Lender Liability During the Great Recession

A. Barry Cappello
October 4, 2011 — 1,708 views  
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Lender liability law says lenders must treat their borrowers fairly, and when they don't, they can be subject to borrower litigation under a variety of legal claims. Today, as lenders and borrowers blame each other for nonperforming loans in the worst economic downturn in almost a century, lender liability is once again at the forefront of many legal battles.

Breach of Contract/Fraud

A loan agreement is like any other contract. If the agreement was fraudulently induced or there was an absence of mutual consent, the agreement cannot be enforced. If the loan contract was breached, the lender can be sued if it was the breaching party.

The most common remedy pursued by borrowers when a breach of a loan agreement has occurred is the recovery of damages. This can include both the difference between the loan amount and the costs for obtaining a replacement loan, and any lost opportunity or lost profit damages.

Fiduciary Relationships

If a lender-borrower relationship is kept at arm's length, the relationship is not fiduciary. Lenders typically argue that all lender-borrower relationships fall under this category. Fortunately, for borrowers, the courts have delineated exceptions where the situation is not arm's length or where the bank is more than merely a lender.

For example, when a lender holds itself out as a financial advisor, the lender will be held to the same fiduciary standard as any financial advisor.

In a case involving an adult son and his elderly mother, the fiduciary relationship was established because the bank failed to keep its banking and investment advice separate.

On the advice of a bank employee, instead of the $5,000 he initially sought, the son borrowed $100,000, secured by his mother's home. He then opened a trading account with the investment arm of the bank with approximately $52,000 of the loan proceeds. The account eventually lost all its value and his mother later defaulted on her mortgage. The son and his mother sued the bank for breach of fiduciary duty and negligence.

After a six-day trial, the jury found in favor of the plaintiffs. Besides monetary awards of $36,000, the bank established a life tenancy for the mother so she could stay in her home in spite of foreclosure.

Inappropriate Collateral Sales

Lenders can also run into trouble by inappropriately selling collateral after a loan defaults. The Uniform Commercial Code requires that the method, manner, time, place and terms of the sale be "commercially reasonable." Courts have found sales to be commercially unreasonable where the lender relied on an appraisal that it knew or should have known was too low, or provided insufficient publicity for the sale to generate a sufficient number of bids.

When collateral has been wrongfully repossessed or disposed of, the lender may lose the right to collect a deficiency, forfeit its security interest or be liable for damages.

As more and more banks fail or desperately try to stay afloat, expect to see more of this type of lender misconduct and the resulting Lender Liability litigation.

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A. Barry Cappello

Cappello & Noël LLP

A. Barry Cappello is managing partner in the Santa Barbara law firm of Cappello & Noël LLP. He represents borrowers in lender liability and lending discrimination claims against their lenders. He is the author of Lender Liability, Fourth Edition (Juris Publishing). [email protected],.To find out more about Lender Liability you can visit http://cappellonoel.com.