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 wo