First American Commerce Co. v. Washington Mutual Savings Bank

Brief Fact Summary. Party 1 loaned money to Party 2.  Party 1 was given a security interest in certain buildings and held back certain funds until certain improvements were made to those buildings.  Party 2 assigned its interest in the loan to Party 3.

Synopsis of Rule of Law. "The essential element of a novation is the discharge of one of the parties to a contract and the acceptance of a new performer by the other party as a substitute for the first original party."

Facts. The Plaintiff, First American Commerce Co. (the "Plaintiff"), borrowed money from Defendant 1, First Security Realty Services ("Defendant 1").  Repayment was secured with a deed of trust and an assignment of rents on a commercial building owned by the Plaintiff.  Pursuant to the loan document, Defendant 1's approval was required on new leases and a percentage of the loan was "withheld in a 'hold-back' fund pending the completion of certain tenant improvements."  Defendant 1 assigned the loan to Defendant 2, Washington Mutual Savings Bank ("Defendant 2"), on the day the loan documents were signed.  The Plaintiff consented to the assignment.  The Plaintiff wished to lease certain space in the building, but neither Defendant 1 or Defendant 2 would consent.  Once all the improvements were made, the Plaintiff wanted the monies held back from the loan.  The Plaintiff contacted Defendant 1 and they refused to release the funds arguing that, that duty was delegated to Defendant 2.  The Plaintiff sued and the lower court granted Defendant 1 summary judgment finding the assignment terminated any duty Defendant 1 had to the Plaintiff.

Issue. Was the document in question an assignment or a novation?

Held. The court first goes through the definition of an assignment, which is a transfer of rights, and a delegation, which is a transfer of duties.  The court then observed a "party who delegates his duties under a contract to a third person is not relieved of his responsibilities, but rather remains ultimately responsible to the party with whom he contracted for guaranteeing the successful execution of the contractual duties."  Defendant 1 contends that the loan agreement was a novation instead of an assignment, but the court does not agree.  The purpose of the general rule that a delegating party remain liable, is to protect the interests of the party receiving the performance.  The court observes the "[b]orrower is entitled to look to Lender's reasonableness and policies respecting the approval of leases and to Lender's solvency to guarantee the release of the remainder of the loan funds."  The court recognizes that whether an agreement is a novation is a matter of intent.  "The essential element of a nov
ation is the discharge of one of the parties to a contract and the acceptance of a new performer by the other party as a substitute for the first original party."  This essential element was not present here.  Additionally, the documents did not use the word novation and the agreements bound "the parties to the documents and their heirs and assigns, not the parties or their assigns which a notation would."

Discussion. "[T]he burden of proof as to a novation by the transaction in question rests upon the party who asserts it; … an intention to effect a novation will not be presumed; … in the absence of evidence indicating a contrary intention, it will be presumed, prima facie, that the new obligation was accepted merely as additional or collateral security, or conditionally, subject to the payment thereof; and that the intention to effect a novation must be clearly shown."