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Lenders Beware: In Tough Economic Times, The Government Gets Into the Act

Lender Liability Litigation Update Matthew J. Flynn, Don P. Martin

The news coverage of government bailouts - particularly of the financial industry - has been non-stop in recent weeks. That's the governmental carrot. The governmental stick - control over lenders' lending and enforcement decisions - has not received the same level of coverage, but that does not mean it is not being wielded. Consider the following events, demonstrating the increasing level of government control of and intervention in lending and enforcement decisions:

  • Cities fed up with lost taxes and blighted neighborhoods have filed suits against lenders to prevent mortgage foreclosures within their boundaries under such theories as nuisance[1] and fair-housing laws[2].
  • The State of Massachusetts successfully enjoined a lender from filing any mortgage foreclosure suits within the entire state, unless the lender first gets permission from the Attorney General's office or the courts. The basis for the injunction was the government's claim that the lender's actions in resetting interest rates under ARMs after the initial introductory rate period was "structurally unfair" under the State's consumer protection act. Under the terms of the injunction, one key predicate to getting permission to file foreclosure is a requirement that the lender swear it has diligently and unsuccessfully tried to work out the loan outside of court[3].
  • When a bank declared a default under its loan to a Chicago window manufacturer (and thus ceased funding the company's operations)[4], 250 of the company's employees staged a sit-in protesting the shut-down of the company. The negative public relations fallout culminated in the president-elect of the United States injecting himself into what was quintessentially a local dispute, and the resulting political pressure and bad publicity forced the bank to resume extending credit.
  • When banks didn't re-open the lending spigots within days of the first financial bailouts, Congressional lenders started threatening to hold Congressional hearings and made unspecified threats against the financial industry generally and individual banks in particular[5].

The general public feeling against the financial industry was colorfully summed up by a prominent California developer, who recently stated, "It's wrong what the banks are doing . . . . Look at the people who get hurt. It's not just the builders. It's the engineers, the surveyors, framers, concrete guys. Cities get left with blighted properties and don't get the fees they were expecting. It's a big domino effect that ends up destroying communities."[6]

As the bad economic news continues to roll in, compounded by the revelation of massive frauds such as the Madoff Ponzi scheme[7], lenders will increasingly find themselves in the cross-hairs of (a) their regulators, (b) their shareholders, (c) state, local and federal governments, (d) their borrowers and (e) their fellow lenders (in multi-lender loans). This is not business as usual, and picking one's way through this minefield will require more than mere knowledge of one's loan agreements - it will require political skills, public-relations skills and an acute awareness of how to avoid and defuse the lender-liability bombs that borrowers, related parties and other lenders are increasingly likely to throw.

At first glance, many lender-liability claims may seem frivolous and, indeed, many of them are likely to be dismissed by the courts. But as the examples cited at the beginning of this advisory indicate, courts are likely to become increasingly sympathetic to them in light of the severity of the economic downturn, and defending even against claims of little or no merit is expensive, distracting and time-consuming.

At Quarles & Brady LLP, we have assembled a team of 30 lawyers, across our six offices in four states around the country, with extensive experience in representing banks and other financial institutions against lender liability claims. Many were deeply involved in representing lenders in the financial crises of the 1970s and 1980s, and they were also involved in assisting the financial industry in enacting significant pro-lender protections such as the Illinois Credit Agreements Act[8]. If you are facing a threat of a lender liability claim, or need assistance in analyzing the best course of action for exercising your remedies, please contact one of our lawyers listed below or your Q&B relationship lawyer:

Matt Flynn, 414-277-5315 / [email protected]
Katie Perhach, 414-277-5699 / [email protected]

Valerie Bailey-Rihn, 608-283-2407 / [email protected]
Roy Prange, 608-283-2485 / [email protected]

Don Martin, 602-229-5700 / [email protected]
Nicole Stanton, 602-229-5662 / [email protected]

Craig Kaufman, 520-770-8707 / [email protected]

Andrew Tretter, 239-434-4955 / [email protected]

[1] City of Cleveland v. Ameriquest Mortgage Co., (Cuyahoga Cty Common Pleas, filed January 2008).
[2] City of Baltimore v. Wells Fargo (D. Md., filed January 2008).
[3] Commonwealth of Massachusetts v. Fremont Investment & Loan (Mass. Super. Ct., February 25, 2008).
[4] See, e.g., M. Davey, "In Factory Sit-In, an Anger Spread Wide," The New York Times, December 8, 2008.
[5] See, e.g., "Frank Statement on TARP Provisions," News Release from Barney Frank, October 31, 2008.

[6] Andrew Eliopulos, President of J.P. Eliopulos Enterprises. Eliopulos borrowed from IndyMac Bank for the development and construction of 900 acres in northern Los Angeles County. IndyMac Bank refused to extend the loan for his construction project after a new appraisal came back 80% lower than the original appraisal. IndyMac Bank demanded that Eliopulus come up with $10 million, the difference between the new appraisal and outstanding balance, or pay the note in full. Eliopulus was unable to pay, and IndyMac foreclosed on the development.

[7] See, e.g., C. Haughney, "Madoff Scandal Shaking Real Estate Industry," The New York Times, December 18, 2008.
[8] 815 ILCS 160, ยง 2.