A loan negotiation generally follows the lines of each party setting out its “want” list and then using whatever leverage it brings to the table to accomplish its goals. The lender typical wants to get paid back in a reasonable time frame and at a market rate while possibly generating other business income from things such as selling cash management services while the borrower wants to obtain favorable repayment terms that leave it with as much discretion to run their business as possible. The size of the loan, documentation costs, regulatory pressures and possible past dealings are all issues that affect the negotiation.
Sometimes the lender’s “want list” includes things such as the borrower providing guarantees or additional collateral or even retaining a consultant to advise the borrower on developing a better business plan. In preparing its request for such items, lenders must work within the strictures set out in the anti-tying provisions of the Bank Holding Company Act. The Act, with some exceptions, generally prohibits a lender from conditioning an extension of credit other services on the requirement that the borrower purchase some other credit, property or services from the lender. (See generally, Blanchard, Lender Liability: Law., Practice and Prevention, Chapter 16, Anti-Tying Provisions.)
The typical loan covenants that lenders ask for such as financial reporting and financial ratios do not violate the anti-tying provisions. The requirements are fairly traditional and both generally understood by both the lender and borrower. Lenders get into trouble, however, when they begin asking for things from a borrower that don’t seem to have anything to do with maintaining the soundness of the borrower’s loan.
A recent example of this is found in the case of Halifax Center, LLC, et al. v. PBI Bank, a decision from the Western District of Kentucky. In this case an investor named David Chandler wanted to purchase a note and mortgage from HUD involving a 165 unit apartment complex in Chicago. The total purchase price was $9,145,020.06. The investor sought financing for $6 million of the purchase price from PBI Bank. In his lawsuit against PBI the investor alleged that PBI indicated that they were willing to extend the requested loan but only on the condition that he purchase some unrelated property located in Owensboro, Kentucky on which the Bank currently held a mortgage (the “Halifax Property”). The underlying loan was in default. The investor did not know the owner of the property and knew nothing about the property but agreed to purchase the property in order to obtain the sought after financing.
The Bank’s credit memorandum produced at trial expressly stated that the purchase of the Halifax Property was a condition to obtaining the loan to purchase the HUD note. On June 29, 2009, Halifax Center, LLC, a limited liability company formed by Chandler, signed the promissory note for the Halifax property in the amount of $1,253,675.74, which he understood was the unpaid balance of the original owner’s loan from PBI.
A year later Chandler needed additional funds for the Halifax Property. As a condition to extending additional credit, Chandler alleged that the Bank required him to refinance the Halifax Property loan at a higher interest rate and to increase his personal guaranty of the Halifax Property loan from $200,000 to a full and complete guaranty. Eventually Chandler sued the Bank arguing that it had violated the anti-tying restrictions in the Bank Holding Company Act. The Bank sought to dismiss the suit.
The court began its analysis by noting that in order to prevail on his claim Chandler would need to show three things:
- the bank conditioned the extension of credit upon the borrower’s obtaining or offering additional credit, property or services to or from the bank or its holding company;
- the arrangement was not usual or traditional in the banking industry; and
- the bank received a benefit
The the court found that Chandler met the first element of the claim by alleging that PBI had demanded Chandler take over and service the loan on the Halifax Property as a condition for obtaining financing to purchase the HUD note. The court looked at a number of other cases dealing with similar fact patterns and found that every court presented with a situation where a lender conditioned an extension of credit on the requirement that the customer somehow help the bank with one of its bad loans to an unrelated customer violated the anti-tying restrictions. Not surprisingly, the court further found that the practice in no way could be construed as a normal or traditional banking practice and that PBI had received a clear benefit from the tying arrangement.
The final issue for the court was the question of whether Chandler had waived his claims by virtue of the refinance that had occurred on the loan for the Halifax Property. The court noted that under Kentucky law a waiver can be expressed or implied. In this case there was no express waiver so the issue was whether the refinance by itself was sufficient to imply a waiver. PBI argued that there was legal support for the proposition that a party who renews or makes payment on a note after knowledge of defenses that may be interposed to its collection, waives them. The court held that because the tying claim was an independent statutory claim and not a defense to payment of the note the claim had not been waived when the Halifax Property note had been refinanced.
Risk minimization for lenders involves getting them to ask the fundamental question when setting out conditions for approving a credit extension: are the requirements “traditional” banking practices related to maintaining the soundness of the credit? If not, then the conditions may be prohibited. If there is any question at all about whether something is permitted bank officers should immediately seek legal counsel because the application of the Bank Holding Company anti-tying restrictions to a particular fact situation is not always immediately apparent, particularly in certain problem loan workout situations where both the lender and the borrower may be looking at creative methods to restructure a troubled credit.