Lender Liability Claims

Lender Liability ClaimsThe bankruptcy litigation lawyers at Mark Anchor Albert and Associates are well-equipped to achieve the best possible outcomes in complicated lender liability cases.

Lender liability in the bankruptcy context can arise under multiple circumstances. Debtors-in-possession, trustees, creditors’ committees, and receivers have sued banks and other lenders for breach of oral and written contracts, breach of the implied duty of good faith, fraud, misrepresentation, aiding and abetting fraud, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, to avoid preferential transfers, and for equitable subordination.

With regard to equitable subordination, 11 U.S.C. § 510(c) provides that the bankruptcy court may subordinate all or part of a lender’s allowed claim or interest, or to transfer any lien securing a subordinated claim to the bankruptcy estate. Absent an approved plan of reorganization allowing equitable subordination of a lender’s claim, equitable subordination must be sought by way of an adversary proceeding. See Fed R. Bankr. P. 7001(8).

Before a lender’s claim of debt (secured or unsecured) will be equitably subordinated, the proponent will need to make a showing that the lender has engaged in some kind of inequitable conduct, such as fraud, misuse of fiduciary status, or domination or control of the debtor to the detriment of other creditors; the misconduct must have resulted in injury to the creditors of the bankrupt or conferred an unfair advantage on the claimant; and equitable subordination of the claim must not be inconsistent with the provisions of the Bankruptcy Code. See Paulman v. Gateway Venture Partners III, L.P. (In re Filtercorp, Inc.) (9th Cir. 1998) 163 F.3d 570, 583 (stating the equitable subordination test); Citicorp Venture Capital v. Comm. of Creditors Holding Unsecured Claims (3d Cir. 1998) 160 F.3d 982, 986-87 (same); In re Lifschultz Fast Freight (7th Cir. 1997) 132 F.3d 339, 344 (same).

Under appropriate circumstances, a lender’s loan claim also may be recharacterized from debt to equity. In the context of lender liability, loans may not only be recharacterized as equity contributions, but sales may be recharacterized as secured loans. In such cases, courts are called on to determine whether a transaction can properly be characterized either as a “true sale” or a “disguised secured loan.” The propriety of recharacterization turns on whether recharacterization is distinct from Bankruptcy Code § 510(c)’s power to equitably subordinate claims. See, e.g., Pacific Express Holding, Inc. v. Pioneer Commercial Funding Corp. (In re Pacific Express, Inc.) (9th Cir. B.A.P. 1986) 69 B.R 112, 115 (although the bankruptcy court may determine the amount and disallowance of claims under section 502(a) of the Bankruptcy Code, those provisions do not provide for recharacterization of claims as equity or debt because such a determination is governed solely by section 510(c).

While a bank or other lender ordinarily does not have a fiduciary duty to its borrowers, there are recognized exceptions to this rule when a bank’s or other lender’s conduct exceeds the usual creditor-debtor relationship. Even where a lender does not have a direct fiduciary relationship with a debtor, it still may be held liable for aiding and abetting another person’s or entity’s breach of fiduciary duty. Factual elements frequently recurring in bank aiding and abetting cases include (i) financing, through a series of transactions, of a fraudulent enterprise over an extended duration; (ii) the bank’s use of actual or alleged “atypical” banking practices, and; (iii) an ultimate bankruptcy (or absconding with funds) by a borrower or client of the bank with whom the bank had more than a mere arms-length relationship.