## Facts

- Real-estate investors borrowed $2 million from a bank to buy a commercial property, signing a note secured by a deed of trust and a separate unrecorded nonrecourse agreement.
- The note included a due-on-sale clause and a limited transfer exception tied to the borrowers’ retaining a 51% interest as individuals or as trustee of their family trust.
- After closing, the property was transferred to the family trust without the bank’s prior written consent.
- The nonrecourse agreement provided that the lender’s nonrecourse commitment would end if the borrowers transferred any interest in the property without the bank’s prior written consent.
- When the property later underperformed, the parties entered a “pre-workout” agreement obligating each side to negotiate in good faith toward a possible loan modification; the borrowers agreed to keep the loan current during negotiations.
- The borrowers submitted multiple restructuring proposals; the bank rejected them and was alleged to have stalled negotiations while insisting the borrowers stay current.
- The borrowers sued for breach of contract, breach of the implied covenant of good faith and fair dealing, and promissory fraud based on an alleged false promise to negotiate.
- The jury was instructed in a manner that treated the borrowers as nonrecourse obligors and awarded roughly $620,000 compensatory damages and $2.6 million punitive damages.

## Issues

1. Whether the unconsented transfer to the family trust terminated the loan’s nonrecourse protection, making it error to treat the borrowers as nonrecourse obligors for damages purposes.
2. Whether payments made on an existing loan obligation can constitute recoverable “out-of-pocket” fraud damages when the plaintiff was already legally bound to make those payments.
3. Whether substantial evidence supported the jury’s award of damages on the breach of contract claim based on the pre-workout agreement.
4. Whether punitive damages could stand given modifications to the compensatory fraud award.

## Decision

- Held the unconsented transfer to the trust triggered the nonrecourse agreement’s termination provision, converting the obligation to full recourse and defeating the trial assumption of nonrecourse status.
- Modified the fraud damages by eliminating amounts grounded on the incorrect theory that borrowers were damaged by making payments they supposedly did not have to make due to nonrecourse protection.
- Reversed the breach of contract damages award for lack of substantial evidence of contract damages distinct from the fraud theory.
- Left the promissory fraud liability determination largely intact but limited recoverable fraud damages to legally cognizable out-of-pocket losses proximately caused by the fraud.
- Remanded for recalculation of punitive damages in light of the reduced compensatory damages; judgment otherwise affirmed as modified.

## Legal Principles

- A nonrecourse agreement may be terminated according to its terms when the borrower transfers an interest in the secured property without the lender’s prior written consent; the resulting obligation may be treated as recourse.
- California fraud damages generally follow the “out-of-pocket” measure (Civ. Code § 3343), allowing recovery only for actual pecuniary loss proximately caused by the misrepresentation.
- Payments that merely satisfy a pre-existing legal obligation are not automatically recoverable as fraud damages; recoverable items must be concrete pecuniary losses caused by reliance on the misrepresentation.
- An agreement to negotiate a loan modification in good faith can create enforceable duties; a promissory fraud claim may lie if a party entered such an agreement without intent to perform the promised good-faith negotiation.
- Contract damages require proof of loss caused by breach and supported by substantial evidence; contract recovery cannot rest solely on an impermissible or unproven damages theory.
- Punitive damages predicated on fraud must be reconsidered when the compensatory fraud award is reduced or modified.

## Conclusion

The court ruled that the borrowers lost nonrecourse protection by transferring the property to their trust without the bank’s written consent, restricted fraud recovery to legally cognizable out-of-pocket losses proximately caused by any fraudulent promise to negotiate, reversed unsupported contract damages, and remanded to reassess punitive damages after reducing compensatory damages.


Auerbach v. Great W. Bank, 74 Cal. App. 4th 1172 (Ct. App. 1999)