Non-accruals are still down and so is impairment; notwithstanding, it is always important for both lenders and special asset managers to review and understand potential areas of liability.

There are both common-law and statutory theories of liability that may be asserted by the borrower. Common law theories of liability that may be asserted by the borrower generally arise in the context of a default/restructuring scenario.

In that regard, we are going to consider several tort theories that could be asserted by borrowers regarding excessive control, including instrumentality theory, agency theory, negligence, fraud, and joint-venture theory.

Torts by Lender

The Lender-Borrower Relationship

The lender-borrower relationship does not by itself impose fiduciary obligations on the lender. However, if there is a “confidential relationship between a bank and its customer,” a fiduciary obligation could be imposed on the bank. A confidential relationship is created when trust is reposed by one party in another with resulting superiority and influence exercised by the other. However, in Hoffman v. Lincoln National Bank & Trust Co., the court held that even if a confidential relationship existed, the plaintiffs had failed to demonstrate that the bank gained an unconscionable advantage by abusing it. Therefore, just the mere existence of a confidential relationship does not necessarily impose liability; albeit, in the Capital Bank v. MVG, Inc., case, a similar test was used to determine whether it established a confidential relationship between the bank and the borrower. In this case, the court found that the bank’s unfair control of the borrower to satisfy the bank’s claim, along with the existence of a confidential relationship was sufficient to support a finding that the bank had breached its fiduciary duty to the borrower.

Instrumentality Theory, Agency Theory, and Joint-Venture Theory

Under instrumentality theory, a lender may expose itself to direct liability to the borrower and third parties where the lender exercises such control over the borrower’s day-to-day operations whereby the lender becomes the borrower. The lender’s actions must be sufficient to establish actual, participating and total control of the debtor by the creditor. However, direct liability can still be incurred even where total control of the borrower pursuant to the instrumentality theory does not exist, but the lender exercises substantial control over the borrower such that the lender may be characterized as an agent or the lender’s relationship with the borrower is more like a partnership or joint venture.

Tortious Interference with a Contract

According to the Restatement of Torts:

One who intentionally or improperly interferes with the performance of a contract between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for pecuniary loss resulting to the other from the failure of the third person to perform the contract.

As stated above, tortious interference with a contract arises when the following elements exit:

-Plaintiff has a valid contract with a third-party,

-The lender knows of the contract,

and intentionally induces the third-party to breach the contract;

-The lender prevents the plaintiff from performing on the contract and the plaintiff is damaged as a result of such interference.

However, lenders who have interfered with contracts through the bona fide exercise of their rights and remedies have been deemed privileged to do so.

Negligence

Lenders may also be found liable to borrowers and third parties on a negligence theory. The plaintiff must show that the lender owed the plaintiff a duty of care and that the lender breached that duty, and the breach proximately caused the plaintiffs injury. As stated above, the general rule is that a lender owes no duty of care to a borrower when the lender’s role in the transaction does not exceed the scope of its conventional role as a lender.

Fraud

The lender may be liable for fraud if it makes a material, false misrepresentation with knowledge of its falsity or conceals a material fact when it has a duty to disclose, resulting in damages to a borrower or third party. However, if it is found that a relationship of confidence and trust exists between borrower and lender, constructive fraud may still arise even if a lender possesses no actual fraudulent intent.

Conclusion

A lender or special servicer should always consult with legal counsel in addressing the legal theories as discussed herein. The cost of litigating lender liability can be significant. An understanding of these theories can help the special assets manager in deciding which workout strategy is best given the factors present. It may also provide an alternative and more favorable workout plan for the bank.

About the author Conrad Andersen

Conrad is the executive managing principal of The Syntax Group; the Syntax Group provides expert witness and litigation support for banks and special servicers. Conrad has approximately 30-years of experience in both master and special servicing, including corporate real estate held-for-sale management and disposition, CMBS underwriting, placement and commercial real estate capital markets

References:

http://apps.americanbar.org/abastore/products/books/abstracts/5070531_SamCh.pdf

https://www.sheppardmullin.com/media/article/713_Lender%20Liability%20Article%20-%20Eugene%20Kim.pdf

https://www.justia.com/trials-litigation/docs/caci/2200/2201.html

Hoffman v. Lincoln National Bank & Trust Co. 636 N.E.2d 185 (1994)

CAPITAL BANK v. MVB, INC.644 So.2d 515 (1994)

Disclaimer: The information discussed herein and in this website is merely for informational purpose only; it is not to be relied upon nor does it constitute legal advice. Legal counsel should be consulted concerning any of the information discussed in this article.

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