White Papers

RFC periodically publishes White Papers on Various subjects of interest to the BankCard community. Click on the links below to locate the paper you are seeking:

Lender Liability

White Paper on Lender Liability[1]

By Resource Finance Company

“Lender liability” is the risk or exposure faced by a lender to claims by a borrower who feels s/he was treated unfairly. For example, if a loan is going bad and a lender steps in to “help” the borrower, the lender can be liable if its conduct strays from the acceptable. Likewise, if the lender institutes some enforcement action such as foreclosure or a set-off of funds, the borrower may bring suit against the lender to avoid the debt and for compensatory and punitive damages alleging some unfairness during the process.

Lender liability is a constantly evolving body of law. No concrete rules have been set so lenders can only learn from others’ mistakes.[2]

 Today, the specter of lender liability casts its shadow over every troubled loan and every credit relationship between borrower and lender.[3]

Another author states it:

Over the past decade, … the lending industry has experienced an expansion of its liability …because of a broadened application by the courts of traditional common law theories to common lender activities. Once the borrower’s claim survives a motion to dismiss or for summary judgment, the juries have taken the expansion of liability the rest of the way by returning unprecedented multimillion dollar verdicts against lenders. …Actions [by lenders] that were acceptable in the past have lately resulted in the return of substantial jury verdicts against such activities.[4]

Aggrieved borrowers have successfully used a scattershot of theories upon which to base liability[5] including breach of contract,[6] breach of fiduciary duty,[7] fraud,[8] misrepresentation,[9] duress[10] and tortious interference with contractual or prospective business relations[11] among others. The lender’s potential liability increases if the lender can be shown to have “control” over the borrower.[12]

The dollar amount of the Lender’s exposure is not insignificant:

The aspect of lender liability actions of greatest concern to lenders is the nature of damages awarded. The damage awards often bear little or no relationship to the amount of the underlying loan transaction. For example, in Conlan v. Wells Fargo Bank, No. 82852 (Cal. Super. Ct. Monterey County, 1987), strawberry …farmer Garth Conlan, who owed $3.8 million, … obtained a lender liability verdict against the lender in the amount of $10 million in compensatory damages and $50 million in punitive damages (later reduced to $25 million).[13]

 In the case of a Processor/Acquirer (“Processor”) lending to its ISO, any of the above mentioned theories on which liability has been based could be asserted against the Processor by way of a lender liability claim. However, as mentioned above, if the Processor can be shown to have “control” over the ISO, the ISO’s chances are improved.

 The following have been held to constitute “control” in cases involving Borrowers and Lenders. Since these factors are present in most typical Processor/ISO relationships, Processor/Lender and Borrower/ISO can be substituted analogously to show how Processor control and therefore liability might be found: 

1) The ISO and Processor are in a supplier/customer relationship,[14]  
2) The Processor controls the funds of the ISO prior to disbursement,[15]  
3) The Processor has veto power over which merchants to accept,[16]  
4) The Processor controls the merchant acquiring activities of the ISO,[17]  
5) The Processor may have the power to cancel the ISO’s contract and/or residuals or set-off amounts as a reserve,[18]  
6) Even the fact that the Processor had various powers and the ISO felt threatened[19] or 
7) The Processor had certain control powers but refrained  from exercising them.[20]  

All these factors have supported lender liability.