About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline
LOG IN
LOG IN

23 Com. Lending Rev. 44 (2008)
Why Loan Documentation Must Control Lender Behavior

handle is hein.journals/cmlrv23 and id is 202 raw text is: LENDER LIABILITY Why Loan Documentation Must Control Lender Behavior By Jay Kim and Gregory Ward The right legal framework can prevent disputes with borrowers. anks and other financial institutions spend valuable resources fighting claims of breach of contract and tortious conduct such as excessive control. Many of these disputes may be avoided by having the right legal framework and systems in place. A lender may be held liable to its borrower pursu- ant to various premises grounded in contract theory, state laws or tort theory. Causes of action in contract include breach of contract and breach of the implied covenant of good faith and fair dealing. Tort actions include the breach of the duty to disburse funds, con- trol liability, the implied existence of a joint venture and the breach of fiduciary duty. The applicability of these diverse theories depends heavily on the facts surrounding the lender-borrower relationship. Breach of Contract The first and most obvious cause of action for lender liability is breach of contract. Where a loan agree- ment exists, the lender may be held liable under the terms of the agreement if the lender fails to fund the loan as agreed. Many loan agreements are drafted to allow the lender to refuse to fund the loan if the borrower fails to meet specific prerequisites. A con- struction loan agreement, for example, may provide for funding at predetermined intervals based on clearly defined phases of the construction project. The phases may be defined by such objective mile- stones as the issuance of a permit or the passing of an inspection. In the case of a line of credit collateral- ized by marketable securities, the lender's obligation to continue funding may be made contingent upon a specified loan-to-value ratio based on the price of the securities as listed in a generally accepted publication such as the WALL STREET JOURNAL. Care- ful drafting, therefore, is an effective way to avoid disputes based on the contract. The breach of contract analysis does not end with a determination of whether the parties have followed the letter of the agreements. Implied in each contract is a covenant of good faith and fair dealing between the parties. This implied covenant of good faith and fair dealing may prevent a lender from using a tech- nical excuse under the agreement to refuse to lend as agreed. As a simple example, a loan agreement may provide that the lender will fund a line of credit as long as the borrower operates a pizza restaurant. If the lender then refuses to fund the line on the grounds that the restaurant has changed its menu to include pasta and sandwiches, the borrower may have a claim for a breach of the implied covenant of good faith and fair dealing, even though the lender would be technically correct that the borrower is no longer just a pizza restaurant. Implied Covenant of Good Faith and Fair Dealing Generally, the obligation of good faith is applicable in two areas. First, where the contract terms give one of the parties the power to exercise discretion, that party must exercise that discretion in good faith. For example, a financing agreement may provide that the lender has sole discretion to advance funds for the borrower's operating capital, rendering the bor- Jay Kim and Gregory Ward are Partners with WardKim, a Florida litigation law firm based in Fort Lauderdale. Contact them at jkim@wardkim.com and gward@wardkim.com, respectively. 44 COMMERCIAL LENDING REVIEW JULY-AUGUST 2008

What Is HeinOnline?

HeinOnline is a subscription-based resource containing thousands of academic and legal journals from inception; complete coverage of government documents such as U.S. Statutes at Large, U.S. Code, Federal Register, Code of Federal Regulations, U.S. Reports, and much more. Documents are image-based, fully searchable PDFs with the authority of print combined with the accessibility of a user-friendly and powerful database. For more information, request a quote or trial for your organization below.



Short-term subscription options include 24 hours, 48 hours, or 1 week to HeinOnline.

Purchase Access

Contact us for annual subscription options:

Contact Us

Already a HeinOnline Subscriber?

Log In

profiles profiles most