Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

This is a special series of blog entries in which we provide some quick answers to lenders' frequently asked questions (FAQ).  Two things should be kept in mind.  First, none of these questions can be answered in a vacuum.  Questions should be considered with a thorough review of the file and an interview with appropriate loan officers.  And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

FAQ #9 – How Do I Deal With The Borrower?

Analyze the borrower's perspective:

• What is the borrower's legal position?
• What are the lender's weaknesses?
• Can the borrower avoid personal liability?
• Who are the guarantors and what is their position?
• What is the borrower's tax position?
• Is the borrower concerned about forgiveness of debt (as income)?
• Does the borrower want to keep cash flow and therefore avoid bankruptcy?
• Is the borrower likely to file bankruptcy?

FAQ #10 – What Are the Risks for Lender Liability?

• Waiver
• Misrepresentation
• Good faith, fair dealing (breach of)
• Risk of improper disclosure (tortuous interference with business relationships)

To read the entire Tough Times FAQ series, please click here:

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It has been a long, long time since claims of lender liability received any real attention.  Indeed, Mike Baggett co-authored a book in the early '90s on lender liability.  Mike's book was somewhat of a best seller among the tough time for lender crowd (which is tough for me to admit, since I went to Texas and Mike went to Texas A&M —and as an former "yell leader" at TAMU, Mike is an "Aggie's Aggie").

Since then, however, the topic has fallen off everyone's radar screen.  The fall off has been this dramatic: the publisher of Baggett's book has NOT updated it since the initial publication, and it is out of circulation.  But to give you a sense of how we see lender liability creeping back into play, below is a short list of where we're dealing with it now.

If nothing else, it will equip you to watch for similar situations—and perhaps get ready.  As always, if you have an example or a question or comment, please post it.

• Defending National Banking Association in a currently certified class action in the Eastern District of Texas challenging the bank's status as trustee for approximately 220 trusts.  The bank is the latest successor trustee in a series of successor trustees and fiduciary substitutions and appointments dating back to the late 1980s. The class alleges defects in the trusteeship chain of title which purportedly disqualify the defendant bank from serving as trustee. The class seeks to recover all trustee fees paid to the bank and its predecessors, together with appointment of new trustees. Class certification is on appeal to the Fifth Circuit.
   
• Currently defending REMIC Trust Lender in state court action alleging Special Servicer induced borrower into making property renovations by misrepresenting its intent to extend loan maturity and interfered in borrower's efforts to secure refinancing.
   
• Secured judgment for Hedge Fund that acted as lender to high-end residential subdivision developer.  Developer contended lender breached promise to lend additional sums to complete subdivision and negligently advised borrower in connection with the development.
   
• Represented lender against allegations by commercial developer/office building owner that lender had failed to fund multimillion dollar construction loan.
   
• Representing bank where borrower and guarantor allege failure to fund and credits on guarantee liability in connection with California residential development.
   
• Represented lender against claims that it and its president had aided and abetted borrower's securities fraud, including borrower's theft of millions of dollars belonging to securities customers.
   
• Defended lender against counterclaim that it had improperly ceased funding loan.  Lender had sued borrower and guarantor for misappropriating collateral in asset based funding arrangement.
   
• Defense of National Banking Association in state court against lender liability lawsuits alleging claims for improper loan servicing and wrongful foreclosure. 
   
• Defended national residential mortgage lender in state court against lender liability actions for wrongful foreclosure.
   
• Successful jury verdict for National Savings and Loan Association to collect debt owed by borrower on SBA loan.  Borrower counterclaimed that bank had misled it about the profitability of the business to induce the loan. 
   
• Defended Lender against borrower's claim that bank had refused to refinance or modify construction loan and wrongful foreclosure on partially developed subdivision, including private water utility.
   
• Defending national bank in Arizona against allegations that one of its workout officers conspired with one of the borrower's officers and other borrower-insiders to steal the borrower (a closely held corporation) from its owners through a negotiated private sale of the borrower's assets. The borrower held inventory, equipment and AR securing the $33M debt.

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The Zerohedge Blog [link] reports on a NY state court filing related to the high-profile Extended Stay Motel bankruptcy case.

Zerohedge focuses on the hedge fund involvement in the case.

I view it as the beginning of the lender liability battles between classes of lenders.

Over the past several months, we've been giving presentations to our clients on basic lender liability stuff―dusting off our materials from the late 80s and early 90s.  (I'll admit it: Texas plaintiff lawyers led the charge back then against lenders and in the development of lender liability causes of action; so, we dealt with it extensively [look at Mike Baggett's bio [link], for example].)

However, this round of lender liability will be different because the last 15 years saw an incredible growth not only in complicated deal structure from the borrower (equity) side of the ledger, but also from the lender (credit) side of the deal.  Co-lender structures (participations, syndications, etc.), A\B\C notes, mezz debt at every point on the equity stack, etc., all seemed to explode during the last 15+ years (it's mantra: "use someone else's money").

So, now that the economy is in the tank, and the long-awaited "stress test" of commercial real estate debt ready to crank up . . .

The prediction is that law suits between lenders will be a new  "feature" of the current story, and "lender liability" will have an expanded meaning.  No longer will it simply mean borrower v lender.

One important reason for the change:  The "new" intercreditor stack no longer is comprised of the relatively homogeneous group of life companies who utilized the old-time "club loan" structure.

Instead, the lender\credit "stack" (i.e., the lender side of the deal) often contains a very diverse group of creditors who (we're discovering) have a very different balance sheet and set of goals.  (See my earlier posting on this perspective and on some tangible tasks to understand the credit stack [link].)  And the stack is much, much more complicated than the structures from the 80s.  Finally, there simply just is more of it.  (Again, the "other people's money" mantra.)

We'll be writing on this subject in future.

• Are you seeing examples of this?
• Do you know of other law suits that we should be tracking?

Please post your comments or your information.

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There's an old, old joke about two old men and a dog.  They see a bus go down the street.  Pretty soon a little dog goes chasing after the bus, barking wildly and looking for all the world like it's going to try to bite it.  One old gentleman looks at the other and says, "There's that dog chasing that bus again."  The other one says, "Yep, he sure is.  And I wonder what he's going to do when he catches it."

Lenders and servicers contemplating foreclosure on property probably should take a moment to remember that dog and its bus before they try to catch foreclosed property.  The foreclosure process itself can be fraught with peril; for example, on September 11, 2008, the Nevada Supreme Court held a lender vicariously liable for punitive damages based upon the improper acts of its local asset manager in disposing of the personal property of a family that had been mistakenly foreclosed upon.  (Countrywide Home Loans, Inc. v. Titchener, 193 P.2d 243 (Nev., September 11, 2008).)  There also is case law to the effect that a foreclosing party's failure to maintain foreclosed property may subject it to claims for nuisance or other torts.  (Nuisance – cf. Willmschen v. Trinity Lakes Improvement Ass'n, 362 Ill. App.3d 546, 840 N.E.2d 1275 (2d Dist. 2005); other torts, see, e.g., Miller v. Everest, 212 N.W.2d 522 (Iowa 1973).)  And even if legal liability is not imposed, imagine the results of a Channel 7 Eyewitness News FocusTeam® Investigation about the meth lab found in a piece of property you foreclosed on . . .  Or on how Mr. & Mrs. Joe Doakes want to buy the property at 1234 Wisteria Lane but can't find anyone to sell it to them.

Whether your foreclosed property is commercial or residential, the same principles apply.  Before foreclosing – even better before lending – ask yourself what you're going to do with that "bus" if you catch it.  Most of the issues are ones you know from your own house: doing the paperwork right, maintenance, upkeep, safety, comps, and curb appeal.  Advance consultation with the right professionals and careful attention to details can spare you a mountain of heartache later.

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In a prior posting, I mentioned the need to watch for local legislative and regulatory\administrative trends or changes.  But don't forget to watch for changes at the court house, too.

We've been watching, waiting and even researching this one: an assertion that Borrower would pay at maturity of the commercial mortgage loan, except that the credit crisis makes it "impossible" for the Borrower to find another loan to pay-off the matured debt!  This is NOT a "new" legal theory.

In the "old" economy, such as argument was, well, perceived as silly in the context of commercial mortgage finance.  What fool will argue impossibility when money is plentiful?  And, today there still is money available - it just costs an arm and a leg (from equity sources and from debt sources).

However, in the "new" economy (or whatever you want to call it), the argument becomes more interesting. 

It's just begging for the right jurisdiction, the right facts, the right judge, etc.  Maybe a jurisdiction where charging an arm or a leg will no longer be tolerated.  Maybe a jurisdiction with an implied covenant of good faith and fair dealing, and a "new" judiciary willing to extend the concept in a crisis . . . .

This "impossible" assertion has bubbled up on two recent cases: (i) a recent posing at The Dirt Lawyer's Blog describes a case in Chicago involving a "dead" acquisition of an office building located at 180 North LaSalle in Chicago, and in passing refers to a case that we've been watching, (ii) the Trump Tower case, also in Chicago, but involving mortgage finance issues.

Succinctly stated:

• I can't buy this office building (180 North LaSalle), because I can't find reasonable funds
• I can't pay off the loan on this building (the Trump Tower), although I can continue to make the monthly payments, because I can't find reasonable funds

Strangely, Chicago seems to be ground zero.  (What 's going on in Chicago?  Recall the River East case in late 2006, which involved a Federal trial court ruling that a yield maintenance clause was an unenforceable penalty under Illinois law.  Of course, the Seventh Circuit Court of Appeals reversed the trial court in 2007.)

I can think of several other jurisdictions where this argument might find a home - if not in Chicago.

From my perspective, this is exactly the type of innovative lawyering that we'll experience in these tough times.

You need to get ready for change from the legislatures, the administrative\regulatory agencies, and the courts.

• are you seeing the "impossibility" argument in any cases where you operate?
• are you hearing borrowers starting to beat the drum on this one?

Please post your comments and observations.

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Once a month, our regular group of authors discuss topics that we view as being of interest (the "hot" topics) in the commercial loan workout arena.  We then hash out a list of what we'll write on for the next month.

Identifying "hot" workout topics can be a dangerous thing for lawyers.   Yes, we -

• are active in industry organizations (such as the several committees with the Mortgage Bankers Association and working on creating workout data standards through MSMO 
• give workout seminars to clients and at legal industry meetings, and
• now handle an increasing number of workouts and bankruptcies every day . . .

BUT as "outside" counsel,  we're keenly aware that we are not privy to all of the discussions (both formal and informal) that you, the front-line participant, are having on this growing topic.  (There you have it: that long sentence proves I'm a lawyer - which is the reason why we need your help.)

While we believe that we're generally in touch with the market, we understand that we still remain "outside" legal counsel.  So, we're looking to you for the "inside" scope on topics of interest.

- Do you have any topics that you'd like us to address in Tough Times?

Please post a comment to give us some guidance.

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In a prior posting, I articulated several suggestions or tips on oral communication with the borrower or principal about a troubled loan.  The most basic goals of a workout (restructure or recovery) require some oral communication.  Another goal is to avoid "bad" communication.

Here are several more tips:

Power of Two:  All conversations should involve at least two (2) lender personnel.  There is strength in numbers – and it can help if (or when) at a later date, the borrower has a “different” version of the conversation.

Disclaimers:  At the start of the conversation, clearly state that you have no authority to bind the lender, that the call is merely meant to collect information, etc.  It is a good idea to repeat the statement at the end of the call.

No Threats:  Never ever threaten a criminal or civil law suit.  Never.

No Oral Agreements:  Agreements should be in writing.  Do not invite or create oral agreements.  In other words, simply agree to put terms into writing as a follow-up to the conversation so the borrower (and its counsel) can review them.  And, as noted above, make it clear that other lender personnel will need to approve the written terms before become a binding agreement.

Stick to Your Business:  Only make statements that are well within the scope of your business. Never suggest ways for the borrower to run its business or improve business.  Use “I need to see” statements.  Avoid statements like “you’d make more money if. . . . “  You should exercise control over your business as the lender, and NOT the operations of the borrower’s business.

One-sided Deals:  Avoid suggesting structures that solely benefit you.  A decision that solely benefits the lender (without benefit to borrower) probably will come back to haunt the lender.  Once again, avoid proposing the “too good to be true” idea.

No Recordings:  Don't. (Sorry that I even mention this, but it is always best to state the obvious.)

As stated in my earlier posting, in future postings, we’ll cover related topics such as (i) theories of lender liability and recommendations on avoiding it, (ii) attorney client communication, and (iii) the “drivers” behind the borrower’s perspective.

Any thoughts, suggestions or other comments on this important topic?

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What can I say in my discussions?
In a prior posting, I commented upon the lack of experience among the entire range of people on the workout team – from outside legal counsel to title company personnel.  Indeed, in our office, the experience topic is a matter of concern, and training and mentoring are focal points for those of us with experience.

One subject that I’m often asked about is this one: “What can I tell the borrower and the guarantors or principals?  What should I NOT say?  I just want to punch him\her in the face! After all the games of golf that we’ve played together through the years, now they . . . . ”

Behind this question is a healthy fear or concern of the “L” words: Lender Liability.   Oral communication with a borrower (and guarantors) and others about a troubled loan is a minefield – where innocent comments, a bad attitude at the end of a hard day, handwritten notes during the conversation, etc., can and will be “used against” the lender in a law suit alleging any number of lender liability claims (and defenses to performance under the loan).  (Theories of lender liability and defenses to performance will be the subject of numerous future postings.)

One important point before you pick up the phone:
Consider the value of entering into a discussion or negotiations agreement with the borrower and the guarantors. (We’ll cover this subject in a future posting.)

The following are some practical thoughts and suggestions on this important “say what” topic (several topics will be discussed in the second part of this two part series):

Attitude:  Be calm, be cool, be factual and don’t take it personally. Don’t react to emotional statements or threats. Stay far away from emotional displays of your own. No name calling. And don’t react to being called some thing. Leave your “bad day” in the other room before you make the call. (Yes, this can resemble a bad day at recess.)

Truth, Fairness and Good Faith:  Regardless of whether your state has an implied covenant of good faith and fair dealing, your statements should be measured against general standards of “fairness and good faith.” Stick with the truth. (In other words, if a jury heard your statement, would they think that you were being a jerk or an untruthful son of a ____ [ you know]?)

Loan Documents:  Know your loan documents and do not make a statement that contradicts them. If you are discussing possible modifications to the loan documents, make it clear that nothing will be modified until there is a written agreement, and that other lender personnel will need to approve all changes before they are binding.

Call Notes: Take written notes, but be careful in what you record (remember, these notes might be used by not only the lender’s lawyer, but also by the borrower’s lawyer in a law suit).

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In difficult economic environments, judges and lawyers struggle with balancing legal rights and stressful economic conditions. Historically, lending relationships contain contractually agreed duties with minimum statutory requirements. However, the stress of the economic conditions has caused imaginative lawyers and sympathetic judges to apply tort causes of action in contractually agreed relationships – sometimes referred to as "contorts."

Stay Within Your Documents
The first law of analysis and evaluation of duties always starts with the agreed duties in the documents. If the performance of the parties is in strict compliance with the documents, there is limited contort analysis.

Liability, Causation and Remedy
Any legal cause of action must be founded upon liability, causation, and remedies. During past stressful economic times, judges and lawyers have struggled with application of difficult facts to establish causes of action. Over time the courts moved to an analysis of the nature of the remedy and in particular, whether contractual damages were sought. If the damages were contractual in nature, the cause of action was viewed as contractual. Southwestern Bell Tel. Co. v. DeLanney, 809 S.W.2d 493 (Tex. 1991).
 

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