Southern Financial Group LLC v. McFarland State Bank
Filing
Filed opinion of the court by Chief Judge Wood. AFFIRMED. Diane P. Wood, Chief Judge; Ann Claire Williams, Circuit Judge and David F. Hamilton, Circuit Judge. [6598276-1] [6598276] [13-3378]
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In the
United States Court of Appeals
For the Seventh Circuit
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No. 13‐3378
SOUTHERN FINANCIAL GROUP, LLC,
Plaintiff‐Appellant,
v.
MCFARLAND STATE BANK,
Defendant‐Appellee.
____________________
Appeal from the United States District Court for the
Eastern District of Wisconsin.
No. 12‐CV‐848 — Nancy Joseph, Magistrate Judge.
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ARGUED MARCH 31, 2014 — DECIDED AUGUST 15, 2014
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Before WOOD, Chief Judge, and WILLIAMS and HAMILTON,
Circuit Judges.
WOOD, Chief Judge. When sophisticated parties are able to
bargain, it is rarely unfair to hold them to their contract.
Southern Financial Group (SFG), a Texas firm specializing in
distressed‐asset investing, bought a loan portfolio from
McFarland State Bank (McFarland) at cents on the dollar.
Both parties were well represented during negotiations over
the sale. The Loan Sale Agreement provided limited reme‐
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dies in the event of a breach and disclaimed all other reme‐
dies. McFarland breached because one of its representations
about the status of the collateral was false. When notified
about the breach, McFarland disputed its liability. Months
later, SFG sued McFarland, seeking damages beyond the
limited remedies provided in the contract. Applying the con‐
tractual remedies limitation, whose formula resulted in zero
recovery under the circumstances, the district court granted
judgment for McFarland. We affirm.
I
McFarland acquired several assets formerly owned by
the Evergreen State Bank. Among those assets was a loan
portfolio with an unpaid balance of $4.42 million. Later,
McFarland put this loan portfolio up at auction. A sophisti‐
cated player in the distressed‐loan business, SFG was inter‐
ested in the portfolio. It accordingly consulted some back‐
ground materials that McFarland’s sales agent, Mission Cap‐
ital, put together about the portfolio. Those materials indi‐
cated that the portfolio was secured by 19 properties in Wis‐
consin, all real estate. SFG purchased the loan portfolio for
$1.27 million (28.8% of the face value of the debt). In the
agreement for the sale of the loans (somewhat confusingly
called the Loan Sale Agreement by the parties), McFarland
represented that “no material portion of the Collateral was
released from the lien … and no instrument of release, can‐
cellation or satisfaction was executed.” Loan Sale Agmt
§ 6.2(h). SFG was represented by counsel throughout negoti‐
ations leading to the purchase.
The Loan Sale Agreement limited available remedies in
the event of breach. First, it provided that “[n]either party
shall be liable to the other party for any consequential, spe‐
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cial or punitive damages.” Id. § 6.3. In the event of McFar‐
land’s breach of a non‐monetary obligation, the agreement
provided the following sole remedy:
If such breach or failure is not duly cured with‐
in [a] thirty (30) day period … then Seller
[McFarland] shall elect, in its sole discretion to
either (i) repurchase [the] Loan at the Repur‐
chase Price, or (ii) pay to Buyer [SFG] the Buy‐
er’s actual damages directly caused by such
breach, up to an amount not exceeding the Re‐
purchase Price. The remedies set forth in this
Section 6.3(b) shall be the exclusive remedies of
the Buyer for any breach by Seller of a Non‐
Monetary Representation or Warranty, and the
Buyer shall not be entitled to any other rights,
remedies or other relief, at law or in equity, for
Seller’s breach of a Non‐Monetary Representa‐
tion or Warranty set forth in this Agreement.
Id. § 6.3(b). The agreement defined the term “Repurchase
Price” to mean the purchase price, minus “all amounts …
collected by [SFG] in respect of the Loans,” minus any dimi‐
nution in value of the loans attributable to SFG’s fault, plus
any reasonable costs incurred by SFG in maintaining the
loans. Id., art. I, pp. 4–5.
Shortly after purchasing the portfolio, SFG learned that
three of the 19 collateral properties that supposedly secured
the loans had been released before the sale. SFG contacted
McFarland to notify it of this breach. After some corre‐
spondence, McFarland told SFG that, because it did not be‐
lieve it was liable for any breach, it would not elect a contrac‐
tual remedy. While the parties went back and forth discuss‐
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ing the alleged breach, SFG approved the sales of 13 of the
remaining 16 collateral properties, netting proceeds of $1.31
million, slightly more than the purchase price for the entire
portfolio. Three additional properties worth an estimated
$320,000 in total remained in the portfolio. Months later, SFG
filed this lawsuit, seeking damages totaling almost $387,000.
This figure represented SFG’s estimate of the profits it lost as
a result of not having the three additional collateral proper‐
ties in the portfolio.
The parties agreed to try the case before a magistrate
judge. See 28 U.S.C. § 636(c)(1). The court found, and McFar‐
land now accepts, that McFarland breached its contractual
representations. But that was where SFG’s success ended.
The court concluded that the limited remedies provided in
the contract were the sole remedies available for the breach.
Under the contract, the greatest recovery SFG could obtain
was the “Repurchase Price,” a defined term. Because SFG
already had obtained a gross return from the portfolio that
exceeded its purchase price, the formula provided in the
contract resulted in a Repurchase Price of less than zero. Ac‐
cordingly, the court determined that SFG was not entitled to
any (additional) remedy for the breach. The court rejected
SFG’s arguments that the limited remedy was unenforceable
or waived, or that it failed of its essential purpose. It there‐
fore granted summary judgment for McFarland. SFG ap‐
pealed the judgment to this court.
II
This is a straightforward case. The parties, represented
by counsel, agreed to limit the remedies available for breach
of their contract. Under the agreed limitations of this profit‐
able bargain, SFG is entitled to nothing. Moreover, the rem‐
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edies limitation does not fail of its essential purpose, assum‐
ing that this inquiry is even appropriate in a contract for the
sale of distressed loans. Finally, McFarland did not waive its
right to insist on the remedies limitation when it disputed its
liability for breach. We expand briefly on these points.
McFarland urges us to apply clear‐error review to the
court’s finding that the agreement entitles SFG to nothing
because SFG’s profits exceed the purchase price. That find‐
ing, however, was not a determination of disputed facts or
the characterization of undisputed facts. See Cent. States, Se.
& Sw. Areas Pension Fund v. Slotky, 956 F.2d 1369, 1373–74
(7th Cir. 1992). Instead, it was a question of contract interpre‐
tation based only on the text of the contract, and thus we
give it a fresh look. Bourke v. Dun & Bradstreet Corp., 159 F.3d
1032, 1036 (7th Cir. 1998). Similarly, we exercise de novo re‐
view over the question whether the limited remedy fails of
its essential purpose. Waukesha Foundry, Inc. v. Indus. Eng’g,
Inc., 91 F.3d 1002, 1006–07 (7th Cir. 1996). Our jurisdiction is
based on diversity. 28 U.S.C. § 1332(a). Wisconsin law, which
applies here, calls for us to interpret the contract in accord‐
ance with the parties’ agreement. Loan Sale Agmt § 10.9; see
also AM Int’l, Inc. v. Graphic Mgmt. Assocs., Inc., 44 F.3d 572,
576 (7th Cir. 1995).
Wisconsin permits the parties to agree to limit remedies
for breach of contract and to disclaim consequential damag‐
es, provided the limitations are not unconscionable. Murray
v. Holiday Rambler, Inc., 265 N.W.2d 513, 519–20 (Wis. 1978).
In the Loan Sale Agreement, the parties agreed to disclaim
all consequential, special, and punitive damages, and they
established exclusive remedies for breach of non‐monetary
obligations. SFG does not argue that the damages limitation
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in the contract is, on its face, unenforceable or unconsciona‐
ble under Wisconsin law.
The agreement provided three options for McFarland in
the event of a non‐monetary breach: (1) cure the breach; (2)
reverse the transaction by paying the “Repurchase Price,” as
defined in the contract, in exchange for SFG’s return of the
loan portfolio; or (3) pay actual damages not to exceed the
Repurchase Price. McFarland had “sole discretion” in elect‐
ing the remedy. The largest recovery SFG could hope to re‐
ceive was the Repurchase Price because, even if McFarland
elected to pay damages, those damages could not exceed the
Repurchase Price. That term was defined as the purchase
price, less amounts SFG had “collected in respect of the
loans” (minus losses attributable to SFG, plus SFG’s mainte‐
nance costs, but those amounts do not affect the outcome
here).
The breach at issue in this case was McFarland’s inaccu‐
rate representation that none of the collateral purportedly
securing the loan had been released. In fact, three pieces of
collateral property already had been released at the time of
sale. This was a non‐monetary breach of the contract that en‐
titled SFG to one of the contractual remedies, at McFarland’s
election. But by the time the case reached the judgment
stage, SFG had received through approved sales of collateral
more money “in respect of the loans” than it paid to pur‐
chase the entire portfolio. Thus, applying the contractually
agreed formula, the Repurchase Price was less than zero.
Therefore, if the contractual remedies limitation is enforcea‐
ble, SFG is not entitled to any recovery for McFarland’s
breach.
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We see no reason to reject the parties’ allocation of risk,
even if this means that SFG will be uncompensated for
McFarland’s breach. Wisconsin courts enforce agreements in
which parties allocate risk in advance. See Brooks v. Hayes,
395 N.W.2d 167, 175 (Wis. 1986). SFG is a sophisticated, re‐
peat player in the distressed‐assets business. It could have
negotiated a different contract had it wanted to shift more
risk to McFarland. In that case, however, McFarland might
have demanded more than 29 cents on the dollar for the
portfolio. Cf. Wis. Power & Light Co. v. Westinghouse Elec.
Corp., 830 F.2d 1405, 1412 (7th Cir. 1987) (Wisconsin law)
(“Wisconsin Power cannot accept the favorable purchase
price and then disclaim the conditions underlying that
price.”).
Nor can we write the remedies limitation out of the con‐
tract for failure of essential purpose. See Wis. Stat.
§ 402.719(2) (codification of U.C.C. § 2‐719(2)). First, the ar‐
gument that the remedy fails of its essential purpose as‐
sumes that Wisconsin interprets U.C.C. Article 2, which gov‐
erns the sale of goods, to apply to the purchase of a loan
portfolio. Perhaps that is so. See Wis. Stat. § 402.102; S&C
Bank v. Wis. Cmty. Bank, No. 2006AP2142, 747 N.W.2d 527, at
8 (Wis. Ct. App. Feb. 5, 2008) (unpublished) (citing Wiscon‐
sin U.C.C. Article 2 in discussion of warranties regarding
sale of loan portfolio); see also Dittman v. Nagel, 168 N.W.2d
190, 193 (Wis. 1969) (applying “legal principles which have
developed regarding express warranties as they apply to the
sale of goods” to an express warranty regarding a sale of re‐
alty). We need not resolve the point, because the remedies
limitation here does not fail of its essential purpose even if
U.C.C. Article 2 applies.
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In Wisconsin, “where [a] limited remedy fails of its essen‐
tial purpose, the limitation will be disregarded and ordinary
U.C.C. remedies will be available,” including consequential
damages. Murray, 265 N.W.2d at 520. A contractual remedy
fails of its essential purpose “when the remedy is ineffectual
or when the seller fails to live up to the remedy’s provisions,
either of which deprives the buyer of the benefit of the bar‐
gain.” Waukesha Foundry, 91 F.3d at 1010. Although parties
may limit damages remedies by contract, they must provide
“at least a fair quantum of remedy for breach of obligations.”
Phillips Petrol. Co. v. Bucyrus‐Erie Co., 388 N.W.2d 584, 592
(Wis. 1986) (citing U.C.C. § 2‐719, cmt. 1); see also Murray,
265 N.W.2d at 520 (limitations on remedies fail “where they
would effectively deprive a party of reasonable protection
against breach”). An unconscionable restriction, or one that
operates to deprive a party of the substantial value of the
bargain, fails of its essential purpose. U.C.C. § 2‐719, cmt. 1.
SFG suggests that the agreed remedy fails of its essential
purpose because it provides no relief to SFG in this case. But
the fact that a limited remedy provides no relief in one set of
circumstances does not mean the remedy fails of its essential
purpose. Indeed, the whole point of limiting remedies is to
make some remedies unavailable. See Wis. Power, 830 F.2d at
1413 (“[P]laintiffs cannot seriously contend that the contract
failed of its essential purpose because they were denied a
fair quantum of remedy when the remedy provided for in
the contract was a product of their own making.”) (quotation
omitted). An agreed remedy does not fail of its essential
purpose because it results in the party that bears the risk suf‐
fering the risk. Rather, it fails only where a party is unfairly
deprived of the substantial value of its bargain. (It is im‐
portant to note that even the U.C.C. does not assume that all
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anticipated value of the bargain must be preserved; instead,
it calls only for “minimum adequate remedies” that address
the bargain as a whole. See U.C.C. § 2‐719 cmt. 1.)
The application of the failure‐of‐essential‐purpose rule in
its usual sphere of sales of goods is illustrative. Many con‐
tracts for the sale of goods limit the buyer’s remedies for
breach of warranty to repair or replacement. See Beal v. Gen.
Motors Corp., 354 F. Supp. 423, 426 (D. Del. 1973) (from sell‐
er’s perspective, the purpose is “to give the seller an oppor‐
tunity to make the goods conforming while limiting the risks
to which he is subject by excluding direct and consequential
damages that might otherwise arise”); Murray, 265 N.W.2d
at 520 (“The purpose of an exclusive remedy of repair or re‐
placement, from the buyer’s standpoint, is to give him goods
which conform to the contract … substantially free of defects
within a reasonable time after a defect is discovered.”) (cit‐
ing Beal). “The repair‐and‐replace remedy fails of its essen‐
tial purpose when [the] seller is unable or unwilling to repair
or replace in a reasonable time.” Douglas Laycock, MODERN
AMERICAN REMEDIES 72 (2010). Where the seller fails to honor
the repair‐or‐replace remedy, the buyer loses the benefit of
its bargain for the goods.
In this case, by contrast, the only reason that the contract
provides SFG no remedy is that SFG already received sub‐
stantial benefit from its bargain, even if not the full benefit it
expected (because it was short three properties). Part of the
overall bargain, however, was the clause limiting its reme‐
dies. The agreement allowed McFarland to pay back the
purchase price less SFG’s profits in exchange for return of
the loan portfolio. The limited remedy, in other words, was
rescission (or McFarland could pay a lesser amount in dam‐
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ages if it preferred). Nothing forced SFG to approve sales of
the collateral properties before McFarland repurchased the
portfolio. SFG could have held onto the properties, litigated
McFarland’s liability for the breach and, using the definition
of Repurchase Price in the contract, collected money in con‐
nection with the rescission. Instead, SFG decided to sell the
collateral and collect the profit. By its conduct, SFG showed
that it did not want the transaction rescinded. The contractu‐
al remedy did not “effectively deprive [SFG] of reasonable
protection against breach,” see Murray, 265 N.W.2d at 520,
nor was it “incapable of curing” the breach, Waukesha Found‐
ry, 91 F.3d at 1010. Instead, SFG preferred to preserve the
imperfect transaction rather than accept the limited remedy
for which it negotiated.
SFG’s reliance on Resolution Trust Corp. v. Key Fin. Servs.,
Inc., 280 F.3d 12 (1st Cir. 2002), is unavailing. In Key Financial,
a repurchase remedy provided in a sale of a loan portfolio
failed of its essential purpose where the seller refused to re‐
purchase the loans. But unlike the agreement here, the
agreement in Key Financial required the seller to repurchase
“upon demand” from the buyer. The latter agreement gave
the buyer, not the seller, the option to rescind the contract
when a breach was discovered. Id. at 18 n.14. The seller’s
failure to repurchase on demand left the buyer holding the
bag as the value of the mortgages declined, thus pinning the
risk of losses on the buyer when the parties had agreed that
those losses would fall on the seller.
In this case, far from bearing any loss caused by the ina‐
bility to rescind, the buyer SFG reaped profits from the
transaction that it would not have earned had the transaction
been rescinded. That is a far cry from the usual case in which
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a limited remedy is found to fail of its essential purpose. E.g.
Phillips Petrol., 388 N.W.2d at 591–92 (limited remedy in sale
of machinery failed of its essential purpose where extensive
delay in making repairs left buyer unable to operate machin‐
ery for months); Murray, 265 N.W.2d at 521–23 (limited rem‐
edy in sale of motorhome failed of its essential purpose
where motorhome had numerous defects that were not cor‐
rected); Midwhey Powder Co., Inc. v. Clayton Indus., 460
N.W.2d 426, 430 (Wis. Ct. App. 1990) (genuine issue of fact
whether seller’s refusal to effect necessary repairs of genera‐
tors caused limited warranty to fail of its essential purpose).
Indeed, we are unaware of any case finding that a limited
remedy failed of its essential purpose where the buyer bene‐
fitted from the transaction. Because SFG was not substantial‐
ly deprived of the bargain’s benefits, the contractual remedy
does not fail of its essential purpose.
Finally, we reject SFG’s contention that McFarland
waived its right to insist on limited remedies when it did not
immediately concede its breach. Unlike the contract in Key
Financial, the contract here contained no express provision
requiring McFarland to elect a remedy by any particular
deadline, much less on demand. For breaches of non‐
monetary obligations, the contract provided that, “If [a]
breach or failure is not duly cured within [a] thirty (30) day
period … then [McFarland] shall elect, in its sole discretion,”
one of the provided remedies. Loan Sale Agmt § 6.3(b). This
provision says nothing about when McFarland was required
to make the election; rather it says only that the remedies be‐
came available if the breach was not cured within thirty
days. By contrast, on the subject of breaches of monetary ob‐
ligations, the agreement provided that, “[w]ithin [a] fifteen
(15) day period, [McFarland] will pay to [SFG] all proper
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and valid amounts due and owing.” Id. § 6.3(c). The parties
knew how to establish a deadline for providing a remedy,
but they chose not to include one for breaches of non‐
monetary obligations.
Nor did McFarland’s statement that it would not elect a
remedy because it disputed its liability constitute an implied
waiver of limited remedies. In the absence of specific con‐
tractual language to the contrary, a party does not waive its
right to insist on contractual limited remedies by disputing
its liability. Cf. Jindra v. Diederich Flooring, 511 N.W.2d 855,
857 (Wis. 1994) (“So long as the locus of liability remained
uncertain, [the insurer]’s obligation was merely contingent
and it had no legal obligation to make any payments under
the [] policy.”). McFarland raised colorable arguments that
the alleged misrepresentation in the Loan Sale Agreement
did not give rise to liability because SFG could have discov‐
ered whether any collateral had been released by reference
to public documents. That meant, McFarland said, that there
was no concealment. In addition, McFarland argued that
SFG failed to provide timely notice and certain information
necessary to McFarland’s election of a remedy. Whether
these arguments might ultimately have prevailed is immate‐
rial. What matters is that McFarland raised genuine chal‐
lenges to its liability. SFG could have avoided this problem
by insisting that the agreement include a liquidated damages
clause or provisions that immediately shifted the risk to
McFarland. Cf. Key Financial, 280 F.3d at 18 n.14.
SFG contends that McFarland’s failure to elect a remedy
was a breach of an independent obligation in the agreement,
and that this breach entitles SFG to a remedy. But that argu‐
ment proves too much. Even if McFarland’s failure to elect a
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remedy were an independent breach, no damage resulted.
As discussed above, had McFarland elected a remedy, the
best that SFG could have hoped for was rescission. Had the
contract been rescinded, SFG would have been required to
return the loan portfolio in exchange for the Repurchase
Price. As a result, SFG would not have profited from the
transaction at all. The consequence of McFarland’s failure to
elect a remedy was that SFG made more money. Therefore,
even if we were to accept SFG’s argument that McFarland’s
failure to elect a remedy was an independent breach, SFG
suffered no loss from that breach.
III
Except in the most extraordinary circumstances, we hold
sophisticated parties to the terms of their bargain. The terms
of the parties’ bargain in this case results in zero recovery for
SFG. The judgment of the district court is AFFIRMED.
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