Aba lending liability presentation 2013 (w o video)

Avoiding Lender Liability Issues in Commercial Lending

American Bankers AssociationNational Commercial Lending School

March 21, 2013

Presented by Tricia R. DeLeon, Lauren J. Brownand Andrea Broyles

Bracewell & Giuliani LLPDallas, Texas

[email protected]@bgllp.com

[email protected]

aba.com |1-800-BANKERS

1


2

Lender Liability Quiz

The number one theory of lender liability used by

Plaintiffs against lenders is:

a. Duressb. Bad Faithc. Breach of Contractd. Fraud and Misrepresentation


3


The number one theory of lender liability used by

Plaintiffs against lenders is:

a. Duressb. Bad Faithc. Breach of Contractd. Fraud and Misrepresentation


4


If a lender comments on a customer's credit and makes a negligent or fraudulent response, it may be the basis of a lender liability lawsuit.

True False


5


If a lender comments on a customer's credit and makes a negligent or fraudulent response, it may be the basis of a lender liability lawsuit.

True False


6


The mere lending of money is not a "good or service" sufficient for a customer to sue a bank for a claim under the Deceptive Trade Practices Act. True False


7


The mere lending of money is not a "good or service" sufficient for a customer to sue a bank for a claim under the Deceptive Trade Practices Act. True False


8


• Commonly used bank software is a contributing factor to the onslaught of wrongful foreclosure suits.

True False


9


• Commonly used bank software is a contributing factor to the onslaught of wrongful foreclosure suits.

True False


10


The lender can always rely on a demand clause in a loan agreement because the borrower agreed to the terms when the loan agreement was signed by the borrower.

True False


11


The lender can always rely on a demand clause in a loan agreement because the borrower agreed to the terms when the loan agreement was signed by the borrower.

True False


12


• The "parol evidence rule" protects lenders from borrowers' lawsuits claiming lenders made oral agreements which contradict the loan agreement.

True False


13


• The "parol evidence rule" protects lenders from borrowers' lawsuits claiming lenders made oral agreements which contradict the loan agreement.

True False


14


• If a lender begins to accept late loan payments the lender may need to notify the borrower before deviating from that established pattern.

True False


15


• If a lender begins to accept late loan payments the lender may need to notify the borrower before deviating from that established pattern.

True False



A lender's best defense in a lender liability suit is:a. Demonstrating that the lender has avoided

excessive control over the borrower's business.b. Demonstrating that the lender followed its own

policies and procedures.c. Proving that the lender fully disclosed all

pertinent points and risks of the loan to the borrower.

16



A lender's best defense in a lender liability suit is:a. Demonstrating that the lender has avoided

excessive control over the borrower's business.b. Demonstrating that the lender followed its own

policies and procedures.c. Proving that the lender fully disclosed all

pertinent points and risks of the loan to the borrower.

17

All of the above


18


The largest lender liability award upheld on appeal was for: A. $7 million B. $17 million C. $70 million D. $700 million


19


The largest lender liability award upheld on appeal was for: A. $7 million B. $17 million C. $70 million D. $700 million


20

Origins of Lender Liability

• First gained prominence in the 1980s.• Claims are more prevalent when the

economy is suffering.


21

Most Common Lender Liability Claims

1. Breach of Contract2. Negligent Misrepresentation3. Fraud4. Bad Faith5. Breach of Fiduciary Duty6. Duress7. Labor Violations 8. Environmental Violations9. Deepening Insolvency10. Wrongful Foreclosure


Consumer Foreclosures

22


Consumer Foreclosures – Timeline

2007 – 2012: 4 million families lost homes due to foreclosure

2008: Truth in Lending Act

2010: validity of foreclosures questioned – sloppy records, robo‐signing, fraud

2011: attorney generals of 40 states investigate abuse, slowing foreclosures

2012: $26 billion settlement with five of the nation’s biggest banks

23


Consumer Foreclosures: Update for 2013

$8.5 billion settlement with ten major lendersResolving claims of

flawed paperwork and loan modifications

Goldman Sachs and Morgan Stanley settle for $557 million ‐resolving claims of wrongful foreclosure

New rules laid out by Consumer Financial Protection Bureau to

curb abuses

24


Consumer Foreclosures: Concerns

• Improper documentation or notice – Problems with chain of title– Distrust of authority signing off on foreclosures

• Misrepresentations about loan modifications or payments

• “Zombie” titles from incomplete foreclosures

25


Consumer Foreclosures: Prevention

• Maintain proper loan documentation

• Avoid total reliance on MERS • Provide quick assistance in the

event of a mistake • Communicate frequently and

thoroughly

• Educate employees on what they are signing and the steps of foreclosure proceedings

26


Multi‐Lender Transactions

• Structures of multi‐lender transactions present difficult questions in lender liability suits

• Primary lender has typical loan and servicing agreements

• Co‐lenders’ relationship governed by co‐lender, participation, or intercreditor agreement

27


Multi‐Lender Transactions:Common Causes of Action

• Lenders can be sued by co‐lenders & borrowers for:– Fraudulent Inducement– Breach of Contract– Breach of Required Standard of Care

– Fraud or Nondisclosure – Breach of Implied Covenant of Good Faith

28


Multi‐Lender Transactions:Case Study

• Northwest Bank enters into participation agreement with First Illinois National Bank (“FINB”) to help finance equipment purchase for FINB’s customer

• FINB provided financial statements and a loan presentation package

• Borrower goes into bankruptcy after 3 years

29


How did the Court rule?

• Northwest Bank claims the information provided was false and misleading and brought claims for: – Fraudulent inducement – Fraudulent conveyance– Breach of fiduciary duty – Breach of contract– Unjust enrichment

How did the court rule? 30


Multi‐Lender Transactions: Recommendations

• Complete documentation • Thorough disclosures • Constant communication

31


32

Breach of ContractExamples and Scenarios

1. Breach of lenders' commitment to fund or renew loan

2. Breach of lenders' oral commitments

3. Breach of good faith and fair dealing


33

Breach of Contract Defense

• Parol Evidence: prevents “oral evidence” from contradicting or adding to the terms of the written contract.


34

Negligent Misrepresentation

Beware of Verbal Agreements

• A borrower's reliance on a lender's alleged, verbal promise, even though not contained in the loan documents, can still result in common-law fraud damages.


Negligent Misrepresentation

• 2 contractors signed a $60kconstruction loan with Burleson State Bank, which funded the remodel of a client’s house.

• A bank employee represented to the contractors and to the clients that the clients were responsible for repaying the $60k loan, not the contractors.

Burleson State Bank v. Burt Plunkett, 27 S.W.3d 605 (Tex. App.—Waco 2000).

36


• When the bank required the contractors to repay the loan, the contractors brought claims against the bank for:

‐Negligent Misrepresentation‐Fraud‐Violation of the DTPA‐Breach of Fiduciary Duty

How did the court rule?

37


38

Loan Documents Should Say It All

• The loan documents must disclaim reliance on anything other than what is contained in the loan documents.


39

Loan Documents Should Say It All

• Make clear there are (1) no agreements other than what is in the contract; and (2) neither party is relying upon promises not in the contract.


41

Sample Disclaimer

• Always insert an integration clause into the contract that is boldfaced, CAPITALIZED, underlined, or otherwise set apart from the surrounding written material so that it is CONSPICUOUS.


42

Model Language for Disclaimer

• THIS WRITTEN LOAN AGREEMENT PRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.


43

Parol Evidence Admitted Against Lender

• Courts will consider an oral agreement when coupled with partial performance.

• Parol evidence does not bar fraud claim.

• Internal commercial loan memo may be admissible.


Parole Evidence Admitted Against Lender

• Courts may consider e‐mail communications to be “signed writings” that modify an existing contract.

• E‐mails may be admissions to modify written agreements, even if the contract disclaims oral modifications.

44


Breach of Good Faith and Fair Dealing

• Contracts governed by UCC are subject to obligation of good faith and fair dealing (1.304).

• Most courts even hold there is a duty for mortgage loan documents, if there is a relationship of trust.

45


Good Faith and Fair Dealing‐Case Scenario

• Customer has a $3.5M discretionary line of credit that is fully secured. Documents provided for repayment of the loan upon demand.

• Without notice, the Lender’s loan officer refuses to advance funds to cover checks the borrower had written despite consent to advance the funds.

46



• Customer claims that the failure to advance the funds caused it to bounce checks and eventually go out of business.

Does the Lender have a duty of good faith and fair dealing when advancing funds to the Customer?

47



• In a proposal letter, a Lender agrees to investigate the possibility of funding a proposed acquisition in exchange for a $20k commitment from the Customer.

•The Customer agrees to supply information and data and the Lender agrees to review this material with reasonable care.Did the Lender have a duty to negotiate the terms of the loan agreement in good faith?

48


49

What is "Deepening the Insolvency of a Borrower?"

• Lender participates in deepening the insolvency of a borrower by lending more money when there is no hope of the borrower being able to repay.


50

Who Sues the Bank?

• Lender becomes liable to a trustee or creditors' committee in bankruptcy.

• Some courts require the "fraudulent prolonging of a corporate existence beyond insolvency" by hiding its true financial condition.

• Lender is considered an aider and abettor of borrower's conduct.


51

Borrower Fraud/Deepening Insolvency

• Often borrowers will use false or misleading information to induce lender to continue lending commitment.

• If lender discovers fraud and continues on with a workout or forbearance, lender may be liable for a deepening the insolvency claim.


Case Study: Deepening Insolvency

• CitX was an insolvent internet company which operated a Ponzi scheme and used its financial statements to attract investors.

52


CitX’s Scam

• CitX incurred millions in debt and exhausted its investors’ money and then filed for Chapter 11. Trustee sued the accounting firm who compiled the financial statements.

53


Accounting Firm’s Missteps

• Accounting firm missed several red flags: (1) CitX’s bookkeeper was a high‐school dropout and was the founder’s girlfriend; (2) CitX was bouncing checks; (3) CitX’s only asset was a receivable from a fraudulent company that was shut down by the Florida AG

54


Should the Accounting Firm be Liable?

• Trustee sued accounting firm for negligence, malpractice and deepening insolvency

55


56

Lender's Checklist to Avoid Deepening Insolvency Claims

Understand the borrower's solvency position under at least 3 tests: balance sheet, cash flow and adequate capital.

Make and memorialize decisions in light of the protections that exist under the business judgment defense.

Resist financing losses with further debt. Monitor key financial ratios and indicators. Get consent or support of major creditors

before implementing strategies that pose a risk to major assets.


57

Don't Take Active Control In Borrower's Business

• Banks should not use lending power to coerce and control the direction of the borrower's business.


58

Case Scenario: Control

• Farah Manufacturing was a family owned apparel company.

• Mr. Farah was the CEO.• A strike financially

crippled the firm.• Farah was ousted and a

fight for internal control ensued.

State National Bank of El Paso v. Farah Manufacturing Co.,678 S.W.2d 661 (Tex. App. – El Paso 1984)


59

Case Scenario: Control

• The lender threatened to call its note if Farah was allowed to regain control of the company.

• Farah contended at trial that the lender hand-picked directors and officers that mismanaged the company.

How did the court rule?


Case Scenario: Control Over Borrower

• Busy Bee, Inc. was a family operated whole‐sale and retail shoe business.

• Busy Bee, Inc. had a banking relationship with Third National Bank.

• Busy Bee relied heavily on letters of credit for their foreign wholesale orders.Busy Bee, Inc. v. Wachovia Bank, N.A., 2006 WL 723487 (Pa. Com. Pl. 2006).

60


Allegations of Control

•Bank required approval before Busy Bee could issue a check to a vendor.

•Bank compelled Busy Bee to abandon its retail business strategy and liquidate the retail arm of the business.

•Bank directed Busy Bee to retain Fox Promotions as a liquidation consultant.

Did the court find that the Bank had too much control?

61


62

How Much Control Is Too Much?

• Don't direct what bills should be paid.

• Don't direct the retention or replacement of management.

• Don't direct the borrower's choice of third-party vendors, consultants, accountants, etc.

• Don't direct the reduction in officers' salaries.

• Don't direct the day-to-day management of borrower's operations.


63

Importance of Disclosure

• Disclosure is a process that may form part of legal proceedings, whereby parties inform ("disclose") to other parties the existence of any relevant facts or documents that are, or have been, in their control.


Case Scenario: The Importance of Disclosure

• A couple entered into a loan agreement to construct a new home.

• The agreement allowed the bank to conduct inspections of the home for the benefit of the bank.

• After the term of the construction loan expired, the construction loan was converted to a traditional loan.

Glascock v. City Nat’l Bank of W. Va., 576 S.E.2d 540 (W. Va. 2002).

65



• During the construction of the home, the couple had to fire the first two contractors for poor workmanship.

• The bank had an inspection done on the home.

• The inspection revealed defects in the siding, floors, and electrical system.

Did the bank have to disclose the inspection report?

66



• A mother and daughter formed a company, ALI, for the purpose of building, owning, and operating a Motel 6 franchise.

• When ALI attempted to obtain financing at Citizens National Bank, the business development officer suggested they invest in the Bed & Bath Inn franchise instead, because it was cheaper, could be built faster, and an SBA loan was available for this franchise.

67



• The bank officer provided ALI with a Bed & Bath brochure, but at the time, the bank had not:1. conducted any due diligence

regarding the company;2. investigated the accuracy of

the information in the brochure; or

3. determined Bed & Bath’s creditworthiness.

• Even when Bed & Bath failed to provide financial statements, the bank encouraged the investment.

68



•Bed & Bath abandoned the construction project and failed to pay subcontractors.

•The bank foreclosed on the project and ALI filed a lawsuit against the bank.

Did the court find that thebank had a duty to disclose?

Citizens Nat’l Bank v. Allen Rae Invs., Inc.,142 S.W.3d 459 (Tex. App.—Fort Worth 2004).

69



• Commercial National Bank and Farmers State Bank had a longstanding correspondent banking relationship.

• Commercial would provide loans to Farmers’ customers who sought credit in excess of Farmers’ lending limit.

• The banks would share relevant financial dataand make a decision to enter into an overlineloan.

70

Commercial Nat’l Bank v. FDIC, 476 N.E.2d 809 (Ill. App. 3d 1985)



• Farmers requested an overline loan for its customer, Tingley Products (“Tingley”), of $90,000 to complete a contract.

• Farmers provided financial statements that evidenced the net worth of Tingley and its owners totaled around $500,000.

• Commercial agreed to make the loan unsecured, backed by the personal guarantees of the owners.

71



• Farmers knew Tingley had:(1) laid off all of their employees

three months prior;(2) an overdraft of $88,000 with

Farmers; and(3) an outstanding loan of

$56,000 payable to its owners.

72

Did Famers have a duty to disclose these facts to Commercial?



• First Fidelity Bank informed a couple looking to make additional income that a grocery store was for sale.

• The grocery store was being sold by customers of First Fidelity.

• The customers told the couple they could earn a “good living” in the business.

• The couple bought the store and pledged their farm and home as collateral.

Buxcel v. First Fid. Bank, 601 N.W.2d 593 (S.D. 1999).

73



•Before buying the grocery store, the couple did not know that:(1) the sellers were

customers of First Fidelity and

(2) the store had significant cash flow problems and was heavily indebted.

74

Did First Fidelity have a duty to disclose the financial condition of the grocery store?


75

Is the Future Better for Banks to Defend Against Lender Liability Suits?

• Yes!• Con/tort defenses are being

recognized.• "Good faith" liability is still a gray area

between contract and tort.• Well drafted loan agreements protect

the Bank.


Consumer Financial Protection Bureau

• Established by Dodd‐Frank: requiring creditors to make a reasonable and good faithdetermination, based on verified and documented information, that customer has reasonable ability to repay

• Goals: – Educate consumers– Enforce regulations and

supervise lenders– Study financial markets

76


Consumer Financial Protection Bureau:Ability to Pay and Qualified Mortgages

• Underwriting Factors– Current financial and employment status

– Monthly payments on the covered transaction and other debt obligations

– Monthly debt‐to‐income ratio or residual income

– Credit history

January 10, 2014

77


Consumer Financial Protection Bureau:Ability to Pay and Qualified Mortgages

• Recordkeeping requirements– Must retain records showing compliance with the rule for THREEyears

*COMING SOON: January 10, 2014*

78


Consumer Financial Protection Bureau:Homeownership and Equity Protection

• Now covers most types of mortgage loans

• Counseling Amendments– Must provide a list of

homeownership counseling organizations to consumer within three business days of loan application

– Must confirm a first‐time borrower received counseling before making loan with negative amortization

*COMING SOON: January 10, 2014*

79


Consumer Financial Protection Bureau:Future Authority?

• Issuing guidance on all areas of lending– Debt collection procedures– Education loan procedures – More to come?

• Stay up‐to‐date• www.consumerfinance.gov

80


Top 10 Takeaways

10. Honor your loan commitments unless legally unreasonable to do so.9. Never make sudden changes in the agreements.8. Don’t “help” or excessively control the borrower’s business.7. Document everything in the file, especially late payments.

81


Top 10 Takeaways

• 6. Keep all e‐mails objective, unemotional and accurate.

• 5. Never lie or fail to disclose unfavorable information if you choose to speak about a customer.

• 4. Train your employees on the risks of lender liability.

82


Top Ten Takeaways

• 3. Be consistent.• 2. Consider discontinuing additional lending if red flags exist.

• 1. Your lawyers are your friends. Consult with them early and often on trouble accounts.

83

Aba lending liability presentation 2013 (w o video)

Documents

Transcript of Aba lending liability presentation 2013 (w o video)