December 3, 2014
Best Practices: Lender Liability, A Primer (Part 1)
by Norman E. Greenspan
The lending environment is constantly evolving. One of the more significant changes in the past twenty-five years has been the proliferation of “lender liability” lawsuits. At first, the lending industry did not give much credence to borrowers attacks on lenders by laughing off these claims as the desperate acts of deadbeats with crazy lawyers. The claims being brought were jokingly referred to as borrowers’ claims against lenders “for the malicious lending of money.” However, rather than going away, claims against lenders have proliferated, with the theories of lender liability circumscribed only by the inventiveness of lawyers, and the countenance of these lawyers’ creative theories by the courts.
There are no specific statutes that define what constitutes lender liability (although the breach of statutory duties giving rise to liability to borrowers or third parties comes within the rubric of “lender liability”). “Lender liability” is merely a catch-all phrase referring to a lender’s actual or potential liability to its borrowers or third parties for claims arising from a lending relationship.
The most common claim of lender liability is for breach of contract. In the context of commercial lending, the contractual relationship between lender and borrower usually begins with the commitment letter. The commitment letter provides the road map for the formal loan relationship. The failure of the lender to follow the terms of the commitment letter gives rise to the possibility of lender liability claims. Once the terms of the loan are agreed to, and conditions precedent such as the payment of a commitment fee are met, an enforceable contract is formed. Lender liability is found when the lender breaches its promise to provide financing, provide the financing timely, or continue the financing consistent with the terms of the loan documents. Even without formal loan documentation, theories of promissory estoppel or negligent misrepresentation may provide an adequate basis for a borrower to claim the existence of a contractual relationship. For example, if a borrower acts in reliance of a lender’s oral promise to fund a loan, the equitable principle of promissory estoppel may bar the lender from claiming that there is no contract.
Probably the most litigated lender liability theory is the breach by the lender of its obligation of good faith and fair dealing. Once a contractual relationship is created, the law imposes on each party the duty of good faith and fair dealing in the performance of their obligations, and neither party can do anything to deprive the other of the benefits of their agreement. The lender must exercise whatever discretion it has under the loan documents reasonably, and not arbitrarily or capriciously. The circumstances must justify the lender’s actions. Because courts often view the borrower as David to the lender’s Goliath, courts reviewing the lender’s exercise of discretion under the loan documents often seem to favor the borrower. If a court views a lender’s actions as having taken advantage of the borrower, it is not a stretch for the court to determine that the lender has breached its duty of good faith and fair dealing owed to the borrower.
Similar to, but different from, the duty of good faith and fair dealing, is the breach by the lender of a fiduciary duty that may be owed to the borrower. A fiduciary duty results from a special relationship of trust where one party places complete confidence in another with regard to a particular transaction; here, the commercial borrowing relationship. Often, a borrower sees his banker as a business and investment advisor (many banks specifically promote these services), and may have sought and relied upon the lender’s advice. In the small business lending environment, there may be more reason for the borrower to seek and rely upon the advice of his banker who may be the most sophisticated businessman the borrower knows. In bad times, lenders may use provisions in the loan documents to exercise some amount of control over the borrower’s business to protect the lender’s collateral. These different circumstances evidence relationships that may give rise to the existence of a fiduciary duty owed by the lender to the borrower. If a fiduciary relationship exists, the lender has a legal duty to act solely in the interest of the person to whom that duty is owed. It is one of the highest duties of care that exists. A breach of that duty by a lender exposes the lender to liability to the borrower.