FIRSTMERIT BANK, N.A., as Assignee of the FDIC, receiver for Midwest Bank and Trust Company v. Quanstrom - Rose L.LC. et al

Filing 47

MEMORANDUM Opinion and Order Written by the Honorable Gary Feinerman on 12/13/2013.Mailed notice.(jlj)

UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
FIRSTMERIT BANK, N.A., successor in interest to the
FDIC, Receiver for Midwest Bank and Trust Company,
Plaintiff,
vs.
QUANSTROM-ROSE L.L.C., MONEE 105, LLC,
BAILLY RIDGE LLC, W&L CORNER LLC,
MICHAEL H. ROSE, not personally but solely as Trustee
of the Michael H. Rose and Timothy A. Rose Trust
Agreement No. 4869 dated August 1, 1993, MICHAEL
H. ROSE, and TIMOTHY A. ROSE,
Defendants.

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12 C 10051
Judge Feinerman

MEMORANDUM OPINION AND ORDER
In this diversity suit, FirstMerit Bank, N.A., alleges breach of a promissory note and
seeks to foreclose on five mortgages securing the note. Doc. 1. Defendants answered and
asserted affirmative defenses invoking the unclean hands doctrine. Docs. 25-29. FirstMerit has
moved under Federal Rule of Civil Procedure 12(f) to strike the unclean hands affirmative
defenses. Doc. 33. The motion is granted.
Background
On or about September 1, 2009, Midwest Bank and Trust Company extended a loan
(“Loan”) to Defendants Quanstrom-Rose and Monee (together, “Borrowers”) in the amount of
$9,359,825 pursuant to a Loan Agreement. Doc. 1 at ¶ 11; Doc. 1-1 at 1, 3; Doc. 25 at p. 6, ¶ 11.
(Defendants’ answers and affirmative defenses are materially identical, so for ease of exposition
only the Borrowers’ pleading, Doc. 25, will be cited.) The Loan’s maturity date was September
5, 2011. Doc. 1-1 at 4. Defendants Quanstrom-Rose, Monee, Bailly Ridge, and W&L each

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executed a Mortgage, Security Agreement, Assignment of Rents and Leases and Fixture Filing
on four separate properties as security for the Loan. Doc. 1 at ¶¶ 13-16; Docs. 1-3, 1-4, 1-5, 1-6.
On or about May 7, 2010, Midwest and the Borrowers executed a First Amendment to Loan
Agreement and Reaffirmation of Guaranty, Doc. 1-8, pursuant to which the Michael H. Rose and
Timothy A. Rose Trust executed a Mortgage, Security Agreement, Assignment of Rents and
Leases and Fixture Filing (together with the other four mortgage agreements, “Mortgages”) on a
fifth property as additional security for the Loan, Doc. 1-7. Doc. 1 at ¶¶ 17-18.
On May 14, 2010, Midwest was closed by the Illinois Department of Financial
Professional Regulation, and the Federal Deposit Insurance Company (“FDIC”) was named
Midwest’s receiver. Doc. 25 at p. 30, ¶ 2. FirstMerit acquired from the FDIC all of Midwest’s
assets, including the Loan and Mortgages, and also entered into a Loss-Share Agreement with
the FDIC. Id. at p. 30, ¶¶ 3-4. Such agreements generally provide that the FDIC will reimburse
a bank (like First Merit) acquiring a failed bank’s assets for the majority of the difference
between the non-discounted value of the failed bank’s loan portfolio and the value actually
collected by the acquiring bank. Id. at p. 30, ¶ 5. The Loan is subject to the Loss-Share
Agreement. Id. at p. 31, ¶ 6. The Loss-Share Agreement is of a limited duration, and after its
expiration, the FDIC will not reimburse FirstMerit for any portion of losses incurred in
connection with the Loan. Id. at p. 31, ¶ 7.
On or about October 5, 2010, FirstMerit and the Borrowers executed: (1) a Second
Amendment to Loan Agreement and Reaffirmation of Guaranty that extended the Loan’s
maturity date to October 5, 2011, Doc. 1-10 at 2; and (2) an Amended and Restated Promissory
Note (“Note”) restating the Borrowers’ agreement to pay to FirstMerit, as successor in interest to
Midwest, the principal sum of the Loan by the amended maturity date, Doc. 1-2 at 1. Doc. 1 at

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¶ 20. On or about July 1, 2011, FirstMerit and the Borrowers executed a Third Amendment to
Loan Agreement and Reaffirmation of Guaranty that extended the maturity date to October 31,
2012. Id. at ¶ 21; Doc 1-11 at 2. The Borrowers also executed an Allonge to Amended and
Restated Promissory Note that, among other things, required that the Borrowers make mandatory
principal prepayments under the Note on or before September 21, 2012 (“Mandatory
Prepayments”). Doc. 1 at ¶ 22; Doc. 25 at pp. 12-13, ¶ 22. The Borrowers did not make the
Mandatory Prepayments, Doc. 25 at pp. 13, ¶ 23, and the Loan matured on October 31, 2012.
Doc. 1 at ¶ 23; Doc. 1-11 at 2.
Defendants’ laches affirmative defense alleges that FirstMerit treats the Loan and
FirstMerit’s other loss-share loans less favorably than non-loss share loans in its portfolio in
order to take advantage of the “substantial economic benefits of the Loss-Share.” Doc. 25 at
p. 31, ¶ 8. Specifically, Defendants allege that FirstMerit (a) subjects loss-share loans to
different appraisal and/or valuation criteria to depress the value of the property securing lossshare loans and thus to maximize recovery from the FDIC, (b) evaluates loss-share loans under
“more stringent criteria” when considering whether to renew, modify, renegotiate, or enter into
workouts, making those loans more likely to default and thus to trigger coverage from the FDIC,
and (c) requires loss-share loan borrowers to pay down more principal than borrowers of other
loans, “with knowledge (not shared with Loss-Share borrowers) that FirstMerit would likely
refuse to renew the Loss-Share loans” or otherwise precipitate defaults. Ibid. Defendants further
allege that the Loan was entitled to non-discriminatory treatment and fair dealing from
FirstMerit, and that FirstMerit engaged in “misconduct or bad faith … because it treated [the
Loan] in [a] discriminatory fashion.” Id. at pp. 31-32, ¶¶ 9, 11.

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Discussion
Rule 12(f) provides that a district court “may strike from a pleading an insufficient
defense or any redundant, immaterial, impertinent, or scandalous matter.” Fed. R. Civ. P. 12(f).
“By its terms, Rule 12(f) gives unrestricted authority to the district court to strike ‘insufficient’
defenses.” United States v. 416.81 Acres of Land, 514 F.2d 627, 630 n.3 (7th Cir. 1975); see
also Delta Consulting Grp., Inc. v. R. Randle Constr., Inc., 554 F.3d 1133, 1141 (7th Cir. 2009).
Affirmative defenses will be stricken “only when they are insufficient on the face of the
pleadings.” Heller Fin., Inc. v. Midwhey Powder Co., 883 F.2d 1286, 1294 (7th Cir. 1989). The
legal and factual sufficiency of an affirmative defense is examined with reference to state law.
See Williams v. Jader Fuel Co., 944 F.2d 1388, 1400 (7th Cir. 1991). The Loan Agreement and
Note provide that they shall be governed by Illinois law. Doc. 1-1 at 30; Doc. 1-2 at 8.
Defendants have not argued that First Merit’s motion to strike was untimely under Rule 12(f)(2),
thereby forfeiting the point. See G&S Holdings LLC v. Cont’l Casualty Co., 697 F.3d 534, 538
(7th Cir. 2012) (“We have repeatedly held that a party waives an argument by failing to make it
before the district court. That is true whether it is an affirmative argument in support of a motion
to dismiss or an argument establishing that dismissal is inappropriate.”) (citations omitted).
“The unclean hands doctrine provides that a party to a lawsuit may not obtain the relief it
seeks if it has engaged in wrongful conduct.” Smith v. United States, 293 F.3d 984, 988 (7th Cir.
2002) (Illinois law); see also Long v. Kemper Life Ins. Co., 553 N.E.2d 439, 441 (Ill. App. 1990).
“The bad conduct constituting unclean hands must involve fraud, unconscionability or bad faith
toward the party proceeded against, and must pertain to the subject matter involved and affect the
equitable relations between the litigants.” Int’l Union, Allied Indus. Workers of Am., AFL-CIO v.
Local Union 589, Allied Indus. Workers of Am., AFL-CIO, 693 F.2d 666, 672 (7th Cir. 1982)

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(internal quotation marks and citations omitted); see also State Bank of Geneva v. Sorenson, 521
N.E.2d 587, 591 (Ill. App. 1988) (discussing the unclean hands defense in the foreclosure
context, and holding that “equitable relief may be denied if the party seeking that relief is guilty
of misconduct, fraud, or bad faith toward the party against whom relief is sought, and further
provided that the misconduct, fraud, or bad faith is in connection with the transaction under
consideration”).
FirstMerit argues that the unclean hands defense is not available in actions at law, and
therefore that the defense cannot possibly apply to its breach of promissory note claim. Doc. 34
at 7. This argument ignores Seventh Circuit precedent holding that unclean hands may be
asserted as a defense to legal and equitable claims alike. See Shondel v. McDermott, 775 F.2d
859, 868 (7th Cir. 1985) (“Today, ‘unclean hands’ really just means that in equity as in law the
plaintiff’s fault, like the defendant’s, may be relevant to the question of what if any remedy the
plaintiff is entitled to.”); Maltz v. Sax, 134 F.2d 2, 5 (7th Cir. 1943) (“As to unclean hands: The
maxims of equity are available as defenses in actions at law.”) (citations omitted). Even if the
distinction between legal and equitable claims has survived for purposes of the unclean hands
defense—and the Appellate Court of Illinois as recently as last year held that it has, see Palmer
v. Heartland Ill. Food Corp., 2012 IL App (3d) 110222-U, at ¶ 47, 2012 WL 7005847, at *9 (Ill.
App. Aug. 29, 2012)—the court would consider Defendants’ affirmative defense to the breach of
promissory note claim to invoke the in pari delicto doctrine, which is equivalent in all pertinent
respects to unclean hands and which indisputably applies to actions at law. See Schlueter v.
Latek, 683 F.3d 350, 355 (7th Cir. 2012) (“When as in such cases the plaintiff is asking for
equitable relief, the in pari delicto defense is referred to as the unclean-hands defense. But the
label doesn’t matter, and the defenses were equated in McKennon v. Nashville Banner

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Publishing Co., 513 U.S. 352, 360-61 (1995).”) (citation omitted); Pieczynzki v. Duffy, 875 F.2d
1331, 1333 (7th Cir. 1989) (“To that extent … there is a defense of ‘unclean hands’ (if equitable
relief is sought) or ‘in pari delicto’ (if legal relief is sought).”).
Defendants’ unclean hands defense nonetheless fails as a matter of law on other grounds.
Defendants admit that they failed to make the Mandatory Prepayments, Doc. 25 at p. 13, ¶ 24,
and the Loan indisputably has matured, Doc. 1-11 at 2; Doc. 25 at p. 12, ¶ 21. Nothing in the
parties’ contracts required FirstMerit to relax the Loan’s terms in any way. Under these
circumstances, a lender does not commit misconduct or act fraudulently or in bad faith, thus
subjecting itself to an unclean hands defense, merely by enforcing a loan or declining to renew a
loan that has come due. In Northern Trust Co. v. VIII South Michigan Associates, 657 N.E.2d
1095 (Ill. App. 1995), as in this case, a lender brought a foreclosure suit and was met with an
unclean hands defense. The trial court dismissed the defense, and the Appellate Court of Illinois
affirmed, explaining as follows:
The loan agreements in this case stated that Northern [the bank] would loan to
VIII South $11.8 million. The Guarantors admit that this entire amount was
disbursed to VIII South. … Northern fulfilled its obligations under the loan
agreement and there is no showing that it committed any wrong in failing to
reveal its internal decision making process or its classification of the loan as
troubled. Northern had no obligation to renew the loan. The Guarantors have
alleged no facts showing that Northern acted in bad faith in enforcing the
terms of the loan.
Id. at 1104-05; see also Kham & Nate’s Shoes No. 2, Inc. v. First Bank of Whiting, 908 F.2d
1351, 1357 (7th Cir. 1990) (“Firms that have negotiated contracts are entitled to enforce them to
the letter … without being mulcted for lack of ‘good faith.’”).
The same result is warranted here. See Guar. Fed. Sav. & Loan Ass’n v. Am. Nat’l Bank
& Trust Co. of Chi., 509 N.E.2d 1313, 1322 (Ill. App. 1987) (holding that where the bank
“merely granted a loan to the defendants, which it was authorized to do, [and] did not engage in

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any illegal or improper activity,” it “was not guilty of unclean hands and was entitled to enforce
the loan”). This is particularly so given the fact, acknowledged by Defendants, that the bank had
already “extended and renegotiated the … Loan twice.” Doc. 37 at 8; Doc. 25 at pp. 11-12,
¶¶ 20-21. It is inconceivable that FirstMerit’s hands could be deemed unclean because it did not
extend and renegotiate the Loan a third time. See Market St. Assocs. L.P. v. Frey, 941 F.2d 588,
594 (7th Cir. 1991) (“even after you have signed a contract, you are not obliged to become an
altruist toward the other party and relax the terms if he gets into trouble in performing his side of
the bargain”); Kham & Nate’s Shoes No. 2, 908 F.2d at 1358 (“Although Bank’s decision left
Debtor scratching for other sources of credit, Bank did not create Debtor’s need for funds, and it
was not contractually obliged to satisfy its customer’s desires. The Bank was entitled to advance
its own interests, and it did not need to put the interests of Debtor and Debtor’s other creditors
first. … First Bank of Whiting is not an eleemosynary institution. It need not throw good money
after bad, even if other persons would catch the lucre.”); Bank of Smithtown v. 264 W. 124 LLC,
105 A.D.3d 468, 469 (N.Y. App. Div. 2013) (finding no unclean hands in a foreclosure action
where the lender “was under no obligation to modify the loan” and where “there [was] nothing
immoral or unconscionable about its decision to proceed with foreclosure”).
Defendants attempt to distinguish Northern Trust on the ground that it “did not involve
an unclean hands defense based on a loss-share agreement.” Doc. 37 at 9. That is, Defendants
contend that FirstMerit has unclean hands not simply because it enforced rather than renegotiated
the Loan Agreement and Note, but because it treated the Loan less favorably because it was a
loss-share loan—in other words, that FirstMerit improperly discriminates against loss-share
loans when it comes to renewals and modifications due to economic incentives created by its
Loss-Share Agreement with the FDIC. Doc. 25 at p. 31, ¶ 8.

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Defendants offer, and the court could find, no authority for the proposition that a bank or
any other party acquires unclean hands by treating different contractual counter-parties
differently for sound economic reasons. (There is no allegation that FirstMerit used some
impermissible criterion, such as race, in deciding which loans to extend or renew.) In fact, the
law holds otherwise. See Elda Arnhold & Byzantio, L.L.C. v. Ocean Atl. Woodland Corp., 284
F.3d 693, 709 (7th Cir. 2002) (rejecting an unclean hands defense where property sellers
exercised their contractual right to terminate a purchase agreement with the prospective buyer,
and deeming it “legally irrelevant” whether the termination was motivated by the sellers’ desire
to “pursue a better deal with another developer”); Northern Trust Co., 657 N.E.2d at 1105
(holding that the bank committed no wrong by declining to renew a loan without revealing its
internal decisionmaking process). If banks could not renegotiate or extend loans for some
borrowers without obligating themselves under the unclean hands doctrine to renegotiate or
extend loans for all borrowers, they likely would raise interest rates and/or get out of the
renegotiation business altogether, to the detriment of banks and borrowers alike. See Smith v.
Check-N-Go of Ill., Inc., 200 F.3d 511, 515 (7th Cir. 1999) (“Uncertainty would redound to
borrowers’ detriment, for in competition lenders must recover their costs, and an unavoidable
cost created by legal dubiety would be passed on to borrowers in the form of higher interest
rates.”); Matter of Lifschultz Fast Freight, 132 F.3d 339, 347 (7th Cir. 1997) (“If the court
incorrectly disregards a bona fide transaction, it commits a double wrong. First, the court has
upset the legitimate expectations of a claimant …. The second wrong is … spawn[ing] legal
uncertainty of a particular type: the risk that a court may refuse to honor an otherwise binding
agreement on amorphous grounds of equity … [, of which] other investors are sure to take heed.
An investor will see that a chance she might not get her money back has gone up slightly. She

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will be less willing to lend … in the future; and the cost of credit will rise for all.”); Cont’l Bank,
N.A. v. Everett, 964 F.2d 701, 705 (7th Cir. 1992) (“When the contracting parties draw up their
own provisions, courts enforce them. People write things down in order to assign duties and
allocate risks—functions vital to economic life yet defeated if courts prefer hypothetical bargains
over real ones or use the ambiguities present in all language to frustrate the achievement of
certainty.”); Kham & Nate’s Shoes No. 2, 908 F.2d at 1357 (“Parties to a contract are not each
others’ fiduciaries; they are not bound to treat customers with the same consideration reserved
for their families. Any attempt to add an overlay of ‘just cause’ … to the exercise of contractual
privileges would reduce commercial certainty and breed costly litigation.”).
Conclusion
For the foregoing reasons, Defendants’ unclean hands affirmative defenses are stricken.

December 13, 2013
United States District Judge

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