Banking – Whether the borrower’s obligation is discharged by virtue of Doctrine of Commercial Frustration?

Different types of loans are granted by banks / financial institutions. For instance educational loan, home loan, project finance loan, etc., Loan availed by the borrower will be for attainment of certain specific objects. 

But there may be instances, wherein, after availing the loan, it comes to light that such objects for which loan was availed cannot be attained. In other words, such objects are impossible to attain or perform, may due to some government policy, vis major, force majeure, etc.,

In such circumstances, can the borrower plead discharge of his obligation to repay the loan availed by pleading of Doctrine of Commercial Frustration?

This question was answered in negative by the Hon’ble Supreme Court, State of Wyoming in EARLD. WALLACE and NAWANA V. WALLACE Vs PINNACLE BANK - WYOMING, wherein, as per the factual matrix, the Loan Agreement specified that the purpose of the loan was to provide a vehicle for the Senior Wallaces’ son. The Loan Agreement also contained a “Third Party Agreement” (Security Agreement), which was signed by the Junior Wallaces. Through the Security Agreement, the Junior Wallaces pledged the 2009 Nissan as collateral for the loan, but the Junior Wallaces assumed no obligation for the debt itself. The day after execution of the Loan Agreement and the Security Agreement, the Junior Wallaces, filed a Chapter bankruptcy petition. As part of that filing, the Junior Wallaces listed the 2009 Nissan in a schedule of personal property that they owned. The Bankruptcy Court allowed sale of 2009 Nisan. Wallaces stopped making payment on the ground that their obligation to repay the amount, they borrowed, extinguished when the collateral vehicle was lost to the bankruptcy estate.  In other words, the Loan Agreement was discharged by a supervening frustration.

The Hon’ble Supreme Court, rejecting the contention of Wallace, held as under:

“¶18] The Senior Wallaces next argue that they are excused from performance under the Loan Agreement based on the doctrine of commercial frustration. Specifically, the Senior Wallaces contend that the purpose of the loan was to allow them to purchase a vehicle for their son, and when Pinnacle released its lien on that vehicle, thereby allowing the bankruptcy trustee to seize the vehicle, Pinnacle effectively destroyed “the basic assumption underlying the loan.” We do not agree that Pinnacle’s action frustrated the purpose of the loan and reject this as a basis to excuse the Senior Wallaces’ performance under the Loan Agreement.

[¶19] This Court has defined the doctrine of commercial frustration in the following terms:

“ * * * The doctrine of commercial frustration is close to but distinct from the doctrine of impossibility of performance. Both concern the effect of supervening circumstances upon the rights and duties of the parties but in cases of commercial frustration ‘[p]erformance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event, which supervenes to cause an actual but not literal failure of consideration.’ Lloyd v. Murphy, 25 Cal.2d 48, 153 P.2d 47, 50 (Cal. en banc1944).”

Downing v. Stiles, 635 P.2d 808, 811 (Wyo. 1981) (quoting Howard v. icholson, 556 S.W.2d 477, 482 (Mo. App. 1977)). The party seeking to be excused from performance under a contract based on this doctrine must prove the following elements:

1.   The contract is at least partially executory.

 2.   A supervening event occurred after the contract was made.

 3.   The non-occurrence of such event was a basic assumption on which the contract was made.

 4.   Such occurrence frustrated the party’s principal purpose for the contract.

 5.   The frustration was substantial, and

 6.   The party has not agreed, expressly or impliedly, to perform in spite of the occurrence of the event.

Downing, 635 P.2d at 814-15.

[¶20] We need not address each of these elements, because it is clear that the Senior Wallaces cannot prove the third element set forth above – that is, that Pinnacle’s retention of its lien was “a basic assumption on which the contract was made.” This argument, like the mitigation argument, is based on the premise that the collateral provision in the Loan Agreement was meant to benefit or protect the borrower, and that Pinnacle had a duty to hold and protect its collateral lien. The Loan Agreement does not support that premise. The Loan Agreement, as discussed above, allows Pinnacle to release, substitute or impair the loan’s collateral, and for its remedies, to foreclose on the collateral or take any other lawful action. The Loan Agreement’s terms make it clear that the pledging of collateral is solely for the protection and benefit of the bank, and it is impossible to argue that a basic assumption on which the loan was made was that Pinnacle would not release its lien, when the Loan Agreement itself expressly allows Pinnacle to do just that.

[¶21] Moreover, there was no failure of consideration. Pinnacle agreed to loan the Senior Wallaces $15,789, which loan the Senior Wallaces indicated in the Loan Agreement would be used to purchase a vehicle for their son. It is undisputed that Pinnacle did make the loan to the Senior Wallaces, that the Senior Wallaces did purchase a 2009 Nissan, and that the Senior Wallaces did transfer that vehicle to the Junior Wallaces. Pinnacle performed as required under the Loan Agreement, there was no supervening frustration of the Agreement’s purpose, and the Senior Wallaces are not excused from their obligations under the Loan Agreement.

[¶24] The Loan Agreement was the note from the Senior Wallaces agreeing to repay the Pinnacle loan, which also allowed Pinnacle to release any collateral securing the loan. The Security Agreement was the third-party agreement signed by the Junior Wallaces pledging the vehicle as collateral for the loan, without any agreement by the Junior Wallaces to be personally responsible for the debt under the Loan Agreement. Under these circumstances, the debt, by the terms of the Loan Agreement, survives separation from the collateral. Whether the lien has any separate meaning in the bankruptcy context or any other context is immaterial. Pinnacle seeks enforcement of the Loan Agreement, not its lien.”