Lender Liability in by ydb15644

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                          AMERICAN BAR ASSOCIATION

                   Section of Real Property, Probate and Trust Law
                          11th Annual Spring CLE Symposia
                      March 22-26, 2000 – South Beach, Florida


                                   March 23, 2000

           Lender Liability in the Context of Lender/Borrower Leasing Issues

                                                              Dennis L. Greenwald, Esq.
                                                    Stern, Neubauer, Greenwald & Pauly
                                                               Santa Monica, California
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                             LENDER LIABILITY IN THE CONTEXT
                           OF LENDER/BORROWER LEASING ISSUES

    I.     Overview

    II.    Context in which Lender Liability Can Arise in a Leasing Process

           1.     Approval of Existing Leases
           2.     Estoppel Certificates
           3.     Subordination, Non-Disturbance and Attornment Agreement
           4.     Lender Communications/Negotiations With Tenants

    III.   Causes of Action in Lender Liability Cases

           1.     Breach of Contract
           2.     Good Faith and Fair Dealing
           3.     Waiver and Estoppel
           4.     Fraud
           5.     Negligence
           6.     Partnership/Principal-Agent/Alter-Ego
           7.     Interference with Contractual Relationship or Prospective Economic Advantage
           8.     Prima Facie Tort

    IV.    Borrower's Damages and Remedies

    V.     Some Practical Tips for the Lender

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                              LENDER LIABILITY IN THE CONTEXT OF
                               LENDER/BORROWER LEASING ISSUES

                                          By: Dennis L. Greenwald

    I.      OVERVIEW

             No discussion of the lender’s role in the leasing process can be complete without considering
    the potential for lender liability. The phrase “lender liability” is a relatively modern one, achieving
    prominence in the law principally beginning in the 1980s. “Lender liability” is neither a specific tort, nor
    a specific contract claim, nor is it any specific cause of action. The term is no more descriptive of a
    cause of action than the phrase “landlord liability” or “tenant liability.” Technically, the term “lender
    liability” only describes the substantive business of a pool of potential defendants. Colloquially,
    however, it has come to refer to a variety of legal theories and causes of action – some sounding in tort
    and some sounding in contract – pursuant to which a lender might be liable to a borrower or a
    prospective borrower (and sometimes others) in connection with:

            •   a commitment to make a loan;

            •   the making of the loan;

            •   the administration of the loan; or

            •   the enforcement of the lender’s rights or remedies and/or a workout or restructure of the

             The potential for lender liability in the context of the relationship between the landlord (i.e.,
    borrower) and tenant is subtle and represents only a very small part of a broad spectrum of potential
    lender liability issues. Because the lender’s “invisible” (if not iron) hand can permeate various aspects of
    the landlord-tenant relationship, lender liability can arise in a variety of ways which neither the borrower
    nor the lender ever contemplated. Therefore, leasing issues can be an unexpectedly fertile ground for
    lender liability claims.

             To some extent, the basic problem starts at the initial stage of the lender-borrower relationship;
    that is, during the initial negotiations between the borrower and lender for the loan; or upon the signing
    of a preliminary letter of intent for the loan; or when a loan commitment is issued. At this stage of the
    relationship, the lender and borrower have competing, and to some degree mutually exclusive, goals.
    The lender is motivated to “lock up” the borrower by getting the borrower committed to the lender.
    The lender thus wants the borrower emotionally committed (if not, as a practical matter, financially
    committed) to that particular lender and wants to induce the borrower to forego pursuing other lenders.
    On the other hand, because the lender has not completed its due diligence on the borrower or the
    property, the lender does not want to be irrevocably committed to making the loan. Therefore, until the
    loan closing, the lender wants to preserve maximum maneuverability to build in new terms and
    conditions to the closing and in the loan documents.

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             The borrower’s goals during the early phase of the lending process are to qualify for a loan and
    lock-in an interest rate as quickly as possible. In most cases (irrespective of whether the loan is for the
    purpose of purchasing the property or refinancing the property), the borrower has a limited amount of
    time to negotiate the fine points at the early stage of the loan process. Frequently, the borrower doesn’t
    bother retaining legal counsel before signing a letter of intent or before accepting a loan commitment.
    (Indeed, a common complaint by borrower’s counsel is that their clients don’t involve them in the
    process until after a loan commitment is issued. By then, of course, the borrower’s negotiating leverage
    is considerably diminished.)

            Thus, it is often the case that, prior to the lender’s preparation of the loan documents, neither the
    lender nor the borrower have carefully considered all of the leasing issues which may be germane to the
    lender. This flawed process is rather surprising since, in many kinds of real property secured financing
    transactions, the leases are of paramount importance to both the borrower and the lender. After all, the
    principal – if not exclusive – value of the property to the borrower is the income stream which the leases
    generate. Correspondingly, credit underwriting decisions by the lender are often based chiefly on the
    quality of the tenants, the amount of the rents, the duration of the terms of the leases and the other terms
    and conditions of the leases. While lenders often say that they “loan to people, not to property,” the
    creditworthiness of the tenants and the terms and conditions of the leases are often ultimately more
    important than the creditworthiness of the borrower. This is particularly true when the loan is to be
    “non-recourse”; that is, when the lender can only seek recourse against the collateral (i.e., the property)
    and the borrower basically has no individual liability for repayment of the loan amount.

              In days gone by, a lender could pretty much dictate requirements concerning the borrower’s
    business (including leasing) without risk that it would be sued for any previously unheard of claim of
    “lender liability.” In those days, the “golden rule” applied to lenders with impunity – that is, “he or she
    who has the gold, makes the rules.” But a body of modern law has been developing over the past few
    decades which has dismantled the lender’s historical insulation from liability for involvement with the
    affairs of the borrower or involvement with the collateral for the loan. Although the preponderance of
    reported lender liability cases do not involve leasing, the legal theories a borrower/plaintiff will put
    forward in a lender liability case involving leasing will likely be no different than in any other lender
    liability case.


            A lender liability claim arising out of the leasing process will be based on the claim that the
    lender somehow improperly exercised or abused its discretion and/or exercised “creditor control” over
    the borrower’s business. Improper lender discretion (or improper control over the leasing process) can
    occur either before or after the loan closing. Before the loan closing, the lender may want the right to
    exercise its discretion, if not control, over certain aspects of the leasing process and the existing leases.
    For example, the lender wants the right to approve or disapprove the creditworthiness and other
    matters pertaining to the existing tenants; approve or disapprove the terms and conditions of the existing
    leases; obtain an acceptable estoppel certificate from existing tenants; and obtain an acceptable
    Subordination, Non-Disturbance Agreement (“SNDA”) from the existing tenants. After the loan
    closing, a lender may want to retain some degree of discretion or control over the leasing process; e.g.,

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    the lender may want the right to approve future leases – sometimes even going so far as to set up
    specific parameters concerning future tenants and lease terms. In certain instances these parameters can
    be extraordinarily specific and restrictive.

           If one had to categorize the kinds of leasing issues which can result in lender liability, they would
    probably fit into four very general categories:

            1.       Approval of Existing Leases

             When a loan commitment is issued (or a letter of intent is executed by the lender and the
    borrower), the borrower is often under the distinct impression that the lender has basically approved the
    existing leases. In fact, however, the loan commitment (or letter of intent) typically preserves the right of
    the lender to approve all of the terms and conditions of leases. Although the loan commitment might
    identify minimum requirements concerning rent, duration of the lease term(s), and perhaps the
    creditworthiness of the major tenants, the lender usually still reserves the right to review all of the terms
    and conditions of all of the leases. The borrower has the impression that the leases have been (or
    definitely will be) approved because the borrower usually knows that the leases and tenants satisfy the
    minimum rent, tenant creditworthiness and duration of term requirements stated in the loan commitment
    or letter of intent. But the borrower neglects to focus on the lender’s ongoing right to approve the
    leases in their entirety. Unfortunately, when the lender (or its counsel) actually reviews the lease(s),
    although the rent and other matters might meet the minimum requirements of the lender, there might be a
    host of provisions which are unacceptable to the lender. Although it would be impossible to prepare a
    list of provisions which are uniformly unacceptable to all lenders (the list of objectionable provisions
    being as plentiful as there are lenders), the following represents only a short list of the kinds of provisions
    which a lender might find problematic.

            •    The right of the tenant to buy-out of the lease; that is, the right to pay the landlord a fee to
                 terminate the lease early. (Sometimes, the tenant has the right to terminate the lease early
                 without any fee.)

            •    The tenant has an option to purchase the property.

            •    The tenant has the right of first refusal to purchase the property.

            •    The tenant has the right to make repairs and offset the cost thereof against rent. (In fact,
                 lender’s usually oppose any tenant offset rights.)

            •    The damage and destruction (or condemnation) provisions in the leases are contrary to the
                 lender requirements for the use of insurance proceeds following damage or destruction to
                 the property, or the use of the condemnation award following a condemnation of all or a
                 portion of the property.

            •    A single tenant (or a number of tenants) leases an excessively large percentage of the

            •    The landlord has outstanding obligations to fund tenant improvements; or the tenant is
                 entitled to a rent-free period; or the tenant is entitled to certain other monetary concessions.

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             Some of the issues enumerated above can be resolved by means of an acceptable SNDA
    (discussed below and elsewhere in the program materials), but the borrower is sometimes stunned by
    what the borrower views as the lender’s extraordinary conservatism and unreasonableness, if not
    outright onerousness and irrationality. In these situations, the borrower feels that it has been misled by
    the lender because the borrower had assumed (perhaps based on prior discussions with the loan officer)
    that as long as the leases verified a certain income level for the property, were of a sufficient duration
    and were with creditworthy tenants, there would be no lease issues for the lender to approve or
    disapprove. If the tenants ultimately refuse to subordinate certain of their rights under the lease to the
    lender’s lien (in order to satisfy the lender’s objection to such rights), the borrower will not be able to
    close the loan. This means, in the case of a refinance, that the borrower may not have sufficient time to
    get a new lender in place to pay off the existing financing before it comes due. In the case of a purchase
    and sale transaction, the borrower/ buyer may not have sufficient time to arrange for new financing. (If
    the borrower does not have the right to then terminate the purchase contract based on its failure to
    obtain a loan, the borrower could be facing a breach of contract claim by the seller.) In either case, the
    borrower is in a very tight spot and may start threatening a “lender liability” claim.

            2.      Estoppel Certificates

             Most lenders require that all commercial tenants, or at least the more important of them, deliver
    an estoppel certificate as a condition to the lender making the loan. Although estoppel certificates are
    often somewhat routine in nature and merely require the tenant to confirm such non-controversial things
    as the existence of the lease, the duration of the term, the rent, etc., some lenders require a form of
    estoppel which effectively modifies the lease, imposes new obligations on the tenant, or results in the
    relinquishment of certain tenant rights. Sometimes these additional requirements are not terribly
    controversial. For example, if the lender requires that the tenant agree to not modify the lease without
    the lender’s prior consent, or if the lender requires that the tenant give the lender notice of any landlord
    default, there is arguably no material substantive change in tenant’s rights or obligations. However,
    sometimes the lender goes further and includes in its form of estoppel certificate the imposition of
    obligations which are not acceptable to the tenant. Some of these things might include the elimination or
    modification of certain provisions in the lease which the lender finds objectionable (some examples of
    which are enumerated in paragraph 1, above). A tenant may, of course, justifiably object to provisions
    in an estoppel certificate which modify or relinquish the tenant’s existing leasehold rights. If the lender
    refuses to make the loan by reason of the tenants’ unwillingness to agree to such provisions in the
    estoppel certificate, the borrower may try to purse a lender liability claim on the basis that the lender has
    unreasonably required that the leases be modified as a condition to closing the loan.

            3.      Subordination, Non-Disturbance And Attornment Agreements (“SNDAs”)

             SNDAs (covered by one of my co-panelists in detail elsewhere in the program materials), can
    create enormous difficulties for the borrower and carry with them the potential for a lender liability claim.
    The first problem involving procuring an SNDA is that, unless the tenant’s lease requires that the tenant
    sign an SNDA, the borrower is completely at the tenant’s mercy in getting the tenant to cooperate. In
    those situations, the borrower will, at a minimum, have to cajole the tenant; and sometimes the borrower
    will have to bribe the tenant with concessions to get the tenant to sign an SNDA. It should be noted
    that, even under those leases where the tenant has agreed to sign an SNDA, there may be no definitive

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    time deadline by which the tenant must sign an SNDA. Moreover, such leases frequently require that
    the tenant sign a “commercially reasonable” SNDA or an SNDA “reasonably satisfactory to a lender,”
    or require a similarly vague standard. (What is a reasonable SNDA for one lender may not be for
    another lender.) Finally, the tenant’s concept of an SNDA might be simply that the tenant will agree
    that, following a foreclosure, the tenant will attorn to the new owner, provided the tenant’s leasehold
    rights remain intact. The lender, of course, has a more expansive view of an SNDA, and this is where
    the trouble begins.

              For example, the tenant does not want insurance proceeds or any condemnation award to be
    used in a manner which is inconsistent with its lease. Yet many lender form SNDAs require that such
    monies be used to pay down the loan, or, alternatively, the lender conditions the landlord’s use of such
    monies in a manner which is inconsistent with the lease terms. As another area of conflict, the lender
    often requires that the tenant agree that (vis-à-vis the lender or any purchaser at a foreclosure sale) the
    tenant will have no right of offset against rent (which might otherwise be permitted under the lease) and
    no right to require the lender (or other foreclosure purchaser) to return the security deposit. The tenant
    feels that there is no reason why the tenant should surrender any leasehold rights it may have to offset
    rent, much less agree that it will lose its security deposit, if the borrower’s interest is foreclosed out. As
    another example, the lender’s SNDA form will usually provide that the lender has no obligation to pay
    any tenant improvement allowance or otherwise be bound by any monetary concession the borrower
    has granted to the tenant (such as a rent-free period or a reduced rent period). Again, the tenant sees
    no reason why it should have to relinquish an economic benefit in its deal just because the landlord fails
    to pay its mortgage. All of the foregoing provisions mentioned in this paragraph might be considered
    “reasonable” by the standard of many lenders and their counsel. Yet these do not seem to be
    reasonable terms to a tenant (or, for that matter, many borrowers). If a tenant refuses to agree to such
    terms and conditions in an SNDA, the borrower will not be able to close its loan and might claim lender
    liability under the theory that the lender has been unreasonable in requiring an unreasonable SNDA.

            4.      Lender Communications/Negotiations With Tenants

             Sometimes lenders (unwisely, in this author’s opinion) go beyond merely delivering to the
    borrower their form of estoppel certificate and SNDA, and actually engage in direct communications
    and/or negotiations with a tenant in an effort to resolve lease issues. The borrower (figuring that it really
    has nothing to lose in how these negotiations come out) is only too anxious to have the lender deal
    directly with the tenant. After all, if the lender and tenant are satisfied, the borrower is satisfied.

             While there is nothing per se wrong with a lender communicating directly with a tenant, the
    lender runs the risk that the tenant might later claim that the lender gave inducements or made promises
    which are outside the four corners of the lease, the estoppel certificate or the SNDA and that the lender
    has some unwritten but legally binding obligation to the tenant. Moreover, the borrower might contend
    that the lender has somehow interfered with the borrower’s relationship with the tenant by virtue of the
    lender having taken positions vis-à-vis the tenant. (See discussion of interference with contractual
    relations, below.) It is therefore generally advisable that the lender not communicate directly with the
    tenant and that the lender have the borrower conduct all negotiations concerning lease issues. This, of
    course, is easier said than done, and if it is necessary for a lender to communicate directly with a tenant,
    it is best if the substance of those communications be confirmed in writing so that there is a clear record

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    of what was discussed and that the lender has promised nothing outside the four corners of any written
    agreement it may ultimately have with the tenant.


             Although many lawyers have the impression that lender liability claims involve new and creative
    legal theories, lender liability claims are all based on existing, legally- recognized causes of action. Like
    many other kinds of business litigation, the potential causes of action span a considerable range of legal
    theories, from the simple (e.g., breach of contract) to the more rarefied (e.g., prima facie tort).

    Breach of Contract

             A good old-fashioned breach of contract claim is frequently one of the easiest claims for a
    borrower to frame. A breach of contract claim has the added advantage of being relatively easy claim
    for a judge or a jury to understand. Of course, this doesn’t mean the case is easy to prove. Most
    lender liability breach of contract cases involve litigating over interpretation of the terms of a contract;
    proving that an oral contract exists; or proving that the lender waived (or is estopped from enforcing)
    certain contract requirements. (See discussion below regarding waiver and estoppel.)

    Good Faith And Fair Dealing

             Although much has been written about “good faith and fair dealing,” it still remains a somewhat
    complicated and misunderstood legal theory. In some jurisdictions, it is considered a tort; in some
    jurisdictions it is considered a contract claim; and in some jurisdictions it can be either. (As a practical
    matter, however, other than for purposes of determining the scope of remedies available, it usually
    makes no difference whether this claim is framed as sounding in contract or in tort.)

            The concept of “good faith” under a contract reaches back as far as Roman times, when a
    court could order payment “ex bona fides;” meaning “what was within the requirement of good faith.”
    The Restatement (Second) of Contracts provides, in § 205, that every contract imposes on each
    party the obligation of good faith and fair dealing. As noted in detail below, the Uniform Commercial
    Code (“UCC”) also requires a somewhat comparable good faith standard in transactions governed by
    the UCC.

            It is important to note that, when speaking of good faith and fair dealing in the context of a
    contract claim, it is generally considered to be a “covenant,” whereas in the context of a tort claim, the
    obligation of good faith and fair dealing is said to be a “duty.” This may be a distinction without a
    difference but, nevertheless, the contract obligation is a covenant and the tort obligation is a duty.

           The topic of good faith and fair dealing is extensive, and the following represents but an
    extremely brief sampling of some of the major issues in this subject.

            Good Faith and Fair Dealing Under Contract

            Language from two cases best summarize the contract obligation of good faith and fair dealing.
    In Palisades Properties, Inc. v. Brunetti, 44 NJ 117, 207 A2d 522 (1965), the New Jersey Supreme
    Court held that “[I]n every contract there is an implied covenant that neither party shall do anything

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    which will have the effect of destroying or injuring the right of the other party to receive the fruits of the
    contract; in other words, in every contract there exists an implied covenant of good faith and fair
    dealing.” Citing the famous treatise by Williston on Contracts, the court also stated that “. . . even
    though the parties to a contract have not expressed an intention in specific language, the courts may
    impose a constructive condition to accomplish such result when it is apparent that it is necessarily
    involved in the contractual relationship.” This theme was supported in Van Gemert v. Boeing Co.,
    553 F.2d 812 (2nd Cir., N.Y., 1997). In that case, the Second Circuit “merely applied the settled
    principle, ‘that in every contract there is an implied covenant that neither party shall do anything which
    will have the effect of destroying or injuring the right of the other party to receive the fruits of the
    contract . . . .’ Simply stated, every contract contains the implied covenant of good faith and fair

              However, not all states have applied the contract obligation of good faith and fair dealing in the
    same manner. For example, in Sunbelt Savings v. Birch, 796 F. Supp. 991 (N.D. Tex., 1993) it was
    held that the covenant of good faith and fair dealing applies only where a “special relationship” exists
    between the parties to the contract. In this case, involving guarantors’ liability under a promissory note,
    it was held that the guarantors could not assert a claim against the lender for breach of “fiduciary duty”
    (that is, the covenant of good faith and fair dealing) when the guarantors were not involved in any way
    with the borrower’s loan transaction.

           Another instructive case regarding good faith and fair dealing is KMC Co. v. Irving Trust, 757
    F.2d 752 (6th Cir., 1985), which fundamentally held that lenders are required to deal with their
    borrowers in good faith, irrespective of the specific terms of the loan documents.

             Not only is the law applicable to the contract claim of good faith and fair dealing different in
    different jurisdictions, but the terminology sometimes differs. In the Sunbelt Savings case (above), the
    covenant was characterized as a “fiduciary duty.” (See also, Black Canyon Racquetball v. First
    National Bank, 804 P2d 900 (Idaho 1991), which also refers to good faith and fair dealing in terms of
    a “fiduciary duty.”).

            It is important to remember that the concept of good faith and fair dealing under contract arises
    only if a contract is already in existence. Contrary to certain misconceptions by many lawyers, “good
    faith and fair dealing” is not the basis for creating a contract which otherwise does not exist.

            Uniform Commercial Code Standard

                     The UCC includes its own good faith standard and, therefore, to the extent the UCC
    applies to a loan transaction, the UCC standard of good faith will apply. UCC § 1-201(19) requires
    that the parties act with “honesty in fact.” UCC § 1-103 provides that “[e]very contract or duty within
    this code imposes an obligation of good faith in its performance or enforcement.” (However, a
    Comment to UCC § 1-203 states that good faith only applies to interpreting a contract, and does not
    create a separate duty which can be independently breached.)

           UCC § 1-102(3) provides that the parties cannot disclaim the good faith performance
    requirement of the UCC. Thus, at least as far as the UCC is concerned, it would appear that a party’s

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    good faith performance cannot be subject to waiver by the other party. (See also, Reid v. Key Bank of
    Southern Maine, Inc., 821 F.2d 9 (1st Cir., ME).)

            Tort Obligation of Good Faith and Fair Dealing

             Many legal analysts believe that the tort aspect of the duty of good faith and fair dealing has its
    roots in California cases involving insurance companies’ conduct amounting to “bad faith.” Because of
    the inherent unfairness in the bargaining position between the insurer and the insured, courts stepped in
    to protect the insured’s rights. This concept of good faith and fair dealing was steadily expanded and,
    for example, in the California case of Schoolcraft v. Ross, 81 CA 3d 75, 146 Cal.Rptr. 211 (1988),
    the lender was required to allow the borrower to use insurance proceeds to reconstruct the
    improvements (instead of applying the proceeds to pay down the loan), even though the loan documents
    provided otherwise. It is presently unclear how far courts in the various jurisdictions will go to allow
    tort-based remedies in commercial cases based on the concept of good faith and fair dealing.
    Nevertheless, whether the claim of good faith and fair dealing is couched in terms of breach of contract
    or tort, the only meaningful difference is whether punitive damages will be recoverable, since they are
    generally recoverable only in tort and not in contract.

    Waiver and Estoppel

            The doctrines of waiver and estoppel are important when considering lender liability arising out
    of either a basic breach of contract claim or a claim for the breach of the covenant (or duty) of good
    faith and fair dealing. Waiver constitutes the knowing, intentional relinquishment of a specific right or
    remedy. Estoppel, on the other hand, precludes one from enforcing rights one did not intend to give up.
    As a practical matter, this distinction may not be terribly germane since the result is often the same;
    namely, that the lender is prevented from enforcing terms which are stated in the loan documents.
    Waiver or estoppel can result over time from a particular course of dealing between the lender and the
    borrower. For example, in Schaller v. Marine National Bank of Neenah, 131 Wis. 2d 389, 388
    N.W. 2d 645 (Wis. App., 1986), the borrower had overdrawn its account 36 times during the course of
    seven years and, in each instance, the bank honored the overdraft. When the bank finally decided to
    dishonor overdrafts, the court held there was a “course of dealing” which supplemented and qualified
    the terms of the contract between the borrower and lender. (For a contrary result, see Kendall Yacht
    Corp. v. United California Bank, 50 CA3d 949, 123 Cal.Rptr. 848 (1975).)

             Waiver or estoppel in the context of leasing issues often occur when the lender has the right to
    approve tenants or approve various leases. Thus, depending on the lender’s conduct, over time the
    lender may eventually waive (or be estopped from exercising) its right to exercise discretion in
    approving or disapproving tenants or leases (or, alternatively, the scope of the lender’s discretion may
    be deemed to be limited). For example, if the lender has consistently refrained from exercising its
    discretionary rights to approve or disapprove leases, it may have lost the right altogether. Alternatively,
    for example, if the lender has consistently approved short-term leases (let’s say, two-year terms), even
    though the loan documents require a minimum of a five-year term, the lender may have waived (or be
    estopped from enforcing) the minimum requirement of five year leases.


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             Sometimes referred to as fraudulent misrepresentation, this tort can be a basis for a claim of
    lender liability. Such a cause of action is, in essence, no different than any other fraud claim and involves
    five elements: a false statement; made with knowledge of its falsity; with an intention to induce the other
    party to act or refrain from acting; the other party acts in justifiable reliance on such misrepresentation;
    and damages to the other party result. (Negligent misrepresentation is essentially the same as fraud, but
    without the requirement that the plaintiff prove that the defendant acted with knowledge that its
    statement was false.)


             Negligence can also a basis for a claim by a borrower against a lender. The success of a cause
    of action of negligence hinges upon, among other things, the ability of borrower to prove that the lender
    owed a duty to the plaintiff. As noted above, this duty might arise out of an obligation of good faith and
    fair dealing, but there can be other bases for a duty to exist.

    Partnership/Principal-Agent/Alter Ego

              Many lender liability claims arise when the lender allegedly exercises control over the
    borrower’s business. This kind of lender liability claim can arise even when the loan documents allow
    the lender discretion in approving various aspects of the borrower’s business. By exercising any degree
    of control over the borrower’s business (including exercising discretion which is specifically granted to
    the lender under the loan documents, such as with respect to leasing matters), the lender can subject
    itself to a claim by the borrower that the lender has become a de facto partner (or co-joint venturer) of
    the borrower; or that the lender has created a principal-agent relationship (pursuant to which the lender
    is the principal); or that the lender is the alter ego of the borrower. (See e.g., A. Gay Jenson Farms
    Co. v. Cargill, Inc. 309 N.W. 2d 285 (Minn. 1981).) While the exercise by the lender of its
    contractual right to approve prospective tenants or certain lease terms might seem a weak basis for a
    claim that the lender controlled the borrower’s leasing program, a lender’s involvement in the leasing
    process can be a slippery slope which sometimes eventually leads to the lender essentially dictating
    which leases will be acceptable and which won’t. (This situation most often occurs in the troubled loan

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    Interference With Contractual Relations Or Prospective Economic Advantage

             A variety of torts involving interference with a contract or a prospective economic advantage
    exist in most jurisdictions. In its simplest form, the tort of interference with contract constitutes an action
    by a plaintiff against a defendant who has induced a breach of contract by a third party (with whom the
    plaintiff has contracted). Sometimes this tort involves a breach of a contract; sometimes it involves the
    defendant merely having interfered with the performance of a contract; and sometimes it involves
    interference with prospective economic advantage generally. In the lender/borrower context, the claim
    would be framed as an allegation that the lender, without justification, interfered with a contract between
    the borrower and a third party, or that by the lender’s interference, the lender prevented a prospective
    advantage for the borrower. Although the elements of this kind of cause of action may differ in various
    jurisdictions, one of the required elements of an “interference” cause of action is proving that the
    lender’s interference was without justification.

             The principle underlying a claim of interference is that a party has the right to pursue its
    contractual relations free from interference of others. The paradox is that lenders sometimes have
    specific contractual rights to be involved in some way with third party contracts. For example, the loan
    commitment and/or the loan documents may provide that the lender has the right to approve the terms
    of future leases; the right to require an acceptable SNDA; and the right to require an acceptable
    estoppel certificate (the latter of which, as noted previously, can sometimes constitute a de facto lease
    amendment). Unfortunately, by the very exercise of those rights, the lender can run the risk of a claim of
    tortious interference. Two hypothetical examples are instructive.

             In the first scenario, let us assume the lender has set up leasing requirements in the loan
    documents (for future leases) which are not entirely definitive or specific; meaning that the lender has
    retained some general discretionary rights to approve or disapprove certain lease terms. If the lender
    disapproves of a lease which the borrower believes is commercially reasonable (or which the borrower
    believes is otherwise within the general parameters of the loan documents), the borrower may claim
    interference with prospective business advantage.

             Under a second scenario, let us assume there are very specific leasing parameters stated in the
    loan documents. In particular, let us assume the lender has required a minimum rent and a minimum
    duration of the lease term for each lease. However, let’s assume the leasing market has changed since
    the closing of the loan and the borrower simply cannot (due to market conditions) find tenants who will
    lease space in the building under those terms and conditions. However, let us also assume the borrower
    previously leased 90% of the space in the building pursuant to very long term leases, each at a rental
    rate which is much higher than the lender’s minimum required rent. Would the tenant’s inability to obtain
    a tenant(s) for the last 10% of the building at the lender’s required minimum rent for a minimum term be
    grounds for the lender insisting on strict enforcement of the leasing parameters? Would the borrower be
    justified in claiming that the lender is unreasonable in holding to the strict leasing requirements stated in
    the loan documents if the average rents (and average lease term) for the building would, under this
    scenario, be considerably higher than the minimum rent and term required leasing parameters stated in
    the loan documents? There are, of course, no universally accepted answers to these questions since
    these kinds of cases are very fact-specific. Nevertheless, the lender should not be too cavalier in taking

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    a hard line with a borrower -- even when the loan documents permit it to do so. The borrower may be
    able to paint the lender as somehow having unreasonably “interfered.”

    Prima Facie Tort

             A somewhat complicated tort-based theory is that of “prima facie tort.” This legal claim is by
    no means universally recognized and the elements which must be proved are somewhat vague.
    Basically, however, the tort constitutes an act by the defendant made with the intent by the defendant to
    cause injury, without any justification (or with insufficient justification). Although the tort has not met
    with much success in the lender/borrower context, there is a possibility that this could be an emerging
    area of liability to lenders. (For a case which held a bank liable under the theory of prima facie tort, see
    Schmitz v. Smentowski, 785 P.2d 726 (N.M. 1990).)


             When considering how the subject of damages and remedies applies to lender liability cases,
    one must first distinguish between when the borrower’s claim sounds in contract and when it sounds in
    tort. If the borrower’s claim is basically a breach of contract claim, one starts with the general contract
    damages rule of foreseeability, initially expressed in Hadley v. Baxendale, 9 Ex. Ch. 341, 165 Eng.
    Rep. 145 (1854). Under this general rule, if a lender improperly fails to approve a lease or otherwise
    causes the loss of an existing or prospective tenant, the measure of damages would normally be (i) lost
    rents during the time it takes the borrower to find a new tenant; and (ii) if the borrower eventually
    procures a tenant at a lower rental rate, the difference between the rental rate of the new tenant and the
    tenant the borrower first lost due to the lender’s improper disapproval. Bear in mind, however, that the
    damage suffered by the borrower might not simply be the loss of a prospective tenant. If the lender
    unjustifiably refuses to accept the tenant’s estoppel certificate; or unjustifiably refuses to accede to the
    tenant’s changes to the lender’s form SNDA; or unjustifiably refuses to approve existing leases, with the
    consequence that the lender refuses to close the loan, the borrower’s damages could be much more
    substantial. For example, if interest rates then rise and the borrower procures a loan from a different
    lender at a higher rate, the borrower’s damages could, in theory, be equal to the difference between the
    two interest rates over the entire life of the loan which the defendant lender was to give to the borrower.
    Consider also whether, if the borrower is unable to procure a different lender in sufficient time to pay off
    its existing loan, and the borrower thereby suffers a foreclosure, would the borrower be entitled to
    recover from the lender the lost equity in its property? If the loan is sought in connection with the
    borrower’s attempt to purchase the property, would the lender liable for the loss of the benefit of the
    borrower’s bargain if the borrower cannot consummate the purchase by reason of the lack of funds?
    There does not appear to be a great body of lender liability cases which helps us answer these
    questions. However, a developer can recover loss profits in a case against a lender. (See Landes
    Construction Co. v. Royal Bank of Canada, 833 F.2d 1365 (9th Cir. 1987).)

            The borrower might also be entitled to specific performance; i.e., the borrower might be able
    compel the lender to make the loan (if the borrower’s goal is to close the loan); or, in the context of
    approving leases, the borrower might be able to obtain a decree of specific performance compelling the
    lender to approve a lease. As a practical matter, it may not be feasible for a borrower to file a lawsuit
    and obtain a decree of specific performance in sufficient time to consummate the desired lease. This is
    because, by the time the borrower gets to court and obtains a decree of specific performance, chances

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    are good that a prospective tenant will have also gone on to lease other premises. Nevertheless,
    depending on the time deadlines the borrower is facing (either to refinance the property or close a
    purchase and sale transaction), specific performance might be a viable remedy.

            If the borrower’s claim sounds in tort, there is the possibility of the borrower recovering punitive
    damages. This is the most frightening scenario for a lender because the amount of punitive damages are
    unlimited and the likelihood of a plaintiff obtaining a punitive damage award (especially from a jury) is


             Generally speaking, there are two aspects to avoiding lender liability. The first is in the loan
    documentation itself. The less control (or discretion) the loan documents grant to the lender in respect
    of the leasing process, the less likelihood there is for a lender liability claim. (This is by virtue of the
    simple axiom that the less involvement the lender has with the borrower or its tenants, the less trouble
    the lender can get into.) To the extent the loan documents require minimum standards for leasing
    matters, the more definitive those standards are, the less likely there will be a claim that the lender
    improperly abused its discretion in leasing issues. Sometimes documenting leasing standards early on in
    the loan process is problematic (since the lender is often disinclined to spell them out in the letter of
    intent or loan commitment). Nevertheless, to the extent that the lender’s “paper trail” (that is, the
    written record of communications with the borrower) makes it clear that the lender forewarned the
    borrower -- early and often -- that the lender would require strict adherence to its leasing standards and
    that the lender would require that its form of estoppel certificate and SNDA be executed without any
    modifications whatsoever, the better the lender’s position will be in litigation. Indeed, the sooner the
    lender provides the borrower with its form of SNDA, estoppel certificate and, if then available, its
    leasing parameters, the better it is for all parties. It is, therefore, the better practice to have these leasing
    issues negotiated before the issuance of the loan commitment. Unfortunately, that is not the standard
    practice among most lenders, both private and institutional alike.

             The second and equally important aspect of avoiding lender liability is for the lender to conduct
    itself in a reasonable and cooperative fashion. This means that the lender must be vigilant to keep a
    clear record of its communications with the borrower, demonstrating that the lender responded
    promptly, courteously and with commercial justification for its actions. It is advisable that the lender
    confirm substantive conversations with the borrower by means of a prompt letter to the borrower so
    that there is no misunderstanding of what was said and when it was said. (Some lenders require that
    their employees keep a phone log identifying the date and substance of each telephone conversation
    with the borrower or the borrower’s representatives.)

             Many a lender has severely damaged its position in litigation by internal memoranda or
    conversations which reflect the lender’s conduct as being insensitive, vulgar, rude or gratuitously critical
    of the borrower. The lender is certainly entitled to be frustrated with a borrower, but the lender’s
    communications (both internally and externally, and whether orally or in writing) should demonstrate a
    business-like approach to any issue. Hand and hand with the lender’s demeanor toward the borrower
    is, of course, the substantive basis for the lender’s action in either approving or disapproving a lease
    matter, or otherwise dealing with the borrower. Thus, instead of a lender taking what a court could
    construe as arbitrary action, it is always best for the lender to document its file with substantive reasons

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    for its actions (and sometimes to explain in writing to the borrower why the lender is taking certain
    action). This may involve procuring reports, information or guidance from appraisers, real estate
    brokers, attorneys, accountants or other advisors sufficient to justify its conduct. Again, the lender’s
    goal is to demonstrate that it acted in a timely, prudent and commercially reasonable fashion.

            Also, to the extent that the lender foregoes enforcing any of its rights or otherwise takes any
    action which could be construed as a waiver of any of the provisions in the loan documents (or as an
    estoppel preventing the lender from enforcing those rights), the lender should make clear that it is taking
    action (or refraining from taking action or otherwise exercising its rights) without the waiver or other loss
    of any of its rights or remedies.

           In certain instances, a lender will have promulgated internal guidelines concerning various
    borrower or lease matters Although these internal guidelines may not be included in the loan
    documents, it is generally better for the lender to be consistent in following its own guidelines than to
    make exceptions for a particular borrower.

              One final thought about lender liability cases. Whenever a jury trial might occur in a lender
    liability case, bear in mind that a typical juror is probably more inclined to identify with a borrower than
    a lender; more likely to be a borrower than a lender; and, therefore, certainly more likely to sympathize
    with a borrower than a lender. (Although many loan documents contain a waiver by the borrower of a
    jury trial, these waivers may not be universally enforceable.)


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