that enters automatically upon the filing of a bankruptcy petition, whether voluntary or involuntary.33/ The automatic stay prohibits almost all actions against the debtor and property of the bankruptcy estate which is broadly defined under section 541(a) to include practically all property of any nature owned by the debtor before the bankruptcy petition was filed. The automatic stay for purposes of this presentation prohibits the sending of notices of default or demand, posting for foreclosure or conducting of the foreclosure sale if the borrower or owner of the property has sought protection under the Bankruptcy Code. Knowing violations of the automatic stay provision may expose the creditor to liability for actual or punitive damages.34/

Briefly, numerous forces delaying or derailing foreclosure emanate from bankruptcy considerations. Bidding and other strategies are often influenced by the fraudulent conveyance provisions of the Bankruptcy Code and the evolving guidelines for minimum bids at foreclosure sales stemming from the Fifth Circuit decision regarding fraudulent conveyances in Durrett v. Washington National Ins. Co. in 1980 and its progeny.35/ Post bankruptcy petition considerations likewise strongly influence foreclosure strategies. For example, popular today is a forced �take-back� liquidating plan of reorganization that crams down36/ an undersecured lienholder/creditor by requiring the lienholder to accept a deed in lieu of foreclosure and treating the deficiency in collateral value, as determined by the court, as a general unsecured claim.37/ The impact on any subsequent loan deficiency action against the borrower and/or any guarantors could be enormous. Similarly, insider guarantees, potentially imposing vicarious liability on a lienholder as a non-insider creditor, is a strong consideration today influencing the timing of forced trustee sales since the effect of such a holding could extend to a full one year the bankruptcy preference period applicable to creditors with recourse to insiders.38/

The duration and far reaches of the automatic stay and other relevant bankruptcy issues are comprehensively explored by the companion ACREL paper presented by Professor Ray Nimmer entitled, �Bankruptcy Impacts on the Foreclosure Process.�

III. ATTACKING FORECLOSURE - BEFORE AND AFTER SALE

Given the private contractual nature of a trustee sale which is merely procedurally restricted pursuant to the applicable state�s statute, typically judicial review of a posted or completed trustee sale will occur only if the debtor, or other interested party with standing, formally attacks the sale by initiating judicial proceedings. Usually, the debtor is well advised to initiate the attack before the sale is completed. Strategically, if the debtor is unsuccessful in obtaining injunctive relief before the sale, then the debtor has more flexibility with his alternatives, including bankruptcy with the advantage of its automatic stay, further work out negotiations, including potentially a deed in lieu or loan restructuring, or possibly, a right of reinstatement upon payment of the defaulted installment.

Further, if the debtor elects to defer the attack until after foreclosure, a third party good faith purchaser for value who either buys at the sale, or more likely, who subsequently buys from

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the foreclosing lienholder who bought the property at the trustee sale with its credit bid, may block the recovery of title to the foreclosed property.39/ However, the doctrine of good faith purchaser for value without notice may not apply to a purchaser at a void foreclosure sale.40/ From an evidentiary point of view, postponing the attack until following the sale may prove more difficult due to presumptions given various recitals contained in either the trustee�s deed or the deed of trust containing the power of sale.41/ In some jurisdictions, a subsequent purchaser from a purchaser at foreclosure sale may take good title even though the original purchaser at foreclosure sale had none to give.42/

Commonly, one of the debtor�s first weapons of choice to stop a foreclosure sale is to obtain a temporary restraining order (�TRO�) or a temporary injunction on the eve of the foreclosure sale. Differences in the two types of injunctive relief normally finds a TRO subject to being issued on an ex parte basis by the court and of short term duration pending notice and hearing on a temporary injunction. If the temporary injunction is issued, it continues typically for as long as the applicant�s cause of action is pending or until final judgment has been entered unless earlier modified or dissolved upon appropriate motion. Obviously, local law must be honored. Failure to honor the injunctive relief granted usually can subject the foreclosing lienholder to liability for contempt, punishable by fine or imprisonment.43/ Foreclosure sales conducted in violation of a TRO or injunction typically are void and pass no title.44/ The purpose of such injunctive relief is to preserve the status quo between the parties by stopping the foreclosure sale.45/ Generally, only the debtor/mortgagor, a party who is in privity with the debtor or other party who has a legal or equitable ownership interest in the property, may apply for injunctive relief.46/

Local procedural rules should be followed closely which customarily require sworn affidavits containing plain and intelligible statements of the grounds for such relief.47/ Further, before the injunctive relief is issued, the applicant customarily must execute and file a bond in a sum fixed by the courtt.48/ The amount of the bond is fertile ground for argument at the injunction hearing. Factors considered may include under or over collateralization of the loan, the interest to accrue from the date injunctive relief is issued, and the overall merits of the substantive grounds on which the injunctive relief is grounded.49/

Typically, the injunction applicant must show that an imminent harm will cause an irreparable injury and that no adequate remedy at law exists; however, the existence of a remedy at law customarily is not grounds for denial of injunctive relief unless the legal remedy is as practical and efficient for judicial fairness purposes as the equitable remedy.50/ This issue usually focuses on the uniqueness of the real property and its potential loss constituting an irreparable injury, where courts have reached different results. Is all land unique and therefore its loss pursuant to an impending foreclosure sale constitutes irreparable harm which would not be adequately compensated by money damages? Or must the unique characteristics of the property or loss to be suffered be explained and persuasive to the court? Courts vary on this position.51/

The debtor usually need only show a probable right and a probable injury, not that the debtor will in fact finally prevail in the ultimate litigation, in order to invoke the court�s discretionary power to grant relief in joining the foreclosure sale.52/ However, in some jurisdictions, the debtor�s cavalier approach to injunctive relief subsequently may result in

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liability for any loss in value of the collateral occurring during delays in foreclosure occasioned by injunction relief.53/ Affirmative acts by the debtor of bad faith waste and improperly delaying a foreclosure sale should not be protected by anti-deficiency laws, since such losses were not part of the original bargain envisioned by the purchase money seller according to one leading authority on California jurisprudence.54/

Thus, the debtor in those jurisdictions where injunctive relief is available should exercise caution in availing itself of such rights. The debtor and its counsel should give careful analysis to the grounds that may exist to restrain a sale, including an entire review of the loan relationship, history, loan structure, payments, nature of default, notices or lack thereof, waivers, loan document terms, applicable statutes and the procedure utilized by the trustee in the foreclosure process. As a result of this analysis, innovative counsel throughout most jurisdictions frequently have discovered substantial bases to challenge the foreclosure process as being wrongful and that it should be restrained.

The grounds for challenging the foreclosure are typically the same grounds for seeking to set aside a foreclosure sale. Again, local law likely will control. Generally, grounds for attacking foreclosure appear to be one of two classifications, being either substantive or procedural in nature. The substantive grounds focus on the lack of authority of the trustee to conduct the sale whereas the procedural grounds focus on a matured right to foreclose having been improperly exercised.55/

Some of the substantive grounds for attacking foreclosure sale can include payment in satisfaction of debt or non-existence of default in payment,56/ inequitable or unconscionable lienholder conduct,57/ property in custodia legis,58/ lien invalidity or release,59/ and other related and unrelated causes of action against lenders that may entitle the borrower to an offset against the debt, including usury,60/ breach of contract,61/ fraud62/, mutual and unilateral mistakes63/, default in payment caused by accident, mistake or inequitable conduct of the lienholder64/ and the numerous defenses addressed in the later discussion herein regarding lender liability.

Procedural grounds typically take the form of improper acceleration of debt,65/ improper appointment of a substitute trustee, and other irregularities or deficiencies in the foreclosure process.66/

As mentioned above, the same substantive and procedural grounds for enjoining the sale are considered in a party�s effort to set aside a sale. Generally, an inadequate sales price alone is insufficient ground for setting aside the trustee sale.67/ Some jurisdictions require evidence of an irregularity which, although slight, causes or contributes to cause the property to be sold for a grossly inadequate price.68/ Some require the grossly inadequate price to so shock the conscience as to raise a presumption of fraud.69/

IV. LENDER LIABILITY - INNOVATIVE APPROACHES TO OLD THEORIES

Headline grabbing judgments against lenders have thrust this topic to the forefront in the

minds of lenders and their counsel, many of whom, prior to the grandfather case of State Nat’l Bank of El Paso v. Farrah Manufacturing Co.,70/ had proceeded with unabashed confidence and in some instances arrogance in its collection efforts of a troubled credit. Most informed lenders

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and their counsel today have replaced their �hardball� approach in handling of troubled credits with a more reasoned, well planned and often conciliatory approach, for fear that harsh administrative and collection efforts could transform that problem loan into a nightmare and possibly a financially crippling judgment in favor of a borrower or other interest party.

Today, lenders not only face an ever increasing pressure - due to general economic conditions, but also must deal with the ever present spector of lender liability that could result in losses greater than the loan the lender seeks to recover. On the other hand, lenders suffering from paralysis by analysis due to the potential of lender liability exposure should take heart that some recent appellate decisions, particularly involving complex commercial transactions, have carefully analyzed the supporting facts with a dispassionate view and overturned large damage awards where those facts were insufficient to support the judgment.71/ These recent favorable lender cases, aberrations as they may be, and other decisions strongly suggest that at least the appellate courts are beginning to observe and rely more and more upon the formal written agreement between the parties and to apply conventional contract law in reaching their conclusions and distancing themselves from the emotion packed juries and their characteristicly large jury awards favoring borrowers. However, it would appear that the pendulent swing will never fully return to the once seemingly one-sided position of the lender, with the result being a more level playing field for both lender and borrower alike. Any time a borrower can take his case to the jury, the lender must proceed with extreme caution. Post-trial jury profiles and studies reflect that the average juror, particularly in financial depressed areas, believe there is a moral obligation to work reasonably with the borrower in bad times and that this moral obligation overrides the legal obligation to repay the loan.

An informed decision by the lender to foreclose a troubled credit must be preceded by thorough due diligence including credit file analysis, complete document audit and evaluation of all credit risks. Appropriate teams, including possibly a change of lending officers and counsel in many instances, together with select consultants and experts, including appraisers and environmental experts, should be assembled and orchestrated as efficiently as possible. Many of the lender liability theories that have been popularized today, some of which are discussed below, may not have met with such ringing success if met with an orchestrated and professional loan underwriting, documentation and administration, including the exercise of the remedy of foreclosure.

While all phases of a loan are fertile ground of exposure to the lender, this paper will focus on the issues and theories commonly encountered in a foreclosure context. Thus, the pre-loan phases involving loan commitments and oral commitments to lend, will receive little attention except to mention the legislative activity in many states to adopt amended statute of fraud provisions statutes aimed at reducing exposure to lender arising from Odal72/ agreements. Given recent trends, the duty of good faith and fair dealing has been given special treatment in the companion paper of Frank St. Clair presented in this collective ACREL work.

Theories of lender liability receiving expanded treatment in this paper include the various forms of control liability, including some federal statutes of particular concern to lenders, including environmental issues.

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The law of lender liability is somewhat confusing and not readily susceptible to categorization, particularly in its state of evolution. The term �lender liability� seems to encompass both the common law theories with its tort and contract based claims, on one hand, and on the other, statutory theories, including bankruptcy, RICO, environmental and Bank Tying Act type claims. Debtors are infamous for including every conceivable cause of action for lender liability as their imagination permits, only to have aggressive lender defense counsel promptly move to narrow the issues. Likely, a number of motivations prompt debtor�s counsel to be non-discriminatory in their pleadings, not the least of which is the confusing nature of such causes of action. You may find certain treatises very helpful. The treatise by Helen Davis Chaitman, �The Law of Lender Liability�, (WGNL 1990) has classified the myriad theories in an orderly manner, with an effort to reconcile confusing case law (herein called �Chaitman�). Similarly, another treatise, �Lender, Liability Law, Practice and Prevention,� by Gerald L. Blanchard (Callaghan & Co. 1990) takes a pragmatic and helpful look at lender liability.

You may also observe a common thread among many of the common law theories of lender liability cases. In many instances, the litigation out of which a borrower recovered substantial damages against its lender arose in retaliation to the lender�s action. The lender is well advised not to take precipitous action before completing its thorough due diligence and developing a strategy for handling threatened as well as unasserted potential claims. Typically, the author�s experience is that the borrower will not take the first strike and instead will make every effort toward a negotiated resolution in an effort to survive prior to �betting the farm� on a lender liability claim. Once the lender�s strategy has been developed, it should proceed with its active or passive approach depending upon the circumstances of each loan transaction.

A. Control by Lender - Lender Liability’s Cornerstone

One of the by-words in lender liability today is �control liability.� It is a cornerstone in so many of the lender liability causes of action, from equitable subordination to Superfund liability. Determining the elements which may transform an ordinary commercial loan into lender liability exposure is at best an art with no bright line test, is yet in an evolving stage, typically is fact-specific and therefore elusive of precise rule making. It is this uncertainty which gives most lenders cause to pause and in some instances, paralysis. As confusing and intimidating as some case results may be, this author believes lenders should not abandon prudent lending business practices in retreat and fear of control liability. Through a better understanding of the theories underlying control liability, you may find the task of advising the lender somewhat easier in maintaining the delicate balance between the legitimate interest of a lender in administering and collecting its debt, on one hand, and on the other, in avoiding or minimizing control liability exposure.

It seems axiomatic that generally foreclosures occur due to financial difficulties of the debtor. For this reason, loan administration, including work outs and restructurings, is fertile ground for generating a lender liability claim. Lenders face their most problematic situation when, in an undersecured position, the lender must make numerous decisions with respect to a debtor in or near a state of insolvency. How to deal with trade creditors, often so important to a continuing operation, and yet be cognizant of the impact on subordinated debenture holders? How to monitor the debtor without becoming involved in its day to day management? How tight should budget controls be? Should advances be conditioned on the debtor�s cessation of

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unprofitable business segments? Should the lender take a pledge on the debtor�s stock? More importantly, should the lender be insistence on a blanket lien around all debtor�s assets to shore up its collateral deficiencies? Should the debtor be encouraged to delay filing of bankruptcy by providing just enough cash flow to keep the debtor alive but clearly without the ability to make significant profits or the ability to move into new areas requiring venture capital? It is here that the lender�s desire to protect its collateral position conflict with the borrower�s right to manage its business for the benefit of itself and other creditors. In the course of advising the lender or analyzing claims for the benefit of the debtor, it should be borne in mind that typically it is the cumulative effect of all the lender activities that is typically measured in order to find liability.

The following will briefly review some of the theories and cases in which control liability has or could be found, forming the basis of a cause of action by the debtor and ancillary to which the debtor seeks leverage in delaying or derailing foreclosure.

1. Breach of Fiduciary Duty

Generally, a lender has no fiduciary to its debtor or to other creditors of the debtor.73/ Accordingly, the normal lender-borrower relationship, including the foreclosure pursuant to trustee sale, would not in and of itself result in liability to the lender.74/ This philosophical underpinning likely accounts for the proposition that lenders in making credit bids at foreclosures, absent other considerations, may make credit bids at the, trustee sale below fair market value in many states.75/

Special relationships can give rise to a fiduciary duty, such as between partners, between directors and shareholders of a corporation, or in an agency relationship between a principal and his agent, in which event significant obligations and burdens are placed upon the fiduciary to act in the best interest of the beneficiary.

When a lender steps over the line in the course of its monitoring and protecting its collateral into practices through which the lender controls the decision making process of its debtor and, �to some extent, a merger of identity�76/ has occurred, that lender may take on a fiduciary obligation to deal fairly with the debtor and its creditors.77/ This special relationship is very fact specific but should not arise based on a mere subjective trust in the lender. That is, it should not be sufficient that the debtor had enjoyed a good relationship with the lender, that the bank had led the debtor to believe the bank was fair and honest in its conduct toward the debtor and that he had come to trust and rely upon the bank and its officers as friends.78/ Lender should not be held accountable for providing financial advice, in the absence of a fiduciary duty arising as a result of the kind of excessive controls condemned by the courts.79/

Consider the extreme case of A. Gay Jenson Farms Co. v. Cargill, Inc., where a fiduciary relationship based on agency principles was imposed upon a showing of �de facto� control. The elements constituting de facto control included the creditor�s constant recommendations, its right of first refusal to the debtor�s product, its veto power over contracts and dividends, its right of entry to the debtor�s premises for audits, and its supervision of finances, salaries and inventories. However, distinguishing this case was the court�s finding of the lender�s primary motive in not making a profit as a lender, but rather to control the borrower as a source of grain product supply. Thus, liability was imposed where the lender had advanced loan proceeds instant to a business relationship with the borrower such that the lender became a principal with liability for

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the transactions entered into by its agent (borrower); in effect, the lender had exercised ownership control over the borrower.

Again, there is no bright line test to measure excessive control over a debtor. However, the following practices have been found by courts applying control theories to be indications of excessive control.

○ Direct involvement in daily management and operation of debtor�s

business. The lender should avoid directing the debtor�s business affairs

with respect to hiring or firing of employees, priority or payment of trade

debt, and other daily internal activities o f the debtor.80/

○ Ownership or voting power. The lender should avoid the practice of

requiring a corporate stock pledge to secure its loan due to the risk the

court will impose a fiduciary duty due to manipulation of the corporation�s

affairs by a shareholder for its own benefit and subordinate the claim of

that controlling shareholder to the claim of other creditors so

disadvantaged.81/ Pledge of voting power, standing alone, should be

insufficient to impose liability.82/ If a stock pledged is deemed absolutely

necessary, then prudent practice dictates that the pledge agreement provide

that the lender has no voting rights unless the loan is in default, and in

such event, to think twice before exercising such voting rights. Mere

ownership of the stock after foreclosure should not alone constitute

control, particularly where the stock is placed in escrow thereafter,83/ but

there are no assurances of this outcome.

○ Interference with management selection. Lenders should avoid threats,

coercion and duress with respect to selection of directors or managers of

its debtor. Interference with corporate governance by preventing the

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debtor�s board of directors from properly performing its duties can lead to

a finding of excessive control.84/ Similarly, care should be exercised in

use of management change clauses, although of legitimate concern

particularly in closely held companies where the underwriting of the loan

was based upon a key individual.85/

○ Possession of debtor�s assets. Taking physical possession should be

avoided by the lender except in the most extreme of circumstances.86/

Financial controls - the lender should avoid controlling the debtor�s

finances, particularly with regard to establishing priority of payment

among creditors.87/ However, lenders would be in breach of their duty to

the lender�s shareholders if the lender failed to properly monitor the debtor

in financial distress and condition further loan advances on the debtor

taking commercially reasonable action as is customary under the

circumstances. Conditioning further advances upon providing

supplemental collateral and upon the acceptance of the lender�s business

advice should not be interpreted as the dominion and control of a

borrower.88/

2. Equitable Subordination Doctrine

Other creditors take aim under the bankruptcy laws at a creditor who has committed fraud or other inequitable conduct resulting in harm to the other creditors or creating an unfair advantage to the offending creditor, with the result that the claim of the offending creditor may be subordinated to the claims of the other creditors on equitable grounds. This court imposed subordination of a creditor�s claim based on the creditor�s conduct is referred to as equitable subordination.89/ The thrust of this doctrine is to correct the results of inequitable or fraudulent conduct not otherwise voided by the expressed provisions of the Bankruptcy Code. Courts, however, have generally retained flexibility and avoided rigid rules in its application. Three specific criteria for applying the doctrine of equitable subordination are:

(i) The claimant must have committed fraud or other inequitable conducts;

059999.0000 HOUSTON 172416 v1 13

(ii) The claimant�s conduct must have resulted in harm to the other creditors or in an

unfair advantage to the claimant; and

(iii) �The subordination of the claim will not be contrary to the principles of

bankruptcy law.90/

Generally the application of the equitable subordination doctrine has been limited to the claims of management creditors, including officers, directors or shareholders of the debtor, who are fiduciaries of the debtor.91/ However, when the creditor is in excessive control of the debtor, the creditor is deemed to be a fiduciary and hence subject to the same standards of dealing required of the fiduciary. If that dominating creditor abuses its control for its own advantage or to the disadvantage of other creditors, such conduct may subject the creditor to equitable subordination of its claim. The instrumentality rule (based on breach of fiduciary duty) of non-bankruptcy fiduciary cases and the doctrine of equitable subordination hold parallel rationale in correcting misuse of control to the detriment of other creditors of the controlled entity and both are measured by the aggregation of conduct standard, where one act of control alone is usually insufficient to warrant imposition of the rule or doctrine. Possibly the instrumentality rule imposes a higher threshold for abusive conduct since damages and losses may exceed the size of the lender�s claim as opposed to equitable subordination wherein a lender is denied a right to share on a equal basis with other creditors in the debtor�s assets in bankruptcy. A classic example of the doctrine of equitable subordination may be found In the re Process-Manz Press, Inc.92/

There is authority for the proposition that if a lender follows its loan agreement as

originally written and speaks truthfully (even if painting the lender in an unbelievably bad light),

there should be no equitable subordination.93/ In the 1990 version of the Fifth Circuit’s opinion

of In re Clark Pipe94/, the court concluded in its revised opinion that the lender had taken action

consistent with the loan agreement in reducing the borrower�s advanced rate. The court

distinguished between unilateral remedies that a lender may properly enforce from inequitable

conduct such as the exercise of total control depriving borrower of power to make its own

decisions. The court deemed that restricting borrower funds under a borrowing base formula,

subject to reduction at discretion of the lender, to a level sufficient only to allow debtor to keep

its doors open and pay down the debt to the lender, with nothing remaining for other creditors,

did not rise to the level of unconscionable conduct necessary to justify application of the doctrine

of equitable subordination. it was strategically advantageous for the lender to keep the debtor

059999.0000 HOUSTON 172416 v1 14

alive, given the inferior lien priority of the lender on inventory. However, there was no

competent evidence that the lender had knowledge that its lien on inventory was inferior to the

vendors� (other creditors) purchase money lien. Further, the lender did not own stock in the

borrower, did not place any of its employees on the board of directors, did not tell the borrower

which creditors to pay, did not mislead creditors to get them to continue supplying debtor, and

did not coerce the debtor into signing additional security agreements after the business had

become insolvent, all of which were apparently noted by the court as control indicia. The court

noted that the lender had power to control but did not exercise total control over the borrower.

All of this in face of a loan officer�s unbelievable testimony.95 The precedent value of Clark

Pipe is subject to debate. Acquiring such discretionary rights to modify the borrowing base

formula during a workout phase of a financial troubled borrower may have altered the result in

this case. On the other hand, the case demonstrates the value of certain discretionary clauses

typically negotiated in lender documentation. There seems nothing wrong in benefitting from a

vendor�s failure to exercise its right of reclamation pursuant to its vendor�s lien. The reduced

advanced rate in a workout obviously improved the lender�s position at the expense of the other

creditors, but then it should not be the lender�s obligation to force a borrower into bankruptcy.

Equitable subordination also can apply in a circumstance in which the creditor has

defrauded another creditor into supplying goods or services to the debtor.96

Innovative approaches today encouraged under the Bankruptcy Code offer new

challenges to lenders where some attacks have focused not on the lender�s culpability or

misconduct but on theories akin to comparative negligence or liability sharing or deep pocket

theories. For example, In Re Virtual Network Services Corp.,97 a 1990 Seventh Circuit decision,

rejected the concept that inequitable or wrongful conduct is an essential element of equitable

059999.0000 HOUSTON 172416 v1 15

subordination under the new Bankruptcy Code, although agreeing with the IRS that the old

Bankruptcy Act did require inequitable conduct as an element of equitable subordination. Based

on a �fairness standard� and that the IRS� claim was for a penalty, the Seventh Circuit agreed

that the IRS penalty claim should be equitably subordinated to the general unsecured creditor

class even though the IRS had not engaged in any inequitable or wrongful conduct. The impact

of this case is not clear and may be limited to a penalty situation. No doubt innovative debtor

counsel will seek an extension of this premise based on �fairness�.

3. Environmental Liability - Control Under Fleet Factors

Once again, control activities of the lender is the topical issue in environmental liability.

Briefly, CERCLA98/ as amended by the Superfund Amendments and Reauthorization Act of

1986 (�SARA�), imposes strict liability for cleanup cost of sites contaminated by

environmentally hazardous substances on responsible parties. Some of the categories of

responsible parties include �owners and operators�, while other provisions appear to offer up a

safe harbor by excluding from the definition of owner or operator the person who, �without

participating in the management of a . . . facility, holds indicia ownership primarily to protect his

security interest in the . . .facility.�99/ If the lender falls within the secured-creditor exemption

from the definition of owner or operator, the lender is exempt from liability under CERCLA.

With respect to foreclosure liability, owner liability may extend to a lender who becomes

owner by foreclosure on the property on which the hazardous substances exist, as confirmed in

the landmark decision of United States v. Maryland Bank & Trust Co. in 1986.100/

Previously, in United States v. Mirabile in 1985101/ CERCLA�s strict liability had been

extended to a lender where it was �involved in the actual operation of the facility.� The Eleventh

Circuit in United States v. Fleet Factors Corp. (�Fleet Factors�)102/ and the Ninth Circuit in In re

Bergsoe Metal Corp. (�Bergsoe�)103/ have taken different approaches in construing the secured

059999.0000 HOUSTON 172416 v1 16

creditor exemption. Fleet Factors denied the exemption to secured lenders if the secured lender

controls or has the power to control the operations of the party disposing of waste. The Ninth

Circuit in Bergsoe would require �some actual management of the facility before a secured

lender will fall outside the exception.�

The Ninth Circuit in Bergsoe stated that the right to inspect the premises and the right to

re-enter and take possession upon foreclosure contained in its lease agreements did not constitute

active management and that the actions of the secured lenders, not the terms of the documents,

should be determinative of whether the secured lender had become an �operator� under

CERCLA.

The Eleventh Circuit in Fleet Factors found that the Mirabile court�s construction of the

statutory exemption was too permissive in exempting a secured lender who did not participate in

day to day management of the business of the debtor either before or after cessation of business

operation. While the Fleet Factor’s court would permit occasional and discrete monitoring of

the debtor�s business without fear of liability, its standard would deny exemption status to a

secured creditor who had, �by participating in the financial management of a facility to a degree

which indicates a capacity to influence the corporation�s treatment of hazardous waste.� The

court further noted that the secured lender need not become involved in the management

decisions regarding hazardous to be denied the exemption, instead stating:

Rather, a secured creditor will be liable if its involvement with the management of the facility is sufficiently broad to support the inference that it could affect hazardous waste disposal decisions if it so choose. The Eleventh Circuit held that Fleet Factors lost its secured creditor exemption status

when the debtor began terminating its business and Fleet Factors took control of shipping and

collections, office administration and disposition of fixtures and equipment. The lender had

059999.0000 HOUSTON 172416 v1 17

prohibited the debtor from selling certain chemicals to potential buyers and in the court�s

judgment that gave the secured lender the capacity to influence the borrower�s treatment of

hazardous waste.

One environmental authority104/ observed that potential lender liability may riot easily be

avoided under the stringent liability standard of Fleet Factors, stating:

A lender risks losing its secured-creditor statutory exemption because it could have exercised control over its borrower�s activities regarding hazardous waste treatment. At the same time, a lender that exercises control over its borrower�s activities regarding hazardous waste treatment also runs the risk of losing its secured creditor statutory exemption. More importantly, the decision in Fleet Factor’s raises substantial doubt that a lender can seize or foreclose on its lateral without incurring liability under CERCLA.105/

The Environmental Protection Agency (�EPA�) has promulgated a revised draft of its

proposed rule on lender liability for environmental cleanup costs, signaling a proposed change in

EPA enforcement policy. Tile proposed rule is intended to clarify the scope of CERCLA�s

secured creditor exemption from �owner or operator� liability where the lender holds indicia of

ownership in property for purposes of protecting their security interests. The draft rule appears

to reject Fleet Factors, which ruling was characterized as �dicta� and suggests the appropriate

standard for determining liability requires �actual participation in the management or operational

affairs by the holder of the security interest, and does not include the mere unexercised capacity

or ability to influence . . . operations.� Under the proposed rule, periodic monitoring or

inspections of secured property, loan refinancing and restructuring, financial advise and similar

activities will not necessarily void the exemption. A lengthy preamble of the draft rule describes

permissable, not a mandatory range of lender activities to include policing the loan, undertaking

a financial work out when the security interest is threatened and foreclosing, including

expeditiously liquidating the assets after foreclosure. Loan policing provisions allow lenders to

059999.0000 HOUSTON 172416 v1 18

monitor the borrower�s business, conduct on-site inspections, and require certified financial

information without imposing CERCLA liability due to lender control, provided the debtor

remains �substantially in possession and control of the operations.� The draft rule contains

provisions strongly encouraging (or even imposing a practical duty), of inspection of a facility,

something not expressly imposed by CERCLA.

Generally, while the proposed regulations appear headed in the right direction for lenders,

it is premature to gauge its real impact, particularly with respect to private actions for clean up

costs.

In any event, prior to foreclosure, lenders should assess the environmental risks

associated with its troubled loan through a careful document audit and credit file review

including notes, photographs and other information on the collateral helpful in assessing

potential environmental liability. Surveys and appraisals may reveal pertinent clues. Site

inspection is a must, but only after becoming intimately familiar with the nature of the

borrower�s operation and the character of the collateral. Environmental audits of various degrees

may be appropriate, depending upon the advice of your environmental expert team member.

4. Bank Tying Act - Control Related

By its very nature, control by a lender is an integral part of the Bank Tying Act (the

�Tying Act�)106/ which was enacted in 1970 to prohibit any competitive banking practices that

require bank customers to accept or provide some other service or produce or refrain from

dealing with other parties in order to obtain a bank (or thrift institution under similar provisions)

product or service that they desire.107/ Such lenders are prohibited from making agreements to

extend credit or to sell one product or service only on the condition that the customer also obtain

additional credit, or purchase a different product or service, or at least agree that he will not

purchase that product or service from any supplier. The policy underpinning appears to be

059999.0000 HOUSTON 172416 v1 19

regulation of holding companies in order to block the powerful banks from dominating smaller

banks.108/ The time bar limitations period is four years.109/

Mandatory treble damages110/ are recoverable by the injured person, including non-

banking customers,111/ in a suit filed in any district court of the United States112/ or in a state

court having concurrent jurisdiction.113/

Under the Tying Act, the burden of proof is on the plaintiff to show that the lending

practice in question was unusual in the lending industry. Further, the plaintiff must show an anti-

competitive tying arrangement. Finally, that practice must benefit the lender.114/ The focal issue

of the Tying Act is whether the lender improperly used its economic leverage to the borrower�s

disadvantage.

Creative approaches to resolving a troubled credit may cause the lender to step out of

bounds and into a Tying Act violation. Again, a complete loan review and documents audit is

appropriate prior to foreclosure, bearing in mind the issues confronting lenders under the Tying

Act.

5. Federal Securities Laws

Section 20 of the Securities Act of 1934115/ and Section 15 of the Securities Act of

1933116/ provide that controlling persons are jointly and severally liable for securities violations

committed by an issuer or other person which they control. SEC regulations. define �control� as

�the possession, direct or indirect, of the power to direct or cause the direction of the

management and policies of a person, which through ownership of voting securities, by contract,

or otherwise.117/ Such a determination is as with the other theories fact-specific. If a lender has

the power to control the actions of the defrauding party, and actively controls the daily

059999.0000 HOUSTON 172416 v1 20

management of its borrower, control liability can be imposed unless a lender can prove one of

the affirmative defenses as set forth under the applicable sections of the securities laws.118/

Numerous pitfalls bely lenders under the securities laws. Traditional lending practices

can expose a lender who is a participant, even collaterally, in a transaction involving a security.

A collateral defendant may be liable as a primary violator119/ if it makes a material

misrepresentation or omission in connection with its customer�s sale or purchase of a security.

The issue usually is whether the lender has a duty to disclose information120/. Among the factors

determinative of such duty to disclose are the benefit derived by the lender, lender�s awareness

of plaintiff�s reliance on the relationship in making an investment decision, and the lender�s

activity in initiating the transaction.121/

Here again, lenders should be concerned that the mere power to control may visit

liability. Despite ambiguity in the regulations, it is likely that plaintiffs must prove the lender

had actual control in, not merely the power to control, the daily affairs of a borrower.122/ In

Merge v. Baehler,123/ substantial involvement by the bank did not result in liability being

imposed. The Eighth Circuit found that the bank, as the primary lender for the debtor, could

foreclose on the debtor�s loans, owned 18% of the debtor�s voting stock, held a proxy on

controlling voting stock, influenced the management of a subsidiary and held a put option under

which the bank could exert power over the debtor�s capital stock policy. Additionally, the lender

caused the borrower to issue notes, sell receivables and loan money to the debtor�s subsidiary.

Further, the lender frequently attended meetings of the debtor and its subsidiary.

Notwithstanding the above, the Eighth Circuit found the lender did not actually control the

borrower, although these factors obviously tended to prove that the lender possessed the power

to control. The Eight Circuit requires a two-prong test of actual participation in the primary

059999.0000 HOUSTON 172416 v1 21

violation and possession of the power to control the specific activity upon which the primary

violation is predicated.124/

B. Other Lender Liability Theories.

In addition to the above control related theories of lender liability, numerous other

theories have been urged to impose lender liability, some of which have been mentioned during

the course of the discussion on control liability. The following is to mention but a few:

1. Negligent Loan Administration. The lender may be liable for negligent loan

administration if the lender takes on a set of responsibilities in connection with a loan and fails to

perform those responsibilities as a reasonably prudent lender would.125/

Where the lender makes a material misrepresentation of fact to third parties such as

contractors or suppliers liability can attach. For example, if the lender makes an overstatement

of the balance of the loan commitment and a contractor or supplier acts in reliance upon such

misrepresentation, the elements of an actional negligent misrepresentation. Careless

disbursement of funds under a loan agreement resulting in a deversion of the funds from other

suppliers and contractors could impose liability.126/

FOOTNOTES TO: FORCES DELAYING OR DERAILING FORECLOSURE

1/ See Sniadach v. Family Financial Corp., 395 U.S. 337 (1969) (state created ex parte

prejudgment garnishment]; Fuentes v. Shevin, 407 U.S. 67 (1972) [state remedies procedure for ex parte prejudgment replevin].

2/ Barrera v. Security Building & Investment Corporation, 519 F.2d 1166 (5th Cir. 1975) [Texas foreclosure statute]; Armenta v. Nussbaum, 519 S.W.2d 673 (Tex. Civ. App.--Corpus Christi 1975, writ ref�d n.r.e.); Fitzgerald v. Cleveland, 650 F.2d 360 (1st Cir. 1981) [Maine foreclosure statute]; Dieffenbach v. Attorney General of Vermont, 604 F.2d 187 (2nd Cir. 1979) [Vermont foreclosure statute]; Utah League of Insured Sav. Assoc. v. State of Utah, 555 F. Supp. 664 (D.C. Utah 1983) [Utah statute]; I.E. Assoc. v. Safeco Title Ins Co., 39 C 3rd 281 (1985) [California foreclosure statute]; Northrip v. Federal National Mortgage Association, 527 F.2d 23 (6th Cir. 1975) [Michigan foreclosure statute]; Daniel v. Ferguson, 839 F.2d 1124 (5th Cir. 1988) [Texas statute]; Charmicor, Inc. v. Deaner, 572 F.2d 694 (9th Cir. 1978) [Nevada foreclosure statute]; Bryant v.

059999.0000 HOUSTON 172416 v1 22

Jefferson Federal Savings and Loan Association, 509 F.2d 511 (Wash. D.C. Cir. 1974); Mildfelt v. Circuit Court of 7ackson County, Missouri, 827 F.2d 343 (8th Cir. 1987) [Missouri foreclosure statute, citing Barrerra v. Security Building, supra as authority); Earnest v. Lowentritt, 690 F.2d 1198 (5th Cir. 1982) [Louisiana foreclosure law]; but see Turner v. Blackburn, 389 F. Supp. 1250 (W.D.N.C. 1975) [North Carolina foreclosure statute -- see footnote 6 below].

3/ Id.

4/ E.g., in 1975 Texas amended its non-judicial foreclosure statute, Article 3810 [now codified as Texas Property Code § 51.002] as follows: �... In addition, the holder of the debt to which the power is related shall at least 21 days preceding the date of sale serve written notice of the proposed sale by certified mail on each debtor obligated to pay such debt according to the records of such holder. Service of such notice shall be completed upon deposit of the notice, enclosed in a postpaid wrapper, properly addressed to such debtor at the most recent address as shown by the records of the holder of the debt, in a post office or official depository under the care and custody of the United States Postal Service...�.

5/ Barrera v. Security Building & Investment Corporation, supra at note 2.

6/ Turner v. Blackburn, 389 F.Supp. 1250 (W.D.N.C. 1975) [North Carolina foreclosure law -- statute incorporated into all deeds of trust by operation of law and government clerk�s role under statute not merely ministerial but discretionary, including discretion to require the �increase� bid to be in cash and, in addition, impose a cash bond requirement in full amount of bid -- deemed to give clerk an important role as to the debtor�s equity and likened to a court of equity in judicial proceeding where clerk can create difficulties for debtor or third party to complete a resale depending upon exercise of discretion; after the Turner decision declared the North Carolina statute unconstitutional, the statutes were rewritten, presumably curing such issues. The Turner decision, however, may be of interest to debtor�s counsel in those states having significant discretionary involvement in their private trustee sales].

7/ 50 U.S.C. § 532 (1981).

8/ 50 U.S.C. § 532(3)(1981).

9/ Enlisted and officer personnel of Regular Army, Army Reserves on active duty and federalized National Guard Units.

10/ Applies only to officers.

11/ 50 U.S.C. § 532(4)(1981).

12/ Federal Truth-in-Lending Regulation § 226.20(a)(2) excludes a reduction in annual percentage rate with corresponding change in payment schedule from classification as a refinancing requiring redisclosure.

059999.0000 HOUSTON 172416 v1 23

13/ As an example, one source of such information on an individual in the Army is USA

Enlisted Records and Evaluation Center, Attention: World Wide Locators Service EREC, Fort Benjamin Harrison, Indiana 46249-5301; its current telephone number is (317) 542-4211. This service likely will have a telephone number for other service branches. The fee for the certified service is $3.50 per debtor by prepaid money order payable to the Treasury of the United States.

14/ I.R.C. § 7425 (1989).

15/ I.R.C. § 7425(d)(1989).

16/ Id. 28 U.S.C.A. § 2410(d)(1978).

17/ I.R.C. § 7425(c)(2).

18/ IRS Publication 783 gives instructions for application of a Certificate of Discharge of property from federal tax lien and outlines necessary information for the IRS� consideration of your requested discharge, including property description, method of taxpayer divestment of property interest, copy of IRS tax lien, prior encumbrances, cost of foreclosure, information regarding values of property, as well as any other information which might enable IRS to make a determination of lien discharge, all of which must be signed under penalty of perjury.

19/ Myers v. United States, 647 F.2d 591, 596 (5th Cir. 1981); Rodriguez v. Escambron Development Corp., 740 F. 2d 9299 ( 1st Cir. 1984) ; Garner v. IRS, 632 F. Supp. 390, 392 (S.D. Tex. 1986).

20/ Pearce v. Stokes, 155 Tex. 564, 291 S.W.2d 309 (1956) [trustee sale was revoked where dependent administration was initiated within a four year statutory period following death and administrator sought cancellation of sale].

21/ Pearce v. Stokes, supra; Riviera v. Morales, 733 S.W.2d 677 (Tex. App.--San Antonio 1987, writ ref�d n.r.e.).

22/ American Savings and Loan v. Jones, 482 S.W.2d 63 (Tex. Civ. App.--Houston [14th Dist.] 1972, writ ref�d n.r.e.).

23/ Albiar v. Arguello, 612 S.W.2d 219 (Tex. Civ. App. -- Eastland 1980, no writ).

24/ See supra, note 7.

25/ Fischer v. Britton, 125 Tex. 505, 83 S.W.2d 307 (1935).

26/ Taylor v. Williams, 108 S.W. 815 (Tex. 1908); Bozeman v. Folliott, 556 S.W.2d 608 (Tex. Civ. App.--Corpus Christi 1977, writ ref�d n.r.e.).

27/ Bozeman v. Folliott, supra.

059999.0000 HOUSTON 172416 v1 24

28/ Estrada v. Reed, 98 S.W.2d 1042 (Tex. Civ. App.--Amarillo 1936, writ ref�d).

29/ Clare v. Cline, 323 S.W.2d 276 (Tex. Civ. App. --Houston 1979, writ ref Id n.r.e. [divorce]; Scott v. Crawford, 41 S.W. 697 (Tex. Civ. App. 1897, writ ref�d) [insolvency].

30/ First S Properties, Inc. v. Vallone, 533 S.W.2d 339 (Tex. 1976).

31/ Adkins v. Edwards, 83 Va. 316, 2 S.E. 439 (1887) [mortgagee has right to appointment of receiver to hold the rents and apply to deficiency remaining after foreclosure sale]; Riverside Properties v. Teacher’s Insurance and Annuity Ass’n of America, 590 S.W.2d 736 (Tex. Civ. App. -- Houston (14th Dist.] 1979, no writ) [based on general equity provision of state receivership statute, coupled with contractual receivership clause]; Walker v. Community Bank, 10 C.3d 729, 111 CR 897 (1974); Mortgage Guaranty Company v. Sampsell, 51 C.2d 180, 124 P.2d 353 (1942) [one-action rule does not preclude the deed of trust beneficiary from recovery of rents held by a receiver to satisfy a deficiency resulting from a private trustee sale concluded prior to final judgment in the receivership proceeding since a trustee sale is not deemed an action and therefore no election of remedies]; In re Flower City Nursing Home, Inc., 38 Bankr. 642 (Bankr. N.Y. 1984) [request for appointment of receiver of mortgaged premises enough to vest right to rents in mortgagee, not actual appointment].

32/ Barclays Bank of California v. Superior Court, 69 Cal. App. 3d 593, 137 Cal. Rptr. 743 (1977); Riverside Properties v. Teacher�s Insurance and Annuity Ass�n of America, supra (contractual receivership provisions have evidentiary weight and were appropriately considered by the trial court, but such provisions are not binding on the court and were deemed one of the equities to be considered where the parties had entered into an unambiguous writing defining the consequences of a default).

33/ 11 U.S.C. § 362(a) (Bankruptcy Code).

34/ 11 U.S.C. § 362(h) (Bankruptcy Code).

35/ Durrett v. Washington National Ins. Co. , 621 F.2d 201 (5th Cir. 1980) [trustee sale that yielded 57.7% of the fair market value of the foreclosed property was set aside as a fraudulent transfer under section 67(d) of the former Bankruptcy Act in a bankruptcy proceeding initiated by the foreclosed debtor within one year after the trustee sale; in dicta the Fifth Circuit suggested that 70% of the fair market value would be a reasonably equivalent value for the foreclosed property. See Section 548(a)(2)(A) of the Bankruptcy Code.] Other circuits have addressed this issue, including In re Hulm, 738 F.2d 323 (8th Cir. 1984) [no safe harbor rule, but bankruptcy court requires hearing on issue of reasonably equivalent value); Butler v. Lomas & Nettleton Co., 862 F.2d 1015 (3rd Cir. 1989) [timing of transfer determinative]; In re Winshall Settlors Trust, 758 F.2d 1136 (6th Cir. 1985) [voidability of sale determined under state law]; Madrid v. Lawyers Title Insurance Corp., 725 F.2d 1197 (9th Cir. 1984) (court avoided issue holding lien perfection was relevant transfer for fraudulent transfer purposes, not foreclosure, but this circuit holding likely overruled by 1984 Bankruptcy Code amendments; however,

059999.0000 HOUSTON 172416 v1 25

Nevada lower court�s proposed standard (bid establishes conclusive presumption that reasonably equivalent value is the bid received at a non-collusive, regularly conducted private trustee sale) is not a settled issue as to substantive test]; In re Littleton, 888 F.2d 90 (11th Cir. 1989) [no detriment to bankruptcy estate since amount of junior liens exceeded equity of first lien and sale was upheld]; the United States Supreme Court has been urged to address this apparent conflict among circuit courts in Community Nat’l Bank v. Sherk with a petition filing date of December, 1990 under No. 90-1171 [Bankruptcy court, which was upheld through Fifth Circuit, ordered bank to pay difference between bid price and fair market value--bank�s 100% full credit bid was less than 50% of FMV for debtor�s home, failing to satisfy Durrett’s minimum 70% of FMV guidelines.]

36/ 11 U.S.C. § 1129(b)(1) (Bankruptcy Code).

37/ Sandy Ridge Development Corporation v. Louisiana National Bank, 881 F.2d 1346 (5th Cir. 1989), reh. den., 889 F.2d 663 (5th Cir. 1989) [Fifth Circuit stated that �common sense tells us that property is the indubitable equivalent of itself� and the bankruptcy courts have the power to set property values in the context of confirmation hearings determined in light of the purpose of the valuation and of the proposed disposition or use of the property. . .� Id. at 1350-1354. The court seemed curious as to the lienholder�s strategy in not filing motions to either lift stay to allow foreclosure or to abandon from the bankruptcy estate, which may have avoided any negative impact on deficiencies or perhaps avoided surviving junior liens as is typically the case with deeds in lieu of foreclosure; although these considerations perhaps were not significant under the instant facts of Sandy Ridge, such may become very important under other fact scenarios].

38/ Levit v. Ingersoll Rand Financial Corp., 874 F.2d 1186 (7th Cir. 1989) aff�d in part and rev�d. in part In re Deprizio Construction Co., Inc., 86 Bankr. 545 (N.D. Ill. 1988) [previously, no cases were discovered under the Bankruptcy Code holding a guarantee creditor liable for the indirect preference to a guarantor--previously, courts had reasoned that section 550 was not intended to expand substantive preference liability under 11 U.S.C. § 547 and in any event, such a result should be precluded on equitable grounds and therefore the bankruptcy trustee could not recover payments to a non-insider creditor beyond the 90-day preference period even if insider guarantees were held]. See In re Compton Corp., 831 F.2d 686 (5th Cir. 1987), modified on other grounds, 835 F.2d 584 (1988); 11 U.S.C. §§ 547(b)(1) and 550(a)(1)(1984). Bankruptcy Code legislative history recognized that a guarantor or surety of a claim against the debtor also will be a creditor, because be will hold a contingent claim against the debtor that will become fixed when he pays the creditor whose claim he has guaranteed or insured. H.R. Rep. No. 95-989, 95th Cong., 1st Sess. 309-10 (1977). Query whether a senior creditor may be exposed to a preference claim if payments to the senior creditor benefit an undersecured junior creditor by increasing the equity of the junior in the collateral under the theory of vicarious liability presented in Deprizio, supra. Tenth Circuit recently endorsed the Deprizio literal interpretation approach in Manufacturer’s Hanover Leasing Corp. v. Lowrey (In re Robinson Brothers Drilling, Inc.), 892 F.2d 850 (10th Cir. 1989).

059999.0000 HOUSTON 172416 v1 26

Generally, see L. Preble, Insider Guaranties and Real Estate Loans: Implications of Deprizio, paper presented to American College of Real Estate Lawyers (Oct. 20, 1990).

39/ See, e.g., Swindell v. Overton, 310 N.C. 707, 314 S.E.2d 512 (1984) [allowed a purchaser at the foreclosure sale to achieve bona fide purchaser status where such purchaser pays value, is unrelated to the mortgagee, has no knowledge of the defects, is not on reasonable notice from a recorded instrument, and the defects are not such that a person attending the sale exercising reasonable care would have been aware of the defect]; Strutt v. Ontario Savings and Loan Association, 11 C.A.3d 547, 90 C.R. 69 (1970); First Southern Properties, Inc. v. Valone, 533 S.W.2d 339 (Tex. 1976).

40/ See e.g., Henke v. First Southern Properties, Inc., 586 S.W.2d 617 (Tex. Civ. App.--Waco 1979, writ ref�d, n.r.e.) [note not in default and court reasoned, �. . . one who bids upon property at a foreclosure sale does so at his peril. If the trustee conducting the sale has no power or authority to offer the property for sale, or if there is other defect or irregularity which would render the foreclosure sale void, then the purchaser cannot acquire title to the property.� Henke, supra at 620.]

41/ Wolfe v. Lipsy, 163 C.A.3d 633, 209 C.R. 801 (1985) [prima facie evidence of facts alleged in a trustee�s deed]; Houston First American Savings v. Musick, 650 S.W.2d 764 (Tex. 1983) [recital in trustee�s deed of compliance with all conditions of deed of trust deemed prima facie but rebuttable evidence of their fulfillment]; Graham and Locke Investments, Inc. v. Madison, 295 S.W.2d 234 (Tex. Civ. App.-- Dallas 1956, writ ref�d n.r.e.) [rebuttable presumption raised that note has properly matured and notice of sale properly posted based on contractual stipulation in deed of trust that all prerequisites to the sale had been performed]; Utah Code Ann. 1953, 57-1-28 [statute providing that recitals of statutory compliance in trustee�s deed create prima facie evidence thereof]; see also Colo. Rev. Stat. 38-39-115; Ore. Rev. Stat. 86.780; So. Dak. Compiled Laws 21-48-23; Ariz. Rev. Stat. § 33-811 [mere execution and delivery of trustee�s deed even without presumption of validity clause recited therein raises presumption of compliance with procedures].

42/ Phillips v. Latham, 523 S.W.2d 19 (Tex. Civ. App.--Dallas 1975, writ ref�d n.r.e.) [good title is acquired not on the theory that good title actually passes by the trustee�s deed after foreclosure sale to the original purchaser, but rather by estoppel on the theory that the debtor/mortgagor, by executing the deed of trust, made it possible for the trustee to create the appearance of good title in the original purchaser at a trustee sale and it would be inequitable to permit the mortgagor to �show otherwise as against those who purchased in good faith and in reliance upon such appearance].

43/ See e.g., Tex. Gov�t. Code Ann. S 21.002 (Vernon 1988).

44/ See, e.g., Beardon v. Knight, 224 S.W.2d 273 (Tex. Civ. App.--San Antonio 1949) rev�d on other grounds, 228 S.W.2d (Tex. 1950).

059999.0000 HOUSTON 172416 v1 27

45/ State v. Southwestern Bell Telephone Co., 5 2 6 S.W.2d 526 (Tex. 1975) [status quo was

defined as the last, actual, peaceable, non-contested status that preceded the controversy].

46/ Goswani v. Metropolitan Savings and Loan, 751 S.W.2d 487 (Tex. 1988); Lincoln National Life Insurance Co. v. Freudenstein, 87 S.W.2d 810 (Tex. Civ. App.--San Antonio 1935, no writ) [creditors of debtor/mortgagor generally were not entitled to restrain sale of real property].

47/ Durrett v. Borger, 234 S.W.2d 898 (Tex. Civ. App.--Texarkana 1950, no writ).

48/ Goodwin, v. Goodwin, 456 S.W.2d 885 (Tex. 1970 [order granting injunction was void where trial court failed to fix amount of bond to be filed); Federal Automotive Service v. Lane Buick Co. , 204 C.A.2d 689 (1962).

49/ Franklin Savings Ass’n. v. Reese, 756 S.W.2d 14 (Tex. App.--Austin 1988, no writ) [injunctive bond of $10,000 held to be abuse of discretion where property valued between $25-50 million and unpaid interest accruing at rate of $300,000 a month); El Paso Development Co. v. Berryman, 729 S.W.2d 883 (Tex. App.--Corpus Christi 1987 , writ) [injunction bond of $15,000 held not to be an abuse of discretion where remaining value of property was for more than $7.4 million balance of note].

50/ Calvert Assoc. v. Harris, 469 F. Supp. 922 (D.C. Mich. 1979) [HUD as mortgage assignee not enjoined from sale since debtor would not be prejudiced if sale permitted due to surviving right of redemption]; Riverside Park Realty Co. v. F.D.I.C., 465 F. Supp. 305 (D.C. Tenn. 1978) [injunction denied against F.D.I.C. based on usury allegations since no injury was presented which equaled irreparable harm, as court could have ordered F.D.I.C. to place sales proceeds into court registry]; Irving Bank & Trust Co. v. Second Land Corp., 544 S.W.2d 684 (Tex. Civ. App.--Dallas 1976, writ ref�d n.r.e.).

51/ Greater Houston Bank v. Conte, 641 S.W.2d 407 (Tex. App.--Houston [14th Dist.] 1982, no writ) [every piece of real property is unique and therefore its loss is not adequately compensated by money damages]; but see Ginther-Davis Center v. Houston National Bank, 600 S.W.2d 856 (Tex. Civ. App.--Houston [lst Dist.] 1980, writ ref�d n.r.e.) [property held for investment and injunction denied due to debtor�s failure to allege and explain why real property was unique or to present any evidence that money damages would not be adequate to compensate for real property loss].

52/ Sara-NEC v. Slape, 546 S.W.2d 703 (Tex. Civ. App.--El Paso 1977, no writ).

53/ Surety Savings & Loan Ass�n v. National Automobile and Casualty Ins. Co., 8 C.A.3d 752 (1970).

54/ R. Bernhardt, California Mortgage & Deed of Trust Practice, 2rid Ed. (1990) S 6.37 at p. 315, citing Cornelison v. Kornbluth (1975) 15 C.3d 590, 125 C.R. 557 [a thorough and well written treatise on California mortgage and deed of trust practice].

059999.0000 HOUSTON 172416 v1 28

55/ See e.g. Burnett v. Manufacturers’ Hanover Trust, 593 S.W.2d 755 (Tex. Civ. App.--

Dallas 1979, no writ); also generally see, Howard, Foreclosures--Nonjudicial Style, Advanced Real Estate Law Course-Texas State Bar (May 1983) at p. P.61 [Texas cases appear to draw a distinction between void and voidable foreclosure sales, with the former involving unauthorized sales conducted without right that warrant a cause of action for wrongful foreclosure damages, trespass to try title and suits to set aside trustee�s sale, whereas voidable sales involve irregularities in the sale procedure and warrants only suits to set aside trustee�s deed without damages]; In re Smith, 99 Bankr. 724 (Bankr. W.D. Va. 1989) [improper acceleration of debt may render foreclosure sale void or voidable]; also generally see Bernhardt, supra at p. 291.

56/ Slaughter v. Qualls, 139 Tex. 340, 162 S.W.2d 671 (1942) [deed of trust authorized sale only upon default of debtor and until that event occurs, there is no authority for sale; if such limitations and conditions on the trustee�s power to convey are not fulfilled, such power never comes into being and any such sale and trustee�s deed thereafter are absolutely void]; Ford v. Emerich, 434 S.W.2d 527 (Tex. Civ. App.--Houston 1961, writ ref�d n.r.e.) [debt cancelled before foreclosure]; Diversified, Inc. v. Gibraltar Savings Ass’n, 762 S.W.2d 620 (Tex. Civ. App.--Houston [14th Dist.] 1988, no writ); also Salot v. Wershow, 157 C.A.2d 352, 320 P.2d 926 (1958).

57/ Winton v. Daves, 614 S.W.2d 464 (Tex. Civ. App.--Waco 1981, no writ) [lienholder�s purpose in accelerating debt and foreclosure was to coerce debtor to compromise an unrelated suit against same lienholder] ; Guenther-Davis Center, Ltd. v. Houston National Bank, 600 S.W.2d 856 (Tex. Civ. App.--Houston [lst Dist.] 1980, writ ref�d. n.r.e.] (injunctive relief preventing foreclosure sale may be appropriate where lienholder has interfered with proposed sale by debtor of property that would have paid mortgage indebtedness].

58/ See generally the probate, receivership and bankruptcy discussions contained in article II, supra and the discussion in this article regarding injunctions.

59/ See e.g., Schneider v. Sellers, 98 Tex. 380, 84 S.W.2d 417 (1905)[land had been released from deed of trust lien prior to trustee�s sale-- however, BFP rule enabled subsequent purchaser from foreclosure purchaser to retain title]; Ward v. Billips, 76 Tex. 466, 13 S.W. 308 (1890) [invalid lien on homestead].

60/ Irving Bank & Trust Co. v. Second Land Corp., 544 S.W.2d 684 (Tex. Civ. App.--Dallas 1976, writ ref�d n.r.e.); El Paso Development Co. v. Berryman, 729 S.W.2d 883 (Tex. App. -- Corpus Christi, 1987); In re Gleasman, 111 Bankr. 595 (Bankr. W.D. Tex. 1990).

But see S. Weiner, Selected Issues in Usury Law, Mortgages in Depth, 1991 sponsored by SMU Law School (herein �Weiner�) for proposition that FDIC, FSLIC and RTC, together with their assignee purchasers, are not subject to usury penalties based on estoppel doctrine in D�oench, Duhme & Co. v. FDIC, 315 U.S. 447 (1942) and 12 U.S.C. § 1823(e) (1988), and upon federal holder in due course doctrine of FDIC v. Wood, 758 F.2d 156 (6th Cir. 1985) and NCNB Texas Nat�l Bank v. Campise, 788 S.W.2d 115 (Tex.

059999.0000 HOUSTON 172416 v1 29

App.--Houston (14th Dist.] 1990, writ denied)(FDIC in bank purchase and assumption,transaction acquired note in good faith, for valtie and without actual knowledge of defenses, deemed holder in due course and likewise for its transferee, even though they would not otherwise have enjoyed such status under Texas UCC § 3.302 since notes acquired in bulk transaction not in regular course of business of transferor. Weiner, a recognized authority on usury, suggests, albeit admittedly without in-depth research, at p. A21 of his outline that the RTC/FDIC group and their assignees should not be entitled to collect, and a right of offset should exist in favor of the debtor in an amount equal to, the usurious portion of interest on a note usurious on its face, including related usury penalties. See Porras v. Petroplex Sav. Ass�n, 903 F.2d 379 (5th Cir. 1990) [facially valid note owned by FDIC assignee overcame usury defenses].

61/ Infra. - see discussion on lender liability.

62/ Infra. - see discussion on lender liability.

63/ Bank of Southwest National Association v. La Gasse, 321 S.W2d 101 (Tex. Civ. App.--Houston 1959, no writ); Persyn v. Ishihara, 608 S.W.2d 279 (Tex. Civ. App.--San Antonio, no writ) [injunction issued based on evidence of fraud or mistake in lienholder�s drafting of note to provide for monthly instead of annual payments].

64/ Hiller v. Prosper Tex, Inc., 437 S.W.2d 412 (Tex. Civ. App.--Houston flst Dist-] 1969, no writ) [lienholder failed to provide information regarding the amount of the substantial, excess proceeds in escrow account which lienholder directed be utilized in payment of monthly installment of principal and interest].

65/ In re Smith, 99 Bankr. 724 (Bankr. W.D. Va. 1989) [failure to give notice of debt acceleration as required by loan documents is grounds for declaring foreclosure sale void or voidable]; Vaughan v. Crown Plumbing & Sewer Service, Inc., 523 S.W.2d 72 (Tex. Civ. App.--Houston [lst Dist-] 1975, writ ref�d n.r.e.) [TRO upheld where debtor alleged waiver of optional right of acceleration by virtue of pattern of late payment acceptance on note].

66/ In re Foster, 108 Bankr. 361 (Bankr. M.D. Ga. 1989) [failure of notice or advertisement of sale to substantially meet legal requirements].

67/ Gottlieb v. McArdle, 580 F. Supp. 1523 (D.C. Mich. 1984); Savers Fed. Savings & Loan Ass’n v. Reetz, 888 F.2d 1497 (5th Cir. 1989)(Texas]; Musgrove v. Glasgow, 212 Va. 852, 188 S.E.2d 94 (1972)[sale properly conducted will not be voided simply due to inadequate price].

68/ American Sav. & Loan Ass’n v. Musick, 531 S.W.2d 581 (Tex. 1975) [Texas Supreme Court faced with evidence that appraised value of property foreclosed had $338,365 FKV on date of sale compared to underbidding price of $25,000.00, ruled that mere inadequacies of sales price did not void an otherwise valid foreclosure unless coupled with evidence of an irregularity which, although slight, causes or contributes to cause the property to be sold for a grossly inadequate price]; Gottlieb v. McArdle, 580 F. Supp.

059999.0000 HOUSTON 172416 v1 30

1523 (D.C. Mich. 1984); In re Foster, 108 Bankr. 361 (Bankr. M.D. Ga. 1989) [circumstances showing fraud, mistake, and the like, accompanied by inadequate price, are sufficient reasons to set aside foreclosure sale]; it should be noted that underbidding in Texas has been substantially discouraged as a result of Durrett v. Washington National, supra at n. ___ and may be further discouraged as a result of recent efforts to pass legislation modifying deficiency actions arising out of foreclosure sales to allow evidence of property value at time of sale as a credit against deficiency claims); Charter Nat’l Bank-Houston v. Stephens, 781 S.W.2d 368 (Tex. App.--Houston [14th Dist.] 1989, no writ) [Texas law does not require a showing of grossly inadequate selling price in situation where bidding was deliberately chilled by the affirmative act of lender (mislead prospective bidder) and injured borrower seeks a recovery of damages rather than setting aside foreclosure sale].

69/ See, e.g., Cromer v. DeJarnette, 188 Va. 680, 51 S.W.2d 201 (1949).

70/ 678 S.W.2d 661 (Tex. App.--El Paso 1984)(false threat of lender�s counsel to accelerate $22 million loan and bankrupt the company if Willie Farah was elected CEO, resulted in swingman voting in favor of candidate acceptable to lenders and jury awarded $18 million in damages for improper management].

71/ See, e.g. , Penthouse Int �I, Ltd. v. Dominion Fed. Sav. & Loan Ass�n, 665 F. Supp. 301 (S.D.N.Y. 1987), rev�d 855 F-2d 963 (2nd Cir. 1988) [non-jury trial resulted in judgment against lender at trial level in the amount of $137 million which was reversed on appeal arising out of loan commitment]; also see In re Clark Pipe & Supply Co., Inc., 893 F-2d 693 (5th Cir. 1990) [Fifth Circuit decision favoring lender who by design and pursuant to original loan terms granting lender discretion, reduced borrowing based formula to a level sufficient only to keep borrower�s doors open and pay down his debt to lender with no funds remaining available for other creditors--court deemed control by lender over financial affairs of debtor did not rise to level of unconscionable conduct to apply doctrine of equitable subordination].

72/ Numerous states have passed recent legislative amendments to their respective statute of frauds generally requiring a loan commitment to be in writing in an effort to combat the evolving lender liability exposure. See, e.g., Tex. Bus. & Comm. Code § 26.02 (effective September 1, 1989) (which is applicable if the loan amount exceeds $50,000 and proper notice has been provided in accordance with the statute; existing loans before the effective date are grandfathered and does not apply to renewal and extension of any grandfathered loan).

73/ In re W.T. Grant Co., 699 F.2d 599, 610 (2d Cir.), cert. denied, 464 U.S. 822 (1983); Thigpen v. Locke, 363 S.W.2d 247 (Tex. 1962); Greater Southwest Office Park, Ltd. v. Texas Commerce Bank N.A., 786 S.W.2d 386 (Tex. App.-- Houston [1st Dist-] 1990 [court rejected borrowers assertion that bank�s credit bid of $4.85 million at trustee sale for property with $10.5 million FMV was �unconscionably low� and followed usual Texas rule that inadequacy of consideration absent some irregularity in sale that caused or contributed in some slight way to the inadequacy is not grounds for setting aside

059999.0000 HOUSTON 172416 v1 31

trustee sale]; In re Teltronics Services, Inc., 29 Bankr. 139 (Bankr. E.D.N.Y. 1983); Weinberger v. Kendrick, 698 F.2d 61 (2d Cir. 1982); Farmer City State Bank v. Guingrich, 139 Ill. App. 3d 416, 487 N. E. 2d 758 (4th Dist. 1985) Also, Metge v. Baehler, 762 F.2d 621 (8th Cir. 1985).

74/ Id.; also see Krivo Industrial Supply Co. v. National Distillers & Chemical Corp. , 483 F-2d 1098 (5th Cir. 1973).

75/ But see, discussion on Durrett v. Washington Nat�l at note 35 and the discussion on grossly inadequate bid prices at note 67 and 68.

76/ In re Teltronics Services Inc., 29 Bankr. 139, 170 (Bankr. E.D.N.Y. 1983).

77/ In re American Lumber Co., 5 Bankr. 470 (Bankr. D. Minn. 1980); also, In re Teltronics Services Inc., supra; also, Greater Southwest Office Park, Ltd. v. Texas Commerce Bank N.A., 786 S.W.2d 386 (Tex. App.-- Houston [lst Dist.] 1990).

78/ Greater Southwest Office Park, Ltd. v. Texas Commerce Bank N.A., 786 S.W.2d 386 (Tex. App.-Houston [1st Dist.] 1990); but see Reid v. Key Bank of South Maine, 821 F.2d 9 (1st Cir. 1987).

79/ Mantooth v. Federal Land Bank of Louisville, 528 N.E.2d 1132 (Ind. App. 1988) [court rejected borrower allegations that lender was charged with duty of advising borrower on operation of its business and if advice rendered incorrectly, then lender should be liable for damages--court also found no evidence that such advice caused business failure as all major decisions were made by debtor].

80/ A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285 (Minn. 1981); In re American Lumber Co., 5 Bankr. 470 D. Minn. 1980); Credit Managers Ass�n v. Superior Court, 51 Cal. App. 3d 352, 124 Cal. 3rd 242 (1975).

81/ Pepper v. Litton, 308 U.S. 295 (1939); In re Beverages International, Ltd., 50 Bankr. 273 (Bankr. D. Mass. 1985).

82/ In re Matter of Process-Manz Press, Inc., 236 F. Supp. 333 (N. D. I11 - 1964) , rev�d on jurisdictional grounds 369 F.2d 513 (7th Cir. 1966).

83/ Valdes v. Leisure Resource Group, Inc., 810 F.2d 1345 (5th Cir. 1987); In re T.E. Mercer Trucking Co., 16 Bankr. 176 (Bankr. N.D. Tex. 1981) [control indicia of stock ownership present but lender did not directly use stock as a tool of control.]

84/ State National Bank v. Farah Manufacturing Co., 678 S.W.2d 661 (Tex. App. 1984) [ingenuine threat to bankrupt and padlock the company when an individual whom the lender opposed as management seemed close to becoming CEO caused swing man vote to reconsider and instead installed persons favored by lender, resulted in an aware of $18 million judgment against lender for fraud, duress and interference].

059999.0000 HOUSTON 172416 v1 32

85/ Camelot Ltd. v. Union Mutual Life Ins. Co., 154 Ariz. 330, 742 P.2d 831 (1987)

[management changed clause in deed of trust upon as proper event of default based on underwriting considerations at time of loan origination].

86/ In the Process-Manz Press, Inc., 236 F. Supp. 333 (N.D. Ill. 1964); Travis v. Schonwald, 131 S.W.2d 827 (Tex. App.--Galveston 1939, writ ref�d.) [lawful possession by lienholder imposes duty, as constructive trustee, to manage mortgaged property in reasonably prudent and careful manner].

87/ In re American Lumber, 5 Bankr. 470 (Bankr. Minn. 1980).

88/ In re W.T. Grant Co., 699 F.2d 599 (2d Cir.)[no problem with creditor using its bargaining position, including refusal to make further advances, to improve the status of its existing claims, excepting, of course, preferential transfers and fraudulent conveyances. Further, the court condoned (i) the lender�s veto over proposed sale of quick assets of the debtor, proceeds of which would have been used to redeem subordinated long-term debt thereby paying debenture holders prior to the lender in breach of subordination provisions, or (ii) delay of the debtor�s bankruptcy filing to allow limitation periods to pass as to preferences and fraudulent conveyances by virtue of keeping the borrower alive with minimal operating funds or (iii) taking inventory security agreements which resulted in substantial reductions in the extension of normal trade credit of borrower]; also see In re Clark Pipe & Supply Co., 893 F.2d 693 (5th Cir. 1990).

89/ 11 U.S.C. S 510(c); In re Mobile Steel Co., 563 F.2d 692 (5th Cir. 1977).

90/ In re Mobile Steel Co., 563 F.2d 692, 699-700 (5th Cir. 1977).

91/ Pepper v. Litton, 308 U.S. 295 (1939).

92/ In re Process--Man’s Press, Inc., 236 F. Supp. 333 (N.D. Ill. 1964) rev�d on jurisdiction grounds, 369 F.2d 513 (7th Cir. 1966) cert. denied; Limperis v. A. J. Armstrong Co., 386 U.S. 957 (1967) [Bankruptcy Court found Armstrong was not a secured creditor but in substance the owner of a debtor through its holding of over 90% of its stock and its control over all of debtor�s income; Armstrong opposed appointment of receiver immediately following filing of petition and boasted that it had control of 92% of the stock and could control the situation].

93/ In re Clark Pipe & Supply Co., Inc., 893 F.2d 693 (5th Cir. 1990).

94/ Id.

95/ Clark Pipe supra, at 1029. [�I just kept on trying to get out of the loan, you know. My attitude was bankruptcy is inevitable. . . I want to get the absolute amount of dollars as low as I can by hook or crook. And, you know, worry about preferences and all of that at a later date which, you know, I was aware there was a danger but I don�t know all of the legal ramifications.�]

059999.0000 HOUSTON 172416 v1 33

96/ In re Bowman Hardware & Electric Co., 67 F. 2d 792 (7th Cir. 1934) [creditor coerce

borrower to omit reference to offending creditor�s loan in the debtor�s books or issue financial statements, to induce another lender to extend credit to the debtor relying upon the debtor�s financial records, resulting in subordination of the offending creditor�s claim to that of the second lender, but not to all other unsecured creditors].

97/ In re Virtual Network Services Corp., 902 F.2d 1246 (7th Cir. 1990).

98/ Comprehensive Environmental Response Compensation and Liability Act of 1980, 42 U.S.C. S 9601 et seq. (CERCLA).

99/ 42 U.S.C. S 9601(20)(A).

100/ United States v. Maryland Bank & Trust Co., 632 F. Supp. 573 (D. Md. 1986).

101/ United States v. Mirabile, 15 E.L.R. (Envtl. L. Rep.) 20, 994 (E.D. Pa. 1985) [two or three lenders from a paint manufacturer were dismissed from the action on summary judgment, while the claims against a third were held sufficient to create a jury question of CERCLA liability, although characterized by the court as �slender� in an involvement; lender had allegedly insisted upon manufacturing changes, reassign of personnel and additional sales efforts; had required the borrower to accept the day to day supervision of another individual; monitored the cash collateral, insuring that the receivables went to proper accounts; had established a reporting system between the lender and borrower; had determined the priority in which orders would be filled; and had visited the site weekly].

102/ United States v. Fleet Factors Corp., 901 F.2d 1550 (11th Cir. 1990), cert. denied.

103/ In re Bergsoe Metal Corp., No. 89-35397, D.C. No. MC-90-132-RE (9th Cir. 1990).

104/ Joseph P. Forte, � An Update on Environmental Liability,� Newsletter of American College of Real Estate Lawyers, Vol. 9, No. 1 (December 1990).

105/ Forte at p. 6.

106/ (Tying Act) 12 U.S.C. S 1971 et seq. as to banking and 12 U.S.C. 1464(q) et seq. 8as to thrift institutions; see also, Bruce v. First Federal Sav. & Loan Ass�n at Conroe, 837 F.2d 712 (5th Cir. 1988).

107/ Lancianese v. Bank of Mount Hope, 783 F.2d 467 (4th Cir. 1986); Parsons Steel, Inc. v. First Alabama Bank, 679 F.2d 242 (llth Cir. 1982); Flintridge Station Assoc. v. Fletcher Mortgage Co., 761 F.2d 434 (7th Cir. 1985).

108/ Parsons Steel, supra at 244.

109/ Tying Act 1977.

059999.0000 HOUSTON 172416 v1 34

110/ Tying Act 1975.

111/ Campbell v. Wells Fargo Bank, 781 F.2d 440 (5th Cir. 1986) [non-banking customers have standing to sue for violations if injuries sustained are not too remote].

112/ Tying Act § 1975.

113/ Cuervo Resources Inc. v. Claydesta Nat�l Bank, 876 F.2d 436 (5th Cir. 1989).

114/ Rae v. Union Bank, 725 F.2d 478 (9th Cir. 1984); Parsons Steel, supra at 246; but see, JST Properties v. First National Bank of Glencoe, 701 F. Supp. 1443 (D. Minn. 1988) [inherent anti-competitive effect of tying arrangement relieves necessity of showing specific adverse effects on competition--where bank was alleged to have conditioned credit extension to plaintiff�s purchase of bank�s REO acquired through foreclosure]; also see Davis v. First National Bank of Westville, 868 F.2d 206 (7th Cir. 1988) [specific adverse anti-competitive practice must be shown]; Amerifirst Properties v. FDIC, 5th Cir. [unfunded loan commitments are included within the term �extend credit� under Tying Act and nonfunding of loan deemed irrelevant].

115/ 15 U.S.C. 781.

116/ 15 U.S.C. 770.

117/ 17 C.F.R. 230.405 (1986).

118/ See, e. g., G. A. Thompson & Co. , Inc. v. Patridge, 636 F-2d 945 (5th Cir. 1981); Technology Exchange Corp. v. Grant County State Bank, 646 F. Supp. 179 (D. Colo. 1986); Lanza v. Drexel & Co., 479 F.2d 1277 (2nd Cir. 1973)(en banc); Metge v. Baehler, 762 F.2d 621 (8th Cir. 1985) cert. denied 474 U.S. 1057 (1986).

119/ See Section 10(b) and Rule 10(b)-(5) of Securities Act.

120/ Gett v. Sunderman, 840 F-2d 1487 (9th Cir. 1988) [lender had no duty to disclose terms of loan to debtor and plaintiff purchaser who had acquired limited partnership interest).

121/ Id.

122/ In re Falstaff Brewing Corp. Anti-Trust Litig., 441 F. Supp. 62 (E.D. Mo. 1977); Stern v. American Bancshares Corp., 429 F. Supp. 818 (E.D. Wis. 1977).

123/ Supra at n ____.

124/ Id. at 631.

125/ Brunswick Bank & Trust Co. v. United States, 707 F.2d 1355 (5th Cir. 1983); Columbia Plaza Corp. v. Security National Bank, 676 F.2d 780 (D.C. Cir. 1982).

059999.0000 HOUSTON 172416 v1 35

126/ Grenada Ready-Mix Concrete, Inc. v. Watkins, 453 F.Supp. 1298 (N.D. Miss. 1978);

Peoples Bank and Trust Company v. L & T Developers, Inc., 434 So.2nd 699 (Miss. 1983); Brunswick Bank & Trust Co. v. United States, 707 F.2d 1355 (5th Cir. 1983); but see Tuscarora, Inc. v. BVA Credit Corp., 241 S.E.2d 778 (Va. 1978); Great Western Savings Bank v. Easely, 778 P.2d 569 (Alaska 1989) (letter from lender agreeing to direct payment to contractor established a direct contract with contractor, resulting in breach of contract and established torte of fraudulent misrepresentation supporting punitive damages).