“Negligent Lending” – Is the Pendulum Swinging Back?

This article was published on citybizlist.com on September 19, 2014.

Following on the heels of the financial crisis, those of us who regularly represent lenders in workouts and enforcement actions have seen an uptick in so-called “negligent lending” cases – lender liability lawsuits where borrowers claim the bank acted “negligently” or “fraudulently” when making or administering loans. Borrowers can raise such claims to defend against collection actions or to strike first by suing the bank preemptively after a loan default. Two Maryland appeals court decisions suggest that the tide may be turning against such claims.

In Welshans et al. v. Sandy Spring Bank, decided by the Maryland Court of Special Appeals in August, a borrower obtained a $263,000 SBA guaranteed loan from Sandy Spring Bank to fund a Coffee Beanery franchise. As part of the application process, the borrower prepared revenue projections and a business plan. Sandy Spring Bank deemed the projections “reasonable,” and submitted them to the SBA which approved the loan. When the franchise did not succeed, the borrower sued Sandy Spring Bank. The centerpiece of the lender liability action was the borrower’s allegation that the Bank “knew that [he] would not be able to repay the… loan or acted with reckless disregard of the truth in telling [him] that [he] qualified for the… loan.” Thus, the borrower sought to turn the tables and blame the bank for the failure of the business.

The Circuit Court for Anne Arundel County dismissed the case, finding that the commercial borrower had no viable claim against the bank. The Maryland Court of Special Appeals agreed. Its well-written opinion contains some useful comments and discussion for lenders faced with similar “negligent lending” claims. First, the court explained that the bank had no contractual or tort duty to perform “due diligence” to establish that the borrower could “generate sufficient revenue to repay the loan.” The bank’s obligation was to follow the terms of the loan documents — nothing more, nothing less, as has long been the law in this state. The fact the borrower submitted an expert witness affidavit claiming the bank should have conducted more due diligence did not change this result.

Second, the borrower failed to prove that the bank owed it any sort of “special” obligation. Third, the court debunked anecdotal arguments that the bank must have done something wrong because, in the lead up to the financial crisis and beyond, “lenders were playing fast and loose with their lending practices…” To the contrary, the Court noted that “the general practices of the banking industry tell us nothing about whether this bank breached its obligations to this borrower in connection with this loan.” In the same vein, the court rejected the borrower’s assertion that the bank acted “fraudulently” because the SBA would pay the bank a portion of the loan amount even if the borrower defaulted.

The result in Welshans is very similar to and consistent with the Maryland Court of Special Appeals’ April 2013 ruling in a case I litigated called Pease et ux. v. Wachovia SBA Lending Inc. In Pease, the borrowers obtained a $1.2 million dollar loan from Wachovia SBA Lending to purchase a Baltimore plumbing operation. The business failed, and the lender confessed judgment against the borrowers and guarantors. The guarantors tried to vacate the confessed judgment, claiming that the bank had acted negligently, had breached its fiduciary duties, and had committed fraud in making the loan. In particular, the guarantors asserted that if Wachovia SBA Lending “had not taken improper actions, the loan would not have closed and [they] would not have suffered damages.” The guarantors also filed an affidavit from a so-called banking expert who averred that the bank acted improperly. The Circuit Court for Baltimore City refused to vacate the judgment based on these loose allegations, and the Court of Special Appeals affirmed that ruling.

Just as in Welshans, the Court of Special Appeals in Pease found no “special circumstances” between the bank and the borrower which could possibly create a tort duty on the bank’s part. Rather, the relationship is contractual, and as long as the bank follows the contract, no duty is breached. To that same end, the court refused to accept the guarantors’ argument that the bank acted fraudulently when it allegedly made certain representations to them during the application process. Because those alleged representations were “plainly contradictory” to the executed loan documents, the guarantors had no right to rely on them. Lastly, the Pease Court confirmed that the guarantors could not “undo” or void the governing agreements because that would violate the Maryland Credit Agreement Act, a statute requiring the terms of commercial loans to be in writing.

Although these two cases are unreported, they signal that the financial crisis has not changed the fundamental relationship between a bank and its commercial loan customers – which is generally governed by the terms of the loan agreements, not by tort law. Indeed, these cases show that Maryland courts are not going to simply accept a borrower’s allegations that a lender acted improperly, even in situations where those allegations are repeated in affidavits from purported expert witnesses the obligors hired to support their claims.