The U.S. Court of Appeals for the Eighth Circuit recently rejected a debtor’s attempt to hold a bank liable for allegedly faulty advice provided in connection with various lending transactions, holding that the debtor could not claim reliance on the bank’s advice when the debtor had an ability to investigate the details of the transaction for itself, and the agreement between parties stated that the debtor was not relying on any of the bank’s representations in entering into the transaction. 

A copy of the opinion is available at: Link to Opinion.

In the late 1990s, the debtor began borrowing money from the bank through floatinginterest-rate loans. The bank and the debtor entered into corresponding interest rate swap agreements to fix the interest rate on the respective loans. “An interest rate swap allows a borrower to hedge his exposure to changes in the interest rate on a floating-rate loan.” 

The swap agreements between the bank and the debtor were governed by an International Swap Dealers Association (“ISDA”) Master Agreement.

In 2005, the debtor sought to borrow $4 million from the bank, but the debtor still owed the bank approximately $7.2 million on previous loans. The debtor’s parties considered refinancing its existing debt in conjunction with the new $4 million loan to execute one $11.2 million loan agreement. Under this arrangement, the debtor and the bank would also execute a new $4 million swap, and the two pre-existing swap agreements for the $7.2 million loan would remain in effect. 

The debtor’s expert testified that this arrangement – having three separate swaps that terminate at different times – would have exposed the debtor to a floating interest rate before the $11.2 million loan matured. 

Subsequently, the bank’s loan officer reviewed the terms of the arrangement with the debtor. The loan officer discovered that the bank was proposing a five-year $11.2 million loan. He informed the debtor that it “might want to fix the rate on the whole deal” – meaning execute one swap agreement for the entire loan – and that the debtor should let him know if it would like to pursue this option.

The bank proposed that it would unwind the two existing swaps and execute one new swap on a notional principal amount of $11.2 million. The parties would then execute one new $11.2 million loan and one new $11.2 million swap. 

The debtor agreed to the terms and entered into an interest rate swap on a notional principal of $11.2 million to terminate on Aug. 1, 2015 (“2005 Loan Agreement”). A few months later, the debtor and the bank entered into a floating-rate loan of $11.2 million with a stated maturity date of Sept. 20, 2010 (“2005 Swap Agreement”).

Under this arrangement, the 2005 Loan Agreement matured in 2010, five years before the 2005 Swap Agreement would terminate. 

The 2005 Loan Agreement matured, the debtor failed to pay the balloon amount due, and the bank declared the debtor in default. Pursuant to cross-default provisions in the debtor’s other loan agreements, the bank accelerated all other outstanding obligations owned. The bank then sued the debtor alleging breach of contract and breach of guaranty. In its answer, the debtor raised several affirmative defenses, including a fraud defense, and asserted counterclaims. 

The jury found the debtor did not breach any agreement with the bank, and the trial court entered judgment in favor of the debtor. The bank appealed and the debtor crossappealed.

On appeal, the Eighth Circuit previously determined that the jury verdict was against the great weight of the evidence and vacated the judgment, and remanded for a new trial on the bank’s breach of contract claim. 

On remand, the bank moved for summary judgment on all claims against the debtor and its parties and affirmative defenses raised by the parties. The trial court granted the bank’s motion for summary judgment because the debtor could not establish that it reasonably relied on the bank’s alleged misrepresentations. Because the trial court concluded that the debtor’s setoff defense was identical to its fraud defenses, it also granted summary judgment for the bank on the setoff defense. 

This appeal followed.

The debtor raised two defenses based on the 2005 Loan Agreement and 2005 Swap Agreement (collectively, “2005 Agreements”) — fraudulent inducement, and fraudulent failure to disclose. 

The debtor argued that the mismatched terms in the 10-year swap agreement and fiveyear loan agreement exposed it to additional risk and caused it to pay more interest overall. The debtor accused the bank of representing that the 2005 Agreements would be a better deal for the debtor and alleged that these representations were false. Both defenses required the debtor to show that its reliance on the bank’s allegedly fraudulent representation was reasonable.

New York law applied to the transactions at issue. As you may recall, New York courts consider three factors to determine reasonable reliance: “the level of sophistication of the parties, the relationship between them, and the information available at the time of the operative decision.” JP Morgan Chase Bank v. Winnick, 350 F. Supp. 2d 393, 406 (S.D.N.Y. 2004).

First, the Eighth Circuit examined the level of sophistication of each party.

Before the debtor entered into the 2005 Agreements, it had experience with these types of agreements based on previous transactions with the bank. During the discussion for these agreements, the debtor was represented by sophisticated business people, including a chief financial officer, a controller, and legal counsel. The debtor also employed professionals, such as tax advisors and accountants, to assist it in operating its business. 

Thus, the Eighth Circuit concluded that the debtor was a sophisticated party. 

Next, on the relationship between the debtor and the bank, the debtor characterized the bank as a “longtime trusted advisor” and argued that it was reasonable for it to rely on the bank’s representations about the 2005 Agreements. However, the ISDA Master Agreement that governed the 2005 Swap Agreement stated that the debtor agreed that it was “not relying on any communication (written or oral) of the [Bank] as investment advice or as a recommendation to enter into [the swap agreement].” 

These facts, according to the Eighth Circuit, established that the bank was not a fiduciary of the debtor and the debtor can determine for itself whether it should enter into a particular transaction. 

The Appellate Court then considered what information was available to the debtor at the time of the operative decision. Because all relevant information was available to the debtor by the time it entered into the 2005 Swap Agreement – that is, the debtor knew the 2005 Loan Agreement matured five years before the 2005 Swap Agreement would terminate – the Appellate Court held that the debtor, as a sophisticated party engaging in an arm’s-length transaction with a lender, cannot complain that it was induced into a five-year loan when the terms were clear from the face of the agreement. 

The Eighth Circuit also rejected the debtor’s argument that the bank stood to profit more from the 2005 Swap Agreement than from the original promised deal. In the view of the Appellate Court, the potential benefit to the bank had no bearing on the debtor’s ability to investigate the details of the transaction and did not tend to show fraud. 

Accordingly, the Appellate Court affirmed the judgment of the trial court in favor of the bank and against the debtor.