CHAPTER 14.01. General

• Jurisdiction: United States

14.01. General

There are many potential bases for a claim that the lender is liable to the borrower or others in connection with a real estate loan. The existence of these potential sources of liability affects (or certainly should affect) how commercial real estate financings are structured and documented.

[1] Liability Based on Borrower Defenses

The most obvious basis for such a claim is one or more of the general defenses that a borrower or a guarantor could have to repayment of the loan. For example, a borrower might claim unconscionability or duress in having entered into the loan.¹ Likewise, a borrower might assert a defense of usury to allow it to avoid repayment of the loan as well as recovering damages from the lender.²

[2] Liability Based on Status

A second type of potential liability arises from claims characterizing the lender's status relative to the borrower. For example, a claim might be made that a lender has fiduciary duties³ to the borrower that the lender has violated through some performance or non-performance.⁴ However, a lender dealing at arm's length with the borrower generally would not be held to have fiduciary duties to the borrower.⁵ Or the lender could be deemed to control the borrower and therefore to assume the liabilities for the borrower.⁶ For these purposes, however, the control necessary to find liability is generally direct control over the borrower's conduct, and not merely the actions of the lender to protect its security.⁷ Of course, if the lender takes possession of the mortgaged property, the lender may be deemed to be a mortgagee-in-possession, thereby assuming liabilities of the owner, such as liabilities for a decline in the value of the property.⁸

[3] Liability Based on Breach

Furthermore, a lender might have potential liability for its actions in making or administering the loan. For example, regardless of the express terms of the loan documents, a lender must also comply with the duties of reasonableness and good faith.⁹ Delaware law imposes a duty of good faith and fair dealing in connection with all contracts.¹⁰ Moreover, the Delaware U.C.C. imposes an obligation of good faith and fair dealing under contracts governed by the Delaware U.C.C.,¹¹ although this statutory duty does not extend to demand obligations that may be called at any time without cause.¹² Moreover, the duty of good faith and fair dealing is a gap filler. In other words, it does not change the express agreement of the parties or create a new agreement beyond the scope of the original agreement.¹³ On the other hand, a breach can have significant consequences, as a lender's breach does not merely expose it to damages claims. For example, a breach of the implied covenant of good faith and fair dealing has been held to affect the lender's status as a holder in due course.¹⁴

Instances of such claims of lender's liability arising from a breach of the implied covenant frequently arise in connection with the negotiation of loan terms and in administering the loan. For example, a lender was alleged to have breached the implied covenant when it included a prepayment premium requirement in the loan documents that was not included in the loan commitment.¹⁵ As another example, lenders have been alleged, in some cases successfully, to have breached the implied covenant in terminating loan advances under a revolving loan.¹⁶ However, courts would generally be reluctant to find such a breach when the lender is preceding under the express terms of the loan documents.¹⁷ Or a borrower might claim that the lender misrepresented to the borrower some material aspect of the transaction or breached the loan documents (e.g., failure to make a loan in breach of the loan commitment or state that a maturity date will be extended and then fail to extend).¹⁸ Claims have also arisen in connection with a lender's change of position from a prior course of conduct that the borrower had a reasonable right to rely on (e.g., acceptance of late payments¹⁹ or waiver of conditions to advances²⁰). Construction loans can be particularly problematic in this regard because of the significant ongoing duties of the lender, such as in making advances of loan funds and inspecting the construction progress.²¹ But courts generally do not seem willing to impose duties on the lender to insure the proper application of construction advances,²² though lenders have been held in breach when making an advance despite the borrower's request not to do so.²³ Likewise, lenders generally will not be held to an implied duty to monitor construction for the benefit of anyone other than themselves.²⁴

Lender liability issues also arise frequently in connection with foreclosures or other exercises of a lender's remedies, but that is beyond the scope of this chapter.

[4] Liability Based on Statute

Finally, the loan transaction can create liability for a lender under statutory or regulatory requirements...