Southern Financial Group, LLC v. McFarland State Bank

Southern Financial Group, LLC v. McFarland State Bank

Southern Financial Group (“SFG”) is a firm that specializes in purchasing distressed assets for investment.  SFG bought at auction a loan portfolio from McFarland State Bank (“McFarland”) which McFarland had previously acquired from Evergreen State Bank.  The Loan Sale Agreement (the “Agreement”) included representations that “no material portion” of the “Collateral” (which consisted of 19 properties in the portfolio) had been released nor had McFarland executed any document which would give that effect.  The Agreement also contained provisions limiting remedies available to SFG for non-monetary breach by McFarland.  Special, punitive and consequential damages were eliminated.  In the event of a breach, and at McFarland’s option, McFarland could either repurchase the “Loan” or pay SFG’s actual damages in accordance with the formula set out in the Agreement.

As it turned out, three of the 19 properties had been released.  Subsequent to discovering this, SFG also sold 13 of the remaining 16 properties at a profit over the portfolio purchase price which it had bought at approximately 28 cents on the dollar.

SFG sued for breach.  The appeals court upheld the summary judgment by the magistrate judge that SFG was not entitled to damages because it had not actually suffered any and that the provision limiting remedies had not failed its essential purpose.

The 7th Circuit looked at the following factors:  (1) SFG was a sophisticated party and not unused to these kinds of transactions or contracts, and (2) the parties contracted to allocate the risk of the transaction.

With respect to the essential purpose of the limitation on remedies, the Court noted that the test is not whether a party gets no relief but whether a party does not get the benefit of the bargain from the remedy(ies) available.  In this case, SFG made a profit after having sold 13 properties and therefore, received the benefit of its bargain with McFarland.

What is the lesson for lenders?  First, if you are the purchaser of a portfolio, do your due diligence.  The case does not make clear if SFG checked title on the 19 properties or if it simply relied on the background material from McFarland’s agent.  And second, whether you are the purchaser or seller, be sure you can live with the remedies under the contract.  Bear in mind, however, that the remedies may be tied to the purchase price, i.e., if the risk allocation is greater for seller, the price may be greater.  Conversely, risk allocation may also be a means to lower the price if purchaser is willing to take on more of the risk.

Southern Financial Group, LLC v. McFarland State Bank, 763 F. 3d 735 (2014)