Wednesday, December 21, 2016

FYI: 4th Cir Rejects UDAP and Constructive Fraud Claims Against Bank on "Seller Holdback" Agreement

The U.S. Court of Appeals for the Fourth Circuit recently held that claims against a bank under North Carolina's Unfair and Deceptive Trade Practices Act ("UDTPA") were barred by the four-year statute of limitations, because the plaintiff was or should have been aware within the limitations period of all the information that led it to file suit.


The Court also held that relationship between the plaintiff and the bank was an ordinary contractual relationship, and not a fiduciary relationship that would give rise to the plaintiff's constructive fraud claims.


A copy of the opinion is available at:  Link to Opinion


This action arose from a "seller holdback" agreement between an investment corporation that was selling a vacant lot for home construction, and a bank that was financing the lot's purchase by a third party individual.


Under the 2008 "seller holdback" agreement, part of the purchase price owed to the corporation would be retained by the bank, pending completion of the home and subject to certain conditions. The corporation entered into the agreement after consulting with its attorney, its banker, and a real estate appraiser.


To secure payment of the holdback amount, the investment corporation also obtained a note signed by the third party buyer, along with a deed of trust on the same collateral property.


In 2010, the bank notified the third party buyer that the "seller holdback" loan had come due and that failure to make payments on the loan had put the loan into default. On March 30, 2012, the bank foreclosed on the collateral property.


Although the investment corporation's promissory note from the third party buyer was also secured by a deed of trust on the same collateral property, the corporation did not assert any security interest in connection with the bank's foreclosure.


Over four years after entering into the "seller holdback" agreement, the investment corporation sued the bank in state court, alleging that the bank fraudulently induced it to enter into the seller holdback agreement, in supposed violation of North Carolina's Unfair and Deceptive Trade Practices Act ("UDTPA"), and for claims under the common-law doctrine of constructive fraud. The bank removed the action to federal district court.


The trial court granted summary judgment to the bank, holding that the investment corporation's UDTPA claim was barred by the four-year statute of limitations. The district court also concluded that the investment corporation could not establish the necessary elements of a constructive fraud claim.


The investment corporation then appealed to the Fourth Circuit.


As you may recall, when a UDTPA claim is based on alleged fraudulent conduct, the limitations clock starts running when the fraud is discovered or should have been discovered with the exercise of reasonable diligence.


The investment corporation argued that it would be more appropriate to analogize its action to one for breach of contract, in which case the 4-year limitations period would begin to run at the time of the breach, asserting that the earliest date on which it could have discovered or been expected to discover the bank's alleged fraud was in 2009, within the four-year limitations period, when the individual received the certificate of compliance on his home.


The investment corporation contended that it was not until then, when the bank was required to make good on the "seller holdback" agreement by releasing the holdback to the corporation, that the corporation could have known that the bank did not intend to honor the agreement.


The Fourth Circuit disagreed, noting that the investment corporation made it clear that its claim was based on deceptive statements made by the bank in order to induce the corporation to enter into a sham seller holdback scheme.


Moreover, the Court noted that in 2009, the investment corporation had already announced that it planned to sue the bank on the same theory. In other words, the Court said, the investment corporation was already privy to the information that ultimately led it to file suit more than four years later.


The Court held that the investment corporation could not, therefore, claim that it lacked capacity and opportunity to discover that fraud until six months later.


Accordingly, the Fourth Circuit concluded that the limitations period on the investment corporation's UDTPA claim began running by in 2009, more than four years before it filed suit. The Court therefore agreed that, with respect to the UDTPA claim, the trial court properly granted summary judgment to the bank on statute of limitation grounds.


The Fourth Circuit next turned next to the investment corporation's constructive fraud claim, on which the trial court also granted summary judgment to the bank.


Under North Carolina law, the key to a constructive fraud claim is a fiduciary relationship between a plaintiff and a defendant, which gives rise to a special duty to act in good faith and with due regard to the interests of the one reposing confidence.


When such a fiduciary relationship exists a plaintiff need not bear the exacting burden of proving actual fraud, but may instead rely on a presumption of constructive fraud that arises under equity when the superior party obtains a possible benefit.


The bank argued that the investment corporation could not show such a relationship in this case, and the Fourth Circuit agreed.


Under North Carolina law, fiduciary relationships are characterized by confidence reposed on one side, and resulting domination and influence on the other.


Lawyers and their clients, for instance, or trustees and their beneficiaries, share such relationships, with a "heightened level of trust" matched with a corresponding duty to "maintain complete loyalty."


By contrast, parties to a contract like the seller holdback agreement between the bank and the investment corporation generally do not become each other's fiduciaries; what they owe each other is defined by the terms of their contracts, with no special duty of loyalty.


The Fourth Circuit, relying on Strickland v. Lawrence, 176 N.C. App. 656, 627 S.E.2d 301, 306 (N.C. Ct. App. 2006), held that as a matter of law, there can be no fiduciary relationship between parties in equal bargaining positions dealing at arm's length, although they are mutually interdependent businesses.


The Fourth Circuit held that that the relationship between the bank and the investment corporation was an ordinary contractual relationship, with nothing that could give rise to a special fiduciary relationship.  Because the existence of a fiduciary relationship is a necessary element of constructive fraud, the Court concluded that the trial court properly granted summary judgment to the bank on this claim.


Accordingly, the Fourth Circuit affirmed the trial court's summary judgment in favor of the bank.





Ralph T. Wutscher
Maurice Wutscher LLP
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