In March 2020, banks were bracing for a deluge of troubled loans. Federal and state legislation and executive orders have created a web of red tape for lenders. Public and government pressure to refrain from applying the loans intensified and the rules seemed to be continually changing. Banks were thinking about lender liability on an almost constant basis.
Two years into the pandemic, most COVID-19 restrictions on foreclosures, evictions and other enforcement measures have expired. But the flood of troubled loans did not come. Training tools may be largely inactive in the current environment. When economic downtown inevitably occurs, liability claims from lenders will surely follow.
What is lender liability?
The liability of the lender may be presented as an affirmative claim in favor of the borrower or another party or as a defense to liability under the loan documents.
If a lender’s liability claim is successful, a lender may be liable for losses suffered by the borrower or a third party directly or indirectly caused by the actions or inactions of the lender, or the lender’s deficiency judgment may be set aside.
In extreme cases, the debt of the lender could be equitably subordinated to the claims of other creditors.
Minimize the risks
Lenders should remain aware of potential exposure and take proactive steps to minimize their risk.
Develop a training strategy: If there is a risk that the debt may not be fully secured, consider the policy for any deficiency claims. Lender liability risks increase when executing a deficiency claim, and lenders must carefully assess the true value of the claim. While a guarantor is a viable repayment option, lenders may choose to avoid certain non-judicial foreclosure alternatives to mitigate potential defenses to guarantor liability.
Avoid sudden movements: Provide advance notice of any enforcement action if possible. Absent fraud, misconduct, or other extreme circumstances, do not rely on provisions allowing the lender to accelerate a loan or seek other remedies without notice.
Avoid inconsistent or misleading communications: Review past communications, including emails, to determine what was communicated to the borrower. Defaulting borrowers often claim that the lender has “promised” to extend the loan or waive defaults. Assign a person as the borrower’s point of contact.
Avoid veiled threats: Do not make requests or offers without internal approval. Credit approvals and internal correspondence are often uncovered in disputes. Make sure correspondence is clear regarding the terms of the agreement and whether a term sheet remains subject to internal bank approval.
Honor your commitments: If the bank has suggested working with the borrower, consider whether the bank is bound by this commitment. Respect contractual obligations and formal commitments. Consult a practice lawyer before relying on a material adverse change or insecurity clause to enforce the loan or refuse to advance funds.
Avoid taking control of the business: The lender-borrower relationship must remain independent. Lenders should not give advice to the borrower or manage the business of the borrower. Do not tell the borrower which employees to lay off, which assets to sell, or which creditors to pay.
Lenders may require submission of a budget under a forbearance agreement, but the lender should not be involved in the preparation of the budget. If a lender has concerns about the management of the borrower, the appointment of a restructuring manager or third-party advisor may be required as a condition of a loan forbearance or extension.
Do not benefit at the expense of others: Lenders should not communicate with employees or other creditors. The borrower’s business should not be operated for the benefit of the lender and to the detriment of other creditors. The borrower must make all business decisions while the lender decides whether to continue the financial relationship or seek recourse.
Keep good records: Document all agreements, timeframes and extensions. Limit internal communications about the relationship, as these can be uncovered in the course of litigation. Record events objectively and accurately. Document any deterioration in the lender’s collateral position.
Transfer a distressed loan to a recovery agent: Coaching agents offer a new perspective. Shifting responsibility for a loan can help the borrower take the situation more seriously.
Talk to a Coaching Advisor: The practice lawyer can help the bank officer implement a default strategy and assess issues of collateral perfection, documentation, and potential counterclaim risks. Communications with the practice attorney are protected by attorney-client privilege.
Be professional: When a borrower defaults, be prepared for potential litigation. The view of a judge or jury should guide the lender’s decisions. The lender’s actions must be seen as fair to the borrower.•
Britton is an Indianapolis-based finance and restructuring partner at Faegre Drinker.