Courts Shift to the Lenders' Side
In perhaps the most positive recent legal development affecting bank bottom lines, a number of state supreme courts have placed paramount importance on the wording of a loan in deciding lawsuits between business borrowers and lenders.
These state supreme court decisions lend permanence to a trend begun in 1988 in lower state and federal courts.
In fact, the last three years have seen the reversal of the previously widespread concept that a loan involves a fiduciary or trust relationship that overrides contract terms. This turnaround is the result of hundreds of state and federal trial and appellate decisions.
The pendulum has swung against the "lender liability" doctrines of breach of good faith, fiduciary duty, and implied or oral commitment to make a loan.
The Final Arbiters
But all those courts must work by divining what the ruling would be in the supreme court of the state in which a case arises.
Given the slow pace of the appellate process, it has taken several years for a new generation of lending disputes to reach and be decided by the state high courts.
In the past year, the following opinions have come down:
* In a 5-to-3 decision, the Texas Supreme Court ruled that language commonly used in loan guaranties - language providing that guaranties remain valid regardless of the lender's method of collecting from the borrower - effectively waives any goodfaith duty to the guarantor regarding the method of selling collateral.
* In a 4-to-3 decision, the California Supreme Court held that even when a lender had forfeited the right to foreclose on a mortgage because the lender already had levied on the borrower's bank account, the lender still could pursue the guarantors for collection of the underlying note.
* The Montana Supreme Court ruled that fiduciary duties rarely arise in lending relationships. Proof of a "course of dealing" - a string of past loan renewals or workouts that allegedly supports a continuing legal duty to renew or work out - is not admissible at trial, the court said. The court gave as its reason the rules barring oral evidence contrary to written agreements.
* While a bank may attempt to work out most troubled loans, the Supreme Court of Washington held a lender is on solid ground if it "simply stands on its rights to require performance of a [loan] contract according to its terms." Proof of a "course of dealing," the court suggested, is irrelevant unless the loan agreement expressly requires a workout or renewal.
* Where a bank is both lender and trustee, and the assets in the trust are used to collateralize a loan to the trust beneficiary, the Maine Supreme Court held the bank is not responsible to investigate the risks of the loan beyond normal underwriting. The borrower/beneficiary's choice to seek the loan curtails his ability to challenge the bank's actions, the court added.
* Lenders have a good faith duty to borrowers under Nebraska law, its Supreme Court said, but this duty does not imply a duty to renew. Rather, the duty is to carry out the contract in accordance with its terms, fairly and consistent with banking industry custom.
* An oral promise to make a loan, even if not fulfilled, is not grounds for "negligent misrepresentation" because it concerns a future promise rather than a past or present fact, the Supreme Court of Mississippi ruled. For such a promise to constitute fraud, the court held, the borrower must prove that the loan officer had an undisclosed intention not to make the loan, and that the borrower's loss resulted from the broken promise. This opinion came in the face of a contrary jury verdict.
* Such oral contracts, the Idaho Supreme Court held, must be very specific to be enforceable. A bank has no duty to disclose its expectation of official action, such as a belief that the Small Business Administration would deny a guaranty application, because the bank has no fiduciary duty to a potential borrower.
A Countervailing Court View
The Mississippi court gave a rationale that reflects the justices' concerns in this time of numerous bank failures: "This court will not require a financial institution to lend funds to a failed business in contradiction to good judgment and in detriment to the resources of the bank."
Only two state supreme courts have issued rulings in the past year that ran contrary to written loan terms.
In New Mexico, the court found that a long "course of dealing" of accepting late payments may limit a bank's ability to accelerate a loan, and that a lender's failure to communicate its concern about an existing loan, during discussions concerning a possible future one, can form the basis of a breach of the duty of good faith.
The Supreme Court of Colorado permitted proof of an oral agreement to substitute one guarantor for another, explaining that the agreement would not modify the first guarantor's commitment, but completely replace it.
An Authoritative Trend
While court-made law never travels in a straight line, these decisions establish an authoritative national trend toward greater reliance on the written terms of business loans.
Although the decisions are tied to the facts of the particular cases, most lower state and federal courts try to follow not only the letter but the spirit of state supreme court rulings.
The spirit here - that lenders don't "owe" borrowers any more than loan agreements promise - should help lenders for years to come.
At least until state supreme courts change their minds.
Vic Simon is an attorney and associate editor of Lender Liability News, a publication of BURAFF Publications, Washington.