Banking and Lender Liability - Is the Genie Slipping out of the Bottle?
Recent decisions from courts in the State of New Jersey and a new wave of lawsuits against financial institutions - particularly class action lawsuits - may be a signal that this is no time for complacency in banking. Plaintiffs' lawyers have regrouped and are ready for a creative new wave of attacks on banking practices. The present case law may give the plaintiffs' lawyers the openings they have been waiting for. A general survey of some of these developments follows:
Sons of Thunder - The Duty of Good Faith and Fair Dealing
In Sons of Thunder, Inc. v. Borden, Inc., the Supreme Court of New Jersey fundamentally altered generally accepted rules of contract construction. Before Sons of Thunder, if a party did not breach its contractual obligations it could not be liable for bad faith. In the banking context, this meant, among other things, that a bank could call a loan, refuse to fund, refuse to roll over a loan, set off accounts, etc., no matter how drastic the foreseeable consequences might be to the borrower/customer, so long as the bank acted within expressly granted rights under the controlling loan documents. That may no longer be the case.
In Sons of Thunder, one party ("Borden") to a contract for the supply of clams exercised a termination clause in the contract with the knowledge that the foreseeable consequences of its action would be the demise of the other party ("Sons of Thunder"). The Supreme Court upheld a jury verdict that, even though Borden did not breach express obligations of the contract in terminating the contract, it did breach the implied covenant of good faith and fair dealing and was, therefore, liable to Sons of Thunder for consequential damages, including lost profits.
In other words, the Court found that Borden had breached the implied covenant of good faith in fair dealing in performing its obligations under the contract. Specifically the Court ruled:
Because its conduct destroyed Sons of Thunder's reasonable expectations and right to receive the fruits of the contract, Borden also breached the implied covenant of good faith found in New Jersey's common law.
Bankers should not take comfort in the fact that Sons of Thunder involved clams instead of dollars. In Maharaja Travel, Inc. ("Maharaja") v. Bank of India ("BOI") a federal judge ruled that, under New York law, a bank could be liable for breach of the implied covenant of good faith of fair dealing even if it performed correctly under the expressed terms of the contract. In Maharaja, BOI entered into a credit facility with Maharaja pursuant to which it would provide letters of credit and other arrangements necessary for Maharaja to operate its travel business. The commitment letter signed by the parties specifically stated that "[t]hese facilities are available at [BOI's] discretion." After BOI refused to provide funds to Maharaja, Maharaja's business failed and the law suit ensued. As in Sons of Thunder, the court found that BOI had not breached its contractual obligations under the credit facility. Nevertheless, the court refused to dismiss Maharaja's claim for breach of contract because it found that even where a party performs according to the express terms of the contract:
A party's action implicates the implied covenant of good faith if it acts so directly to impair the value of the contract for another party that it may be assumed that they are inconsistent with the intent of the parties.
Read together, Sons of Thunder and Maharaja signal an erosion, if not an outright end to the general rule of contract construction that a party will not incur liability for simply exercising the rights it contracted for, even if the consequences of that action are harsh on the other party to the contract. Banks in particular will now have to consider both the express terms of its contractual obligations, as well as the consequences of its acts or failure to act. Indeed, banks should assume that in every loan document there is a covenant substantively providing as follows:
Notwithstanding any right granted herein to Bank, nor any obligations undertaken by borrowers/customer, Bank shall be obligated to take such action as necessary to carry out the purposes for which this Agreement was made and to refrain from doing anything that would destroy or injure borrowers/customers' right to receive the reasonably anticipated benefits of this Agreement.
Fiduciary Duties/Duty to Disclose
Last year, the New Jersey Appellate Division issued two important opinions addressing the legal relationship between a bank and its borrower/customer. In United Jersey Bank, Central v. 914 Westfield Avenue Associates, et al., the borrower claimed that the bank had fraudulently induced him to borrow funds in order to purchase a business that was also a customer of the bank and which t he bank knew was in declining financial condition.
According to the court, the borrower's contentions raised "novel and far-reaching issues concerning a bank's relationship with a client/customer and whether such relationship carries some fiduciary obligations." The court denied summary judgment to the bank on the theory that a duty to disclose may exist even in the absence of a fiduciary relationship. Here, where the allegation was that the bank officers did offer some opinion as to the viability of the business, the allegations were sufficient to state a prima facia case for common law fraud against the bank.United Jersey Bank v. Kensey, et al., the courts were presented with different facts but substantively the same issue. In Kensey, the borrower knew that it was borrowing money to purchase a business and some property from an individual who was also a borrower of the bank, but whose loans were in default and being handled by the work-out department. The bank did not disclose, however, that it had an appraisal in its files indicating that the value of the property/business was less than the purchase price the borrower was paying for the property/business. When the new borrower defaulted and litigation ensued, he claimed that the bank breached a fiduciary duty owed to him to disclose the value in the bank's own appraisal. Once again, the Appellate Division saw the case as presenting "novel and far-reaching issues concerning a bank's relationship with its customers."
The court noted, however, "the growing trend to impose a duty to disclose in many circumstances in which silence historically sufficed." According to the court, "the common thread running through them is that the lender encouraged the borrower to repose special trust or confidence in its advice, thereby inducing the borrower's reliance." Finding that factor to be absent in the case before it, the court reaffirmed the general rule that banks have no duty to disclose information they may have concerning the financial viability of the transactions their borrowers are about to enter into. Accordingly, summary judgment was entered for the bank.
Although Kensey was a win for the bank, it is troubling that the Kensey and 914 Westfield Avenue courts recognized a trend of cases imposing liabilities on banks that historically were only imposed in the context of fiduciary relationships.
Other Banking Litigation Developments
Class Actions. There is a trend, which we predict will grow, for class actions attacking any uniform bank practice. Earlier updates discussed the wave of collateral protection insurance class action lawsuits. Now, the New Jersey Supreme Court in Lemelledo v. Beneficial Management, has ruled that the New Jersey Consumer Fraud Act, which allows treble damages and recovery of attorney's fees, applies to a financial institution's sale of insurance in conjunction with loans. Also, in Noel v. Fleet Finance, Inc., a Federal Judge in the Eastern District of Michigan recognized, among other things, the viability of a class action claim against lenders and mortgage brokers under the Truth In Lending Act for failing to disclose the yield spread premium paid by the lender to mortgage brokers. And this year, after the Eleventh Circuit in Culpepper v. Inland Mtge ruled that yield spread premiums were prohibited referral fees under RESPA, plaintiffs instituted a RICO class action based on that practice. Finally, in Cannon v. Nationwide Acceptance Corporation, a Federal Judge in the Northern District of Illinois allowed a RICO class action to be maintained on the basic premise that the lenders' solicitation of new business induced existing borrowers to refinance existing loans rather than going the cheaper route of just borrowing more funds.
Environmental. In CoreStates/New Jersey National Bank v. D.E.P., a New Jersey Administrative Law Judge ruled that a lender obtaining property through foreclosure may lose the protections otherwise provided to lenders under the Spill Act if, after obtaining the property, it acts negligently in its maintenance of the property.
ECOA. In Machis Savings Bank v. Ramsdell, the Maine Supreme Court ruled that wives who co-signed a series of loans to their husbands' construction company could defeat summary judgment on a foreclosure action on the basis of the allegation that they had not signed the loan modification agreements and on the affirmative defense of ECOA violations.
Parole Evidence/Statute of Frauds. In Nation Banks of Tennessee v. JDRC Corporation, et al., the Court of Appeals of Tennessee ruled that an internal commercial loan memorandum could satisfy the Statute of Frauds and that such internal bank documents were admissible, notwithstanding the Parole Evidence Rule, to prove an oral modification to written loan documents.
Bankruptcy. In, In re: Shady Grove Tech Center Associates Limited Partnership, a federal bankruptcy court in Maryland found "cause" to lift a stay where the debtor had executed a pre-p etition stay waiver, even though the real estate mortgage lender was adequately protected. The case is particularly interesting for its thorough discussion of the enforceability of pre-petition stay waiver agreements.