Plaintiff Unable to Demonstrate Economic Duress to Avoid the Voluntary Payment Doctrine

• Posted on: Nov 26 2018

In March of this year, this Blog wrote about the voluntary payment doctrine (here) and how it is alive and well in New York. On November 15, 2018, the Appellate Division, First Department, addressed the doctrine and the defense of economic duress in affirming the dismissal of a complaint under the doctrine. Beltway 7 & Props., Ltd. v. Blackrock Realty Advisers, Inc., 2018 NY Slip Op. 07844 (1st Dept. Nov. 15, 2018) (here).

The “voluntary payment doctrine … bars recovery of payments voluntarily made with full knowledge of the facts, in the absence of fraud or mistake of material fact or law.” Dillon v. U–A Columbia Cablevision of Westchester, 100 N.Y.2d 525, 525 (2003). Under the doctrine, “[t]he onus is on a party that receives what it perceives as an improper demand for money to “‘take its position at the time of the demand, and litigate the issue before, rather than after, payment is made.’” DRMAK Realty LLC v. Progressive Credit Union, 133 A.D.3d 401, 403 (1st Dept. 2015) (citation omitted).

To protest the payment to overcome the voluntary payment doctrine, the aggrieved party must do so “in writing and … at the time of payment.” Neuner v. Newburgh City Sch. Dist., 92 A.D.2d 888 (2d Dept. 1983). The written protest must also indicate that the plaintiff was reserving his/her rights when the payment was made (DRMAK Realty, 133 A.D.3d at 405) and must communicate as much to the party receiving the payment. C.f. Walton v New York State Dept. of Correctional Servs., 13 N.Y.3d 475, 489 (2009) (noting that “the protest requirement would have been fulfilled by a letter to MCI,” the entity levying the charge, “and DOCS,” the entity receiving commission for that charge “at the time the bills were paid”).

“[T]he voluntary payment doctrine does not apply when a party makes payments under economic duress or compulsion, e.g., when a party must make payment or face the loss of possession of its property.” Rocky Knoll Estates MHC, LLC v. C W Capital Asset Mgmt., LLC, 2015 WL 1632637, at *2 (W.D.N.Y. Apr. 13, 2015); see also U.S. Bank Nat. Ass’n v. PHL Variable Ins. Co., 2014 WL 2199428, at *10 (S.D.N.Y. May 23, 2014) (voluntary payment doctrine does not apply “where payments were necessary in order to preserve [the plaintiff’s] property or protect his business interests”). The rationale behind the duress defense was explained by the New York Court of Appeals in 805 Third Ave. Co. v. M.W. Realty Assoc., 58 N.Y.2d 447, 451 (1983) as follows:

The theory on which plaintiff seeks recovery permits a complaining party to void a contract and recover damages when it establishes that it was compelled to agree to the contract terms because of a wrongful threat by the other party which precluded the exercise of its free will. The existence of economic duress is demonstrated by proof that one party to a contract has threatened to breach the agreement by withholding performance unless the other party agrees to some further demand.

Citations omitted.

Notably, “[h]owever, a mere threat by one party to breach the contract by not delivering the required items, though wrongful, does not in itself constitute economic duress. It must also appear that the threatened party could not obtain the goods from another source of supply and that the ordinary remedy of an action for breach of contract would not be adequate.” Austin Instr. v. Loral Corp., 29 N.Y.2d 124, 130 (1971). See also Oleet v. Pennsylvania Exch. Bank, 285 A.D. 411, 414-15 (1st Dept. 1955).

In Beltway 7, the First Department applied a two-prong test to determine whether the plaintiff was under economic duress when it made payments to the defendant. First, the Court looked at whether the decision to demand the payment was lawful (e.g., if an agreement existed, was the demand based on rights enumerated in the agreement?). Interpharm, Inc. v. Wells Fargo Bank, Nat’l Ass’n, 655 F.3d 136, 142 (2d Cir. 2011) (“The law demands threatening conduct that is ‘wrongful,’ i.e., outside a party’s legal rights.”). Second, if the demand was not lawful, the Court looked to whether the demand placed the plaintiff in a position such that it had no other choice but to accede. This prong is necessary, said the Court, to distinguish between “a viable” claim of economic duress and “a garden variety dispute over the meaning of contractual terms.” Beltway 7, Slip op. at 5. Thus, to satisfy the second prong, the plaintiff must establish facts showing that breach of an obligation “will result in an irreparable injury or harm.” Sosnoff v. Carter, 165 A.D.2d 486, 491 (1st Dept. 1991). The possibility, or even the fear, of litigation is insufficient to establish economic duress. Oleet, 285 A.D. at 414. Moreover, merely facing “financial pressures” and “lack[ing] equal bargaining power” is not sufficient to survive dismissal. Bethlehem Steel Corp. v. Solow, 63 A.D.2d 611, 611 (1st Dept. 1978); Stewart M. Muller Constr. Co. v. New York Tel. Co., 50 A.D.2d 580, 581 (2d Dept. 1975) (being “financially constrained … does not constitute economic duress”).

A contract procured by duress is not void, but merely voidable. Thus, if a party wants to disaffirm a contract made under duress, he/she must act promptly to repudiate it or be deemed to have ratified or affirmed it. Bethlehem Steel, 63 A.D.2d at 612. However, where, during the period of acquiescence or at the time of the alleged ratification, the disaffirming party remains under the same continuing duress, he/she has no obligation to repudiate the contract until the duress has ceased. Austin Instr., 29 N.Y. 2d at 133). In fact, such continuing economic duress would even have the effect of tolling any period of limitations if the disaffirming party had commenced the action. Baratta v. Kozlowski, 94 A.D.2d 454, 458-459 (2d Dept. 1983).

As discussed below, in Beltway 7, the Court found issues of fact surrounding the first prong of the test. It did not squarely address the second prong of the test because the plaintiff failed to act promptly to repudiate the duress: “while there is a question whether Blackrock acted reasonably in imposing the penalty, we must also consider the consequence of plaintiff’s failure to seek recovery of the payment after the threat of foreclosure [i.e., the economic duress] had passed.”

Beltway 7 & Properties, Ltd. v. Blackrock Realty Advisers, Inc.

Background

Beltway 7 involved payments due under a $25 million mezzanine loan originally made by non-party JP Morgan to Plaintiff, Beltway 7 & Properties, Ltd. The loan was secured by Plaintiff’s interest in an affiliated entity called L Reit Ltd., which in turn owned real property in Texas. Defendants (collectively, “Blackrock”) were the assignees of the loan. Around the time that JP Morgan extended the loan to Plaintiff, it made a $26 million mortgage loan to L Reit.

Pursuant to the agreement that governed the loan, Plaintiff was required to make payments on the “Payment Date,” defined as “the ninth (9th) day of each calendar month during the term of the Loan,” or the nearest previous business day if the ninth day was not a business day. The portion of those monthly payments attributable to interest was to be calculated based on interest accruing between the fifteenth day of the prior calendar month and the fourteenth day of the calendar month during which a “Payment Date” fell. The agreement provided that the maturity date for the loan would be November 9, 2014, at which time Plaintiff would be required to pay off the principal balance, including all accrued and unpaid interest. November 9, 2014 was a Sunday, so the actual maturity date pursuant to the agreement was November 7. The agreement also provided for a late payment penalty, which entitled the lender to demand, upon Plaintiff’s failure to make any required payment, “the lesser of five percent (5%) of such unpaid sum or the Maximum Legal Rate” (defined in the agreement as the maximum nonusurious interest rate under applicable law).

As the maturity date approached, Plaintiff negotiated to refinance the loan and the mortgage loan with JP Morgan, and scheduled a closing for November 7, 2014, the maturity date for both loans. However, shortly before that date, Plaintiff discovered that an umbrella insurance policy it was required to maintain for the properties securing the mortgage loan had lapsed. Keybank, which JP Morgan had appointed to service the mortgage loan, was responsible for paying the insurance premiums out of Plaintiff’s monthly loan payments. However, it failed to make the $8,600 payment necessary to renew the umbrella policy. JP Morgan refused to refinance the two loans until the insurance issue was resolved, which was on November 14, when the new loans closed.

Plaintiff missed the maturity date payment by one week causing Blackrock to exercise its right under the mezzanine loan agreement to impose a late charge. It calculated the charge as 5% of the unpaid indebtedness, a sum of approximately $1.2 million. Further, it sought an additional interest payment to cover the interest period running from November 15 to December 14. In contrast to Blackrock, JP Morgan did not penalize Plaintiff for settling the mortgage loan one week late. It did persuade Blackrock, however, to reduce the late charge to $500,000. Nevertheless, needing to satisfy the mezzanine loan before it could close on the refinance, and facing the imminent loss of its properties to foreclosure, Plaintiff paid the amount demanded by Blackrock – approximately $844,000.

The Proceedings Before the Motion Court

Approximately 1½ years later, Plaintiff commenced the action. Plaintiff asserted three causes of action: breach of contract, asserting that Blackrock misconstrued the loan agreement in charging interest; a declaratory judgment that the late charge and additional interest were unenforceable as penalties that were disproportionate to the harm suffered by Blackrock; and restitution to recover the amounts that Plaintiff claimed it was unlawfully forced to pay to Blackrock.

Blackrock moved to dismiss, pursuant to CPLR sections 3211(a)(1) and (7). It argued that it properly applied all relevant contractual provisions, and that, in any event, Plaintiff’s claims were barred by the voluntary payment doctrine. In response, Plaintiff submitted an amended complaint, which added a cause of action seeking a declaratory judgment that Plaintiff made the payment under economic duress and under protest, and upon a mistake of law and fact, such that the voluntary payment doctrine did not apply. Plaintiff also submitted the affidavit of its president, Mohammad Nasr, in which he reiterated the allegations in the amended complaint, including that Plaintiff protested the charges after Blackrock announced its intention to impose them, but determined that it had no choice but to pay.

Blackrock agreed to treat its motion as if directed to the amended complaint. It argued that there was no allegation of a written protest, as required, that Plaintiff’s allegations of duress were substantively insufficient and, in any event, waived by the passage of time, and that there was no cognizable mistake of law or fact. Blackrock also argued that the charges were all proper under the mezzanine loan agreement.

The motion court granted the motion in its entirety and dismissed the amended complaint. It rejected Plaintiff’s allegation that it made the payment under protest, since it had stated no facts concerning the manner in which such protest was lodged. The court also rejected Plaintiff’s argument that it made the payment under a mistake of fact or law since Blackrock had explained the basis for the charges. Moreover, the court held that Plaintiff failed to allege that it made a reasonable effort to learn what its actual legal obligations to Blackrock were. Finally, the court rejected Plaintiff’s economic duress argument. Though acknowledging that a threatened loss of property could form the basis of a claim of economic duress, and intimating that Plaintiff had sufficiently alleged duress, the court found that Plaintiff sat on its rights, having waited 1½ years to commence the action.

The First Department affirmed.

The First Department’s Decision

As noted, in affirming the motion court’s decision, the First Department applied a two-prong test to determine whether Plaintiff suffered economic duress sufficient to avoid the application of the voluntary payment doctrine.

As to the first prong – “whether Blackrock’s decision to demand the late charge and extra interest payment was lawful, that is, based on rights enumerated in the agreement” – the Court found that “relevant contractual provisions [were] ambiguous,” and “susceptible to more than one reasonable interpretation.” Slip op. at 4. The Court explained:

As plaintiff notes, the 5% rate is expressly stated to apply to the “unpaid sum.” However, whether the “Maximum Legal Rate” is to be applied to the unpaid sum or something else is unclear. Plaintiff suggests that it was intended to apply to the length of time that payment was outstanding, which was seven days. Blackrock counters by, inter alia, characterizing the “Maximum Legal Rate” as a standard savings provision designed to ensure that it not be deprived of any recourse at all if payment is tardy. Each of these arguments has merit, and neither is susceptible of resolution at the pleading stage. [Citation omitted.]

The Court also found “uncertainty concerning whether Blackrock was justified in charging interest for the November to December period.” Finding sufficient ambiguity in the parties’ interpretation of the term “Payment Date” and Plaintiff’s obligations under the agreement, the Court declined to “determine[e] how the provision should be properly interpreted.” Id. at 4.

Similarly, the Court was “unwilling … to declare that the amount charged by Blackrock was not an unenforceable penalty.” Id.

The late charge was, according to the agreement, designed “to defray the expense incurred by Lender in handling and processing such delinquent payment and to compensate Lender for the loss of the use of such delinquent payment.” However, we are unable to determine on the limited record before us whether such damages were incapable of calculation at the time the mezzanine loan agreement was executed, or whether there is a proportional relationship between the consequences to Blackrock of receiving late payment, and the sum plaintiff was required to pay. [Citation omitted.]

As to the second prong – whether Plaintiff was deprived “of meaningful choice” – the Court did not explicitly make a ruling, though it indicated that Plaintiff had sufficiently alleged, for pleading purposes, irreparable injury had it not paid “the late charges and extra interest” because it would lose the ability to refinance the mortgage loan and Blackrock would foreclose on “Plaintiff’s very valuable portfolio of properties.” Id. The Court explained that it could not ignore “the consequence of plaintiff’s failure to seek recovery of the payment after the threat of foreclosure had passed.” Id. The Court rejected Plaintiff’s argument that there was no contract ratification “because Blackrock did not procure a contract by duress, but rather a payment concomitant with an already existing contract.” Id.  In doing so, the Court said that Plaintiff’s argument was based upon “a distinction without a difference.” Id.

The Court also rejected Plaintiff’s argument that the proper way to analyze ratification is through the prism of laches. Noting that there was no case authority supporting Plaintiff’s argument and that prejudice was not an element of the analysis, the Court found that the passage of time without explanation could not support a claim of duress:

Plaintiff further asserts that the proper analysis where a party fails to promptly seek recovery of a payment made under duress is whether it is guilty of laches. It argues that because a showing of laches requires prejudice on the part of the party asserting the defense, it must prevail here, because Blackrock was not prejudiced. We disagree. Plaintiff has not cited any authority to support its theory that prejudice enters the analysis. Indeed, decisions by this Court declaring that a party has waived a duress claim have not even suggested that prejudice is a relevant factor. This is not to say that a lengthy wait to recover funds paid under duress bars the claim absolutely.… Here, however, plaintiff fails to allege any set of facts justifying its decision to wait nearly two years to invoke duress, and then only after defendant invoked the voluntary payment doctrine. [Citations omitted.]

Takeaway

In the takeaway of this Blog’s prior post about the doctrine, we said the following: “A lesson to be learned from these cases is that payors should not ‘pay now and ask questions (or litigate) later,’ lest they run the risk that a court will not permit the recovery of such payments from the payee.  Known rights should be asserted promptly.” (Internal quotation marks altered.) This lessen was highlighted in Beltway 7, wherein the First Department found that waiting 1 ½  years to invoke the economic duress defense negated any bar to the application of the voluntary payment doctrine.

Tagged with: Breach of Contract, Business Litigation, Commercial Litigation, Economic Duress, Mistake Of Fact Or Law, Voluntary Payment Doctrine