Few trends in recent years have struck lenders as more unwarranted than the proliferation of law-suits seeking to hold them liable for borrowers' soured real estate investments, bad business decisions, and polluted properties.
Until recently, courts throughout the country have tended to rule in favor of borrowers. Today, however, a number of key court decisions point to a restoration of balance between lender and creditor rights.
The emerging trend is evident in such key areas as mortgage lending, commercial lending, and environmental Superfund litigation.
The Search for Deep Pockets
Many reasons can be advanced to explain the phenomenal growth of lender liability lawsuits in the 1980s. In an overheated and often speculative economy, banks were often the only "deep pockets" in sight from which litigious individuals, businesses, or governments might seek to recoup losses.
As courts tended to side with debtors, banks were forced to bear the burden of demonstrating that they had acted in good faith and had exercised due diligence when suspending the credit of certain borrowers, in extending credit to others, and when assuming ownership, typically through foreclosure, of contaminated properties in Superfund situations.
Now these pressures are easing.
A decision by the U.S. District Court for Massachusetts, in the Concord Green case - named for a troubled condominium development - granted summary judgment to all defendants named in the suit, including Bay Bank and two smaller banks that had given mortgages to 13 individual investors in properties that later became financially distressed.
Bay Bank, represented by the Boston law firm of Riemer & Braunstein, decided to litigate rather than settle these charges, which lead attorney John Kuzinevich characterized in court documents as "sophisticated nuisance suits."
The strategy to fight rather than settle was successful, and Judge Rya Zobel's decision mirrored the arguments advanced by the banks. Judge Zobel observed sharply that the plaintiffs had "invested in a number of condominium units hoping to cash in on the real estate boom of the mid-1980s.
"Unfortunately, the real estate tides turned in the late 1980s, and the investments went sour." The borrowers' attempt to hold the banks responsible for their own inherently risky investments, she ruled, was wholly lacking in merit.
Commercial Loan Agreements
The trend is also evident in commercial lending, where for years banks have been forced to prove that they had acted in good faith when suspending credit to a borrower, regardless of any discretionary right stipulated in the loan agreement.
But in a recent court case involving Continental Bank of Chicago, the U.S. District Court for Illinois awarded the bank, which had terminated a loan to a lumber company in default, $4 million.
The lumber company, which was the defendant, argued that Continental had acted in bad faith by threatening to call the loan unless the debtor took certain specified business actions.
The import of this decision, according to legal experts and banking industry observers, is that lenders' rights as they are spelled out in loan agreements are now being upheld.
In another commercial loan dispute, the U.S. Bankruptcy Court for the Central District of Illinois ruled last summer in favor of Banque Paribas, which had terminated a loan to a chemical company.
The judge ruled that if a loan agreement includes the right to terminate lending, a bank may suspend credit, regardless of its motivation or the subsequent consequences to the borrower.
Since enactment of the Superfund Law in 1980, banks have had to endure the threat of potentially massive but bafflingly unpredictable environmental liabilities.
Probably the most notorious regulatory action under Superfund is the Environmental Protection Agency's successful suit against Fleet Factors Corp. for $400,000 to clean up an asbestos-contaminated property that Fleet, as the secured lender to a Georgia company that had gone into liquidation, had never actually foreclosed on.
But Fleet Factors was the only "deep pocket" the EPA could find to recover its own costs for cleaning up the property.
Here again the liability situation is changing. In April 1992, the EPA moved to address concerns of secured tenders about open-ended liability by adopting a new rule, which clarifies lender liability by defining more carefully which parties may be held responsible for environmental damage, and under what specific circumstances.
In one of the first court decisions under the new EPA rule, the U.S. District Court for Minnesota excluded from Superfund liability, a secured lender, Industry Financial Corp., which had foreclosed on a property with an environmental cleanup cost estimated at $10 million.
According to attorney involved in the case, Ashland Oil Co. v. Sonford Products Corp., the court's decision strongly suggests that a lender is now shielded from liability under Superfund when engaged in "ordinary lending activities."
In Superfund matters, as in commercial lending and mortgage lending, banks clearly seem to be gaining an edge in liability litigation. The recent court decisions and the new EPA rule should be encouraging to lenders as they move to face the complex challenges of an uncertain economy.
Even so, with myriad lawsuits still pending in state and federal courts and the inherent risk of any lawsuit, lenders cannot afford to let down their guard.
Ms. Addis, a certified management consultant, is a principal of Addis & Reed Consulting Inc. in Boston.