McFarland State Bank (“McFarland”) acquired a loan portfolio (the “Portfolio”) with an unpaid balance of $4.42 million from Evergreen State Bank. Subsequent thereto, McFarland put the Portfolio up for auction. Southern Financial Group, LLC (“SFG”), a Texas firm specializing in distressed‑asset investing, had an interest in the Portfolio and requested background materials on the Portfolio from McFarland’s sales agent. The sales agent provided SFG with the requested materials which indicated that the Portfolio was secured by 19 real estate properties in Wisconsin (the “Properties”). Subsequent thereto, SFG purchased the Portfolio from McFarland in accordance with the terms of a loan sale agreement (the “Agreement”) for $1.27 million (which was 28.8% of the face value of unpaid debt of the loans).
Pursuant to the terms of the Agreement, McFarland represented, among other things, that “no material portion of the Collateral was released from the lien… and no instrument of release, cancellation or satisfaction was executed” (the “Representation”). The Agreement also expressly addressed the availability of certain remedies by providing that (i) neither party would be liable for consequential, special or punitive damages and (ii) in the event of a non‑monetary breach, which was not cured within 30 days, McFarland’s exclusive remedy would be to either (1) repurchase the Portfolio and pay the “Repurchase Price;” or (2) pay SFG’s actual damages caused by such breach up to an amount not to exceed the “Repurchase Price.” The Agreement defined “Repurchase Price” as the original purchase price of the Portfolio less any amounts SFG was able to collect with respect to the loans less any diminution of the value of the loans attributable to SFG’s fault plus any reasonable costs incurred by SFG in maintaining the loans.
Shortly after purchasing the Portfolio, SFG learned that three of the Properties had been released prior to the Agreement. SFG then contacted McFarland to notify it of the alleged breached of the Representation. While McFarland and SFG corresponded about the alleged breach of the Representation, SFG sold 13 of the remaining 16 Properties, netting proceeds of $1.31 million, which exceeded the purchase price of the Portfolio. Thereafter, despite the contractual limitation on remedies in the Agreement, SFG sued McFarland in the United States District Court for the Eastern District of Wisconsin (the “District Court”) to recover lost profits related to the three released properties in the amount of $387,000 (which represented SFG’s estimate of the profits it lost as a result of not having the three Properties in the Portfolio). The District Court found that although McFarland breached the Representation, SFG was limited to the remedies outlined in the Agreement and since the overall gross return obtained by SFG as a result of the sale of the Portfolio exceeded the Repurchase Price, SFG was not entitled to any additional remedy. The District Court rejected SFG’s arguments that the remedy was unenforceable or waived, or in the alternative, that the remedy failed of its essential purpose. As a result, the District Court granted summary judgment in favor of McFarland. SFG then appealed to the Seventh Circuit Court of Appeals (the “Circuit Court”).
The Circuit Court affirmed the District Court ruling. In making its determination, the Circuit Court first evaluated SFG’s assertion that the limitation on remedies was unenforceable. With respect thereto, the Circuit Court noted that Wisconsin law permits parties to limit remedies for breach of contract and to disclaim consequential damages so long as the limitations are not unconscionable. Characterizing the limitation on remedies provision as the parties’ allocation of risk, the Circuit Court noted that SFG was a “sophisticated player in the distressed‑loan business”, had consulted background materials concerning the loans and was at all times represented by counsel. Thus, the limitation was not unconscionable, particularly in light of the recovery obtained by SFG as a result of the sale of the remainder of the Portfolio. The Circuit Court noted that the deep discount that SFG paid for the Portfolio (29 cents on the dollar) was a reflection of the terms of the deal to which it agreed and SFG could have negotiated a different contract to shift more risk to McFarland, but it did not.
The Circuit Court then addressed SFG’s assertion that the remedies limitation failed its essential purpose under the UCC since the remedy resulted in no contractual recovery to SFG due to the breach of the Representation. With respect thereto, the Circuit Court noted that it is unclear whether UCC Article 2 (governing the sale of goods) applied to a sale of the Portfolio, but even if it did, the limitation on remedies did not fail of its essential purpose and could not be written out of the contract. Applying Wisconsin law, the Court noted that a contractual remedy fails its essential purpose when, among other things, the remedy is ineffectual or when it serves to deprive a party of the substantial value of the bargain. The Circuit Court noted that the entire purpose of limiting remedies is to make some remedies unavailable. Applying the law to the facts at hand, the Circuit Court noted that the only reason the Agreement provided SFG no remedy is that SFG already received the substantial benefit of its bargain even if the benefit was not the full benefit it expected. If the sale of the loans did not generate proceeds in excess of the Repurchase Price, SFG would have had a remedy under the Agreement. The Circuit Court characterized this case as one in which the party who agreed to bear the risk, in fact, ended up bearing that risk and not recovering under the Agreement. The Circuit Court noted that, except in extraordinary circumstances, sophisticated parties will be held to the terms of their bargain. In this case, the terms of the parties’ bargain under the Agreement resulted in a zero recovery for SFG. In light of the foregoing, the Circuit Court affirmed the District Court decision and held that the limitation on remedies under the Agreement was enforceable and SFG was not entitled to additional recovery despite McFarland’s breach of the Representation. Southern Financial Group, LLC v. McFarland State Bank, 763 F.3d 735 (2014).
