09.29.2021 | Articles

Why Do We Care About Demand Obligations?

By Richard E. Gentilli, Jonathan M. Hixon, Brian F. Plunkett

We are often asked by clients whether a lender is permitted to make demand on a demand obligation for any reason or no reason or whether good faith and fair dealing require that there be a reasonable basis undergirding making demand.

While certain other states impose obligations on a lender only to exercise discretionary powers granted under the loan documents reasonably, the good news for lenders (and bad news for borrowers) is that Massachusetts is not one of those states.

In 1993, in Shawmut Bank, N.A. v. Miller, 415 Mass. 482 (1993), a case of first impression, litigated by Hackett Feinberg partner Richard Gentilli, the Supreme Judicial Court affirmed that in a commercial setting, in Massachusetts, demand notes mean exactly what they say.  That is:

“a holder of [a demand] note may determine to collect the balance due for any reason, good or bad.  Good faith is not a condition of a holder’s decision to collect the amount due on a demand note.”

In the Miller case, SJC determined that allegations by the borrower that the actions of the bank “were malevolent and deplorable” were not sufficient to undercut the bank’s right to make demand.  Provided the instrument is a true demand instrument, the lender is free to call the loan.  This is true even if the note lists specific events of default in the note in addition to its demand feature.  The itemization of other events of default did not invalidate the lender’s unfettered right to make demand.

A lender’s absolute right to make demand on a demand instrument under Massachusetts law has been repeatedly reaffirmed by state and federal courts over the years, most recently in another case litigated by HF, Santander Bank, N.A. v. Santilli Enterprises, Inc., 2018 WL 1385430, at *4 (Mass. Super. 2018) (“Under the express terms of the Demand Note, [the lender] was entitled to make a demand in light of [borrower’s] default, even if (as occurred) [the borrower] later made all overdue payments.”)

This right to exercise contractually given rights by a party in its sole unfettered discretion is consistent with Massachusetts law generally in regard to the implied covenant of good faith and fair dealing.  Massachusetts law implies a covenant of good faith and fair dealing in all contracts.  What this means is that a party may not try to deprive the other party of the benefits granted to it in the contract.  In the vernacular, a party cannot take away with one hand what is being granted by the other.  However, the covenant is limited to the intended scope of the contract and does not create rights and duties not otherwise provided for in the existing contractual relationship.  That is to say, the covenant can fill in gaps in the contract or govern how the parties are to behave in regard to rights and obligations set forth in the contract.  The covenant of good faith and fair dealing is not intended to supply contractual terms that the parties were free to negotiate, but elected not to.  Nor does the implied covenant serve to contradict or abrogate rights granted in a contract.  If a contract explicitly permits a course of action a lender can pursue, the lender may do so for whatever selfish, unreasonable or other purposes it may have, provided it does not seek to deprive a party of explicitly granted rights or benefits.  This is why so often borrower’s counsel try to add the limitation “reasonably” to any discretionary rights given a bank in a loan document-to supply a reasonableness limitation on the lender’s right to purse a particular right or remedy.  (Again, it bears emphasizing that there are a number of jurisdictions outside of Massachusetts which impose reasonableness limitations on a lender’s exercise of discretionary rights and remedies, so one should not assume these principles apply nationwide.)

Courts in Massachusetts have made clear that the holder of a demand note has complete discretion on when and if to call the note.  That unfettered right to make demand may permit a lender leverage to insist on changes in the terms of loan documents or require additional collateral as a condition to not proceeding with acceleration and demand.  Of course, as in most circumstances, lenders should be judicious in making unreasonable demands as a matter of sound banking policy.

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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