Capital One Taxi Medallion Finance, Respondent,v.Patton R. Corrigan et al., Appellants.BriefN.Y.October 11, 2018To Be Argued By: ROBERT S. SMITH Time Requested: 20 Minutes APL-2017-00190 New York County Clerk’s Index No. 651841/15 Court of Appeals STATE OF NEW YORK CAPITAL ONE TAXI MEDALLION FINANCE, Plaintiff-Respondent, —against— PATTON R. CORRIGAN and MICHAEL LEVINE, Defendants-Appellants. BRIEF FOR DEFENDANTS-APPELLANTS d ROBERT S. SMITH JENNIFER A. MUSTES FRIEDMAN KAPLAN SEILER & ADELMAN LLP 7 Times Square New York, New York 10036 Telephone: (212) 833-1100 Facsimile: (212) 833-1250 rsmith@fklaw.com STEVEN F. MOLO ROBERT K. KRY MICHELLE J. PARTHUM MOLOLAMKEN LLP 430 Park Avenue New York, New York 10022 Telephone: (212) 607-8160 Facsimile: (212) 607-8161 rkry@mololamken.com Attorneys for Defendants-AppellantsDecember 13, 2017 i STATUS OF RELATED LITIGATION This action is related to Transit Funding Associates LLC v. Capital One Equipment Finance Corp., Index No. 652346/2015, pending in Supreme Court, New York County. Plaintiffs in that litigation include Patton R. Corrigan and Michael Levine, the defendants-appellants in this appeal, and one of the defendants in that litigation is the plaintiff-respondent in this appeal. Corrigan and Levine assert claims for negligent impairment of collateral and fraud. A motion to dismiss plaintiffs’ amended fraud claim was submitted on March 29, 2017 and remains pending. ii TABLE OF CONTENTS Page TABLE OF AUTHORITIES ................................................................................... iii INTRODUCTION ..................................................................................................... 1 STATEMENT OF QUESTIONS PRESENTED ....................................................... 4 STATEMENT OF JURISDICTION.......................................................................... 5 STATEMENT OF THE CASE .................................................................................. 6 A. The Credit Facility and the Guaranties ................................................. 6 B. Capital One’s Impairment of the Collateral’s Value ............................ 7 C. The Litigations ...................................................................................... 9 D. Supreme Court’s Decision .................................................................. 11 E. The Appellate Division’s Decision ..................................................... 12 F. Final Judgment and Leave Grant ........................................................ 13 ARGUMENT ........................................................................................................... 13 I. GUARANTORS ENJOY A NON-WAIVABLE IMPAIRMENT OF COLLATERAL DEFENSE ............................... 13 II. THE EXCEPTION IN CORRIGAN’S AND LEVINE’S GUARANTIES FOR A FINAL ADJUDICATION OF A VALID DEFENSE TO TFA’S PAYMENT OBLIGATIONS IS AN ALTERNATIVE GROUND FOR DENYING SUMMARY JUDGMENT ....................................................................................... 21 CONCLUSION ........................................................................................................ 24 CERTIFICATE OF COMPLIANCE ....................................................................... 25 iii TABLE OF AUTHORITIES Page(s) Cases Bank of India v. Subramanian, No. 06 Civ. 2026 WHP, 2007 WL 1424668 (S.D.N.Y. May 15, 2007).............................................................................. 13, 17 Barclays Bank of New York, N.A. v. Heady Elec. Co., 174 A.D.2d 963 (3d Dep’t 1991) .................................................................passim Canterbury Realty & Equip. Corp. v. Poughkeepsie Savings Bank, 135 A.D.2d 102 (3d Dep’t 1988) ........................................................................ 19 Chrysler Credit Corp. v. Mitchell, 94 A.D.2d 971 (4th Dep’t 1983) ......................................................................... 18 Color Mate v. Chase Manhattan Bank, 168 A.D.2d 534 (2d Dep’t 1990) ........................................................................ 18 Cooperatieve Centrale Raiffeisen-Boerenleenbank, B.A. v. Navarro, 25 N.Y.3d 485 (2015) ................................................................................... 19, 20 European Am. Bank v. Kahn, 175 A.D.2d 704 (1st Dep’t 1991) ....................................................................... 18 FDIC v. Frank L. Marino Corp., 74 A.D.2d 620 (2d Dep’t 1980) ...................................................................passim Gen. Trading Co. v. A&D Food Corp., 292 A.D.2d 266 (1st Dep’t 2002) ....................................................................... 18 Grace v. Sterling, Grace & Co., 30 A.D.2d 61 (1st Dep’t 1968) ........................................................................... 13 Greenwich Capital Fin. Prods., Inc. v. Negrin, 74 A.D.3d 413 (1st Dep’t 2010) ......................................................................... 23 HSBC Bank USA v. IPO, LLC, 290 A.D.2d 246 (1st Dep’t 2002) ....................................................................... 18 iv IBJ Schroder Bank & Trust Co. v. Kerney, 200 A.D.2d 519 (1st Dep’t 1994) ....................................................................... 16 Marine Midland Bank v. CMR Indus., Inc., 159 A.D.2d 94 (2d Dep’t 1990) .................................................................... 13, 18 Merchants Bank of New York v. Gold Lane Corp., 28 A.D.3d 266 (1st Dep’t 2006) ......................................................................... 18 MTI Sys. Corp. v. Hatziemanuel, 151 A.D.2d 649 (2d Dep’t 1989) ........................................................................ 18 NatWest Bank v. Grauberd, 228 A.D.2d 337 (1st Dep’t 1996) ....................................................... 2, 11, 16, 17 New Netherlands Bank of New York v. Dernburg, 206 A.D. 212 (1st Dep’t 1923) ....................................................................passim Nickell v. IAG Fed. Credit Union, 445 S.E.2d 335 (Ga. Ct. App. 1994) ............................................................. 14, 17 Nugent v. Hubbard, 130 A.D.3d 893 (2d Dep’t 2015) ........................................................................ 17 Romeo v. Schmidt, 244 A.D.2d 861 (4th Dep’t 1997) ....................................................................... 23 Schoenfeld v. Shonfeld, 266 A.D.2d 449 (2d Dep’t 1999) ........................................................................ 18 Transit Funding Assocs. LLC v. Capital One Equip. Fin. Corp., 149 A.D.3d 23 (1st Dep’t 2017) ......................................................................... 11 Weinsten v. Fleet Factors Corp., 210 A.D.2d 74 (1st Dep’t 1994) ......................................................................... 18 Statutes CPLR 2201 ............................................................................................................... 23 CPLR 5602 ........................................................................................................... 5, 13 N.Y. U.C.C. Law §1-302 ......................................................................................... 14 v N.Y. U.C.C. Law §9-207 ............................................................................. 13, 14, 17 N.Y. U.C.C. Law §9-504 ......................................................................................... 18 N.Y. U.C.C. Law §9-610 ......................................................................................... 17 N.Y. U.C.C. Law §9-611 ......................................................................................... 17 N.Y. U.C.C. Law §9-624 ......................................................................................... 18 Other Authorities BLACK’S LAW DICTIONARY (10th ed. 2014) ............................................................ 22 1 INTRODUCTION Ignoring clear and well-settled law, the Appellate Division has granted a bank summary judgment against two guarantors for the full balance outstanding on a loan before allowing proof that the bank itself destroyed the value of the loan collateral. The result is a massive judgment that threatens to deprive the guarantors of the financial means to prove their claims against the bank. Those claims are powerful ones, supported by detailed allegations and upheld against the bank’s motion to dismiss. The guarantors, Patton R. Corrigan and Michael Levine, have alleged, and will prove, that the bank, Capital One Taxi Medallion Finance (“Capital One”), refused for no good reason to permit the sale of pledged taxi medallions and substitution of the cash proceeds as collateral. They have also alleged, and will prove, that Capital One triggered the collapse of Chicago’s medallion financing market by abruptly withdrawing from it, at a time when the sale of medallions or refinancing of the medallion lending portfolio could have vastly reduced if not eliminated the debt that Corrigan and Levine guaranteed. The Appellate Division did not suggest that the guarantors’ claims were lacking in merit – but it held that the guarantors must suffer a nearly $64 million judgment before the merits can be litigated, which may well mean that Corrigan and Levine will lack the means to litigate them. 2 This is not only an unfair result, but one contrary to clear precedent. A line of cases stretching back almost a century, including decisions from three Appellate Division Departments, establish the applicable rule: A viable claim that a creditor negligently impaired the value of collateral is a defense and offset to an action on a guaranty – one that cannot be validly waived or disclaimed in the guaranty.1 The Appellate Division did not distinguish, discuss, or even cite any of these cases. Instead, the Appellate Division focused exclusively on a clause in Corrigan’s and Levine’s guaranties that protects the guarantors where the borrower is adjudicated to have “a valid defense . . . to payment of its liabilities.” The Appellate Division held that negligent impairment of collateral was not a “defense” but “merely [a] counterclaim[]” – overlooking the cases making clear that impairment of collateral is a defense, and that the language of a guaranty cannot validly provide otherwise. Those cases, cited in footnote 1, are explicit in saying that negligent impairment of collateral is a “defense” in an action on a guaranty, New Netherlands Bank of New York, 206 A.D. at 213; Barclays Bank of New York, N.A., 174 A.D.2d at 966, and that a waiver contained in a guaranty will not be enforced to bar “a viable setoff or counterclaim” for negligent impairment, Frank 1 See New Netherlands Bank of New York v. Dernburg, 206 A.D. 212, 213 (1st Dep’t 1923); FDIC v. Frank L. Marino Corp., 74 A.D.2d 620, 620-21 (2d Dep’t 1980); Barclays Bank of New York, N.A. v. Heady Elec. Co., 174 A.D.2d 963, 965-66 (3d Dep’t 1991); NatWest Bank v. Grauberd, 228 A.D.2d 337, 337-38 (1st Dep’t 1996). 3 L. Marino Corp., 74 A.D.2d at 620-21; Barclays Bank of New York, N.A., 174 A.D.2d at 965. Since even an unqualified guaranty, purporting to waive all of the guarantors’ defenses, is ineffective in negligent-impairment cases, the Appellate Division’s exclusive focus on the language of the guaranties in this case (which actually contain a condition to enforcement favoring the guarantors not found in the language of typical, unqualified, guaranties) was misconceived. But in any event, as we show below, the Appellate Division’s interpretation of the guaranty language was wrong. We therefore ask this Court to reverse the decision of the Appellate Division. 4 STATEMENT OF QUESTIONS PRESENTED 1. Is a lender entitled to summary judgment for the full amount of a guaranty when the guarantor has raised a triable issue of fact about whether the lender exercised reasonable care in the custody and preservation of collateral in its possession? 2. Does the term “defense” as used in a clause of a guaranty written to protect a guarantor where the borrower has a “valid defense . . . to payment of its liabilities” include an allegation that the lender negligently impaired the collateral securing the debt which will, if proven, negate part or all of the lender’s claim? 5 STATEMENT OF JURISDICTION This Court has jurisdiction over this appeal under CPLR 5602(a)(1)(ii). This action originated in Supreme Court, New York County, A29- 30, and Supreme Court entered a final judgment on April 6, 2017, A5-9. That judgment was necessarily affected by an order of the Appellate Division, First Department, entered on February 28, 2017, which is not appealable as of right. A10-13. This Court granted leave to appeal on September 14, 2017. A4. Corrigan and Levine preserved their negligent impairment argument by opposing Capital One’s motion for summary judgment in lieu of complaint on the ground that Capital One had negligently impaired the value of the collateral it was holding for the debt. A320-22, 325-26. 6 STATEMENT OF THE CASE A. The Credit Facility and the Guaranties In 2006, Corrigan and Levine formed Transit Funding Associates LLC (“TFA”) to provide loans to purchasers of taxi medallions in Chicago. A38 ¶ 2. To finance that business, TFA entered into a series of credit facilities with Capital One starting in 2009, including an April 6, 2012 Loan and Security Agreement that provided for an $80 million line of credit (the “Loan Agreement”). A39-41 ¶¶ 6-12; A63-133. The Loan Agreement required Capital One to advance funds to TFA on request throughout the term of the agreement, but permitted Capital One to decline particular requests in its discretion. A76-77 §§2.1(c), (g). In August 2013, the parties extended the expiration of the credit facility to July 1, 2014, with an automatic three-month extension for repayment. A41 ¶ 13; A134- 42. Capital One required Corrigan, Levine, and several TFA affiliates to guarantee TFA’s obligations under the Loan Agreement, and to extend those guaranties in conjunction with extending the credit facility in August 2013. A42 ¶¶ 17, 19; A143-50; A287 ¶¶ 2, 3; A291-98. The guaranties stated they were “absolute, irrevocable, and unconditional” and would not be affected, modified or impaired by several specified occurrences or “any other circumstances which might constitute a legal or equitable discharge or defense of a surety or a 7 guarantor,” although those defenses were only waived “[t]o the extent permitted by law.” A144-45; A292-93. The guarantors’ liability was also expressly conditioned by a limitation “to the extent that there is a final adjudication by a court of competent jurisdiction of a valid defense to Borrower’s obligations under the Loan Documents to payment of its liabilities.” A145; A293. This provision, not found in typical, unconditional, guaranties, favored the guarantors by carving out an exception to the otherwise absolute and unconditional nature of the guaranties. Capital One required TFA and its guarantors to post collateral for the credit facility. The Loan Agreement gave Capital One a security interest in virtually all of TFA’s property, including its medallion loans. A84-86 §3.1. The bank also took a security interest in a separate portfolio of 48 medallions owned by affiliates of TFA. A43 ¶ 21; A81 §2.4.1(c)(v)-(vi). Capital One retained custody of all the collateral. A43 ¶ 22; A81 §2.4.1. B. Capital One’s Impairment of the Collateral’s Value In early 2014, the credit facility was far from expiring and well below its lending limit. A45 ¶ 28. TFA had never experienced a loss of principal or interest on any of its medallion loans. A39 ¶ 5. Without warning or explanation, however, Capital One abruptly began denying funding requests. A45 ¶ 29; A151- 52. In February 2014, when TFA asked whether Capital One was “still lending in the Chicago medallion market,” Capital One responded that it was not. A45 ¶ 30; 8 A153-54. Capital One never made another advance to TFA throughout the remaining term of the facility. A46 ¶ 32. Through its partnership with TFA and other similar lenders, Capital One had acquired a dominant position in the Chicago medallion financing market. A47 ¶ 37. Its sudden departure from that market alarmed other lenders, who also stopped making new loans. Id.; A289 ¶ 9. The resulting liquidity crunch deprived TFA of any alternative source of funding, and also drove down the value of the medallions and medallion loans securing the facility. A47-48 ¶ 38; A289 ¶ 9. Prior to Capital One’s abrupt exit from the market, the collateral for the medallion loans that TFA had pledged was worth millions of dollars – more than the outstanding balance of the credit facility. See A47-48 ¶¶ 38-39; A50 ¶ 46. In early 2014, before the credit facility expired, TFA and its guarantors sought Capital One’s permission to sell the separate portfolio of 48 medallions and substitute the cash proceeds as collateral. A48 ¶ 39; A155-57. Even though Corrigan and Levine had lined up buyers willing to buy the medallions for approximately $17 million, Capital One refused to release its liens on all but a handful of them (and even for the few liens Capital One eventually released, it negligently delayed doing so for months). Id. It gave no reason then, and has given none since, for this disastrous decision. As a result, the guarantors 9 were unable to sell the vast majority of the medallions before the market collapsed and the collateral’s value plummeted. A48 ¶ 39. C. The Litigations On May 19, 2015, TFA, Levine, Corrigan and several affiliated entities filed suit against Capital One in Illinois for negligently impairing the collateral for the credit facility, among other claims. A158-204. On May 27, 2015, Capital One reacted by moving in Supreme Court for summary judgment in lieu of complaint under CPLR 3213, seeking to collect on Corrigan’s and Levine’s guaranties for the over $57 million outstanding under the credit facility, plus interest. A29-30. The Illinois suit was dismissed based on an expansive reading of the Loan Agreement’s forum selection clause, and plaintiffs sought to expedite an appeal of that dismissal. A205-22. In its June 23, 2015 opposition, Capital One argued that speed was unnecessary because “even if Capital One succeeds in enforcing its rights under the guaranties of the loan agreement, it would not be before Plaintiffs [including Corrigan and Levine] were afforded their day in court, where they could raise any and all defenses to collection, including the claims raised in the action below.” A225. Likewise, Capital One contended that Corrigan and Levine “are in no way prevented from bringing all their Illinois claims as defenses to [Capital One’s motion for summary judgment in lieu of complaint 10 pursuant to CPLR 3213].” A231. The Illinois appellate court declined to expedite the appeal. A238. Levine and Corrigan followed the approach endorsed by Capital One and raised the arguments made in their Illinois complaint in opposition to Capital One’s New York motion for summary judgment in lieu of complaint. A299-331. In particular, they contended that disputed issues of fact as to the enforceability of the guaranties due to Capital One’s impairment of collateral precluded summary judgment. A320-22. The guarantors argued that Capital One had impaired the collateral for the credit facility in two ways: first, by abruptly withdrawing from the Chicago medallion financing market, which led to a dramatic reduction in liquidity and medallion prices; and secondly, by refusing to release its liens on medallions collateralizing TFA’s credit facility so that they could be sold to the ready and willing buyers that had been identified before the market collapsed. Id. If Capital One had not driven down the value of the collateral for TFA’s credit facility, its need to collect on the guaranties by Corrigan and Levine would have been much reduced, if not eliminated. In their opposition to Capital One’s CPLR 3213 motion, Corrigan and Levine also noted that in June 2015 they (and TFA and certain of its affiliates) had refiled their Illinois suit in Supreme Court, alleging negligent impairment of collateral, breach of contract, and other claims (the “TFA Action”). A239-86; 11 A312-13.2 The guarantors argued that their “defense of impairment of collateral is not waivable” (A325-26, citing NatWest Bank, 228 A.D.2d at 338; Frank L. Marino Corp., 74 A.D.2d at 620-21; Barclays Bank of New York, N.A., 174 A.D.2d at 965), and also that if plaintiffs prevailed in the TFA Action, it would satisfy the express exception in the guaranties in the event of “a final adjudication by a court of competent jurisdiction of a valid defense to Borrower’s obligations under the Loan Documents to payment of its liabilities.” A145; A293; A328-29. D. Supreme Court’s Decision Supreme Court denied Capital One’s motion for summary judgment in lieu of complaint. The court pointed out that Corrigan and Levine raised essentially two arguments, asserting that “there are genuine issues of fact as to whether the Guarantors are liable on the Guaranties,” and also disputing whether “the waivers of defenses are relevant and enforceable in this action.” A18. The court denied summary judgment on the basis of the first argument, which invoked the language in the guaranties referring to “a valid defense to Borrower’s obligations under the Loan Documents to payment of its liabilities.” A19. The court held that whether such a defense existed was being determined in the TFA Action, and that because Corrigan and Levine’s “liabilities under the Guarantees 2 Transit Funding Assocs. LLC et al. v. Capital One Equip. Fin. Corp. et al., Index. No. 652346/2015 (Sup. Ct. N.Y. Cnty.). Supreme Court denied Capital One’s motion to dismiss plaintiffs’ negligent impairment claim, and Capital One did not appeal that ruling. See Transit Funding Assocs. LLC v. Capital One Equip. Fin. Corp., 149 A.D.3d 23, 28-29 (1st Dep’t 2017). 12 are enmeshed” with those defenses, triable issues of fact precluded summary judgment. Id. The court thus did not reach Corrigan’s and Levine’s other argument – that the waiver of defenses in the guaranties was not “relevant and enforceable in this action” because Capital One had violated its non-waivable duty of care over the collateral. E. The Appellate Division’s Decision The Appellate Division reversed Supreme Court’s denial of Capital One’s motion for summary judgment in lieu of complaint, discussing only the language of the guaranties, but not addressing the enforceability of the waivers. A11-13. The basis for the Appellate Division decision was that the guaranty language protecting the guarantors spoke only of a “valid defense,” not a setoff or counterclaim. A12. The Appellate Division held that summary judgment was appropriate because “the claims [in the TFA Action] of breach of contract and negligent interference with collateral are not defenses to TFA’s liability under the loan agreement; they are merely counterclaims.” Id. According to the Appellate Division, although TFA may be entitled to damages on these claims, they “will not affect TFA’s liability for repayment of the amounts borrowed” under the Loan Agreement, and therefore Capital One is entitled to judgment for the full amount of the guaranties, approximately $57 million, plus interest. A8; A11-12. 13 F. Final Judgment and Leave Grant On remand, after Capital One abandoned its claim for attorneys’ fees, judgment was entered against Corrigan and Levine for nearly $64 million. A6-8.3 This Court granted Corrigan and Levine leave to appeal from that judgment under CPLR 5602(a)(1)(ii), bringing up for review the Appellate Division’s decision. A4. ARGUMENT I. GUARANTORS ENJOY A NON-WAIVABLE IMPAIRMENT OF COLLATERAL DEFENSE Under both statute and common law, secured lenders like Capital One that are in possession of collateral must exercise reasonable care in the custody and preservation of that collateral. The Uniform Commercial Code states that, with an exception not relevant here, “a secured party shall use reasonable care in the custody and preservation of collateral in the secured party’s possession.” N.Y. U.C.C. Law §9-207(a).4 The negligent refusal to liquidate collateral upon request is a breach of a lender’s duty of care.5 3 The parties have stipulated to limitations on the enforcement of the judgment while appellate proceedings are pending. 4 See also Grace v. Sterling, Grace & Co., 30 A.D.2d 61, 63-64 (1st Dep’t 1968); Marine Midland Bank v. CMR Indus., Inc., 159 A.D.2d 94, 102 (2d Dep’t 1990). 5 See Frank L. Marino Corp., 74 A.D.2d at 621; Barclays Bank of New York, N.A., 174 A.D.2d at 965-66; Bank of India v. Subramanian, No. 06 Civ. 2026 WHP, 2007 WL 1424668, at *6 14 Lenders cannot disclaim their obligation to exercise reasonable care over collateral. The U.C.C. expressly provides that “[t]he obligations of good faith, diligence, reasonableness, and care prescribed by this act may not be disclaimed by agreement.” N.Y. U.C.C. Law §1-302(b). The Official Comment to Section 9-207 makes clear that this proscription applies with full force to lenders’ duty to preserve collateral: “Under Section 1-102 [now 1-302] the duty to exercise reasonable care may not be disclaimed by agreement . . . .” N.Y. U.C.C. Law §9-207 cmt. 2. Thus, the defense of negligent impairment of collateral differs in a critical respect from many other “defenses” courts have considered in cases involving purportedly absolute and unconditional guaranties: By statute, the defense may not be waived. At least since 1923, a secured lender’s violation of its duty to preserve collateral in its possession has been recognized as a defense to liability on a guaranty. New Netherlands Bank of New York v. Dernburg was an action by a bank lender against two guarantors. “[A] receipt for 5,000 Kolinsky skins” had been deposited with the bank as collateral for the underlying debt. 206 A.D. at 213. The guarantors pleaded as a defense “that the collateral deposited as aforesaid was sold by the plaintiff before the maturity of the draft and that the plaintiff thereby converted the same.” Id. Supreme Court granted judgment on the (S.D.N.Y. May 15, 2007) (applying New York law); Nickell v. IAG Fed. Credit Union, 445 S.E.2d 335, 336 (Ga. Ct. App. 1994) (applying New York law). 15 pleadings against the guarantors despite that defense. Id. at 212. The Appellate Division reversed. Justice Finch, later a Judge of this Court, stated the rule plainly: “[A]ny improper dealing with collateral deposited to secure an indebtedness guaranteed by another is available to the guarantor as a defense.” Id. at 213. New Netherlands Bank did not deal with the issue of waiver, but in 1980 the Second Department held in FDIC v. Frank L. Marino Corp., a case similar to this one, that the negligent impairment defense recognized in New Netherlands Bank is not waivable. The individual defendants, Frank and Joseph Marino, had guaranteed a note given to a bank by the Frank L. Marino Corporation, and had also posted collateral. The corporation “suffered financial setbacks and was unable to pay its obligations. Frank and Joseph Marino requested the bank to liquidate the collateral in light of this development,” but the bank did not do so. 74 A.D.2d at 620. The bank was then taken over by the FDIC, which “was requested to sell the collateral but did not, and the collateral subsequently declined in value.” Id. The FDIC sued the guarantors, who asserted in defense that the failure to liquidate the collateral was negligent. Supreme Court denied the FDIC’s motion for summary judgment against the guarantors, and the FDIC appealed, arguing that the guarantors, “by the express terms of the guaranties, waived any right to assert a counterclaim or to 16 require the bank to liquidate the collateral.” Id. The Appellate Division rejected this argument and affirmed the denial of summary judgment. The court explained: A waiver of the right to assert a setoff or counterclaim is not against public policy and has been enforced by this court. However . . . , where a viable setoff or counterclaim is asserted based upon the creditor’s negligence in failing to liquidate collateral upon the guarantor’s demand, such a waiver provision will not be enforced. To enforce such a waiver provision in the face of a triable issue of fact as to the creditor’s negligence would allow a creditor to shield itself from its own tortious conduct. Id. at 620-21 (citation omitted; emphasis added). The rule of the Frank L. Marino Corp. case was later adopted by the First Department, in NatWest Bank, 228 A.D.2d at 337-38 (“a lender’s obligation to deal in a commercially reasonable manner with collateral securing a loan may not be waived by a guarantor as a matter of law”), and the Third Department, in Barclays Bank of New York, N.A., 174 A.D.2d at 965 (“a waiver provision will not be enforced to bar a viable setoff or counterclaim . . . which is based upon the creditor’s negligence in failing to liquidate collateral upon the guarantor’s demand”). A number of other cases have adopted the same approach as New Netherlands Bank, Frank L. Marino Corp., NatWest Bank, and Barclays Bank of New York, N.A. See IBJ Schroder Bank & Trust Co. v. Kerney, 200 A.D.2d 519, 519 (1st Dep’t 1994) (citing Frank L. Marino Corp. in affirming denial of lender’s 17 summary judgment motion); Nugent v. Hubbard, 130 A.D.3d 893, 894 (2d Dep’t 2015) (denying summary judgment because of issues of fact as to “commercial reasonableness” of secured party’s conduct with respect to collateral); Bank of India, 2007 WL 1424668, at *6 (applying New York law; refusing to enforce guarantors’ supposed waiver of their right to assert a defense that a lender violated its duty to exercise reasonable care by refusing to sell stock pledged as collateral before value declined below amount of guaranties); Nickell, 445 S.E.2d at 336-37 (applying New York U.C.C. Law §9-207; summary judgment for lender was error because of a “jury question” as to whether lender negligently failed to sell collateral after demand). But the Appellate Division decision in this case departed from the well-settled rule that negligent impairment of collateral is a non-waivable defense for a guarantor without even mentioning New Netherlands Bank, Frank L. Marino Corp., NatWest Bank, Barclays Bank of New York, N.A., or any of the other authorities we have cited. In a similar context, where a lender is seeking to enforce guaranties to recover debt outstanding after disposition of collateral, Appellate Division cases also deny summary judgment motions – including motions for summary judgment in lieu of complaint – when the guarantor raises a triable issue as to whether the lender satisfied its obligation to dispose of the collateral in a “commercially reasonable” manner. See N.Y. U.C.C. Law §§9-610, 9-611 and 18 9-624 (re-codifying the obligation formerly found at N.Y. U.C.C. Law §9-504). These cases include HSBC Bank USA v. IPO, LLC, 290 A.D.2d 246, 246 (1st Dep’t 2002) (reversing award of summary judgment in lieu of complaint because of factual dispute regarding commercial reasonableness of lender’s disposal of collateral); Schoenfeld v. Shonfeld, 266 A.D.2d 449, 449-50 (2d Dep’t 1999) (same); Marine Midland Bank, 159 A.D.2d at 100 (affirming denial of summary judgment due to dispute over whether bank’s disposition of collateral satisfied the U.C.C.’s commercial reasonableness requirement); Merchants Bank of New York v. Gold Lane Corp., 28 A.D.3d 266, 266-67 (1st Dep’t 2006) (affirming denial of summary judgment in light of triable dispute over commercial reasonableness of sale of collateral); Weinsten v. Fleet Factors Corp., 210 A.D.2d 74, 74 (1st Dep’t 1994) (same); MTI Sys. Corp. v. Hatziemanuel, 151 A.D.2d 649, 649 (2d Dep’t 1989) (summary judgment inappropriate where guarantor raised triable issue concerning lender’s compliance with U.C.C. §9-504). In some cases in which guarantors have alleged a negligent sale of collateral, courts have granted summary judgment on the guarantors’ liability, but recognized that the alleged negligent sale presents an issue of damages. See, e.g., Gen. Trading Co. v. A&D Food Corp., 292 A.D.2d 266, 266-67 (1st Dep’t 2002); European Am. Bank v. Kahn, 175 A.D.2d 704, 707 (1st Dep’t 1991); Color Mate v. Chase Manhattan Bank, 168 A.D.2d 534, 535 (2d Dep’t 1990); Chrysler Credit 19 Corp. v. Mitchell, 94 A.D.2d 971, 971 (4th Dep’t 1983). These cases, too, support reversal here because the Appellate Division granted summary judgment as to both liability and damages, and its ruling compelled the entry of a nearly $64 million final judgment. This would be a different case if the Appellate Division had permitted Corrigan and Levine to litigate, either as a matter of liability or damages, Capital One’s collateral-impairing conduct before final judgment was entered. The result, in either scenario, would have been a sharp reduction in Capital One’s damages – quite possibly to zero. This Court’s decision in Cooperatieve Centrale Raiffeisen- Boerenleenbank, B.A. v. Navarro, 25 N.Y.3d 485 (2015), while it does not involve an impairment of collateral defense, is consistent with the principle established by Frank L. Marino Corp. and similar cases. In Cooperatieve Centrale, the Court held that an “unconditional and absolute” guaranty waived a defense that the plaintiff bank colluded to obtain a default judgment against the guarantor. In so doing, the Court did not cite or question the Netherlands Bank/Frank L. Marino line of cases, relating to the distinct, non-waivable impairment-of-collateral defense under the U.C.C. The Court also did not disapprove of, but distinguished, Canterbury Realty & Equipment Corp. v. Poughkeepsie Savings Bank, 135 A.D.2d 102 (3d Dep’t 1988), which this Court interpreted as standing “for the proposition that an absolute and unconditional guaranty does not foreclose a guarantor’s 20 challenge that the creditor’s wrongful post-execution conduct triggered the event that accelerates or causes the guarantor’s liability.” Id. at 496. The Court held this principle inapplicable to the facts of Cooperatieve Centrale. Id. at 496-97. But here, it is precisely Capital One’s misconduct “post-execution” – i.e., after entering into the guaranties – that “triggered the event” that creates Capital One’s claim under the guaranty – not acceleration as in Canterbury, but destruction of the collateral’s value, as in Frank L. Marino Corp. and the many other cases cited above. The rule that a guarantor should be allowed to defend on the ground that a secured lender negligently impaired the value of collateral is not only well established. It is sound as a matter of policy. The cases adopting the rule recognize that, absent the secured lender’s misconduct, the collateral would have been available to satisfy part or all of the underlying debt, thus reducing or eliminating the need to resort to the guaranty. They also recognize the unfairness of subjecting guarantors to large judgments when a viable defense based on the impairment of collateral remains outstanding; in such a case, there is a real risk that the financial pressure on the guarantors will deprive them of their day in court. Capital One’s actions here illustrate these points. Had Capital One complied with Corrigan’s and Levine’s repeated requests to remove its liens on the separate portfolio of medallions pledged as collateral for TFA’s credit facility, the 21 medallion collateral would have been substituted with cash sales proceeds. A48 ¶ 39; A155-57. Capital One could have used those proceeds to satisfy indebtedness it is now seeking to recover from the guarantors. Absent Capital One’s abrupt withdrawal from its dominant position in Chicago’s medallion financing market, moreover, the medallion loans TFA had pledged as collateral could have been sold or refinanced, which would have significantly reduced or eliminated the need to collect on Corrigan’s and Levine’s guaranties. A47-49 ¶¶ 37-41; A289 ¶ 9. Yet as it stands, Corrigan and Levine have been subjected to a nearly $64 million judgment before being given an opportunity to prove Capital One’s misconduct and its consequences. II. THE EXCEPTION IN CORRIGAN’S AND LEVINE’S GUARANTIES FOR A FINAL ADJUDICATION OF A VALID DEFENSE TO TFA’S PAYMENT OBLIGATIONS IS AN ALTERNATIVE GROUND FOR DENYING SUMMARY JUDGMENT Supreme Court denied Capital One’s motion for summary judgment in lieu of complaint on the basis of a clause in the guaranties stating the guarantors’ liability shall in no way be limited or impaired by . . . the invalidity, irregularity or unenforceability, in whole or in part, of any of the Loan Documents, this Guaranty or any other instrument or agreement executed or delivered to Lender in connection with the Loan, except to the extent that there is a final adjudication by a court of competent 22 jurisdiction of a valid defense to Borrower’s obligations under the Loan Documents to payment of its liabilities. A145; A293 (emphasis added). The Appellate Division’s decision focused exclusively on this clause, ignoring the more basic point argued above (one that Supreme Court, because of its ruling, did not need to reach): Negligent impairment of collateral is a valid, unwaivable defense to a claim on a guaranty, whatever the guaranty may say. Because overwhelming precedent and simple fairness support that argument, there is no need for this Court to consider the text of the guaranties. If it does consider it, however, the text provides an independent reason for reversal: The Appellate Division’s interpretation of the condition to the guarantors’ liability was wrong, and Supreme Court’s was right. The Appellate Division’s interpretation of the language rested on an artificial distinction between a “defense” and a “counterclaim.” A12. But where, as here, the “counterclaim” is based on conduct directly related to the main claim, it is functionally indistinguishable from a “defense,” and should in justice reduce or defeat the main claim. In other words, the “counterclaim” here is a “setoff” as that term is defined in Black’s Law Dictionary: “A debtor’s right to reduce the amount of a debt by any sum the creditor owes the debtor; the counterbalancing sum owed by the creditor.” BLACK’S LAW DICTIONARY (10th ed. 2014) (“setoff” definition no. 2). The Appellate Division’s exercise of “formalistic literalism” at 23 the expense of common sense and commercial reasonableness, which is the touchstone of the U.C.C., should be rejected. See Greenwich Capital Fin. Prods., Inc. v. Negrin, 74 A.D.3d 413, 415 (1st Dep’t 2010) (internal quotation marks omitted). As a practical matter, it does not make sense, as Supreme Court recognized, to allow Capital One to obtain judgment against Corrigan and Levine for the whole of TFA’s debt, and then wait for a determination in the TFA Action as to how much, if any, of that debt was justly owing – as opposed to being attributable to Capital One’s own misconduct in impairing the collateral. To proceed in this way effectively gives lenders subject to triable negligent impairment claims like Capital One the use of the guarantors’ money while the “counterclaim” is being litigated.6 Doing so puts enormous, and unjustified, financial pressure on guarantors like Corrigan and Levine, perhaps disabling them from litigating and thus allowing negligent lenders to profit from their own wrongs. 6 This result could be avoided by trial courts staying enforcement of lenders’ judgments while guarantors’ negligent impairment claims are being adjudicated. See CPLR 2201; Romeo v. Schmidt, 244 A.D.2d 861, 861 (4th Dep’t 1997) (holding that the trial court “did not abuse its discretion in granting a stay of enforcement of the judgment awarded by this Court on the prior appeal”). But stays are committed to the discretion of trial courts, and may not always be granted. No stay of enforcement of the judgment pending resolution of the guarantors’ negligent impairment claim has been entered to date in this proceeding. CONCLUSION Capital One was not entitled to summary judgment enforcing Corrigan’s and Levine’s guaranties for the full amount ofTFA’s outstanding loan balance because the guarantors raised Capital One’s impairment of the loan collateral as a defense and offset. The Appellate Division decision overlooked this defense, which is not waivable as a matter of statute and long-standing precedent. The court instead focused on an explicit exception to the liability in the guaranties, but improperly determined it inapplicable based on an artificial and commercially unreasonable distinction between a “defense” and a “counterclaim.” The judgment appealed from and the February 28, 2017 Decision and Order of the Appellate Division, First Department brought up for review should be reversed. Respectfully submitted,December 12, 2017 New York, New York Robert S. Smith Jennifer A. Mustes FRIEDMAN KAPLAN SEILER & ADELMAN LLP 7 Times Square New York, New York 10036 (212) 833-1100 Steven F. Molo Robert K. Kry Michelle J. Parthum MOLO LAMKEN LLP 430 Park Ave. New York, New York 10022 (212) 607-8160 Attorneys for Defendants-Appellants Patton R. Corrigan and Michael Levine 24 CERTIFICATE OF COMPLIANCE I hereby certify pursuant to 22 NYCRR §500.13(c) that this brief was prepared on a computer. A proportionally spaced typeface was used as follows: Name of typeface: Times New Roman Point size: 14 Line spacing: Double The total number of words in the brief, inclusive of point headings and footnotes and exclusive of pages containing the status of related litigation, the corporate disclosure statement, the table of contents, the table of cases and authorities, the statement of questions presented, and any addendum containing material required by subsection 500.1(h) is 5,154. Dated: December 12, 2017 Robert S. Smith 25