R. Geoff Layne Charles E. Johnson, Jr. v. Bank One, Kentucky, N.A. Banc One Securities CorporationR. Geoff Layne Charles E. Johnson, Jr. v. Bank One, Kentucky, N.A. Banc One Securities Corporation
Plaintiff-Appellant, Charles E. Johnson, Jr. (“Johnson”), appeals the district court’s grant of summary judgment in favor of Defendants-Appellees, Bank One, Kentucky, N.A. and Banc One Securities Corporation (collectively, “Bank One”). The district court found that under Kentucky law, Bank One was not liable for the depreciation in value of the shares it held as collateral for a loan to Johnson. Furthermore, the district court found that by selling the stock on a national stock exchange, Bank One acted in a commercially reasonable way in disposing of the collateral. On appeal, Johnson asserts that the district court erred in these findings, as well as by granting Bank One summary judgment on his breach of fiduciary duty and breach of contract claims. Johnson also arguеs that summary judgment is inappropriate with regards to Bank One’s counterclaims against him. We conclude that the district court did not err on any of these issues, and thus, the grant of summary judgment to the defendants is AFFIRMED.
I. BACKGROUND
This case arises out of two loan transactions made by Bank One to plaintiffs Johnson and Geoff Layne (“Layne”).
1
Johnson was the founder and CEO of Purchase-Pro.com, Inc. (“PurchasePro”); Layne served as the national marketing director of the company. Following a successful initial public offering, both Johnson and Layne had considerable net worth, though their PurchasePro shares were subject to securities laws restricting their sale.
2
To increase their liquidity, Johnson and Layne entered into separate loan agreements with Bank One for an apprоximately $2.8 million and $3.25 million line of credit respectively, secured by their shares of PurchasePro stock.
3
The loan agreements included a Loan-to-Value (“LTV”) ratio, which conditioned default on the market value of the collateral stock. The LTV ratio was calculated as the outstanding balance on the line of credit over the market value of the collateral stock. Specifically, Layne’s loan agreement had a 50% LTV ratio, which meant that the market
In February 2001, along with the rest of the Internet sector, the stock price of Pur-chasePro fell considerably, such that both loans exceeded their respective LTV ratios.
5
Rather than selling the collateral stock, Bank One entered into discussions with Johnson and Layne to pledge more collateral. The record reveals that Layne and Johnson repeatedly stated their intentions to pledge additional collateral to meet the LTV requirements. On March 6, 2001, Layne wrote that he had “been able to hold [Bank One] off from calling it in because of additional collateral that I have pledged.” J.A. at 355 (Email from Layne to Lichtenberger). On March 19, 2001, Johnson sent an email to Layne inquiring about whеther Bank One was “hanging in there.” J.A. at 517 (Email from Johnson to Layne). On March 22, 2001, Bank One sent a letter to Layne informing him that the loan was in default. J.A. at 362 (Letter from Holton to Layne). That same day, in a conversation with Bank One, Layne stated that “[you] guys have been great ... holding on for this long,” but he indicated he would like to begin selling some of the collateral stock. J.A. at 357 (Tr. of call between Layne and Thompson). After this conversation, Bank One began taking steps to liquidate the collateral stock for both loans. Later that same day, however, Johnson sent an email to Layne under the subject heading “Bank 1” which stated “they want to sell our shares and I want to stop it with additional collateral-pis call.” J.A. at 364 (Email from Johnson to Layne). Later that night, Layne sent an emаil to Burr Holton (“Holton”), Bank One’s loan officer, under the heading “[h]old off on selling” which stated that “[Johnson] is putting together a collateral package (real estate, additional shares, etc.) to secure the note at acceptable levels.” J.A. at 366 (Email from Layne to Holton). Early the next morning, Layne left a voicemail for Doug Thompson, Bank One’s senior trader, stating “[i]t’s a possibility that ... [Johnson]’s gonna put up
[Johnson] and myself are putting together a collateral package to secure our notes with Bank One. I DO NOT wish for the bank to proceed with any liquidation whatsoever of my PurchasePro stock at this time. I believe we have a strong company and that market conditions will improve, thus enabling the stock to recover to a price that allows me to pay my debt to Bank One in it’s [sic] entirety. And that is certainly in everybody’s best interest.
J.A. at 371 (Letter from Layne to Holton). The same day, Layne sent an email to Holton which stated “[Johnson] will be back this afternoon and we will firm the plan then. I would like to have time to discuss this [sic] him before we start liquidation.” J.A. at 369 (Email from Layne to Holton). The record reveals that Johnson and Bank One were involved in discussions in the end of April and May to pay down the balance or pledge additional collateral including his house in Las Vegas. At the end of May, the proposed deal fell through and Bank One sent letters to Johnson notifying him of his continued default on the loans. Throughout the entire time frоm February to May 2001, Layne and Johnson continued to make principal and interest payments under the terms of the agreement, but both loans significantly exceeded their respective LTV ratios. Bank One finally sold Johnson’s PurchasePro shares over four days in July, recovering $524,757.39 in net proceeds to pay down his debt, leaving approximately a $2.2 million unpaid balance. 6
Layne and Johnson separately filed suit against Bank One in the United States District Court for the Eastern District of Kentucky on a number of counts. On January 30, 2002, the cases were consolidated. Bank One filed counterclaims against Johnson and Layne, seeking payment for the deficiencies on the loans. On November 1, 2002, Bank One filed a motion for summary judgment on all counts as well as its counterclaims. On March 26, 2003, the district court granted Bank One’s motion. Johnson appeals from that ruling.
II. ANALYSIS
A. Standard of Review
We review “the grant of summary judgment de novo, viewing all evidence in the light most favorable to the nonmoving party.”
Boone v. Spurgess,
B. Duty to Preserve Collateral
We first consider Johnson’s argument that Bank One violated a duty under Kentucky law to preserve the value of the collateral held in its possession. With respect to the regulation of secured transactions, Kentucky has adopted the Uniform Commercial Code (“U.C.C.”), which states that “a secured рarty shall use reasonable care in the custody and preservation of collateral in the secured party’s possession. In the case of chattel paper or an instrument, reasonable care includes taking necessary steps to preserve rights against prior parties unless otherwise agreed.”
The comment to § 9-207 states that the provision “imposes a duty of care, similar to that imposed on a pledgee at common law, on a secured party in possession of collateral,” and cites to §§ 17-18 of the Restatement of Security. U.C.C. § 9-207 cmt. 2. Section 17 of the Restatement is essentially identical to the first sentence of § 9-207, and its accompanying explanatory comment states that “[t]he rule of reasonable care expressed in this Section is confined to the
physical care
of the chattel, whethеr an object such as a horse or piece of jewelry, or a negotiable instrument or document of title.” Restatement of Security^ 17 cmt. a (1941) (emphasis added). Section 18 of the Restatement mirrors the second sentence of § 9-207 and addresses “instruments representing claims, of the pledgor against third persons.” Restatement of Security § 18. Though it deals with negotiable instruments rather than equity investments, § 18 sheds light on the topic of preserving collateral value. Specifically, the explanatory comment accompanying the section states “[t]he pledgee is not liable
for a decline in the value
of pledged instruments, even if timely action could have prevented such decline.” Restatement of Security § 18 cmt. a (1941) (emphasis added). In the context of pledgеd stock, courts have used this language from the Restatement to hold that “a bank has no duty to its borrower to sell collateral stock of declining value.”
Capos v. Mid-Am. Nat’l Bank,
We agree with the reasoning of these courts and believe that the Kentucky Supreme Court would adopt a similar approach with regards to
Generally, the dual purpose of collateral is to secure financing for the borrower and hedge against credit risk for the lender. Where a lender extends credit solely on the basis of over-secured collateral, it is because of perceived heightened risk, and therefore over-collateralization provides the lender with more flexibility. In this case, Bank One agreed to loan Johnson $2.8 million dollars only if he pledged two- and-a-half times that value in PurchasePro stock, or $6.9 million. The underlying rationale was that unless the surplus value was included, the collateral may be insufficient at the time of any -default. The LTV ratio was to provide a cushion so that Bank One could either wait for the stock to rebound, restructure the loan, solicit additional collateral, or call the loan with enough time to sell the stock to recoup the value. If accepted, Johnson’s argument would bifurcate the collateral amount between the actual value of the loan and the surplus value, and impose a duty upon the lender to preserve the latter. Requiring preservation of the surplus value, however, leaves only the actual value of the loan to serve as collateral and wipes out any flexibility for the lender. Under Johnson’s theory, Bank One would have had only $2.8 million worth of stock as collateral for the $2.8 million loan and would have been required to preserve the remaining $4.1 million of surplus. On the first day the market value of the stock fell below the LTV requirement, Bank One-would have called the loan or risked liability under § 9-207. Imposing automatic liability for the decreased value of the surplus defeats the inherent purposе of requiring over-collateralization in the first place.
The two cases Johnson cites for support do not stand for the proposition that over-collateralization necessarily implies a duty of the lender to preserve, but rather suggest that the borrower does have a valid interest in the surplus value and therefore his wishes should not be ignored in over-collateralized situations.. In
Fidelity Bank & Trust Co. v. Production Metals Corp.,
In sum, we conclude that, under Kentucky law, a lender is not under any duty or obligation to sell collateral in its possession merely because the collateral is declining in value, regardless of whether the loan is over-collateralized.. Therefore, the district court’s grant of summary judgment on this issue is affirmed.
C. Commercially Reasonable Disposition
Johnson’s second argument raised on appeal is that Bank One violated Kentucky law by failing to dispose of the PurchasePro stock in a commercially reasonable manner. Following the U.C.C., Kentucky law requires that “[ejvery aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.”
[a]disposition of collateral is made in a commercially reasonable manner if the disposition is made:
(a) In the usual manner on any recognized market;
(b) At the price current in any recognized market at the time of disposition; or
(c) Otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition.
Applying the U.C.C. provisions to this case, the district court was correct to find that Bank One’s disposition of the PurehasePro shares through a sale on the NASDAQ national market was commercially reasonable. Johnson rеhashes his arguments about preserving collateral value to contend that delaying the sale of the pledged stock from February was commercially unreasonable. Appellant’s Br. at 45. Johnson’s argument, however, misinterprets the statute. Section 9-610 does not impose an obligation on a lender to liquidate and sell the collateral stock at a specific time during the life of the loan. Put another way, § 9-610 does not address
whether
a lender should dispose of its collateral, but rather once that decision has been made,
how
the disposition should occur. When Johnson’s loan fell below the LTV ratio, Bank One attempted to restructure the loan and secure additional collateral rather than sell the shares. Under the pledge agreement and Kentucky law, Bank One was not under any obligation to sell the stock at that point. In late May, after repeated negotiations with Johnson fell through, Bank One decided to begin the liquidation process, which was completed by July.
9
The sale of the stock
D. Breach of Fiduciary Duty
The third argument Johnson raises on appeal is that Bank One breached a fiduciary duty by failing to sell the PurchasePro stock when the LTV ratio exceeded 40%. Under Kentucky law, a fiduciary relationship is “founded on trust or confidence reposed by one person in the integrity and fidelity of another and which also necessarily involves an undertaking in which a duty is created in one person
to act primarily for another’s benefit
in matters connected with such undertaking.”
Steelvest, Inc. v. Scansteel Serv. Ctr., Inc.,
banks do not generally have fiduciary relationships with their debtors. This flows from the nature of the creditor-debtor relationship. As a matter of business, banks seek to maximize their earnings by charging interest rates or fees as high as the market will allow. Banks seek as much security for their loans as they can obtain. In contrast, debtors hope to pay the lowest pоssible interest rate and fee charges and give as little security as possible. Without a great deal more, a mere confidence that a bank will act fairly does not create a fiduciary relationship obligating the bank to act in the borrower’s interest ahead of its own interest. .
Id.
As one court noted, “it would be absurd to think that [a bank] could never take its own interests into account, or that [the borrowers’] interest had to be absolutely paramount at all times and in all situa
Applying these principles to this case, we conclude that Bank One did not breach a fiduciary duty owed to Johnson by failing to sell the collateral stock earlier. Johnson relies on language in the pledge asset agreement which authorized Bank One “as my agent and attorney in fact to buy, sell ... and trade” securities. J.A. at 399 (Pledge Asset Agmt.). The agreement also states that Bank One “as attorney in fact is authorized to act for me and in my behalf in the same manner and with the same force and effect as I might or could do.” J.A. at 399 (Pledge Asset Agmt.). Johnson contends that the effect of this language is to create a fiduciary relationship where Bank One must act in his best interests. In his deposition, Johnson stated that he believed the language created an automatic trigger whereby Bank One was obligated to sell the stock if the LTV ratio еxceeded 40% because he “did not want to get [his] personal opinion or feelings at the time involved.” J.A. at 566 (Johnson Dep.). Indeed, it appears from his deposition that Johnson viewed the agreement similar to a stop-order transaction, whereby the stock would be sold if it fell below a certain value.
While that might have been Johnson’s intention, the agreement did not reflect it. The language which Johnson cites in his brief does not create a fiduciary relationship, but rather merely authorizes Bank One to trade his stock. Nowhere in the agreement does it say that Bank One’s trading must be done in Johnson’s best interests. In fact, the commercial pledge and security agreement explicitly states otherwise — in the event of default, “Lender may exercise any one оr more of the [prescribed] rights and remedies.” J.A. at 353 (Comm. Pledge & Sec. Agmt.) (emphasis added). One of the prescribed remedies in the event of a default is “[s]ell the Collateral, at Lender’s discretion.” J.A. at 353 (Comm. Pledge & Sec. Agmt.) (emphasis added). “Lender shall not be obligated to make any sale of Collateral regardless of a notice of sale having been given.” J.A. at 353 (Comm. Pledge & Sec. Agmt.)(emphasis added). The language clearly sets forth that Bank One entered into the loan agreement with Johnson with the sole intention to act in the best interests of its shareholders. Pursuant to that intention, Bank One determined that it was better to add collateral and maintain the loan rather than call it in and sell the shares.
Because neither Kentucky law nor the contract created a fiduciary relationship between the parties, we affirm the district cоurt’s grant of summary judgment to Bank One on this issue.
E. Breach of Contract and the Implied Covenant of Good Faith
Johnson’s next argument on appeal is that Bank One is liable for breach of contract or for breach of the implied covenant of good faith. Rather than providing new arguments, Johnson restyles his earlier ones into contract claims. Specifically, he argues that because Bank One had a duty to preserve the value of the collateral and parties cannot contract away U.C.C. duties, Bank One is liable for a breach of contract. Appellant’s Br. at 58. Having concluded that U.C.C. § 9-207 does not impose such a duty on a secured party, we affirm the grant of summary judgment on the breach of contract claim.
Similarly, with regards to the breach of the implied covenant of good faith, John
F. Bank One’s Counterclaims
Finally, Johnson appeals the grant of summary judgment to Bank One on its counterclaim for the deficiency on the loan. Johnson failed to raise any arguments other than the ones dismissed above about why Bank One should not prevail on its collection claims. As the district court noted, Johnson has not “disputed [that he] knowingly and willingly executed the loan agreements in question or that he defaulted on the loans.” J.A. at 270 (Dist.Ct.Order). Accordingly, we affirm the grant of summary judgment on this issue as well.
III. CONCLUSION
In summary, we conclude that none of issues Johnson raises on appeal are compelling, and therefore we AFFIRM the grant of summary judgment in favor of Bank One.
Notes
. On March 29, 2004, Bаnk One and Layne entered into a settlement agreement of all of their claims. As a result, Layne agreed to voluntarily dismiss his appeal pursuant to
. Johnson and Layne were considered “affiliates” of PurchasePro as defined under SEC Rule 144 and therefore, their shares in the company were restricted.
.It is unclear from the record if other assets were offered or accepted to secure the loans. With regards to their PurchasePro shares, Layne pledged 482, 142 shares to secure his $3.25 million credit line, while Johnson pledged 410,000 shares for his $2.8 million credit linе.
. For example, if Johnson utilized the entire line of credit, approximately $2.8 million, the market value of his collateral stock would need to be approximately $6.9 million to comply with the required LTV ratio of 40%.
. Because the loans were over-collateralized, though the market value of the stock was below the required LTV level, it was still greater than the outstanding loan balances. Thus, Bank One could have sold the stock in February, recouped the value of the loans, and returned the surplus proceeds to Layne and Johnson.
. If the full $2.8 million credit line was used, the market price of the 410,000 shares would need to be approximately $16.89 in order to maintain an LTV ratio of 40%. In July, the shares were sold at an average price of $1.28 over the four-day period. The LTV ratio at the time the collateral was sold was approximately 530%.
. As noted by the district court, the few courts which have found differently involved cases in which the securities held as collateral were convertible debentures, and the secured party failed to covert them into stock.
Reed v. Cent. Nat’l Bank,
. Johnson argues that these options were not available to him in this case because he did not have other assets to substitute and was unable to sell the stock on his own because of his insider status. Appellant's Reply Br. at 13-14. Particularized facts of the borrower’s situation, however, are insufficient to alter the law and burden the lender with the responsibility of being an investment adviser. The fact that the borrower adopted a risky investment strategy does not transform the legal obligations of the lender unless explicitly specified in the contract. Moreover, the record does not support Johnson's contention that he could not avail himself of other options to preserve the value of his collateral. Johnson had other assets which he could have substituted for the collateral stock. In his deposition, Johnson stated that his house in Las Vegas was valued at around $5.0 million and was free of any mortgages and encumbrances. J.A. at 591-92 (Johnson Dep.). Discussions were held between Bank One and Johnson during the months of April and May specifically about using the Las Vegas house as additiоnal collateral. Furthermore, despite the fact that he was an insider, Johnson could have sold his restricted stock through a Rule 144 transaction so long as he ensured the sale was not a result of any material, nonpublic information.
. Johnson argues in the alternative that the delay from the time of the liquidation decision in May until July was commercially unreasonable because the stock value dropped during these months. This argument is similarly unpersuasive. As
. Johnson argues that the recognized-market exception cannot be per-se reasonable as to timing because it would allow a lender to delay potentially a sale for years, which would be an unreasonable result. Appellant's Br. at 45. We need not address the issue about whether a disposition of collateral on a recognized market is per-se reasonable, because the facts in this case reveal that Bank One sold the stock shortly after negotiations with Johnson broke down, after ensuring cоmpliance with the securities laws and taking into ■ account market volume.
See supra
note 9. Addressing Johnson's issue, however, in the situation where a loan has been called, the lender has an incentive to sell the collateral for the greatest value possible so as to pay off the outstanding debt. The situation where a lender would hold off on the sale of collateral until the price drops precipitously and thereby risk the ability to recover its loan would be rare. The comment to § 9-610 states, however, that where a secured party does not dispose of collateral and "there is no.good reason for not making a prompt disposition, the secured party may be determined not to have acted in a 'commerciаlly reasonable’ manner.” U.C.C. § 9-610 cmt. 3. Though the language seems at odds with § 9-627(a), the comment to that section states there is no inconsistency, but rather while a low price is insufficient of itself to prove commercial unreasonableness, in such a situation "a court should scrutinize carefully all aspects of a disposition to ensure that each aspect was commercially reasonable.” U.C.C. § 9-627 cmt. 2. Despite this language, courts have been reluctant to second-guess the timing of the disposition of collateral in most situations, even where the price has declined precipitously.
See, e.g., Air Atl. Inc.,