Lender Liability After the “Riverisland” Ruling – A Time To Assess Lending Procedures?

In the wake of the California Supreme Court’s Riverisland ruling concerning lender liability, lenders in the San Francisco Bay Area and Silicon Valley may want to evaluate and consider modifying their current lending procedures. As a San Jose based attorney experienced in loan documentation, problem loans and loan workouts throughout California, I have followed the ebb and flow of lender liability law for many years. Although it is a bit early to assess the long term impact of the California Supreme Court’s Riverisland decision, it is not too early to consider precautionary steps, which generally have to be taken at the outset when the loan is being negotiated and documented, to minimize the chance of claims being asserted later.

The court in Riverisland said that a lender’s oral statements about loan terms, even if made before the documents were signed, can come into evidence in a lawsuit if the purpose is to show that the lender used fraud to induce the borrower to enter into the transaction. The facts of Riverisland are discussed below. Before Riverisland, if the borrower’s evidence of oral statements by the lender about the loan terms was inconsistent with the loan documents, the borrower’s evidence could not even come into the case. Now it can, if the purpose is to show fraudulent inducement by the lender. And the facts supporting the borrower’s claims can be taken from the borrower’s own testimony of his or her recollections. This shifts some bargaining strength toward the disgruntled borrower in problem loan negotiations, as it will be difficult after Riverisland to eliminate such fraud claims early in litigation, or perhaps even before a trial.

The immediate question for lenders is whether any changes in the loan-making and loan documentation process are needed to protect against the potential effect of the Riverisland ruling. Some ideas of possible changes are offered below.

Summary of the Riverisland Case.

A recap of the Riverisland case is helpful. Formally known as Riverisland Cold Storage v. Fresno-Madera Credit Association, 55 C.4th 1169 (2013), this case dealt with a commercial loan secured by California real estate. (The court’s ruling, however, applies equally to technology financing, asset based lines, or any other kind of financing facility.) The borrowers fell behind on their payments and the lender and borrowers entered into a restructuring agreement in which the borrowers put up additional real estate collateral for the loan, while the lender promised to forbear and take no enforcement action. The borrowers, however, again missed payments and new loan defaults occurred. At this point, faced with the prospect of enforcement actions and foreclosure, the borrowers paid off the loan.

The borrowers then filed litigation claims against the lender alleging fraud and negligent misrepresentation, stating that two weeks before the restructuring agreement was signed a vice-president of the lender orally promised that the loan extension would be for a period of two years and only two new properties would be required as additional collateral. The actual written forbearance, however, provided for only a three month extension and identified eight parcels of additional collateral. The borrowers signed the forbearance agreement without reading it.

The trial court relied on a 1935 case commonly known as Pendergrass in ruling that the alleged oral statements of the lender could not be introduced into evidence precisely because they varied from the written loan documents. That is, the written loan documents, which contained an integration or merger clause, could not be contradicted by “parol” (oral) evidence that the lender stated the terms of the loan document were something different. In fact, the purported evidence of inconsistent oral statements could not even be considered. This “Pendergrass rule” had stood for over 75 years and has been a useful weapon in eliminating claims that fraud was used to induce a borrower to enter into a loan that actually contained different terms than those the borrower later said it had bargained for.

The California Supreme Court, however, explicitly overturned the Pendergrass rule and held that evidence of purported fraud by the bank could not be kept out. The court nevertheless indicated that the mere fact the evidence of fraud could come in did not mean it would be a winning argument; that is, the borrowers may have been negligent themselves for failing to read the loan documents even if the lender’s oral statements were made.

The Potential Problem for Lenders.

The key point from Riverisland is that the evidence of oral discussions to support a fraud claim can no longer simply be kept out of litigation. That opens the door to discovery and evidence gathering, and makes it more likely the matter will go to trial. Given this new reality, the lender should consider if it has established a foundation that makes it as easy as possible to show that the disgruntled borrower’s recollection of oral discussions are inaccurate or unreliable, or are put in proper context by other evidence.

Tips for Reducing Potential Claims.

To mitigate the potential negative effects of the Riverisland case, a lender should consider changes in how it conducts loan negotiations, documentation and closings. As always, business judgment will be important in deciding whether a specific change is necessary or makes sense in your particular situation. Some ideas to consider are:

1. During oral discussions with borrowers the lender should qualify statements by noting that all terms must be confirmed by the lender in writing. Be vigilant to follow up any oral discussions about loan terms with email, written summaries and/or term sheets to the borrower. If there is an important provision on which the parties do not agree, put the lender’s position in writing, or note the fact that the lender has not agreed to the borrower’s request.

2. Provide execution versions of final loan documents well before closing, so the borrower has sufficient time to review them prior to signing. Do not present drafts of written documents for the first time at a meeting to sign documents and close the loan.

3. Include a summary of key terms in an obvious place in the loan documents.

4. Include with the loan documents a statement that the borrower has thoroughly reviewed the loan documents and they are consistent with the agreement of the parties and no other agreements have been made. Alternatives for expanding this: (a) have that section initialed; (b) add a representation that the borrower’s counsel also reviewed the loan documents; (c) have the statement made/signed on a separate document; and/or (d) include a representation that the statement is made under penalty of perjury.

5. Increase the use of initials on loan documents, so the borrower explicitly acknowledges its awareness of important provisions.

6. Increase the use of bold or large size font to highlight important sections of the loan documents.

7. The potential for increased litigation makes it more important than ever that a jury trial waiver and alternative non-jury proceedings are specified in loan documents, such as judicial reference or arbitration.

The above points indicate ways of reducing potential claims of fraud, in the wake of Riverisland.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.