Two New Court Decisions Impacting Lenders

This month we review two recent court decisions that hold valuable lessons for lenders. The first decision involves a bank that was sued following the collapse of its customer's business. The second decision involves a creditor trying to except its claim from its former customer's bankruptcy discharge based on the customer's allegedly false statements.

Fourth Circuit: Bank Owed Customer No Duty of Care Outside of Contract Terms

On May 30, 2018, the federal Fourth Circuit Court of Appeals, which covers Virginia among some other states, ruled that a bank did not commit negligence or breach of fiduciary duty when it expelled its customer (the debtor) from an online foreign exchange system and online treasury management system (together, the "Online Systems"). The case is Fort v. SunTrust Bank (Int'l Payment Grp., Inc.), 2018 U.S. App. LEXIS 14214 (4th Cir. May 30, 2018).

The debtor's business involved facilitating foreign currency transactions, and the debtor and the bank entered into contracts under which the bank provided related services, including access to the Online Systems. The contracts, which included one governing deposit accounts, provided that the bank was merely a creditor of the debtor and not a fiduciary, that there was no "special relationship" between them, and that the bank would be liable only for gross negligence or wanton and intentional misconduct. The contracts also allowed the bank to block the debtor from the Online Systems at any time, upon written notice. The bank also performed other services not required by the contracts, such as providing daily accounting and opening foreign bank accounts in the bank's name to expedite the debtor's transactions. The bank even exempted the debtor from the bank's general policy against relationships with money service businesses. The relationship generated hundreds of thousands of dollars of profits for both parties.

After about three years, the debtor's president informed the bank that a debtor employee had been embezzling, that the losses might exceed $1 million, and that he was uncertain whether others were involved in the embezzlement. Two weeks later, the bank barred the debtor's employees from the Online Systems after telling the debtor's president by telephone that it would do so. The bank's actions eliminated the debtor's ability to view its transaction history and account data, but the bank helped the debtor access and analyze data. The debtor subsequently collapsed and filed Chapter 7 bankruptcy.

The debtor's bankruptcy trustee sued the bank, alleging that barring the debtor's employees from the Online Systems caused the debtor's collapse. The Fourth Circuit was presented with the trustee's actions for negligence, gross negligence, and breach of fiduciary duty under South Carolina law. The Fourth Circuit noted that under South Carolina law, "a bank owes general depositors no duty of care unless it is created by statute, contract, relationship, status, property interest, or some other special circumstance." The trustee argued that the bank owed the debtor a duty of care and a fiduciary duty, each arising outside of the parties' contracts, due to the services the bank provided beyond those contracted for, the debtor's reliance on those services, and the relationship's profitability for both sides.

The court rejected the trustee's argument. First, the court relied on the contract's terms, which disclaimed any duty of care or "special relationship." Second, the court held that the bank's services beyond those contracted for did not create a duty because the bank did not separate the debtor's funds into a special account, advise the debtor on how to run its business, or perform any roles beyond those contemplated by the contracts. In short, while the debtor was a unique client, "the character of what [the debtor] was doing through [the bank's] systems did not differ significantly from the average depositor's relationship with the bank." (italics in original) The court also pointed out that even if the bank had a fiduciary duty, it did not immediately bar the debtor's employees from the Online Systems after learning of the embezzlement but instead waited two weeks before doing so. While this case arises under South Carolina law, it seems likely that the result would be the same under Virginia law, which is similar.

At least three lessons can be taken from this case. First, a bank's contract with its customer should clearly define what the relationship is and isn't and should disclaim any duties not expressly provided for in the contract. Second, if a bank does provide services in addition to those outlined in its contract, the bank's role should nonetheless remain the same - i.e., the additional services should not be of a different nature than those contemplated by the contract. For example, if the bank in the above case had advised the debtor on how to run its business, the trustee might have prevailed. Finally, even when a difficult situation arises with a customer, a bank should act reasonably to assist the customer while protecting the bank's own interests. The fact that the court mentioned that the bank waited two weeks before barring the debtor's employees from the Online Systems and then helped the debtor access its data suggests that the court believed the bank had acted reasonably toward its customer and therefore did not deserve punishment.

U.S. Supreme Court: Customer's Alleged Lies About Single Asset Were Not Basis to Deny Discharge of Creditor's Claim Because They Weren't In Writing

On June 4, 2018, the U.S. Supreme Court ruled that a debtor's oral statement about a single asset was a statement "respecting" his financial condition and, therefore, could not be used to declare his creditor's claim nondischargeable in bankruptcy because it was not made in writing. The case is Lamar, Archer & Cofrin, LLP v. Appling, 2018 U.S. Lexis 3384** (U.S. June 4, 2018).

The Appling case involved a client who persuaded a law firm to continue representing him by allegedly lying about an expected tax refund. He first told the firm the tax refund was going to be "approximately $100,000" even though it was really only going to be only approximately $60,000, and then he told them he had not yet received the refund (though he had received it and spent it on his business). After the firm completed its representation, the client filed Chapter 7 bankruptcy. The firm filed a lawsuit in the bankruptcy arguing that its claim should be declared nondischargeable because the client obtained its services by "false pretenses, a false representation, of actual fraud," which is prohibited by Bankruptcy Code section 523.

However, section 523 contains an exception: if the false pretenses, etc. is a "statement respecting the debtor's or an insider's financial condition," then it only counts if it was in writing. Accordingly, the client argued that his alleged lies were statements respecting his financial condition and therefore were not actionable because they were not in writing.

The question then was "whether a statement about a single asset can be a statement respecting the debtor's financial condition," which the Supreme Court boiled down to the meaning of the word "respecting." The law firm contended that a statement is one respecting financial condition only if it is "about" the financial condition generally - e.g., "I am above water."

The court disagreed, holding that a statement is one respecting a debtor's financial condition "if it has a direct relation to or impact on the debtor's overall financial status." The court wrote that "[a] single asset has a direct relation to and impact on aggregate financial condition .... Naturally, then, a statement about a single asset can be a statement respecting the debtor's financial condition." The court brushed aside the law firm's counter argument that such a broad definition means that little is covered by the general rule against "false pretenses, a false representation, or actual fraud" - i.e., almost any statement will have to be in writing in order to be actionable. The court pointed out that the general rule still covers, for example, a fraudulent conveyance scheme or a misrepresentation concerning the value of assets other than ones belonging to the debtor. Finally, the court rejected the law firm's view that the court's ruling will leave creditors defenseless against lying debtors, stating that creditors need merely insist that debtors make statements relating to their financial condition in writing.

The lesson from this case is clear: any statement that the lender relies on in providing credit (including loan renewals or refinancings) that relates to or has an impact on any of the debtor's assets or liabilities, or that in any other way relates to the debtor's overall financial condition, should be received in writing. Otherwise the statement is likely worthless in protecting the lender once the debtor files bankruptcy.

Neil McCullagh is an attorney at Spotts Fain PC who works with banks on a wide variety of issues, including lending, insolvency, workouts, creditors' rights, bankruptcy, and collections.


Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.

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