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Professional Cleaning and Innovative Building Services, Inc. v. Kennedy Funding Inc.

2010 WL 4823377 (U.S. Ct. App. 3d Cir. 2010) (Unpublished)

LOANS; FRAUD — Where a lender, even a reputed hard money lender, includes a definition of “as is market value” in its writings and clearly explains its meaning, it is not guilty of fraudulently obtaining non-refundable commitment fees if, in fact, it turns out that use of this definition frequently results in the failure of loans to close and the lender commonly keeps substantial loan fees despite failure of the loans to close.

A developer, urgently in need of a loan to acquire a desirable property, contacted a lender. The following month, the lender sent a letter of interest indicating it would make a five-year loan for up to 60% of the property’s “as is market value.” The letter defined “as is market value” as the price that would be paid in a three to four month cash sale. The developer paid a $10,000 fee and then received a draft loan commitment. The proposed commitment reiterated the definition of “as is market value.” It was to be determined by the lender selecting an appraiser to render an initial valuation. The developer could then select another appraiser, agreed upon by the parties, to conduct a second appraisal. The loan commitment was executed. It provided that the loan would be issued if the property appraised at more than $3,100,000, which was the amount the developer thought it to be worth, and the developer paid the required non-refundable $54,000 fee.

Two appraisals were prepared. The developer’s was for only $2,430,000 and this meant that the loan size would be insufficient to acquire the property. The developer ultimately sued the lender to recover the fees it had paid pursuant to the loan commitment. It alleged that the lender had a pattern of luring borrowers into paying fees for loans that rarely closed, was in violation of the New Jersey Consumer Fraud Act (CFA), and had violated the RICO federal racketeering statute. The developer also alleged common law fraud and unjust enrichment. Finally, it sought punitive damages. The lower court dismissed all counts, permitting recovery of only compensatory damages under common law principles of fraud. Noting that the developer alleged a compensatory damage figure less than the $75,000 amount in dispute required to permit a diversity action in federal court, the lower court dismissed the action.

On appeal, the United States Court of Appeals affirmed, holding that the CFA did not apply where a commercial transaction was between sophisticated business parties. It noted that the developer had recently purchased a real estate business, and so possessed a degree of financial savvy. As to the RICO claim, which requires a finding of fraudulent practices, the Court agreed with the lower court that the definition of “as-is” as a three to four month sale to a cash buyer was “insufficiently ambiguous” to be considered false under the RICO statute. Significantly, as to the developer’s general case for fraud, that the lender misled borrowers whom it knew needed a specific amount of loan money, into parting with hefty non-refundable fees while knowing that the “as-is” calculation would leave the borrowers short of that amount, each of the appraisers retained by the parties provided a valuation of the real property under which each had discounted its market value opinion by approximately the same amount. The Court concluded that, with each appraiser having exercised its independent discretion in discounting the appraisal in a similar manner, the developer could not sustain its position that the lender exploited a term whose meaning only it knew, and thus the developer could not pursue a RICO claim for punitive damages based on deliberately false or misleading representations. The Court held that even if the developer could prevail on a common law fraud claim and obviate the applicable damage limitation clause, its recovery would be limited to $54,000 of alleged compensatory damages sought in its complaint, and this was less than the $75,000 amount in controversy threshold required for jurisdiction in a federal court. Therefore, the Court held the lower court acted appropriately in dismissing the action on jurisdictional grounds.

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