Lender Liability

Sometimes borrowers have disputes with banks and other lenders over misconduct by the lender. For example, if the lender acts in bad faith to advance its own interests at the expense of the borrower, that may give rise to a lender liability dispute.

During the 1980s, a body of law, called lender liability law, developed that gives special protections to borrowers injured by banks and other lenders. The caselaw gives the borrower both an affirmative claim against the lender, as well as a defense to actions by the borrower to compel repayment of the loan. And borrowers began to bring lender liability lawsuits.

The innovation introduced by the new law was based on the concept that every contract had an implied covenant of good faith. Thus, even if the bank was entitled to behave in a particular way, it can't behave in that way if acting in bad faith. For example, one court has held that the stated reason for taking a certain act must be the real reason, and not a pretext for some ulterior motive.

For example, banks sometimes become worried about recovering a loan made under a line of credit to a business experiencing financial difficulties. The bank may try to improve it's situation by indicating that it will lend new money if the business pays down the existing debt. And once the debt has been paid off, the bank may invoke a clause in the lending agreement that entitles it to withhold new loans. That's an act of bad faith, which may entitle the business to advance a lender liability claim.

In a leading case on lender liability, a business borrower gave a lender a security interest on all of the borrower's assets in return for a line of credit. The security interest given by the borrower effectively prevented the borrower from seeking financing from another lender.

Under the terms of the line of credit, the lender had discretion as to whether to make further advances under the line. At a point when the lender was fully secured, the lender declined to advance funds without first giving the borrower notice of its decision. There was some evidence that the individual banker bore a principal of the borrower ill will.

In any event, as a result of the lack of notice, the borrower was unable to meet its debts and collapsed. In an action by the borrower, the court held that, under the circumstances, the implied covenant of good faith and fair dealing obligated the lender to give notice of its decision to discontinue lending.

In a case handled by the Firm, the court imposed sanctions on a bank for taking a frivolous appeal to coerce action helpful to it. The case was discussed in the leading treatise involving lender liability cases. Chu v. Green Point Savings Bank and Cullen and Dykman, 218 A.D.2d 781, 631 N.Y.S.2d 252 (2nd Dept. 1995), discussed at M. Budnitz, The Law of Lender Liability p. S-13-1 (Warren, Gorham & Lamont 1990).

In some cases, courts have deemed claims for breach of the covenant of good faith to be duplicative of a breach of contract claim, and therefore subject to dismissal. But in such cases, the allegations supporting the claim for breach of covenant of good faith were identical to those supporting the breach of contract claim. Where there are different facts supporting the claim for breach of covenant of good faith-- such a fraud, conversion and breach of fiduciary duty-- the claim for breach of the covenant of good faith is not duplicative and is not subject to dismissal.