National Insolvency Review February 2013 Volume 30, No. 1 • ASSESSING “LENDER LIABILITY” IN WORKOUTS • Lee Cassey and Lily Coodin Torys LLP This article addresses some of the main theories (ii) under tort theories, where lenders are alleged by which lenders may be exposed to liability in either to have acted negligently or interfered a workout situation. So-called “lender liability” intentionally with the economic relationships or is not itself a separate cause of action. Rather, it interests of the borrower.1 As we will discuss, is a term of art often used to describe a situation while each of these potential risks of liability in which a lender has been found liable to a bor- has been subject to a relatively considerable rower (or others) for an act or omission of the amount of attention and judicial consideration in lender. Much has been written on the potential the United States, in Canada, fewer examples liabilities faced by secured lenders in the con- exist in the jurisprudence. The jurisprudence text of the enforcement of their security— that does exist, in general, appears to indicate owner/occupier environmental liabilities, suc- that the risks to lenders in a workout situation cessor employer liabilities, liabilities resulting are minimal, provided that a lender is acting qua from improvident realization efforts, etc.—but lender and in accordance with its contractual little commentary in Canada exists on the poten- rights. tial liability risks to lenders in a workout situa- Fiduciary Duty tion where there is an existing lending relationship and some negotiation involving the One major threshold question arising in a work- restructuring of such loan (including forbear- out situation will be whether a lender owes a ance of any rights or remedies) or a proposed fiduciary duty to a borrower. As noted in the 2 transaction by the borrower subject to lender Ontario case of Scavarelli v. Bank of Montreal, consent under the loan agreement. the general rule in Canada is that the relation- ship between borrower and lender does not give This article seeks to add to the little existing rise to a fiduciary obligation owed by the lender commentary on the subject by discussing certain absent “special circumstances.”3 of the main potential bases of lender liability in a workout situation—namely, (i) where lenders In the recent case of J.R. Investments Ltd. v. 4 are alleged to owe a fiduciary duty to the bor- Moncton Flying Club Estate, the New Bruns- rower and to have breached such duty and wick Queen’s Bench canvassed certain recent 9 National Insolvency Review February 2013 Volume 30, No. 1 case law on the topic of fiduciary duties in the party would act in the former’s best interests context of lending. The court, citing the Ontario with respect to the subject matter at issue. Dis- Court of Appeal in Standard Standard Invest- cretion, influence, vulnerability and trust are ments Ltd. et al. v. Canadian Imperial Bank of factors to be considered.”10 This may arise, for Commerce,5 determined that, “The relationship example, where the lender or its agent provides of banker and customer does not per se give rise financial advice or uses confidential information to a fiduciary relationship … [I]n the absence of of the borrower to the borrower’s detriment.11 special circumstances the general relationship The case law in this area demonstrates the diffi- between the bank and its customer or depositor, culty borrowers have had in trying to show the 6 The court is simply that of debtor and creditor.” existence of a fiduciary duty in the relationship went on to find that, “From my reading of the between lender and borrower and that, even if authorities, it seems clear that the usual relation- shown, there has been an abuse of that relation- ship between a bank and its customers does not ship within the confines of the contract. In normally create a fiduciary duty. A marked de- Scavarelli, the court held that, “The plaintiff has parture from the norm must occur to create such the onus of demonstrating the existence of a fi- 7 a fiduciary duty.” 12 duciary relationship.” In order to establish the The court went on to cite the Supreme Court of existence of a fiduciary duty, the plaintiff must British Columbia in Waryk v. Bank of Montreal demonstrate that the following four elements are for the notion that, “It is rare in the context of an satisfied: arm’s length commercial transaction that there (i) the advice was provided and was relied is a finding of a fiduciary relationship between a upon, bank and its customers. Parties’ relations are governed by contract in these situations. There (ii) the defendant was aware of the reliance, 8 are no peculiar vulnerabilities.” Further, the (iii) the defendant derived a benefit from the court cited the Ontario Superior Court of Justice transaction, and in Baldwin v. Daubney to reinforce the idea that, (iv) the relationship was one of a confidential “A fiduciary duty arises where a relationship nature.13 between the parties, such as trustee and benefi- ciary, is established in order to give one party Moreover, the court in Scavarelli cited other the responsibility to look out for the best inter- jurisprudence indicating that, “the banks are en- ests of the other. The relationship between a titled to exercise their rights solely in their inter- lender and a borrower is not of that kind. ests.”14 Clearly, the threshold to be met by a Rather, it is a typical commercial relationship in borrower alleging the existence of a fiduciary which the interests of the parties are not the duty on the lender and in demonstrating the nec- same and each party seeks to secure its own in- essary abuse to constitute a breach of the duty is terest and can reasonably believe only that the not easily overcome.15 9 other party is doing the same.” The Ontario Court of Appeal recently consid- The case law has generally found that these ered the issue of lender liability and fiduciary “special circumstances” exist where, “one party duty in the context of a limited partnership in could reasonably have expected that the other the case of Empire Life Insurance Co. v. Krystal 10 National Insolvency Review February 2013 Volume 30, No. 1 Holdings Inc.16 In finding that the lender had not sion making of the borrower and, as such, be breached a fiduciary duty toward the limited exposed to the same liabilities as the borrower partners because no fiduciary duty was owed, in respect of such decision. This has the poten- the court commented on the importance of the tial to, for example, leave the lender responsible contractual nature of the relationship between for tax liabilities or damages to a third party lender and borrower. The court determined that, whose business is affected by the decision. while there could be some duties owed by the The “control doctrine”, as it is often referred to, lender to the limited partners, the existence of a is much more developed under the American contract was a paramount consideration in jurisprudence than under the Canadian jurispru- evaluating the liability of the lender. Specifi- dence.18 Few Canadian courts have addressed cally, the lender would not be found liable be- this particular area of potential liability. In gen- cause it had operated within the confines of eral, under the American jurisprudence, a lender what it promised contractually, which, in this will not be held to exercise control (and thus be case, was to communicate with the general part- subject to liability under this theory of liability) ner and not the limited partners. The court found where the lender is acting only to protect its se- that, “The relationship between [the parties] is a curity interest.19 But certain American courts contractual one. … [T]he contractual nature of have found lenders liable where the protection the relationship cannot be ignored.”17 of security interests is coupled with control over The foregoing jurisprudence shows the factual the borrower. and legal burden a borrower must demonstrate For example, in the 1984 decision of the Texas on breach of fiduciary duty claims against a Court of Appeal in State National Bank of El lender: (i) that a fiduciary duty is owed by such Paso v. Farah Manufacturing Co.,20 the lenders lenders through the existence of a “special cir- to a public company, pursuant the applicable cumstance” or some form of special reliance on loan agreement, were permitted to, among other the lender and (ii) that, contractually, the lender things, prevent certain people from being was not permitted to so act and breached such elected to the board of directors and auctioning duty. off certain assets of the borrower.21 While the The “Control Doctrine” court noted that the lenders were acting in ac- As noted, unless “special circumstances” are cordance with their contractual rights and pro- present (which onus is on the debtor and is tecting their security interests, the lenders were highly fact specific), a lender will not be found found ultimately to have exerted a level of con- to owe a borrower a fiduciary duty. One type of trol over the borrower by essentially installing “special circumstance” of note occurs where a their own management of the business while lender is alleged to be the mind or management leading the borrower’s board of directors to be- of, or to exert operational control over, the bor- lieve that the lenders would accelerate the loan rower. The risk is that, in the context of a deci- and force bankruptcy if unacceptable manage- sion being made by a lender to provide a further ment were appointed.