When Does a Commercial Lender Have a Fiduciary Relationship to Its Borrower?

August 04, 2015

he North Carolina Court of Appeals is not required to publish an opinion in each of its decisions. The appellate rules state that the reasons for that are to minimize the cost of publication and of providing storage space for published reports (each of which seems like an anachronism in an electronic era where everything is stored in the cloud). If the panel that hears the case determines that the appeal involves no new legal principles and the opinion, if published, would have no precedential value, it may direct that no opinion be published.

Of significance is that the rules further provide that an unpublished decision does not constitute “controlling legal authority”. The court even admonishes lawyers not to cite unpublished opinions unless the unpublished opinion has “precedential value to a material issue in the case and that there is no published opinion that would serve as well”. Essentially, unpublished opinions bridge the gap and provide a sneak preview, if not actual legal guidance, of how similar issues would be decided by the court when there is no case directly on point.

Such was the case in the July 7, 2015 unpublished opinion of the Court of Appeals in the case of Shallotte Partners, LLC v. Berkadia Commercial Mortgage, LLC. The case involved a claim of a commercial borrower against its lender for breach of a fiduciary duty. Berkadia had made a $14.5 million HUD insured multi-family loan to Shallotte for an apartment project in Brunswick County. The project went south, Shallotte defaulted on the loan, and Berkadia proceeded to enforce its rights as a secured lender and sued to collect the debt and foreclose on its collateral.

Shallotte defended, claiming that it had suffered damages on account of actions taken by Berkadia in assisting Shallotte in procuring the loan from HUD. Berkadia had participated in meetings with Shallotte and the general contractor, it had procured all of the studies and opinions of independent agents required by HUD regulations for Shallotte and the project to qualify for the HUD insured loan under federal law, and it had submitted the loan application to HUD on behalf of Shallotte. HUD ultimately approved the loan based upon the representations made by Berkadia, on behalf of Shallotte, in the loan application. However, there was one material fact that Shallotte claimed that Berkadia deliberately concealed from HUD and failed to include in the loan application – namely, that Brunswick County had assessed a $873,000 impact fee for water and sewer costs association with the project. The complaint further alleged that after default, when Shallotte was attempting to increase the loan and obtain additional investors for the project, Berkadia learned that its employees had failed to report the impact fee to HUD in violation of HUD regulations, but it nevertheless still did not report the impact fee to HUD. HUD eventually did its own investigation and discovered that the impact fee had been omitted from the loan application and denied the request to increase the loan. Ultimately, Shallotte defaulted on the loan and, after first assigning the loan to HUD for enforcement, Berkadia repurchased the loan from HUD and sought to enforce it.

Berkadia moved to dismiss the fiduciary claim. In deciding the motion, the court took the allegations of the complaint in the light most favorable to Shallotte and summarized those allegations as follows:

The long standing rule in North Carolina is that ordinary borrower-lender transactions are considered arms’ length and do not give rise to fiduciary duties on the part of the lender that would require the lender to put its borrower’s interests ahead of its own. Rather, borrowers and lenders are generally bound only by the terms of their contract and relevant statutory rules. However, the existence of a borrower-lender relationship does not per se foreclose the possibility of the creation of a fiduciary duty if there are some additional facts which tend to elevate the relationship above that of a typical debtor and creditor. But what kind of additional facts or circumstances concerning the relationship are sufficient to show a fiduciary relationship? There is a 2007 federal case where a federal court in Charlotte, applying North Carolina law, found the existence of a fiduciary relationship where the borrower made certain payments in escrow to the lender for the payment of insurance and the lender breached its contractual obligation to remit those payments to the insurer for the premium payments, causing the borrower to default under the loan. There, the court denied a motion to dismiss and held it was for the jury to find whether the lender’s undertaking to collect the payments and remit payment was the kind of additional facts that create a fiduciary relationship.

Other cases finding such additional facts and circumstances are few and far between and that is why the Shalotte Partners case helps to fill the gap. It provides an example of the kinds of actions taken or additional duties undertaken by a lender that should be avoided as they elevate the typical borrower-lender relationship to a fiduciary relationship that creates greater responsibilities and duties on the part of the lender in enforcing its rights. Or, if the lender elects to perform those additional duties, at least it should do so with a full understanding of the legal consequences if it breaches any of those additional duties and how that may result in its inability to collect a loan.

The court was careful to point out the limited nature of its holding. It held that under the “unique circumstances” set out in Shallotte’s complaint, Shallotte had sufficiently pled a fiduciary claim and that its ruling was not a departure from the long standing rule in North Carolina that a borrower-lender relationship is not sufficient in and of itself to establish a fiduciary relationship. The court also went out of its way to predict the difficulties Shallotte may face at trial “particularly on the issue of proximate cause”. The court gives no elaboration of that prediction and one can only speculate if the impact fee, considering its amount in relationship to the overall cost of the project, was truly material or if its non-disclosure to HUD was truly the cause of the project’s failure.

The takeaway in all of this is very simple. A commercial lender should stick to its knitting. If a commercial lender chooses to venture into providing financial products or services related to lending to its borrower, it does so at its peril. Those related areas may consist of sophisticated and complex derivative products like swaps that the borrower may not truly understand; wealth management or investment advisory advice; cash management and treasury products; trade support services; investment banking services; or even insurance services. Whatever additional duties or responsibilities the lender may choose to undertake, it should do so carefully and be mindful of legal consequences. Any wrongful – or even negligent – conduct in the providing of those related financial products or services to a borrower may prove to be costly and jeopardize the collectability of the lender’s loan.