For banks that buy or sell loan syndications, Hitachi Credit America Corp.'s recent legal victory over Signet Banking Corp. imparts a valuable lesson: Details matter.
A federal judge ruled last week that Signet must pay Hitachi more than $9 million for failing to detect fraud in a $324 million loan Signet syndicated.
The fraud occurred in 1996 when Edward Reiners posed as a Philip Morris executive seeking credit to buy computer equipment for a secret offshore nicotine research facility. In fact, the entire deal was bogus.
Signet, unaware it was being duped, made the loan and syndicated it to several lenders, including a $24 million chunk to Hitachi. After Mr. Reiners was arrested, and authorities were only able to return to the lenders two-thirds of the amount of the loan, Hitachi sued to try and recover the rest.
U.S. District Judge James R. Spencer of Richmond, Va., in a series of rulings during the past 12 months, has handed both sides some victories. The judge dismissed allegations that Signet defrauded Hitachi but he agreed that the Richmond-based bank was guilty of breach of warranty.
A Signet spokeswoman declined to discuss the case in-depth or make the bank's lawyers available for interviews, but she said the bank would fight the ruling. "We are planning on appealing and are confident that the appeal will be successful," she said.
Banking lawyers said an in-depth review of the decision shows just how important the finer points of a contract are when deals fall apart.
Signet defeated the fraud charges because Hitachi signed a contract requiring it to conduct its own due diligence. This is boilerplate language found in almost every syndication and means Hitachi should have checked out Mr. Reiners rather than relying on Signet to determine if the deal was above board.
Hitachi tried to get around the contract by arguing that Signet was deliberately deceptive. "Signet affirmatively misrepresented the deal to avoid having Hitachi ask questions whose answers could not be provided," said Brian Sher, a partner at the Chicago law firm Ross & Hardies who represented Hitachi.
But the judge refused to budge, ruling that the contract absolved Signet of responsibility.
Signet's luck ran out on Hitachi's second claim. As part of the deal, Signet agreed to provide an incumbency certificate, which is a legal document that shows Philip Morris intended to lease the computers from the company that was financing the purchase.
Signet argued that it said only that the incumbency certificate would be valid to the best of its knowledge. Signet said because it had no knowledge at the time that the document was fake, it should not be held liable.
The argument may have prevailed, but elsewhere in the contract Signet defined knowledge as "actual knowledge." This distinction meant that Signet had a responsibility to deliver a legitimate certificate, not just one that it thought was valid.
"Signet warranted that the underlying lease was in full effect," the judge wrote. "The lease was not in full force as Philip Morris was never involved in the transaction. Hence, Hitachi must prevail as a matter of law."
Walter Effross, a professor at American University's Washington College of Law, said the case serves as a reminder that banks must carefully review all the wording in a contract.
"The bottom-line lesson for me is that you have to be really careful," he said. "If you want to qualify your warranty, you need to do that explicitly and clearly."
Another lawyer said Signet forgot the basic tenet of contract law. "When you give a representation it is a form of guarantee," the lawyer said. "If the representation is false, you are liable for damages to the party that relied on it."