By Thomas J. McCormack

Citigroup Global Markets Realty Corp. is appealing a decision by a New York appeals court that required it to continue funding a construction loan even after Citigroup found the borrower to be in default.

The appeal is to New York’s highest court. The court must agree to hear the appeal. If it does, it will be the third court to adjudicate the dispute between the parties.

The lawsuit arose out of a 2005 agreement by which Citigroup agreed to provide financing to Destiny USA Holdings, LLC for construction of a “green” development project, a major shopping center and tourist destination in Syracuse.

The case has attracted significant attention both because of the size and nature of the underlying project and because the order to allow the borrower to continue drawing on a construction loan after it defaulted has been viewed as a clear departure from established legal precedent and raises concerns for lenders.

Facts

The project uses a financing model for green economic development that was described as visionary and revolutionary. In addition to the $155 million loan from Citigroup, the financing included funding from the proceeds of bonds issued by the City of Syracuse Industrial Development Agency and equity from Destiny USA itself. The project was designed to be a showcase for using state-of-the-art green technology, renewable energy resources and sustainable design for both its construction and operations. It was also to serve as a means for creating new jobs and a new source of capital in the region. Citigroup funded the project as part of a $50 billion global initiative to address global climate change.

As agent, Citigroup was charged with approving all advances of funds to Destiny USA, regardless of the source. Draw requests were to be funded by Citigroup so long as certain conditions precedent were met and unless Citigroup determined there was a deficiency, meaning the remaining funds available fell short of the expected cost to finish construction.

Destiny USA sued after Citigroup decided there was such a deficiency. The developer was on the verge of making its 27th draw on the construction loan. Citigroup calculated that the project would fall more than $15 million short of what was needed to finish the project.

The alleged deficiency was the direct result of Citigroup’s inclusion of tenant improvement costs in the deficiency calculation. Destiny USA contends that tenant improvement costs (which involve changes to the interior of a building, like floor coverings, partitions, heating and cooling systems and other customized finishings, to accommodate tenants) should not be included in the calculation. Destiny USA allegedly did not cure the deficiency within the 10 days allowed after notice, and thus Citigroup determined the loan to be in default and did not fund any subsequent draw requests.

Destiny USA charged in its suit that Citigroup breached the terms of the loan agreement. It asked the court for a preliminary injunction ordering Citigroup to continue funding the loan.

Generally under New York law, to obtain injunctive relief of the kind sought by Destiny USA would require the party seeking that relief to demonstrate that without an injunction it would suffer irreparable harm. Irreparable harm, however, normally cannot be demonstrated where the party seeking injunctive relief has an adequate remedy in the form of calculable money damages. This is usually the case in disputes involving pure money contracts. Simply put, if your damages are monetary and calculable, you are not entitled to injunctive relief.

Reasoning

Thus, although Destiny USA was seeking injunctive relief in what appears to be a pure contract money action, the trial court nevertheless granted a preliminary injunction. A “preliminary” injunction is one of short duration until the court can hear the full case on its merits. However, the trial court decided the merits by finding that the term “deficiency” was not a budget-based term and that tenant improvement costs could not be used in calculating whether a deficiency existed. It found that Citigroup was in breach of the loan agreement and ordered it to continue funding the loan.

The preliminary injunction was upheld on appeal. The appeals court said Destiny USA had demonstrated a likelihood of success on the merits based on evidence that tenant improvement costs should not be included in deficiency calculations, and further determined that Destiny USA had demonstrated that it would suffer irreparable harm if the injunction did not issue.

The thrust of the court’s decision was based on two so-called exceptions to the general rule that a party cannot obtain preliminary injunctive relief in a pure money damages contract action.

First, although there apparently was no evidence in the record that Destiny USA even attempted to obtain replacement funds to mitigate its damages, the court in essence determined that such a showing was not necessary as the court could take judicial notice of “the economic conditions that prevailed when Citigroup ceased making the loan advances.” (Of course, if Destiny USA had been able to find replacement financing, that fact would likely have precluded a claim of irreparable harm.)

Second, the court determined that because of the unique “green economic” financing, for which there was apparently no precedent, it would be virtually impossible to quantify damages. The court did not enumerate reasons for why it considered the financing unique, other than a reference to the parties’ prior statements about how the project was “groundbreaking” and “revolutionary,” particularly as to the use of federal “green bonds.” Instead the court focused more generally on the scope and impact of the project as “unique.”

Lessons

Although the Destiny USA decision is limited in its unique facts, counsel drafting loan agreements — in particular construction loans — should be mindful of the following.

The decision has seemingly left wide open an argument by borrowers that they need not even attempt to mitigate damages in times of economic duress when it would be difficult to find another lender, a result hard to square with long‑standing mitigation precedents. If nothing else, that portion of the ruling should alert lenders to the importance of drafting specific mitigation clauses in loan agreements. An example is a clause that would specifically require a borrower to mitigate its damages by trying to find another lender if funding stops on the loan.

It is not in the interest of a lender to suggest in the loan documents or other papers that the loan is anything more than a standard loan, even if its ultimate purpose is unique. Otherwise, the lender will open the door to a claim by the borrower that he cannot replicate the financing elsewhere.