Lender Liability is when a lender is alleged to have violated a duty of good faith and fair dealing owed to the borrower. Approximately 40% of directors and officers (D&O) policy claims paid fall under the lender liability insuring agreement of the policy. Almost half lender liability paid claims are brought forth by commercial borrowers because of the complexity of commercial lending. Most lender liability complaints are filed against the bank entity, but individuals can also be named.
All lender liability policies have different insuring agreements, different triggers, and different exclusions. Perhaps the biggest difference between lender liability policies is between standard and broad-form lender liability policy forms.
- A standard lender liability endorsement form on a bank’s Management Professional Liability (D&O) policy covers suits brought by borrowers and guarantors only.
- A broad-form lender liability endorsement form on a bank’s Management Professional Liability policy covers suits brought by borrowers, guarantors and other third parties such as other financial institutions, contractors, spouses, etc.
The most common lender liability complaints against a bank involve matters of breach of contract, fraud, breach of the implied covenant of good faith and fair dealing, breach of fiduciary duty, negligence, economic duress and misrepresentation. These claims include:
- Wrongfully refusing to honor a loan commitment.
- Wrongfully refusing to honor an alleged “side deal” that is not clearly spelled out in the loan agreement.
- Wrongfully refusing to renew a loan.
- Negligently processing or administering a loan.
- Misrepresenting information about a borrower in responding to credit inquiries.
- Threatening to take enforcement action which the lender does not carry out, but which causes the customer to act to their detriment.
- Improperly foreclosing a deed, trust, mortgage or security agreement without giving the required notice or otherwise following proper statutory procedures.
- Selling a borrower’s collateral for less than its fair market value.
- Interfering, to the borrower’s detriment, with a borrower’s day to day management or contractual relations with third parties.
- Breaching a fiduciary duty that may have arisen or that a lender may have assumed either purposely or inadvertently with respect to the borrower.
- Violation of consumer lender laws or regulation.
The type and frequency of lender liability claims are constantly increasing, especially in our current economic climate. Many borrowers are no longer accepting foreclosure as a consequence of their inability to repay the loan. Often, a countersuit is filed stating the bank took advantage of the unsophisticated borrower by making them agree to terms they did not understand. In addition, borrowers are also alleging the lender violated certain federal or state laws that are in place to protect borrowers for illegal lending practices. Even if the bank does everything right, the bank risks a jury empathizing with the borrowers rather than the lender, given banks continue to face an ever-increasing regulatory and public perception challenges.
Here are a few items to review and consider:
- What is the insurance carrier’s definition of lender liability?
- How many days are required to put a carrier on notice after discovering a potential matter?
- Are the directors, officers, employees and bank entities covered?
- Will a paid claim under the lender liability endorsement reduce the future limit for other insuring agreements within your D&O policy?
- Is it the banks or insurer’s duty to defend?
- In the event the insured wants to settle a claim, but the bank does not agree to the terms, will the bank be responsible for a part or all future defense expense and settlement (Hammer Clause)?
- Does the lender liability insuring agreement cover complaints brought by guarantors and third parties?
- Does the lender liability insuring agreement include coverage for loan participations?
- Is the lender liability limit adequate compared to the bank’s legal lending limit and exposure?
Mitch Florea, Vice President of Marketing, NBISCO