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Talking Shop in the Courtroom: Courts Set a High Bar for Using Industry Custom to Interpret Contracts

Industry jargon becomes second nature to those in the industry.  Wall Street knows “poison pills” and Silicon Valley knows “burn rates.”  But what is second nature to industry insiders may be entirely foreign to others, and courts have set a high bar for allowing industry custom to color their interpretation of contracts.  Two recent decisions of the New York Commercial Division underscore the danger of relying on custom and usage to supply meaning to contract terms.  See Lehman Bros. Holdings Inc. v. IVC WH HG II, LLC, No. 652178/2012, 2016 N.Y. Misc. LEXIS 3215 (N.Y. Sup. Ct. Aug. 31, 2016) and IFC v. Carrera Holdings Inc., No. 601705/2007, 2016 N.Y. Misc. LEXIS 2640 (N.Y. Sup. Ct. June 29, 2016).

In Lehman Bros., Justice Friedman held that a loan participation agreement was ambiguous and that the parties’ evidence of customs and practices in the commercial real estate finance industry did not resolve the ambiguity.[1]

That case involved Lehman Brothers’s sale of a mezzanine loan to IVC WH HG II, LLC (“IVC”),[2] an affiliate of a global real estate investment firm,[3] three months before Lehman declared bankruptcy.  Lehman Brothers and IVC simultaneously entered into a participation agreement that gave Lehman Brothers a junior participation interest in the principal balance of the loan, and gave IVC a senior participation interest.[4]  When the borrower defaulted, IVC held a foreclosure sale and purchased the collateral—i.e., equity interests in a hotel venture—using a credit bid.[5]

Lehman Brothers sued IVC claiming that the participation agreement required IVC to form a limited liability company to hold the collateral on behalf of both participants in proportion to their interests.  IVC countered that it could, and did, take title to the collateral solely on its own behalf, and that the agreement merely provided that if IVC took title on behalf of both participants, then they would form an entity to hold their respective interests.[6]   

Justice Friedman concluded that the language of the agreement did not clearly support either party’s position.  Since the agreement was ambiguous, the court turned to extrinsic evidence—including industry customs and practices—to determine the contract’s meaning.[7]

Although the court did not find any specialized terms of art in the agreement, it noted that it may consider industry custom “where the parties to a contract have employed ‘[t]erms in common use in a business or art’ that ‘may be understood by those engaged in the business or art . . . but which convey no meaning to those who are not initiated into the mysteries of the craft[.]’”[8]  However, a court will not grant summary judgment when evidence of custom and usage is offered to explain the meaning of a contract term unless: (1) the custom and usage is so definitive as to establish the term’s meaning to the industry; (2) the parties are aware of the established usage, or it is so notorious that a person of ordinary care would be aware of it; and (3) the parties intended to follow the industry custom at issue.[9]

The court concluded that the extrinsic evidence at issue—i.e., reports from commercial real estate finance experts—did not demonstrate an established custom and usage, and did not resolve the ambiguity.  While the experts’ reports offered reasoned interpretations of the relevant provision, and made reference to “ordinary expectations and standards in the lending marketplace” and what the parties “would have known” given their experience in the field, the court found that the experts failed to substantiate their claims with evidence of specific industry practices relevant to whether IVC was required to foreclose on behalf of both participants.[10]  The court denied the parties’ motions for summary judgment and allowed the case to proceed to trial, where “more specific expert testimony may be elicited on industry standards relevant to the capacity in which IVC was required to act at the foreclosure.”[11]

In another recent case, IFC, Justice Bransten rejected an invitation to apply international law to an international investment contract under the rubric of industry custom and usage.[12]  The defendant in IFC argued that an ambiguous provision paralleled concepts of international expropriation law, and that this “borrowing” demonstrated the parties’ intent to have international law apply to the contract.[13]  The court was not persuaded.  There was no other evidence that the parties intended international law to apply, or that international law principles are so notorious in international investment contracts that a person of ordinary care would be aware of their application.[14]  “If the parties so desired,” the court noted, “they were capable of invoking international law[.]”[15]

These cases serve as a reminder that parties should not expect “inside baseball” knowledge to fill in gaps in their agreements.  Courts consider industry custom and usage only under limited circumstances, and even then, parties must offer non‑conclusory evidence of well‑established custom and their intent to follow it.  If parties wish to incorporate industry customs and practices into their agreements, they should do so expressly, defining terms of art where necessary, and ensuring that their intent aligns with common understandings of the relevant customs and practices.


[1] Lehman Bros. Holdings Inc., 2016 N.Y. Misc. LEXIS 3215, at *19-27.

[2] Id. at *3-4.

[3] See Stewart Bishop, Lehman Fights for Stake in $63M Foreclosed Hotel Loan, Law360 (Mar. 12, 2015, 4:34 PM), https://www.law360.com/articles/630801/lehman-fights-for-stake-in-63m-foreclosed-hotel-loan.

[4] Lehman Bros. Holdings Inc., 2016 N.Y. Misc. LEXIS 3215, at *3-4.

[5] Id. at *5-6.

[6] Id. at *6.

[7] Id. at *11-19.

[8] Id. at *20 (quoting Fox Film Corp. v. Springer, 273 N.Y. 434, 436-37 (1937)).

[9] Id. at *20-21.

[10] Id. at *22-27.

[11] Id. at *29-30.

[12] IFC, 2016 N.Y. Misc. LEXIS 2640, at *35-37.

[13] Id. at *36.

[14] Id. at *36-37.

[15] Id. at *37.