Defending Lender Liability Suits
| Publication year | 1990 |
| Pages | 2409 |
| Citation | Vol. 19 No. 12 Pg. 2409 |
1990, December, Pg. 2409. Defending Lender Liability Suits
Within the past few years, lender liability litigation has evolved from a novelty to a fact of life in the banking landscape. Although courts have shown an increasing willingness to limit the circumstances in which borrowers can sue lenders,(fn1) they have been unwilling to insulate lenders from liability altogether.(fn2) Troubled borrowers now have as much reason to litigate with their lenders as ever.
Correspondingly, attorneys who represent financial institutions in litigation have had to develop a new set of skills. Before the rise of lender liability claims, the focus in banking litigation was on marshalling the assets of the debtor. Banks were seldom, if ever, named as defendants by their borrowers, and counterclaims by borrowers were virtually unheard of. Lawyers used their knowledge of Article 9 of the Uniform Commercial Code, real estate foreclosure procedures, bankruptcy law and loan documents as their principal tools in representing lenders.
In most cases, these remain the banking attorney's most frequently used tools. However, lender liability claims, which consume a disproportionate amount of a lender's time and resources, call on lender's counsel to develop and use a different set of skills. They must concern themselves not only with collecting debts, but also with minimizing the lender's exposure to a borrower's claims. Often, the loan agreements that borrowers and lenders labored to put together are secondary, or even irrelevant, to the substance of the borrower's claims.
As a practical matter, the exposure that lenders face from a borrower's claims may depend as much on the equities of the claim as on the fine points of a loan agreement. At trial, borrowers whose businesses may have failed or may be near failure may portray themselves as the injured victim of a deep-pocket wrongdoer.(fn3) In this respect, lender liability cases have more in common with personal injury suits than with conventional banking litigation. No matter how strong the lender's position under the loan documents, the lender ultimately must convince the jury that the borrower was treated in accordance with basic principles of fair play.
This article explores some of the strategies and techniques that attorneys representing lenders can use to investigate and defend lender liability cases. Most lender liability actions are dismissed or settled prior to trial. Therefore, this article emphasizes pre-trial strategies rather than trial tactics, particularly areas which differ from other kinds of litigation. It specifically discusses (1) investigating the case and assessing risks before litigation or discovery begins, (2) pretrial strategies, including discovery, and (3) certain aspects of trial preparation and trial.
Like legal malpractice claims, lender liability claims are most often asserted as counterclaims in collection actions brought by lenders. Initially, at least, they usually serve some limited business purpose of the borrower: to forestall collection on a note, to compel the lender to provide more favorable terms on a loan or more credit, to try to reduce a deficiency, or to obtain further advances on a line of credit from a reluctant lender. However, these claims may spiral out of control as borrowers and lenders harden their positions. In some cases, borrowers may find evidence of bad faith in the files that lends support to substantial claims for damages. In others, one party's unrealistic expectations may make a resolution of the issues impossible.
Because borrowers usually file lender liability claims in response to collection suits, lenders have an opportunity to assess the likelihood that a counterclaim will be filed and the merits of such a counterclaim before becoming involved in expensive litigation. Increasingly,
James W. Hubbell, Denver, is a partner in the firm of Kelly/Haglund/Garnsey & Kahn.
As is true for any kind of litigation, there is no science of risk assessment for lender liability claims. However, some circumstances tend to recur in such cases. The following list describes circumstances that, while not actionable in themselves, should serve as a warning to lender's counsel.
1. The precipitous acceleration of demand notes(fn4) or suits against borrowers for nonmonetary defaults or under insecurity clauses of loan agreements.(fn5)
2. High levels of involvement by a lender in the management of the borrower's business.(fn6)
3. After entering into a loan commitment, failing to honor the commitment or the imposition of new, material terms into a loan agreement.(fn7)
4. The substitution of a new, stronger borrower for a weaker one on a loan for a failing business or property.
5. A substantial deficiency bid by the lender for a property in foreclosure, especially where unsupported by an appraisal.(fn8)
6. Any case in which a borrower has complained of unmet promises or untrue statements made by a lender.
Other circumstances suggest that the risk of a lender liability counterclaim is small. For example, if the borrower cannot challenge the validity of the debt, the size of the obligation may discourage counterclaims. Also, releases, recitals or arbitration clauses in workout agreements may make it less likely that borrowers will assert or pursue claims.(fn9) If such mitigating circumstances are not present, the lender should consider a thorough investigation of the loan before bringing suit against the borrower.
Increasingly, lenders conduct reviews of loans prior to filing suit against borrowers if they believe there is a significant possibility of a lender liability counterclaim. Often, such reviews are done internally, either by the loan officer to whom the loan is assigned or by in-house counsel; in some instances, they are assigned to outside counsel. Such procedures are too time-consuming and expensive to be used every time a lender seeks to collect on a commercial loan. However, if used properly, risk audits can steer lenders away from legal actions that may prompt expensive lender liability counterclaims where the likelihood of a significant recovery from a borrower is small.
The extent of a risk audit by counsel should be determined by the likelihood and the size of a possible lender liability claim. Some guidelines apply regardless of the scope of the examination. If the lender requests a thorough investigation, it usually is not sufficient merely to interview the current officer administering the loan or to limit interviews to potential witnesses still employed by the bank. Lender liability...
To continue reading
Request your trial