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The Mercado - Implied Covenant Claims - AZ Business Magazine September/October 2011

Implied Covenant Claims And How Wells Fargo Changed Them

In this article, Peter Moolenar, a partner at Dioguardi Flynn LLP, explains how Wells Fargo changed the way we look at implied covenant claims in Arizona law.

The Arizona Supreme Court’s opinion in Wells Fargo Bank v. Arizona Laborers, Teamsters and Cement Masons Local No. 395 Pension Trust Fund, 201 Ariz. 474 (2002), and its progeny have substantially impacted commercial litigation by expanding the implied covenant of good faith and fair dealing (“implied covenant”). In contrast to a written, agreed upon term, Arizona law implies this covenant in every contract.

However, rather than eviscerating parties’ right to negotiate and enter into contracts on express terms, as some naysayers originally prophesied, its largest impact may be more economic than substantive.

Implied covenant claims are exceedingly prevalent in commercial litigation. Indeed, they are present more often than not. Due to the expansion of the implied covenant in Wells Fargo and its progeny, these claims are less likely to be resolved by early motions — resulting in longer, and often more expensive litigation. Without question, this result has only fanned the popularity of these claims.

Wells Fargo arose from a Tri-party Agreement between the Mercado Developers (a partnership headed by Arizona’s former Governor, J. Fife Symington, III) (“Symington”), First Interstate Bank (Wells Fargo’s predecessor) (the “Bank”), and various union pension funds (the “Funds”). The Bank agreed to provide temporary construction financing if Symington was able to secure permanent financing from another lender. The Funds agreed to be that lender.

The Funds took out the Bank’s construction loan and Symington eventually defaulted on the permanent loan. The Funds ultimately claimed, among other things, that the Bank breached the implied covenant by failing to disclose Symington’s deteriorating financial condition to the Funds.

Although the Bank was not expressly required to make such disclosures to the Funds, the Supreme Court found that a jury might reasonably conclude that the Bank’s actions were inconsistent with the Funds’ “justified expectations” under the Tri-party Agreement.

As a result of Wells Fargo and its progeny, a party may breach the implied covenant without actually breaching an express term of the contract. Courts must make a factual determination whether a party acted in a manner inconsistent with the other party’s reasonable or justified expectations. However, these factual questions typically require the parties to undertake costly and time consuming discovery, and make it very challenging for either party to prevail on an implied covenant claim in the early stages of litigation. Therefore, the unintended consequence of the Wells Fargo decision is often longer, more costly litigation.

Arizona Business Magazine September-October 2011

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This Isn’t the First Crisis The Valley’s Banking Industry Has Faced

The Valley has come a long way over the past 25 years, and the banking and financial sector is no exception. Challenges, crises and legislation brought about dramatic change that has created a new era in banking and finance. In the mid-80s local banks dominated the sector, while regional and national banks were nonexistent. The Valley was home to the “big three” — Valley National, First Interstate Bank of Arizona and The Arizona Bank.

The financial sector was real estate driven, with a considerable concentration in housing and commercial real estate development. Second to real estate were the “Five C’s” of Arizona’s economy: climate, cotton, citrus, cattle and copper.

The savings and loan and real estate crises of the late-80s were the turning point in the Valley’s banking sector. At a time when Arizona’s “big three” were suffering, large banking corporations invaded. Bank of America’s first “real” presence in the Valley was assimilating five different savings and loans in the state.

In summary, there have been many milestones over the past 25 years that have shaped the banking sector. Such milestones include sustaining itself through the S&L crisis and the severe commercial real estate downturn of the late-80s; recovering from the infamous Lincoln Savings and American Continental debacle; weathering the “dot-com” implosion of 2000; and passing the Interstate Banking Act that led to dramatic industry consolidation of local banks into regional, national and global banking organizations. More recently, the securitization boom in both the residential and commercial real estate market revolutionized real estate lending.

Today’s “big three” — Chase, Wells Fargo and Bank of America — control the vast majority of deposits statewide and a much more dramatic concentration of banking resources overall. But more importantly, small and mid-size banks have reemerged. 
There is also now more proactive leadership in the business community.

Arizona and the Valley have a more diverse economic base due to the dramatic progress of our investment in education, as well as the high-tech, defense, life sciences, health care, biotech, telecom, optics, hospitality, entertainment and transportation industries. We now have an “alignment” of stakeholders, including the public, business, academic and philanthropic sectors, and therefore stronger initiatives for more diverse economic development, such as sustainable systems, solar and renewable energy and land management.

That said, in 2009 we are again faced with many economic challenges that will no doubt continue to shape our industry and affect how we operate. Banks need to grow wiser and smarter in serving their communities and Arizona’s businesses. We are resource constrained from a state revenue standpoint and by expenditures driven by our phenomenal population growth and federal-mandated programs. Arizona is a high-growth state and we need to strike the right balance between infrastructure “catch-up” and smart and balanced growth. The banking industry has and will continue to support a more knowledge-based and service-oriented economy.

What does the future hold for the banking and financial sector? Banks will need to play a transformational leadership role in public issues, specifically economic diversification and development, as well as public finance. The industry must become a recognized leader for innovative approaches to capital formation and connecting intellectual capital with financial capital.

We must also promote a diverse array of financial institutions from small local community banks and mid-size niche banks to larger regional and global institutions that promote cross-border trade finance and strategic alliances.

There is no doubt that the next 25 years will bring as many challenges and reforms as we have overcome in the past, but our state’s banks will regain their strength; the strong will survive, consolidate the weak and prosper with our state’s growth. And as Arizona’s banking industry continues to grow stronger and smarter, we foster confidence as we reaffirm the leadership role in Arizona’s economic foundation.