Lessons for Lenders in Avoiding Liability When Exercising Setoff Rights

by Poyner Spruill LLP
Contact

[authors: Christopher H. Roede, Jill C. Walters]

Last year the Superior Court of Forsyth County, North Carolina awarded approximately $2.1 million in damages against a large lender for its decision to offset debt against a deposit account of a guarantor. The trial court ruled that the lender’s decision to offset against the deposit account rose to the level of an unfair trade practice considering the lender’s past dealings with defaults by other borrowing entities owned by the guarantor. On appeal the North Carolina Court of Appeals (Appellate Court) overturned the trial court’s ruling that the exercise of the setoff against the deposit account violated North Carolina’s statute regarding unfair or deceptive trade practices (UDTPA) that entitled the guarantor to treble damages. The Appellate Court vacated the award of treble damages, but upheld the jury’s verdict that the lender was not permitted to collect on the remaining balance of the loan after the setoff. This case is an important reminder to lenders to be cognizant of lender liability issues when exercising its setoff rights. Below is a short history of this case followed by a few valuable lessons learned from it.

The guarantor was a residential real estate developer who formed the borrowing entity to develop a townhome project in Guilford County, financed by the lender. The guarantor was a long term customer with the lender and its predecessor institutions. In the past, whenever any of the guarantor’s loans were in trouble, a representative of the lender would contact the guarantor by phone and work with him to resolve the issues. In August of 2009, the lender transitioned the guarantor’s banking relationship to the lender’s special assets department. By this time the lender believed that the value of the townhome project was no longer sufficient to secure the borrower’s loan. The lender’s special assets officer telephoned the guarantor in 2009 to discuss the various troubled loans, and when the conversation eventually turned to the townhome project loan, the lender was not satisfied with the guarantor’s claims that the loan was not in jeopardy. During this phone call, the lender informed the guarantor that his deposit accounts maintained by the lender would be frozen due to the lender’s concerns that the borrower’s loan for the townhome project was in default.

In January of 2010 the lender filed suit to recover amounts owed to it under the terms of the townhome project loan. The guarantor counterclaimed asserting that the freezing of the guarantor’s deposit account and eventual offset denied the borrower access to the working capital needed to keep the townhome project going, caused that project to fail and was unfair and oppressive in light of the lender’s history with the guarantor. In a confusing and contradictory jury verdict, the jury determined that neither the lender nor the borrower breached the underlying loan contract (despite the fact that the loan remained unpaid), but still awarded $700,000.00 in damages (this $700,000.00 award was later dismissed on procedural grounds) to the borrower based on a theory of lost business opportunities and profits for the townhome project. Despite the fact that the jury’s verdict included a determination that the lender did not breach the loan contract, the court sided with the guarantor and borrower and ruled that as a matter of law the lender’s sudden decision to freeze the guarantor’s accounts without prior notice was unfair and an oppressive and inequitable exercise of power by the lender in light of its past practice of giving the guarantor notice and opportunity to cure loan defaults. This ruling resulted in UDTPA liability for the lender in the amount of $2.1 million (triple the amount of the $700,000.00 jury award).

On appeal the lender argued that UDTPA liability cannot arise as a matter of law where the lender never breaches the loan contract and is simply exercising legitimate, contractually agreed to remedies, absent any kind of fraud, constructive fraud, misrepresentation or other malicious conduct of the lender. The Appellate Court largely sided with the lender on this issue, noting that UDTPA liability generally arises under two circumstances: (1) a UDTPA claim separate and distinct from a breach of contract claim combined with allegations of fraud, constructive fraud, misrepresentation or the like; or (2) a claim based on a breach of contract together with substantial aggravating circumstances making the alleged conduct immoral, unethical, oppressive, unscrupulous or deceptive. Because the misconduct alleged by the borrower and guarantor related exclusively to actions the lender took pursuant to the terms of the loan contract, and the jury determined that the lender never breached this contract, the Appellate Court ruled there was no legal basis for imposing UDTPA liability. The borrower and guarantor never made any allegations relating to malicious conduct occurring outside of the loan contract that could support any UDTPA liability.

While the lender was successful in overturning UDTPA liability, the Appellate Court refused to order a verdict in favor of the lender for the unpaid balance of the loan. The Appellate Court reasoned that even though the jury’s finding that there was no breach of the loan contract by the borrower - despite the loan remaining unpaid - was factually contradictory and confusing, it was not necessarily legally inconsistent if the jury believed the remaining unpaid balance on the loan resulted from the lender’s own actions. Presumably, this is what the jury believed since it found no default under the loan contract by the borrower.

The primary lesson for lenders to take from this case is to stick to the terms of the loan agreement when dealing with borrowers and guarantors. In this case, the written agreement governing the terms of the deposit account maintained by the borrower and the guarantor with the lender expressly permitted the lender to offset against the account for monies owed to the lender. This is likely to be what the jury relied on in determining that the lender’s exercise of its setoff rights did not constitute a breach of the loan contract. Additionally, it was the lender’s deviation from the written terms of the loan agreement in repeatedly permitting the guarantor extra time to cure loan defaults that was the ultimate basis of the borrower and guarantor’s defenses to the enforcement of the loan contract. Where the lender has knowledge of a history of significant deviation from the written terms of the loan agreement for any particular loan, it would be well served to put the borrower and guarantors on notice of the lender’s insistence of strict performance under the written terms of the loan agreement whenever the loan becomes seriously troubled.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Poyner Spruill LLP | Attorney Advertising

Written by:

Poyner Spruill LLP
Contact
more
less

Poyner Spruill LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.