BANKING: Borrowers Fight Back With Lender Liability

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  • BANKING: Borrowers Fight Back With Lender LiabilityAuthor(s): DEBRA CASSENS MOSSSource: ABA Journal, Vol. 73, No. 3 (MARCH 1, 1987), pp. 64-68, 70, 72Published by: American Bar AssociationStable URL: .Accessed: 16/06/2014 22:42

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    BY DEBRA CASSENS MOSS It sounds like an episode from

    "Dallas ." A group of hard-nosed bankers embark on a secret plan

    to bankrupt two Texas energy compa nies owned by a family of billionaires, in order to gain control of offshore oil drilling.

    Wheeling and dealing, the banks leak confidential information to the energy companies' competitors and hold off on restructuring the loans until they can work the best possible terms.

    But this isn't a soap opera, and it isn't Bobby and J.R. Ewing. The sons of the late oil billionaire H.L. Hunt, Nelson Bunker, Lamar and William Herbert, have sued 23 banks and lend ing institutions charging that the banks manipulated their loan struc tures in a conspiracy to destroy two Hunt-owned energy companies and create an oligopoly over offshore drill ing.

    Though it is not likely to break new ground in legal theory, the drama inherent in this Texas-size ($13.8 bil lion in claimed damages) lawsuit has drawn public attention to an emerging set of legal problems facing the bank ing and lending community. The Hunt brothers' lawsuit embodies virtually every known theory incorporated un der the umbrella of lender liability.

    Debra Cossens Moss, a lawyer, is a reporter for the ABA Journal.

    Lender liability uses traditional legal theories such as fraud, bad faith, fiduciary responsibility and interfer ence with a business to hold lenders accountable for unfairness in calling a loan or mistakes made in controlling the management decisions of a debtor in trouble.

    Plaintiffs' lawyers hail recent lender liability judgments as an im portant curb on the power of credi tors. The other side?banks and fi nancial institutions?foresee huge losses for banks and as a result, more cautious lending policies.

    Another question is whether, as critics charge, these suits are filed pri marily as a stalling tactic to give the plaintiffs time to raise funds.

    The Hunts' lawsuit was originally filed as two ?separate suits, and then consolidated. The first suit, filed in U.S. District Court in Dallas last June, accuses the banks of trying to destroy the Hunts' Penrod Drilling Company and Placid Oil Company. It seeks $3.6 billion in damages.

    The second suit, filed by Penrod Drilling and Placid Oil in July, charges that the same banks engaged in a price-fixing scheme to control off shore oil drilling and seeks $10.2 bil lion.

    THE THEORIES The lawsuits proceed on a litany

    of lender liability theories: wrongful control, domination, economic coer

    cion, bad faith, breach of fiduciary duty, breach of contract, fraudulent misrepresentation, and violation of the Sherman Antitrust Act, the Bank Holding Company Act, and RICO.

    The lawsuits include allegations that:

    The banks controlled Penrod and Placid's affairs to their own ad vantage, and delayed loan restructur ing to force the companies to agree to unreasonable terms, such as a pay ment schedule that could not be met and a pledge of additional assets as collateral.

    Many of the banks granted concessions and gave better credit terms to other customers, some of them Penrod and Placid competitors.

    Several banks promised to re structure Penrod's loan before Febru ary 1986, but intended to break that promise.

    Some Placid creditors dis closed confidential information to po tential bidders for property that Placid was attempting to sell to pay off its debts, and "sabotaged" efforts by Placid to refinance its debt with an other bank.

    The banks drafted a secret plan in March 1986 to create and con trol an offshore oil drilling oligopoly. By exercising certain creditors' rights, the banks would determine which borrowers would survive, and obtain ownership interests in those compa nies.

    ?4 William Herbert Hunt, Left, and Nelson Bunker Hunt charge that banks have con

    spired to destroy their energy companies.

    ABA JOURNAL / MARCH 1, 1987 ?5

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    Penrod was invited to partici pate in the secret plan, but refused, prompting the banks to retaliate by attempting to destroy Penrod.

    Far from conceding any points, the banks denied the charges, and filed counterclaims seeking payment of about $1.5 billion borrowed by the Hunt companies, and moved for sum

    mary judgment on the claims. The lender liability theory of the

    Hunts' lawsuits is a recent phenome non. Lender liability first attracted widespread attention in 1984, when the Texas Court of Appeals affirmed the result (although it reduced the $18.9 million award to $18.6 million) in State National Bank of El Paso v.

    Farah Manufacturing Co., 678 S.W.2d 661.

    "At that time, when Farah was

    decided, we really thought it was a

    fairly isolated event," said Maury Poscover of Donohue, Cornfeld & Jen kins in St. Louis. "Now there are liter ally stacks of lender liability cases

    coming in. And it isn't just going one way?a few of them are good case law for the lenders, limiting the scope of their liability."

    A. Barry Cappello, a Santa Barbara, Calif., attorney who won a

    multimillion dollar judgment against Bank of America in a lender liability suit, said he receives about 10 phone calls a week from borrowers who would like him to represent them.

    Cappello says the big increase in these lawsuits may be caused by sev eral factors, including a poor econ

    omy, and publicity about large judg ments.

    Many lawsuits are brought by farmers who fell victim to the farm crisis, he said. Farmers who borrowed

    heavily when the value of their land was high are now suing their banks when the banks call the loans or insist on changes in the farmers' manage ment. The weak economy also affects the banks, spurring them to call loans they would continue to hold in more prosperous times.

    "When there's good times, the banks work with their borrowers, roll over the loans, work it out, find an other lender for them," Cappello said. "But when times are tough you've got some banks in the country that are in financial trouble, and they move pre cipitously against the borrower."

    Farah and the cases that fol lowed established three primary areas

    66 ABA JOURNAL / MARCH 1, 1987

    iB^^Hl^ ^^^^^^^^ A. Barry Cappello, the Santa

    Barbara, Calif., attorney who won a multimillion dollar judgment against Bank of America.

    of lender liability: controlling and in terfering in a borrower's affairs; not dealing with a borrower in good faith; and misrepresentation and fraud.

    MANAGEMENT CHANGE CLAUSES The Farah case dealt with bank

    interference, duress and fraud.

    The dispute centered on William Farah's bid to become CEO of Farah Manufacturing, a clothing manufac

    turer. A management change clause in the loan agreement gave any two banks veto power over any change in the executive management of Farah, if they considered the change, "for any reason whatsoever, to be adverse to

    the interests of the banks." Any change that occurred despite the banks' objections could be treated as a default.

    The lenders, basing their author ity on that clause, told company direc tors that Farah was unacceptable, and if he were elected CEO, the banks

    would bankrupt Farah Manufacturing, and padlock it the next day.

    Under the management of two lender-backed CEO's, the company's position in the market deteriorated, and Farah assets were sold to pay interest and reduce the outstanding liability on the loans. Some equipment

    was sold to Farah competitors, with one of the Farah lenders financing the

    competitor's purchase before Farah regained control as CEO.

    The Texas Court of Appeals said that Farah lenders went too far in con trolling Farah management. "Al

    though the lenders may have been acting to exercise legitimate legal rights or to protect justifiable business interests," the court said, "their con

    duct failed to comport with the stan dards of fair play.. . . [Farah] was enti

    tled to have its affairs managed by competent directors and officers.

    The court also upheld a fraud claim based on a bank's warnings that it would declare the loan in default

    when in fact the bank either had made no decision on the matter, or did not plan to call the loan.

    The court also upheld a duress claim based on the warnings that Farah would be bankrupt and pad locked the next day if Farah were in stalled as CEO.

    DUTY OF GOOD FAITH Although no separate claim was

    made for breach of good faith, the court discussed good faith in its opin ion, saying a threat made in bad faith can be considered duress and that the lenders should have acted in good faith rather than making the false and

    misleading warnings. The good faith theory got a big

    boost in a 1985 decision, KMC. Co. Inc. v. Irving Trust Co., 757 F.2d 752 (6th Cir.), upholding a $7.5 million jury award that included punitive damages.

    K.M.C., a food broker in Knox

    ville, Tenn., alleged its bank failed to advance funds under a loan agree ment. The Sixth Circuit said the obli gation of good faith implied in every contract covered by the U.C.C. im

    posed a duty on the bank to give no tice before discontinuing financing, even though the bank had a discre tionary right to make advances.

    Since KMC, the good faith the ory has been the basis of many lender liability lawsuits, focusing primarily on the establishment of a course of dealing between the bank and the borrower that the borrower expects to continue despite strict enforcement provisions in the loan agreement.

    "The hottest new area of lender liability is a widening of the breach of the duty of good faith and fair deal ing," said Cappello, a partner in the


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  • law firm of Cappello & Foley. "There have been a rash of law

    suits that have held that under the U.C.C. there's a good faith duty to ne gotiate and to give the other party time to find a new source of finance in the situation in which a bank may be pulling its line of credit from the bor rower," said Phoenix, Ariz., attorney Robert E. L. Walker, who chairs the ABA Banking Law Committee.

    Some borrowers are going be yond allegations of breach of good faith, and claiming the lender

    breached a fiduciary relationship.

    LENDERS AS FIDUCIARIES In an Ohio case, Dennis v.

    BancOhio National Bank, No. 18738 (Perry County), Columbus attorney J. Stephen Teetor claimed the financial problems of his farmer clients were caused when the bank breached a fi duciary relationship. A jury found for Teetor's clients, Keith and Nancy Dennis of Rushville, Ohio.

    The jury awarded the Dennises $1.04 million, but the amount was to

    be offset by the amount of the loan? about $700,000. The case was later settled under undisclosed terms to avoid appeal.

    Teetor, of Isaac, Brant, Ledman & Becker, argued that the bank assumed a fiduciary relationship when it began to advise the Dennis family on how to run their farm?advice that resulted in financial losses.

    "Bank personnel began advising Dennis as to when and how to market products, how to run and manage the farming operation, and assisted plain

    ABA JOURNAL / MARCH 1, 1987 67

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    tiffs to prepare and analyze their fi nancial matters," Teetor said in his trial brief. "In fact, the bank even went so far as to order that plaintiffs fire their independent marketing consul tant."

    The trial judge sent the issue of breach of fiduciary relationship to the jury, along with issues of whether the bank exerted economic duress to get the Dennises to follow its advice, and whether the bank was negligent in structuring loans.

    In what may be the largest lender liability verdict to date, the Jewell family, which owns an apple orchard in California, won $46.6 million in a lender liability suit against Bank of

    America in 1985. The trial judge re duced the amount awarded to $22 million, and an appeal is pending. Kruse v. Jewell v. Bank of America, No. 112439 (Sonoma County).

    In the Jewell case, the apple growers argued at trial that the bank agreed to provide long-term financing, prompting the Jewells to turn over more collateral to the bank. Then, after security was given, the bank re fused further financing, which the Jewells said destroyed their business.

    THE POLICY ISSUE Some lawyers are questioning

    the policy behind the decisions. Is it right to hold bankers liable for lack of good faith? What do the new decisions mean for bank lending policies?

    "I think the banking industry, like everybody else that deals in the business world, ought to be held to standards of reasonableness," says Teetor. "When a bank comes in and tells you how to run your business, and you lose money, the bank ought to be responsible for the loss."

    Lenders do not assume a fiduci ary relationship in every transaction, Teetor says, but in some cases they do. "If the relationship evolves into one of special confidence and trust, the bank owes special duties.

    "It doesn't mean the bank is going to be responsible for everything that goes wrong," he says. "It means

    they're going to have to exercise their judgment in the best interest of the customer."

    W. Ted Minick, attorney for one of the Hunt defendants, the First Na tional Bank of Chicago, criticizes ap plication of the fiduciary duty theory to the creditor-debtor area. Ma...