Lender Liability Definition and Explanation - Essay Example

Lender Liability Introduction Lending provides backbone to the economy of the United s of America. From small businesses to large multi-billion dollar businesses, it is the work of loan injection that enables them to create new business ventures and create economic opportunities for newly qualified students and provide source of revenue to the government. In other words, the entire business structure regardless of size and level of investment, loans and the process of lending activity play a pivotal and central role for bringing economic development, increasing living standard, enabling consumers to buy more, providing a platform to new and young individuals to prove their business and commercial skills and expertise. More importantly, according to the recent estimates that US Small Medium Enterprises (SMEs) accounted for 97 per cent of total exports in 2012 (Soroka, 2012). In this regard, it is important to mention that SMEs are those business units which do not have enough funds for injecting into business instead they considerably rely on the use and support of loans from venture capitalists, investment banks, commercial banks and other financial institutions. Based on these statistics, it can be deduced that the entire economy structure and functioning is purely based on the pillars of SMEs which contribute to 97 per cent exports in 2012 as mentioned above. At the same time, from this information, it can also be extracted that the US government is also collecting revenue from the exports and other business, economic and financial transactions between borrowers and lenders. However, the relationship between lender and borrower is filled with many risks, including trust, reliability, fiduciary duty, implied and explicit roles and responsibilities on both parties. In the recent years, it has been observed that this relationship is deteriorating as level of trust and breach of contractual terms and conditions are becoming common. Keeping in view this aspect, this paper would attempt to elucidate and critically assess these areas of lending with special focus on the part of lender’s liability. For this purpose, in the following parts, first lender liability has been defined. It is followed by elucidation of lender and borrower relationship in which different aspects would be considered and evaluated as well. Subsequently, bad faith and fiduciary duty are detailed. Before the conclusion part, one case study has been included to highlight the practical examples and demonstrations of lenders liability. Lender liability definition and explanation Contract commitments are bindings on borrower and lender as well. A contract takes place when two parties enter into a contractual relationship in which both agree to comply with the terms of engagement mentioned in the contract document. In this agreement, some terms are specifically mentioned and they require little elucidation and they are called as explicit terms whereas some terms are not particularly accounted for and it is generally believed that both parties are required to act on the those terms and conditions which are implied as well. As far as explicit terms and conditions are concerned, both parties ponder over them and exchange their respective positions about them; subsequently an understanding develops which leads to the ultimate consensus regarding the type, time, when, where, how and what aspects are discussed and finally are incorporated into the contracting document. In contrast, problem occurs for those terms and conditions which are not explicit but implicit as they are mainly assumed and presumed by parties and they expect that both would do them in a good faith. It is this point where majority of the lender liability issues are concerned and legal cases mostly represent situations inside the world of implicit terms and conditions. Law is considerably strict in the United States. For example, the federal Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) represents federal laws relating to the imposition of liabilities and obligations for cleanup of contamination properties; under this legal framework, liability has been classified into two categories: “strict” and “joint and several”; in the former category, the parties can be held accountable because of their identification provided in the statutory classes whereas the latter involves payment from all parties including lenders as well (Ahrens and Langer, 2008). However, the CERCLA framework entails certain exceptions allowing lenders to include “secured creditor exemption” clause which would defend the lender’s liability (Ahrens and Langer, 2008). Lender and borrower relationship Determination of lender’s liability Multiple factors are considered for assessing, determining and establishing lender’s liability. In a conventional concept, lender is a person or institution providing and offering lending services and lending funds to borrower. And there are different types of loans with different types, ranges of interest or financial charge is levied on the extended amount of loan to the borrower. Some loans are given for a short term, middle and long term; for each term, different conditions and attached terms are provided in the contracting documents. And one of the most commonly found lending institution is bank, which has been identified as a financial entity enshrined with the prime objective of extending loan facility to different types of borrowers. At the same time, there are different types of borrowers ranging from small to multi-billion dollars businesses. Based on their business requirement, they all have different types of debt requirements. More importantly, the legal and regulatory regimes have substantial ramifications for financial and corporate governance system (Kroszner and Strahan, 2001). At the macro level, both legal and regulatory systems determine and control business and commercial activities that are and that will be carried out within the geographical boundaries of that country. Through this mechanism, they encourage, discourage, protect, defend and expose all those commercial and non-commercial activities that would directly harm or benefit to the business activity in the country. In other words, through these two macro level mechanisms, the business community determines their commercial and business activities in a way to comply with the explicit and implicit obligations mentioned in the regulatory and legal systems. Keeping this view in mind, it is important to mention that the lender’s liability also largely rely on the use of such frameworks as well. for example, a corporate and legal system makes it clear that a lender cannot work in the capacity of advisor and if a lender wants to serve and offer advisory services to business community, for this, it is highly essential that the lender should renounce or withdraw from the position of lender and after this renouncement, the lender would become eligible for the position of advisor. In other words, the legal system has explicitly demarcated a boundary between lender and advisor and this demarcation will have serious ramifications for business activities especially for those dealing with debt and loans in the country. In other words, the law has established certain parameters relating to the difference between advisor and lender. However, the law has not explicitly highlighted that any indirect involvement of any person or entity in such business situations would be exempted from punitive measure for violating this provision of law. It means there are other ways which can be used for accessing to both roles for obtaining the commercial objectives. Under this situation, the court would be required to two basic objectives: the ultimate beneficiary and intention of individuals involved. More clearly, if the court ascertains that the lender has used illegal means to perform the role of advisor for obtaining the financial and commercial benefits from the situation of the borrower. In this regard, it is important to mention that the borrower’s situation and loss incurred by the borrower would also be taken into account and along with the situation the use of circumstantial evidence would also be used for examining the level of lender’s involvement in the reported case. Negligence Generally speaking, negligence refers to failure to take due care of the related parties (Negligence has two aspects: deliberate and unintentional (Cane, 1997). Situations causing deliberate negligence would bring liability whereas unintentional negligence has little scope to attract liability (Cane, 1997). In the borrower-lender relationship, negligence has a considerable significance as it has substantial impact on the business relationship and level of trust existing between two parties. In this regard, it is important to mention that the application and determination of both types of negligence would be a matter of colossal importance as it would determine whether the subsequent damages claim by the borrower should be given. The deliberate negligence attracts liability for the lender (Cane, 1997). For example, if a lender extend credit letter facility to a borrower and all related terms and conditions have been included in the contract agreement between the parties and the contract has been signed and the parties have started to play their contract-determined part as well. In the contract agreement, it is clearly and specifically stipulated that the lender would not charge market interest rate instead it would apply the agreed interest’s rate on the loan extended to the borrower. And this application would be practical throughout the contract period and till the maturity of the contract as well. However, in the middle of agreement, the lender changes mind and has sent a new agreement copy to the borrower mentioning that the market interest rate would be charged after the end of the current month. As a result, this change in the interest rate is tantamount to deliberate negligence at the part of the lender. However, during the proceedings, the lender argues that it is a common practice in the industry that every lender applies market interest rates. Subsequently, the court does not agree with the notion of the lender as it is clearly mentioned in the contract agreement that the lender would not charge market rate instead it would apply the rate stipulated in the contract agreement. Under this situation, the borrower can claim damages as this change of heart from the lender side has significant business implications for the borrower. Consequently, the court would determine the level and type of damages applicable to the lender. Business relationship Relationship between lender and borrower remains highly risky and volatile as well. In this relationship, both have certain rights and responsibilities and it is expected that both would carry out their respective duties and responsibilities till the maturity of contract. In this regard, it is important to highlight that it is a risk that lender may not fulfill its responsibilities and obligations. For example, in a contractual relationship, if lender specifies in the contract document that the next installment of loan would be given after the period of three months, and during the period of three months, the borrower injects the first loan payment from the lender into the business, subsequently, at the end of three month, the lender refuses to release the next loan payment and mentions certain financial problems or shortage of funds or any other excuses. Under this situation, the lender would be held responsible for breaching the contract commitment and it would be reasonable for the borrower to sue the lender and claim the damages caused by the contract breach on the part of the lender. In addition, there are numerous situations where lenders use their actions to cause commercial loss to borrowers including interference in the routine business activities, fraud, bad faith, breach of contract, duty of good faith and fiduciary duty are some of the common issues that are observed in cases relating to lenders liability. Interference Interference refers to explicit or implicit lender’s direct or indirect involvement in the business operations of the borrower. For example, if the borrower enters a contractual relationship with any other party and the lender interferes for making it hard for the borrower to avail benefit from the transaction with the third party. More specifically, if the lender uses influence to deter the third party from entering into a commercial relationship with the borrower, that situation holds the lender responsible for interfering in the business dealings of the borrowers. In this regard, it is highly that the motivations and objectives of the lender should be unequivocally established so as to carry out the litigation process. Without establishing and proving the involvement of the lender in the third party’s commercial dealings, it would be very difficult to hold accountable and responsible the lender for its involvement and interference. At the same time, Fraud Fraud occurs in form of false representations in the contractual agreement. For example, the lender has clearly mentioned that it would provide certain amount to the borrower within six months and within the span of three months, two final loan installments would be given to the borrower. Later on, the lender fails to extend the required amount to the borrower and the borrower receives information that the lender does not have the amount mentioned in the contract agreement. Under this situation, the lender has committed fraud in the relationship by not correctly stating its actual and real amount in the contract document. However, in this regard, it is pertinent to highlight that the lender can avoid fraud by explicitly mentioning certain clauses which are conditional and are relying on certain unforeseen events. For example, in the contractual agreement, the lender could have mentioned that the particular loan installment is conditional and is relying on the occurrence of sale of the property. In case the property is not sold, the subsequent mentioned payment would not be released to the borrower. Additionally, in order to prove this claim, the lender would be required to present required documentary evidence substantiating the claim that is being made by the lender. Breach of contract Terms and conditions are inbuilt part of contract. Every contract entails and details specific terms and conditions relating to parties involved in the contract. At the same time, the contract document elucidates the role and responsibilities of each party. Before going to sign the contract document, both lender and borrower are required to give full heed for understanding the scope of the mentioned terms and conditions and must take into account their commercial and legal aspects as well. Moreover, the terms and conditions are those aspects that give life to the relationship existing between lender and borrower as they represent, explain and elucidate responsibilities and obligations binding both parties. Each term is always written with maximum clarity so as to enable the contracting parties to understand it in the manner that is understood by both parties. More clearly, each term must not be ambiguous to any party. In case any party finds that the term is vague, it is the responsibility of the other party to elaborate it and this elaboration is highly important as it would enable both parties to find meaning, sense, responsibility and scope of the term with common but same type of understanding. In this regard, it is important to highlight that both parties should interpret the terms and conditions in a way to seek unambiguous understanding about the term. Term ambiguity may cause breach of term and which may lead to the breach of contract as well. The significance of term understanding is highly vital for the contract continuity as it entails the position of both parties with regard to the terms mentioned in the contract. It enables both parties to remove ambiguity from the terms and their practical application. In this regard, it is important to understand that certain terms have both implicit and explicit connotations and it is the responsibility of both parties to deliberate on these two aspects as well. In other words, both are required to determine and restrict the scope of the terms not only in the implicit but also in the explicit aspect as well. Bad faith Alleged breach of duty of good faith represents the occurrence of bad faith (Mannino, 2006). This problem is largely found in large debt agreement between banks and business entities where dishonest activity is used to obtain or secure one’s interest at the cost of the other. For example, if a bank wants to collect its debt from the business and the business is unable to repay the debt. During this period, the business requires additional debt and the bank have received this information from other reliable sources. However, the business is unable to approach the bank as due to current outstanding dues. Meanwhile, the bank has approached the business and offers the additional debt facility if the business repays the whole debt to the bank. Subsequently, the business pays the debt but the bank refuses to extend the promised new debt to the business. This denial to loan extension is tantamount to bad faith as the bank is attempted to serve its own interest at the cost of the business. As a result, the borrower is legally capable and authorized to sue the bank and claim the damages that were caused by such behavior of the bank. Fiduciary duty Certain specific conditions invoke fiduciary relationship between lender and borrower. The fiduciary duty can be simply defined as a trust that exists between two parties at the contract. Under this framework, both parties understand each other and act in a way that either benefits both or does not harm other party at the benefit of one party. In other words, the fiduciary duty is an implied trust and level of confidence that exists between lender and borrower. And as far as the fiduciary duty within the context of lender-borrower relationship is concerned, there are certain specific conditions that need to be satisfied before the borrower to use the notion of fiduciary duty for claiming damages against the lender. Generally speaking, both do not have this type of relationship unless it is mentioned in the contract between both parties because most of the time the role of lender is restricted to the advancement of credit line or loan facility to borrower. At the same time, this relationship is more common in situations where two delegation of authority is forwarded to agent who is under legal or moral obligation to act in good faith and the agent is required to strive for serving the interest of the principal. However, in certain conditions relating to the borrower-lender relationship, fiduciary duty or obligations exist. For example, if the lender also assumes the role of advisor to the borrower, which is common in certain financial institution, and gives advice to the borrower for taking or not taking certain commercial activities. And if the borrower acts on the advice of the lender-cum-advisor, the subsequent actions and results have repercussions for the lender as the lender-cum-advisor has assumed dual role through which it has tried to influence the borrower and its business operations. Subsequently, if a substantial amount of loss takes place, the borrower may access to a court for ascertaining the level and amount of penalty to be paid by the lender-cum-advisor. However, in this regard, it is important to mention that the court would be required to take into account the contract and terms and conditions mentioned in the contract. If the borrower has used one contract in which both roles of the lender are specified, the court would use this contract and its terms and conditions for determining the level of damages to be paid by the borrower. In case, the borrower has used two separate contracts for entering into relationship with the lender, the court would ascertain whether both are applicable to the claim made by the borrower. Case study: K.M.C. Co. v. Irving Trust Co. This case deals with the duty of good faith in lender liability. K.M.C. Co. (borrower) sues Irving Trust Co. (the lender) for not extending the subsequent loan advance and the borrower insisted that the lender should have served notice before refusing the fund advance under the framework of a letter of credit agreement; in the litigation process, the lender argued that the notice condition was not in cognizance with the demand provision; later on, the Sixth Circuit Court held that the lender has clearly violated the duty of good faith by not appropriately informing the borrower before refusing to extend the debt installment to the borrower (Fischel, 1989). The case verdict highlights various ramifications for the relationship between the lender and the borrower. First, the held takes into account the terms and conditions mentioned in the agreement between both parties. Based on the terms and conditions in which both implied and explicit scope of terms and conditions was evaluated and considered. This consideration enabled the Court to assess the impact of such provisions for the contractual relationship. For example, the Court has appropriately taken into account the perspective of the borrower as it has mentioned its status with regard to the terms and conditions along with its duties and obligations. As a result, this situation enabled the Court to entertain their perspective. Conclusion Lending provides a fundamental structure to the US economy. Both lenders and borrowers are required to develop a constructive and long term relationship which enables them to conduct their individual activities in a professional manner. However, developing and retaining this relationship has various challenges which make it hard for the borrower to carry out this business relationship. For example, lender’s liability occurs when the lender fails to fulfill his contractual responsibilities and obligations; and the failure to do so brings loss to the borrower. In every contract, it is clearly mentioned that both lender and borrower are required to understand their roles and obligations and before going to formally announce or sign the contract, it is highly recommended that terms and conditions are fully understood by them. This is important because after the agreement, both parties are legally bound to carry out their obligations mentioned in the contract. In case, one party fails to satisfy the contractual commitment, this would enable the aggrieved party to sue and claim damages. For example, tort law has clearly stipulated that if the lender commits deliberate negligence, this enables the borrower to sue the lender and claim for the damages. At the same time, it the lender commits fraud through providing false representations and the subsequently the borrower incurs loss caused by the false representations; the borrower is legally authorize to take legal action against the lender. Additionally, the lender become liable for actions if acts as an advisor to the borrower. For example, if the lender adopts two roles in which it not only provides loan but also works as advisor to the borrower, under this situation and the borrower incurs loss which is directly or indirectly caused by the ill-advice of the advisor, the borrower can also sue the lender as it has assumed two controversial roles in which only the lender benefits at the cost of the borrower. References Ahrens, M.H., Langer, D.S. (2008). Lender Liability Under CERCLA: Environmental Risks for Lenders Under Superfund: A Refresher For the Economic Downturn. Environment Risks for Lenders, 3, 482-393 Baez, B. (2010). Tort Law in The USA. New York, NY: Kluwer Law International. Cane, P. (1997). Anatomy of Tort Law. Oxford: Hart Publishing. Fischel, D.R. (1989). The Economics of Lender Liability. Yale Law Journal, 99, 131-154 Kroszner, R.S., & Strahan, P.E. (2001). Bankers on boards: monitoring, conflicts of interest, and lender liability. Journal of Financial Economics, 62, 415-452 Mannino, E.F. (2006). Lender Liability and Banking Litigation. New York, NY: ALM Media. Soroka, N. (2012). U.S. Trading Companies. International Trading Administration. Retrieved: http://www.trade.gov/mas/ian/build/groups/public/@tg_ian/documents/webcontent/tg_ian_004048.pdf Read More