Banks are becoming more and more aggressive in how they go about getting their money back. Sometimes, people, for one reason or another, do what the bank wants. When the Bank does end up making a decision and things go bad, when is the Bank on the hook?
All businesses need money to operate. Most businesses turn to banks and lenders to fund their needs. Traditionally, the primary concern of the bank or lender is getting back the money they lent your business. More and more, banks are becoming aggressive in how they go about getting it back. Generally, a business should make decisions based on the best business advice, not what the bank wants. Sometimes, people either trust the bank too much or have no other choice than to do what the bank wants. When the Bank does end up making the decision and things go bad, the question then arises if the Bank should be on the hook, what courts generally refer to as “lender liability.”
Lender liability is the result of a lender’s conduct. Generally, lender liability arises from either a breach of a common law (or judicially created) obligation or a violation, whether intentional or inadvertent, or a breach of a federal or state statutory obligation. Liability has been found in situations where a lender exercises excessive control over a borrower’s affairs, or engages in inequitable or fraudulent conduct with respect to the borrower or other creditors of the borrower. When control is exercised, the lender may be held liable to the borrower or third parties for damages.
Generally, the Courts seem to make a distinction between “leverage” and “control”. The Courts acknowledge that Lenders generally have a great deal more leverage in negotiating loan documents, particularly in a default/restructuring scenario, and the loan documents themselves (e.g., contractual provisions that restrict the borrower’s activities or require the borrower to take certain actions in the event of default) arguably could constitute a starting point for purposes of establishing lender liability, the leverage itself does not equal control. At the same time, the Courts don’t seem to have any issues with the Bank’s use of this leverage to create terms in contracts that seem to cross the line from a lending relationship to something other than a lending relationship. The trend has been to find no liability when a lender has acted strictly within the terms of its agreement with the borrower as long as its actions have been reasonable.
But, the actions of the lender in using an agreement’s provisions and remedies, not their mere existence, may be the basis for a court’s finding of liability. Thus, a great deal of the case law depends on an analysis of the facts and circumstances of the individual case and frequently requires difficult judgments in balancing the lender’s interest in maximizing its recovery against the risks inherent in the lender’s assertion of its contractual rights.
Lender Exercising Control
A lender may exercise control over a debtor in many different ways, some subtle, some not so subtle. For example, a lender may assert control when it (a) develops a fiduciary relationship with the debtor; (b) exercises direct control over the board of directors or management of the debtor, (c) exercises indirect control over the debtor by use of default provisions, or (d) exercises control through the breach of the duty of good faith and fair dealing.
Lender as Fiduciary
The mere existence of a lender-borrower relationship does not
impose fiduciary obligations on the lender. As stated by the South Carolina
arrangement creates a creditor-debtor relationship rather than a fiduciary
one.” National Loan And Exchange Bank
v. New York Life Insurance Company, 149 S.C. 378, 147 S.E. 322 (1929). “In
limited circumstances, ... a fiduciary relationship may be created between a
bank and a customer if the bank undertakes to advise the customer as a part of
the services the bank offers. Such a relationship charges the bank with a duty
to disclose material facts which may affect its customers' interest.
The term fiduciary implies that one party is in a superior position to the other and that such a position enables him to exercise influence over one who reposes special trust and confidence in him. 36A C.J.S. Fiduciary (1961). As a general rule, mere respect for another's judgment or trust in his character is usually not sufficient to establish such a relationship. The facts and circumstances must indicate that the one reposing the trust has foundation for his belief that the one giving advice or presenting arguments is acting not in his own behalf, but in the interests of the other party. 36A C.J.S. Fiduciary (1961).
Generally, a lender does
not owe fiduciary duties to a borrower. See Regions Bank v. Schmauch,
354 S.C. 648, 582 S.E.2d 432, 444 (S.C.Ct.App.2003). Trustee asserts that the fiduciary
relationship existed based upon Defendants' control over Debtor prior to the
petition date. At common law, a fiduciary relationship may be established when
a lender exercises improper control over a borrower. See In re K Town, Inc.,
171 B.R. 313, 319 (Bankr.N.D.Ill.1994). Lender control may be established by a
lender engaging in the day-to-day management and operations of the borrower or
compelling borrower to engage in unusual transactions. See NCNB Nat. Bank of
N.C. v. Tiller, 814 F.2d 931, 936 (4th Cir.1987) (overruled on other
grounds Busby v. Crown Supply, Inc., 896 F.2d 833 (4th Cir.1990)); Temp–Way
Corp. v. Continental Bank, 139 B.R. 299, 318 (E.D.Pa.1992). Courts have
also looked to whether the lender was an insider of the borrower, whether the
lender has the contractual right to control the management of the borrower, and
whether the lender dictated corporate policy and determined the disposition of
the borrower's assets. See K Town, 171 B.R. at 319. This theory of
lender liability is consistent with South Carolina law that a lender may be
liable to third parties if lender assumes control over a borrower's business. See
Peoples Fed. Savs. & Loan Ass'n v. Myrtle Beach Golf & Yacht Club,
310 S.C. 132, 145, 425 S.E.2d 764, 769–774 (S.C.Ct.App.1992).
In determining whether a fiduciary relationship exists, one
needs to examine not just the relationship of the borrower and the lender but
also the representations made by the lender generally. In this regard,
examining the lender’s policies and procedures may be helpful. In one example, a well known bank in South
Carolina was surprised to find that in its own policies was a statement that
said, “we are fiduciaries to our customers.”
When asked about this statement in their policies, the loan officer
attempted to distinguish between a customer that deposits money with the bank
and a customer that borrows money from the bank. When it was pointed out that the particular
case, the customer was both a depositor and a borrower, the follow up question
was when would the customer know that the bank had the duties of a fiduciary
and when it did not. The questioning
then proceeded to ask the loan officer if he had two different hats, one
labeled “fiduciary” and one labeled “not a fiduciary” so that the loan officer
could switch between hats to let the customer know when the loan officer could
be trusted. When the loan officer
protested and stated that he could always be trusted, he then had to concede
that he was always acting as a fiduciary.
In a second example, a well known bank developed an
advertising campaign insisting to the public in South Carolina that the
individuals should let the bank be their “business partner.” Partners are fiduciaries and entities that
represent themselves as your partners are generally estopped from later denying
the fiduciary relationship exists.
In Maryland, the Courts have stated that there are four
special circumstances under which a fiduciary relationship can exist between a
lender and a borrower: when the lender (1) took on any extra services on behalf
of the borrower other than furnishing money; (2) received a greater economic
benefit from the transaction other than the normal mortgage; (3) exercised
extensive control; or (4) was asked by the borrower if there were any lien
Other courts, like South Carolina have similarly held that a
fiduciary relationship exists between a borrower and a bank when the
relationship between the parties ripens into one in which borrowers are
dependent on, and reposed trust and confidence in, the bank in the conduct of
Similarly, Under Washington law, when a special relationship develops between a
lender and a borrower a fiduciary duty may exist.
Direct Control through the Board
A lender’s ownership of an equity
interest in the borrower, particularly stock with voting rights, may provide
the lender with the power to control or influence the borrower’s management
once it has the right to exercise such voting rights. The lender’s ownership interest would make
the lender an insider and that is one of the indicia looked at by the
Bankruptcy Court in assessing control.
Although merely taking a pledge of stock as collateral for a loan does
not evidence control, a lender that exercises voting rights of pledged stock to
elect directors and influence the day-to-day affairs and business decisions of
the borrower may be found to be in a control position.
Indirect Control through the
Board of Directors.
A lender’s influence over the
composition of its borrower’s board and management may also expose the lender
to liability. In State National Bank v. Farah Manufacturing Co.,
, a company’s loan agreement provided that a change in management would
constitute an event of default if for any reason the lender considered that
change to be adverse to their interests.
The lenders led the borrower’s board of directors to believe that the lenders
would accelerate the loan and force the company into bankruptcy if management
unacceptable to them was installed. Basically, the lenders had used their
leverage under the management change clause to cause the board not to elect on
person (Mr. Farah) as chief executive officer, to prevent the election of two
directors, to pack the board with the lenders’ hand-picked nominees who engaged
in a proxy fight against Mr. Farah, and instead elected a chief executive
officer who auctioned off assets of the borrower.
When, Mr. Farah eventually assumed
the position of chief executive officer, the borrower sued the lenders for
fraud, duress, and tortious interference with the borrower’s business
relationship. The borrower obtained a multimillion dollar judgment against the
lenders for installing incompetent management and preventing the election of
competent management. Simply, a lender
that “takes control” of the management of its borrower and makes the borrower’s
policy and management decisions risks exposure to causes of action for damages
resulting from its exercise of control.
In the case A. Gay Jenson Farms
Co. v. Cargill, Inc., ,
creditors of the debtor successfully asserted claims against the lender
asserting that the debtor was the agent and the lender was the principal on the
debtor’s contracts for the sale of grain. Generally, principals control the
actions of their agents and generally, principals are liable for the actions of
their agents. In Cargill, the
court held that the following as indicia of control supported its conclusion
that the debtor was agent and lender was the principal under the contracts: the
lender critiqued and made recommendations to the borrower relating to the
contracts; the lender had the right of first refusal to purchase the debtor’s
grain; the debtor was prevented from entering into mortgages, purchase stock,
or pay dividends without the lender’s approval; the lender had the right to
enter the debtor’s premises for periodic checks and audits; the lender issued
an internal memo stating the need for “strong paternal guidance”; the lender’s
name was imprinted upon the drafts and forms furnished to the debtor for use in
its day to day activities; the lender financed all the borrower’s purchases of
grain and operating expenses; and the lender could discontinue financing at its
sole discretion. In Cargill, the court held that the lender’s actions
were sufficient to find that the debtor and the lender actually had an agency
In the case of Peoples Fed. Sav.
& Loan Ass’n v. Myrtle Beach Golf
& Yacht Club, ,
the South Carolina Court of Appeals cited the Cargill case and held:
is a fiduciary relationship which results from the manifestation of consent by
one person to another to be subject to the control of the other and to act on
his behalf. Restatement (Second) of Agency § 1 (1958). An agreement may result
in the creation of an agency relationship although the parties did not call it
an agency and did not intend the consequences of the relationship to follow.
Agency may be proved by circumstantial evidence showing a course of dealing
between the two parties. If requisite facts exist to prove a principal/agent
relationship, this theory has been used to hold a lender liable for the debts
of a borrower. 10 S.C. Juris. Banks and Banking § 171 (1992).
The Court of Appeals goes further
to discuss the Restatement (Second) of Agency as follows:
Restatement (Second) of Agency § 14(O) (1958) supports the concept of lender
liability under the agency theory where the lender takes control of its
borrower. Comment (a) to § 14(O) states:
A security holder who merely exercises a veto power over the business acts of his debtor by preventing purchases or sales above specified amounts does not thereby become a principal. However, if he takes over management of the debtor's business either in person or through an agent, and directs what contracts may or may not be made, he becomes a principal, liable as any principal for the obligations incurred thereafter in the normal course of business by the debtor who has now become his general agent. The point at which the creditor becomes a principal is that at which he assumes de facto control over the conduct of his debtor, whatever the terms of the formal contract with his debtor may be.
Lastly, the Court of Appeals
discusses the instrumentality theory of liability for a lender. Basically, this theory is like piercing of
the corporate veil but instead of making the shareholder liability, the court
would make the lender liable. As to this
theory, the Court states:
this theory of liability, when a lender controls the business decisions and
actions of its borrower, the borrower becomes the instrument or alter ego of
the lender. 10 S.C.Juris. Banks and Banking § 170 (1992); see also Krivo
Indus. Supply Co. v. National Distillers & Chem. Corp., 483 F.2d 1098
In the Krivo case, the Fifth Circuit Court of Appeals gave expression to the elements of an instrumentality or alter-ego theory. The court stated the control required for liability under the “instrumentality” doctrine amounted to total domination of the subservient corporation to the extent the subservient corporation manifested no separate corporate interests of its own and functioned solely to achieve the purpose of the dominant corporation. Id. at 1106. The court noted the instrumentality theory would not apply even in the presence of “total domination” without some misuse of control by the dominant corporation resulting in injustices or inequitable consequences. Id.
In some cases, the Court finds that the leverage obtained by the lender through the negotiation of the original contracts does not trump the requirement that the lender exercise these rights in good faith. In Duffield v. First Interstate Bank, an individual borrowed $2,000,000 from a bank. The United States Court of Appeals for the Tenth Circuit held that under applicable Colorado law, even where the express terms of a contractual provision appear to permit unreasonable actions, “the implied duty of good faith and fair dealing limit[s] the parties’ ability to act unreasonably in contravention of the other party’s reasonable expectations.” By holding that the bank breached its duty of good faith, it appears that the Duffield court not only followed Big Horn Coal Co., but expanded its scope. In Big Horn Coal Co., the court had held that the offended party’s expectations had to be created “by the contract.” In Duffield, however, the court held that the bank had violated the duty of good faith because “the proper interpretation of the agreement and its surrounding circumstances mandate[d] the conclusion that the agreed common purpose of the loan and security agreements was to permit [the borrower] to repay the loan within its terms through the continued operation of his business.” By closing the debtor, the lender exercises control over the debtor. By violating the reasonable expectations either from a proper interpretation of the agreement or by the surrounding circumstances, the lender has breached the duty of good faith and has moved past having leverage and instead exercised control over the debtor. For this breach, the lender has been found liable.
A lender may exercise control over a debtor by (a) developing a fiduciary relationship with the debtor; (b) exercising direct control over the board of directors or management of the debtor, (c) exercising indirect control over the debtor by use of default provisions, or (d) exercising control through the breach of the duty of good faith and fair dealing. If the lender exercises such control, it may find itself liable.
 Cosoff v. Rodman (In re W.T. Grant Co.), 699 F.2d 599, 609 (2d Cir.), cert. denied, 464 U.S. 822 (1983)
 Adams v. G.J. Creel and Sons, Inc., 320 S.C. 274, 465 S.E.2d 84 (1995) (“there is no breach of an implied covenant of good faith where a party to a contract has done what provisions of the contract expressly gave him the right to do.” Citing First Federal Savings and Loan Ass'n. of South Carolina v. Dangerfield, 307 S.C. 260, 414 S.E.2d 590 (Ct.App.1992)); but see United Energy Distributors, Inc. v. ConocoPhillips Co., Not Reported in F.Supp.2d, 66 UCC Rep.Serv.2d 997(2008) (citing with approval Justice Toal’s dissent in Dangerfield that “reasonableness and good faith are each jury questions”).
 When the Supreme Court stated “bank-depositor” relationship, it perhaps mis-spoke. Ordinarily, the entrusting of money or things by one person to another person or entity does create a fiduciary relationship. Most Banks recognize that they are fiduciaries when it comes to money deposited with them. The misuse of money deposited with a bank is even a criminal offense. See 18 USC §656 (criminal statute for when a bank officer misapplies money).
 Burwell v. S. Carolina Nat. Bank, 288 S.C. 34, 40-41, 340 S.E.2d 786, 790 (1986); See also Kerr v. Branch Banking & Trust Co., 408 S.C. 328, 333, 759 S.E.2d 724, 726-27 (2014) (“It is well-established that banks owe a limited duty of care to their customers. See, e.g., Burwell v. S.C. Nat'l Bank, 288 S.C. 34, 40, 340 S.E.2d 786, 790 (1986) (finding that a bank-customer relationship is merely a lender-borrower relationship and is not fiduciary in nature unless the bank undertakes to advise its customers as part of the services that the bank offers); Regions Bank v. Schmauch, 354 S.C. 648, 671, 582 S.E.2d 432, 444 (Ct.App.2003) (explaining that, if the bank does create a fiduciary relationship with its customer, the bank must only “disclose material facts that may affect its customer's interests”)”).
 In re Worldwide Wholesale Lumber, Inc., 372 B.R. 796, 812-13 (Bankr. D.S.C. 2007).
 Windesheim v. Larocca, 443 Md. 312, 116 A.3d 954 (2015).
 TBF Financial, LLC v. Gregoire, 2015 VT 36, 118 A.3d 511 (Vt. 2015).
 In re Residential Capital, LLC, 531 B.R. 1 (Bankr. S.D. N.Y. 2015) (applying Washington law).
 Citibank, N.A. v. Data Lease Fin. Corp., 828 F.2d 686 (11th Cir. 1987), cert. denied, 484 U.S. 1062 (1988); Metge v. Baehler, 762 F.2d 621, 631 (8th Cir. 1985), cert. denied, 474 U.S. 1057 (1986).
 678 S.W.2d 661 (Tex. Ct. App. 1984) (writ granted, judgment set aside, cause dismissed)
 309 N.W.2d 285, 290-91 (Minn. 1981)
 Id.; see also Korea Exp. USA, Inc. v. K.K.D. Imports, Inc., No. 99 Civ. 5140 (NRB), 1999 WL 1034755, at *1 (S.D.N.Y. Nov. 15, 1999) (recognizing Cargill’s continuing vitality and describing the case as “seminal”).
 310 S.C. 132, 145©46, 425 S.E.2d 764, 773 (Ct. App. 1992)
 See Duffield v. First Interstate Bank, 13 F.3d 1403 (10th Cir. 1993); accord Mike Naughton Ford, Inc. v. Ford Motor Co., 862 F. Supp. 264, 272 (D. Colo. 1994) (the duty of good faith and fair dealing requires that parties perform their obligations under contracts in good faith, even if the contractual obligations are unambiguous); Tufankjian v. Rockland Trust Co., 782 N.E.2d 1, 5 (Mass. App. Ct. 2003) (“Good faith performance or enforcement of a contract emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party.”) (internal quotations and citations omitted).
 Id. at 1405-06. See also Big Horn Coal Co. v. Commonwealth Edison Co.,852 F.2d 1259 (10th Cir. 1988)(“where a contract provision is exercisable only at some discretion of one of the parties, and expectations are created by the contract, good faith limitations are applicable to protect the non-exercising party from unexpected invocation of the option”).