The Complicated World of Lender Liability
| Publication year | 2011 |
| Pages | 13 |
| Citation | Vol. 40 No. 4 Pg. 13 |
2011, April, Pg. 13. The Complicated World of Lender Liability
April 2011
Vol. 40, No. 4 [Page13]
Business Law articles are sponsoredby the CBA Business Law Section to apprise members of current substantive law. Articles focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, and securities law.
Coordinating Editors
Trygve E. Kjellsen of Lathrop and Gage LLP, Denver-(720) 931-3145, tkjellsen@lathropgage.com; David P. Steigerwald of Sparks Willson Borges Brandt and Johnson, P.C., Colorado Springs-(719) 475-0097, dpsteig@sparkswillson.com
About the Author
Michelle Z. McDonald is of counsel with Jacobs Chase, LLC. Her practice areas include commercial real estate transactions, lending and finance, leasing and development, and hospitality-(303) 892-4422, mmcdonald@jacobschase.com.
As the credit markets worsen and the dramatic decline in the value of commercial real estate continues, an accurate prediction of financial recovery is virtually impossible. Consequently, borrower claims of lender liability in response to lenders' remedial actions have increased. This article identifies practical lender mitigation strategies in diffusing lender liability claims.
As a result of the current downturn in the U.S. economy, distressed loans and loan defaults have increased at an alarming rate. This environment is proving to be fertile ground for borrower challenges against lender actions and, in certain circumstances, potential theories of lender liability. Many lenders are familiar with the pervasive lender liability claims in the mid-1980s, when courts expanded theories of liability under which lenders could be held liable. Courts reversed such expansion in the 1990s. Today, lender liability theories look similar to those of the 1980s; however, because of the increased complexity of today's commercial real estate world, the underlying rationale for such theories is based on different facts and circumstances.
This article discusses some current legal theories being used against lendersby borrowers and describes the circumstances under which a court may find a lender liable to its borrower. It also suggests practical lender mitigation strategies. Many of the lender liability theories asserted against lenders may be overstated. In fact, many borrower challenges are made in an effort to leverage the lender into renegotiating the terms of its loan or to avoid the borrower's loan obligations altogether. Although a lender cannot stop these claims, it can take certain steps to minimize its risk in facing such claims.
Today's Commercial Real Estate Lending World
As the credit markets continue to worsen beyond what was seen in the 1980s and as the dramatic decline in the value of commercial real estate continues, an accurate prediction of financial recovery is virtually impossible. As a result, commercial banks have dramatically reduced their lending and, in many instances, banks are refusing to accommodate borrower requests to extend or restructure existing deals for various reasons, including regulatory requirements, cost of capital, portfolio troubles, and internal efforts to reduce the bank's credit exposure. With many commercial loans scheduled to mature over the next several years, lenders and borrowers are being faced with unprecedented challenges.
Many existing projects are unable to meet applicable loan extension requirements, and even more frequent, a borrower is unable to satisfy the equity and other covenants in its loan documents. To further complicate the situation, a borrower might be struggling to find opportunities to secure new capital to refinance its existing debt. If a borrower fails to secure adequate capital sources outside the loan and defaults, the lender can elect to enforce its remedies, which usually include foreclosure and the enforcement of personal guarantees. As a result, as maturity dates approach, a borrower likely will commence negotiations with its lenders. It is during the negotiation process where, in general, allegations of lender liability originate. In many instances, these allegations are being used as an offensive weapon against the lender to attempt to gain leverage in the negotiation process.
A borrower's primary objective usually is to retain the property and equity serving as collateral. In many cases, the borrower also will be looking for creative ways to avoid having to pay on a personal guaranty. In these situations, a borrower is looking for additional time to attract additional equity, secure a new loan, stabilize the project, secure a viable buyer, or otherwise restructure or refinance its existing loans. Although the borrower's objective can be met in various ways, a lender often may refuse such requests due to a belief that the value of the collateral or the project cannot support the amount of the loan.(fn1) Consequently, the borrower may demonstrate a willingness to litigate (or threaten to litigate) its claims in hopes that doing so will bolster its bargaining position and pressure the lender to agree to its requests to avoid the cost, publicity, and distraction of litigation.
Although "lender liability" is a term used to describe a broad category of claims, the typical claims being raised include one or a combination of the following: (1) violation of the covenant of good faith and fair dealing; (2) promissory estoppel based on oral representations; and (3) breach of fiduciary duty arising due to a special relationship between the borrower and the lender. These claims historically have been raised as counterclaimsby a borrower in defense to lender legal actions; however, it is becoming commonplace for the borrower to preemptively initiate such claims when its lender fails to take borrower's requested actions following a default.(fn2) These claims are discussed below.
Bad Faith
The basic premise underlying a borrower's allegation of a lender's breach of the covenant of good faith and fair dealing is based on unfair treatmentby the lender. Under Colorado law, in every contract there is an implied covenant of good faith and fair dealing in each party's performance and enforcement.(fn3) The good faith performance of a contractby a party requires the "faithfulness to an agreed common purpose and consistency with the justified expectations of the other party."(fn4) The covenant of good faith and fair dealing applies where the performance of a specific contract term allows for discretion on the part of the performing party; however, it will not be applied to contradict the express terms or conditions of the contract.(fn5)
The application of the covenant does not "obligate a party to accept a material change in the terms of the contract or to assume obligations that vary or contradict the contract's express provisions."(fn6) Allegations of lender liability based on a breach of the implied covenant of good faith and fair dealing usually arise right before or shortly following a breachby the borrower, and frequently in connection with failed attempts to work out the loan.
The risk of a lender being held liable for bad faith usually is exaggerated. In most cases where a lender is found liable for exercising bad faith, the lender's conduct was obviously dishonest and flagrant. Colorado courts have demonstrated a willingness to hold a lender liable for breach of a contractual duty of good faith and fair dealing only where the lender's discretionary conduct as a whole is dishonest, intentionally deceptive, or constitutes egregious and outrageous behavior. A mere allegationby the borrower that its lender's actions or inactions were unreasonable or undesirable to the borrower likely is insufficient.(fn7)
Despite such standards, allegations of bad faith continue to be madeby borrowers. As a general rule, absent express provisions contained in the loan documents to the contrary, there is no obligation on the part of a lender to assist a borrower in restructuring an existing loan, and the failure of a lender to do so alone is not enough for a successful claim for breach of the duty of good faith and fair dealing.(fn8) Accordingly, in situations where there has been no obvious lender misconduct, lenders should not avoid implementing normal loan enforcement actions simply out of fear of borrower allegations of lender liability; however, it is becoming increasingly more important for lenders to take precautionary steps when handling a defaulted loan and approaching a workout situation.
In today's economic environment, careful consideration should be givenby lenders before electing to exercise harsh remedies, and good faith actions always should be demonstrated during foreclosure proceedings. For example, providing the borrower with reasonable written notice before taking certain material actions, even if written notice is not requiredby the loan documentation, and at least considering reasonable proposals madeby a borrower in connection with any restructuring or modification of the loan within a reasonable time period will go a long way in showing the borrower...
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