November 20, 2013
Best Practices: Avoiding the Unauthorized Practice of Law and Lender Liability Claims
by Jennifer E. Borra
Lenders participating in the U.S. Small Business Administration lending programs often encounter borrowers who are unrepresented by legal counsel for the loan transaction. As a result, borrowers may try to rely on the loan closer, business development officer, and frequently lender’s closing counsel for guidance on due diligence items such as the EPC/OC lease, compliance with bulk sales requirements, entity formation issues, and terms of the purchase agreement. In these situations, the question then arises, what is the appropriate response for lender and its counsel?
State laws on the unauthorized practice of law are broad and diverse, and the actions that would give rise to claims of the unauthorized practice of law depend on the jurisdiction. For lenders, the actions which may give rise to a potential claim of the unauthorized practice of law are often asserted in the form of a lender liability claim. Lenders must develop clear policies and procedures with all SBA personnel to avoid assuming an advisory role and inadvertently establishing a fiduciary relationship, which the borrower may rely upon and subsequently sustain damages as a result of the advice, or, any legal documents provided. There is a fine line between counseling a borrower on SBA rules and requirements related to legal due diligence, and providing “legal advice” by supplying the borrower with sample legal documents to satisfy needs list items.
Below are suggested practices to avoid the unauthorized practice of law and potential lender liability claims:
- Require use of borrower’s counsel for the transaction. Oftentimes, lenders will include this condition in the commitment letter, particularly on larger transactions.
- Remind borrowers that the bank is not in a position to provide legal advice, and any guidance provided related to SBA requirements is solely that, and not a substitute for legal advice by an attorney of the borrower’s choosing.
- Ensure the borrower understands that lender’s legal counsel represents the interests of the lender only, not the borrower.
- Confer with your legal counsel regarding local state laws, and be sure your closing attorney is aware of state specific prohibitions on attorneys handling transactions outside of their licensed jurisdiction.
- When in doubt, seek guidance from your in-house counsel or your outside closing counsel, and they can assist in communicating with the borrower on any legal requirements.
Ultimately, when the loan defaults, and lenders are pursuing all available remedies, borrowers are also examining all possible defenses to the lender’s enforcement actions. By implementing and enforcing policies that provide best practices in communicating with the borrower, lenders will mitigate their risk of engaging in the unauthorized practice of law and the resulting potential lender liability claims.
For more information regarding mitigating lender liability risk, please contact Jen at firstname.lastname@example.org or at 267.470.1206.