A recent Massachusetts Appeals Court decision holds timely lessons for lenders who are reassessing existing loans.

The Massachusetts Appeals Court recently upheld a trial court’s imposition of double damages and attorneys’ fees in favor of a corporate borrower against a bank in Renovator’s Supply, Inc. v. Sovereign Bank. The court ruled that, under the circumstances, the bank was barred from terminating the borrower’s line of credit and that it had violated the state’s unfair and deceptive practices statute.

The following discusses the facts and law that led to the court’s decision, and the lessons that decision holds for lenders, particularly in the current economy where lenders are reassessing their existing loans.

The Facts

Renovator’s Supply manufactures and sells home renovation and remodeling supplies through retail stores, the internet and large-scale mail order catalogs. The company established a line of credit in 1997 with a limit of $3 million secured solely by the personal guarantees of the company’s owners, a couple who founded the business decades earlier. The credit agreement was renewed annually, although the renewal agreement was typically not executed until after the expiration of the previous term. During the period between the end of one term and the execution of a renewal agreement, the bank maintained the credit line.

The company’s account was serviced by a financial analyst, a relationship manager and a team leader. During a meeting with the analyst and relationship manager in the summer of 2001, the company’s owners told the bank representatives that, due to their increasing age, they intended to downsize the business. Neither the financial analyst nor the relationship manager expressed concerns about this strategy or the company’s creditworthiness, and the bank renewed the line until July 31, 2002.

In the summer of 2002, when the relationship manager was promoted to team leader, a new relationship manager was put in charge of the company’s account. The new relationship manager was concerned with the decline in the company’s gross revenues—an apparent breach of a covenant in the credit agreement requiring annual profitability—and a lack of security beyond the owners’ personal guarantees.

During a meeting with the company’s owners on October 3, 2002, the relationship manager and the financial analyst asked if the company would consider adding additional security to the loan. The owners rejected this idea, saying that they had often cited to vendors the lack of a lien on the company’s assets as evidence of the company’s financial health. The relationship manager and financial analyst did not pursue the point. At the end of the meeting, the financial analyst said that he simply needed to “write it up.” The relationship manager did not disagree with this statement.

Between October 3 and October 31 the bank and the company did not communicate with each other. The bank received the company’s updated quarterly financial statement by October 18. The financial analyst then forwarded an analytical memorandum of approval of the loan renewal on the existing loan terms to the relationship manager. On October 25, the relationship manager endorsed the loan approval memorandum from the financial analyst, which included a provision waiving the violations of the profitability covenant during the previous year. The relationship manager inserted a note into the memorandum saying that he would “negotiate with the borrower to secure the credit and raise the pricing (probably by 1 percent).”

The team leader’s approval was required before a final renewal decision could be made. On November 1, 2002, the team leader and the relationship manager met to discuss the renewal. The team leader told the relationship manager to urge the company to accept the increased interest rate and to add an all business asset lien to the security package. The credit memo advised that the bank would be waiving the apparent covenant default concerning profitability. The relationship manager called the company’s owners to inform them that the bank would renew the line of credit only with additional security and with a 1 percent increase in the interest rate. The owners rejected the new terms.

Based on the previous assurances from the bank that the loan would be approved, the borrower had written large checks to pay for the mailing of its Christmas catalog—the most important catalog mailing of the year—and to pay for its employees’ health insurance coverage.

When the company asked if the bank would honor the checks, the bank refused to do so. The owners of the company converted certain securities accounts to cash and reduced the catalog mailing by half even though it had sufficient cash to complete the full mailing. By the time the bank sent a new credit proposal to the company, it was too late to send out the remaining catalogs in time for the holiday shopping season. The company paid off the balance of the account and terminated its relationship with the bank.

The Litigation

The Borrower’s Claims

The company sued the bank for lost profits caused by the reduced catalog distribution. The company argued that it was reasonable to assume that the bank would approve the renewal on the same terms as the previous credit agreement, and keep the line of credit open while the renewal was processed. It also argued that the bank’s conduct was unfair and deceptive.

The Court’s Decision

The Bank’s Course of Dealing - Equitable Estoppel

The court held that the course of conduct between the bank and the company, including the annual renewals and the lack of communication by the bank to the company of any credit concerns during the renewal process in 2002, barred the bank from terminating the line without reasonable notice. Therefore, the bank was liable for damages it caused to the company from termination of the loan. The court applied the legal doctrine of equitable estoppel.

Massachusetts General Laws, Chapter 93A

Massachusetts General Laws, Chapter 93A, section 2, states that “unfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce are hereby declared unlawful.” Whether or not an act is “unfair” depends on the facts of the case.

The court noted that one of the specific categories of unfairness developed in case law consists of “coercive or extortionate tactics designed to extract undeserved concessions from other business entities or consumers.” The court ruled that under Chapter 93A, the bank’s behavior was unfair because it had “lulled Renovator to a point beyond its credit deadline and had exploited that timing in an attempt to force the unwanted additional credit terms upon the company.” The court focused on the fact that the bank decided on its renewal decision by early October, but failed to communicate this decision to the company until November. In addition, in an internal bank memorandum, the relationship manager waived any violation of the profitability covenant, but invoked that violation as a reason for imposing stricter lending terms. The court found that the bank employed a strategy of unjustified delay and coercive pressure, and awarded the company compensatory damages, attorneys’ fees and costs.

The court also found that the bank’s unfair behavior was “willful and deliberate.” It focused on the explanation for increasing the price and demanding security—that the company had breached the profitability covenant—disingenuous because the loan officer had written that the lender was waiving this covenant. Therefore, the court doubled the compensatory damages.

Lessons for Lenders

Lenders should communicate concerns about the loan as soon as possible, and not let the loan renewal process continue without addressing these concerns. While it is often uncomfortable to deal with problems, failure to address problems today can lead to potential lender liability in the future.

Renegotiate loan terms only when the bank has the right to renegotiate. While it is generally fair to renegotiate loan terms when a loan is up for renewal, when the borrower is in default, or when a customer is seeking a new extension of credit or a change in terms, renegotiation of loan terms in other circumstances, particularly when the borrower faces an acute business deadline of its own, may present risks. In other words, the bank should exercise caution in using its leverage and refrain from backing a borrower into a corner without reasonable advance notice and affording a borrower adequate time to react or pursue other options.

Finally, communications to the borrower should be consistent with internal bank communications. The court in Renovators’ Supply imposed multiple damages because the relationship manager wrote in a credit memo that the bank was waiving the covenant default while he had told the company that the covenant default was the reason for the demanded change in loan terms.