When working with a prospective borrower, lenders should take the steps necessary to avoid the potential of future lender liability claims in the event that the relationship between the borrower and lender deteriorates.
In terms of commercial lending transactions, “lender liability” generally refers to claims by a borrower (or other obligor) against a lender which, if successful, could result in a lender being held liable for losses suffered by the borrower (or other obligor) caused by the lender’s actions, or failure to act. Lender liability claims are often based on various legal arguments such as breach of contract, breach of duty of good faith, negligence or willful misconduct, or violations of applicable laws and statutes.
There are many proactive practices that lenders may utilize to avoid, or limit, the potential exposure of lender liability claims, such as the following:
- Confirm who will be the primary point of contact for the borrower to avoid potential inconsistent discussions or communications.
- Verbal negotiation of terms and conditions may give rise to future disputes between a lender and borrower. Lenders should summarize any verbal negotiations in writing to minimize the potential of misunderstandings, misinterpretations, or confusion.
- Proposal letters or letters of intent should include a disclaimer of any commitment to extend credit until final approval is issued through the lender’s loan approval process.
- Commitment letters may be considered a binding contract between the lender and borrower, and a lender’s failure to abide by terms of the commitment letter may give rise to a lender liability claim. Accordingly, lenders should determine whether their form of commitment letter contains any applicable conditions or prerequisites for the proposed loan.
- Obtain a signed acknowledgement from the borrower and/or guarantors confirming their obligation to reimburse lender for any costs or expenses incurred by the lender, regardless of whether or not the loan closes.
- Ensure that all applicable consents and waivers are obtained, and control who is provided access to confidential borrower information and other due diligence materials.
- Avoid preparing or negotiating documents on behalf of the borrower (e.g. negotiating terms of a purchase agreement with seller or seller’s counsel).
- Ensure that specific loan provisions and covenants are consistent with the lender’s loan approval requirements, as well as the negotiations with the borrower, such as:
- Financial covenants and ratios
- Financial reporting requirements
- Borrower affirmative covenants
- Borrower negative covenants
- Lender obligations and commitments
(e.g. obligatory vs discretionary advances) - Modifications to the loan documents must be in writing and only effective if signed by the appropriate parties.
- Merger clause stating that the loan documents contain the entire agreement of the parties.
- Accurately detailing the order of application of payments.
- Ensure consistency between documents in a singular transaction.
- Ensure consistency between documents for multiple loans for the same borrower.
- Ensure that all documents are executed and/or acknowledged properly by all necessary parties.
- Ensure that loan proceeds are properly distributed according to the terms of the loan documents.
While this is not an exhaustive list, it is meant to provide examples of best practices to assist lending institutions in ensuring that their commercial loan processes minimize potential lender liability claims.