In the wake of the post-2008 “Great Recession,” many financial institutions were left holding an odoriferous bag of non-performing loans and bank-owned real estate (“REO Property”) resulting from foreclosures on collateral. As banks formulated creative strategies to realize financial gains (or minimize losses) from their inventory of “toxic assets,” several banks apparently decided that a potential panacea presented itself in forcing new, solvent borrowers to assume or purchase the bank’s bad loans or stagnant REO Properties. This specious solution, unfortunately, runs afoul of the anti-tying provisions of the Bank Holding Company Act, 12 U.S.C. § 1972(1) (“BHCA”), potentially exposing a bank to liability for actual damages, treble damages and attorneys’ fees. One Kentucky bank recently learned this lesson the hard way.
The Bank’s “Brilliant” Solution
In Halifax Center, LLC v. PBI Bank, Inc., Civil Action No. 1:13 CV-00071-JHM, 2014 WL 626753 (W.D. Ky. Feb. 18, 2014), PBI Bank arrived at a brilliant solution, during the dark economic period of May 2009, for its problematic portfolio of bad loans and REO Property. Mr. Chandler sought $6 million in new financing from PBI (the “Chicago loan”) to purchase a HUD loan secured by a mortgage on an apartment complex in Chicago. Mr. Chandler alleged that PBI representatives told him that they would make the new Chicago loan only if he bought some land located on Halifax Drive in Owensboro, Kentucky. PBI had made a secured loan to the owner of the Halifax property, and that loan was in default. The Bank did not own the Halifax land that it wanted Chandler to buy. Chandler’s claim that PBI required him to buy the Halifax property as a condition of making the new $6 million Chicago loan was supported by an unfortunate piece of evidence for the Bank: PBI’s written credit memorandum for the Chicago loan stated that Chandler’s purchase of the Halifax property was a condition of the loan. PBI and Chandler then entered into an agreement for the purchase and sale of the Halifax property. Strangely, the purchase and sale agreement was executed by Chandler and the Bank, not the owner of the Halifax property -- though the agreement recited that PBI would “cause” the owner of the Halifax property to sell the property to Chandler for the precise amount that the property owner owed the bank. Halifax Center, LLC, a new entity formed by Chandler, signed a promissory note to the Bank for the purchase price of the Halifax property -- coincidentally, the identical amount outstanding under the original Halifax owner’s loan from PBI. The Halifax purchase and sale agreement closed the same day as PBI’s $6 million new loan to Chandler.
One year later, Chandler sought additional financing from PBI to develop the apartment complex that secured the Chicago loan. Chandler claimed that PBI insisted, as condition of making the new loan, that the Halifax loan be refinanced at an increased interest rate and that Chandler personally guarantee the Halifax loan. After agreeing to the bank’s terms, Chandler sued the bank for violating the anti-tying provisions of the BHCA.
The BHCA Prohibits Tying Arrangements for Unrelated Products and Services
The anti-tying provisions of the BHCA prohibit a bank from extending credit or furnishing any service “on the condition or requirement” that a customer must obtain some additional credit, property or service from the bank or that the customer must provide some additional credit, property or service to the bank. 12 U.S.C. §1972(1). To establish an unlawful tying arrangement claim under the BHCA, a plaintiff must prove that:
The bank imposed an anticompetitive tying arrangement, conditioning the extension of credit upon the borrower’s obtaining additional credit, property or services from the bank or offering additional credit, property or services to the bank;
The arrangement was not usual or traditional in the banking industry; and
The practice conferred a benefit on the bank.
In Halifax, the plaintiff easily stated a claim under the BHCA. First, PBI was hoisted on the petard of its own credit memorandum that expressly conditioned its loan to Chandler on his purchase of the Halifax property. Second, the court found that conditioning an extension of new credit on a requirement that the customer assume the Bank’s defaulted loan to an unrelated customer was “an unusual banking practice.” Third, and finally, Halifax showed that the alleged tying relationship benefited PBI, by (a) eliminating the Bank’s earlier bad loan to the prior owner of the Halifax property, (b) allowing the Bank to avoid the expense of bringing a foreclosure action, and (c) eliminating the need for the Bank to take title to the Halifax property and carry it as REO Property on the Bank’s books. Based on these allegations, Halifax stated a valid claim against PBI for actual damages, treble damages, and attorneys’ fees.
Staying on the Right Side of the Line
Numerous cases, in addition to Halifax, provide examples of banks that have been unable to resist the temptation to unload bad loans or unwanted REO Property by foisting them on unrelated borrowers as a condition of new loans. It is not difficult for banks to stay on the right side of the anti-tying line, however, if they remember that the BHCA is not intended to punish usual and customary banking and credit underwriting practices. Banks should keep in mind the two guidelines of (1) focusing on relationships among related entities and (2) adhering to “traditional banking practices.” The 10th Circuit Court of Appeals, which includes Colorado’s federal courts, described the distinction as follows:
[I]t is not an unusual banking practice for a lender to evaluate its entire existing relationship with a customer, including the customer’s related loans, when deciding whether to renew existing credit or extend new credit. Nor is it an unusual practice, we held, for a bank to require a customer to guarantee an affiliated debt before extending further credit.
The focus on related versus unrelated entities in conditioning and extending credit is critical. The 10th Circuit has also ruled that a BHCA anti-tying claim existed where a lender conditioned a loan to a customer on the customer’s assumption of nonperforming loans to an unrelated borrower. Conditioning credit on the totality of a borrower’s and its affiliates’ relationships with the bank is generally a normal and customary banking practice that would not run afoul of the BHCA. In contrast, sweeping in unrelated borrowers’ problem loans and REO Properties raises a red flag for a potential “unusual banking practice” that could violate the BHCA’s anti-tying provisions.
 Quintana v. First National Bank of Santa Fe, 125 F.3d 862, 1997 WL 618640, *3 (10th Cir. Oct. 6, 1997).