According to the American Bar Association, the number one theory of lender liability used by defendant commercial borrowers against lenders is breach of contract. However, lender liability may also often be found in theories of fraud and duress, improper control, interference with borrower’s business opportunity, or failure to comply with the statute of frauds. Additionally, but to a lesser extent, relief for a commercial borrower may be sought under theories of usury, negligence, conversion, defamation, infliction of emotional distress and other statutory liability. Such claims are fact specific and in the event of foreclosure a slew of equitable, contractual, and statutory defenses become available to the borrower, under applicable circumstances. The ensuing is a list of some commercial foreclosure defenses.
Breach of contract claims can include issues arising in the loan commitments, refusal of the lender to advance the funds, improper acceleration and demand, failure of adequate notice, failure to provide new financing, failure to restructure, or breach of oral commitments made by lender contemporaneous with, or after, the written loan agreement. Some developing theories of lender liability include: constructive fraud based on a fiduciary duty; breach of the duty of good faith and fair dealing; improper control over borrower; interference with borrower’s prospective business advantage; or interference with borrower’s contractual relations.
Loan origination issues arise from a lender’s treatment of the applications, commitments, documentation and closing, as well as disclosure of adverse information in relation to the formation of the loan agreement. In terms of applications and commitments, a lender becomes liable where the handling of the application and commitment to extend credit does not comport with regulations or duties. Specifically, a lender owes the borrower a duty of reasonable care to act without delay. Additionally, a lender may owe borrower a duty to process the application if a prior relationship exists or if the lender accepts a fee.
Though in many contract scenarios oral agreements will be disregarded in favor of the written agreement, in terms of commercial loan obligations parol evidence will be admitted. This particularly comes into play with respect to oral modifications of the terms of the loan agreement, including payment terms, as well as oral waiver of the lender’s rights where he promises to forbear from foreclosing or taking other remedial measures in the face of default. Additionally, such oral statements can form the basis of fraudulent misrepresentation claims,
Every contract is governed by the principles of good faith and fair dealing, an implied obligation that is imposed on both parties to a commercial contract including a commercial loan agreement under UCC 1-304. This duty requires that neither party do anything to deprive the other of the benefits of the agreement. This duty is well recognized in New York however, it will not be expanded to a point of conflict with the express terms of the bargained-for exchange, and equitable considerations will not allow an extension of coverage beyond [the agreement’s] fair intent and meaning in order to obviate objections which might have been foreseen and guarded against. In other words, though the lender must act reasonably in asserting its rights under the contract, the court will refer to the contents of the four corners of the contract in order to determine the scope of the duty of good faith. As with any contract, the parties’ intent controls.
Although unconscionability would generally form the basis for relief from a contract, including a loan agreement, in “a commercial transaction by business people in a commercial setting, under terms that are standard in the trade, [the facts give] rise to a presumption of lack of unconscionability.” Thus, the burden is higher to prove unconscionability in the commercial context unless you can prove the agreement was not made under terms standard in the trade or conducted by business people in a commercial setting.
Where fraud or misrepresentation in the procurement of a mortgage are successfully alleged and proved by the borrower, a mortgage may be set aside and cancelled. Definitionally, the concept of fraud is divided into two categories, fraud (or “actual fraud”) and constructive fraud (also referred to as “legal fraud”). Actual fraud can generally be viewed as the knowing and intentional deprivation of another’s legal rights. Alternately, legal fraud is the gaining of advantage by unfair means to the detriment of another. A cause of action for fraud—whether couched as a counterclaim or an affirmative defense—cannot arise when the sole fraud asserted relates to breach of contract. Similarly, a fraud claim would be dismissed as duplicative when founded upon the same facts as a contract claim.
To sustain a cause of action for fraudulent inducement, a commercial borrower must show misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury. Fraudulent misrepresentation need not be intentional but rather a borrower’s reliance upon a lender’s alleged, verbal promise, even though not contained in the loan documents, may rise to the level of common law fraud, negligent misrepresentation may be found, and lender liability imposed.
Constructive duress may be found where a lender has developed a fiduciary relationship with a borrower. A simple lending relationship, however, will not create a fiduciary relationship. A lender who only acts as a lender cannot be held a fiduciary, but rather there must be an understanding that the borrower is acting in reliance upon the expertise and advice of the borrower. Specifically, although the unilateral expressions of a borrower will not change the relationship, a fiduciary relationship may be found where a loan officer gives business advice to borrower, a borrower shares confidential information with the lender and the lender uses the information, or the borrower puts “trust and confidence” in the lender.
Duress in the commercial lending context can include threats to reputation, business or property interests, economic duress, or equitable duress to defeat lender’s defenses or counterclaims. Only the first two apply in the context of borrower instigated litigation. Threats to Economic duress may be found where a lender uses the knowledge of a borrower’s precarious financial situation to acquire unconditional guarantees or other favorable outcomes. It is important to note, however, that even were this to rise to the level of economic duress, where the parties to a lending agreement have signed a release, said release “against sophisticated commercial actors . . . may be voided on grounds of economic duress only in extreme and extraordinary cases.
One of the biggest areas of liability for lenders lies in the exercise of improper control over the borrower. Particularly, this control is found outside of the construction lending context where the lender exerts some dominion over management of the Borrower Company, or control over operations through withholding or reduction of advances.
Control is most often to be found where the lender directs what bills to be paid; the retention or replacement of management; the borrower’s choice of third party vendors; consultants; accountants or the like; reduction of officers’ salaries; or the day to day management of borrower’s operations.
In the event a lender commits a tortious interference with borrower’s business contract, borrower may recover punitive damages in addition to remedial damages. The business advantage in the contract must be actual, however, not just borrower’s expectation. This requires an independent wrong by the lender and lender’s knowledge that action is substantially certain to disrupt an economic relationship between borrower and a third party. To establish a case for tortious interference with contract, it is necessary that there must be a breach of that contract by the other party.
The applicable Statute of Frauds provides: “A contract for the leasing for a longer period than one year, or for the sale, of any real property, or an interest therein, is void unless the contract or some note or memorandum thereof, expressing the consideration, is in writing, subscribed by the party to be charged, or by his lawful agent thereunto authorized in writing.” General Obligations Law § 5-703 (2). It is said, “[T]o satisfy the statute of frauds, a memorandum evidencing a contract and subscribed by the party to be charged must designate the parties, identify and describe the subject matter, and state all of the essential terms of a complete agreement.” Thus, if the material terms are not included in the signed memorandum with sufficiency, which would include the terms pertaining to the mortgage or financing, then the contract is void.
The complexity of commercial foreclosure litigation necessitates a thorough understanding of the defenses available to commercial borrowers to optimize the likelihood of a successful commercial foreclosure defense. Contact our office today to schedule a consultation.