Lenders are quite serious about loan documents. Millions are spent on vendors and attorneys for stock and custom loan documents. Enforceability and lender protection are paramount. Yet lenders are often less cautious when committing to lend to commercial borrowers—even when millions of dollars are at stake.
Loan commitments are contracts. Treat them like they are.
Loan commitments in Ohio are contracts, which usually take the form of a letter signed by the lender and borrower.[1] They are, in short, binding letters of intent like those used by bank customers to buy a business. And because loan commitments are contracts, potential borrowers can sue banks to force loan funding or for their losses—including losses for lost business, lost opportunities, and lost business value, among others. It is, therefore, vital to treat commitments like the contracts that they are. Ohio case law is rife with examples of the consequences for failing to do so.
Example: Lost Opportunity[2]
Phillip Frey owned a store that sold Orange Julius smoothies, which he had to remodel under his lease with a mall. He applied to Fifth Third Bank for a loan, which promised to turn the loan around in five days. Frey didn’t hear from the bank again until it sought more information three months later. After providing that information, he and the bank signed a loan commitment letter.
A few days later, the bank told Frey that it fired his loan officer and couldn’t find his commitment letter. Frey provided a copy to the bank, but never heard from it again. Eventually, Frey’s deadline to remodel his store passed and he breached his lease with the mall. In response, Frey sold his store and sued Fifth Third.
Ohio’s Sixth District Court of Appeals ruled in favor of Frey. It found that Fifth Third breached its promise to close the loan in five days and its promise to close the loan under the commitment letter. The court also ruled that the bank could be liable for the forced sale of Frey’s store.
The takeaways from this example are three: (1) commitments to lend are contracts, (2) borrowers can sue lenders for breach of oral or written commitments, and (3) lenders can be liable for damage to a borrower’s business.
Example: Verbal Changes?[3]
Facilities Asset Management sought two loans from National City Bank: a $500,000 term loan and a $400,000 line of credit. Even so, that company signed a commitment letter for a $500,000 term loan but only a $200,000 line of credit.
Eventually Facilities Asset Management stopped paying its loans, and the bank sued and obtained judgment. The company sought to reverse the bank’s judgment by arguing that the bank breached the commitment letter by only lending $200,000 on the line. It also argued that the bank’s loan officer orally promised that an extra $200,000 would be available on that line in the future. The Eighth District Court of Appeals ruled in favor of the bank by holding that the written terms of the commitment letter (e.g., $200,000) control. Even so, the bank incurred litigation costs at the trial and appellate levels.
The takeaways from this example are two: (1) be mindful of oral promises about terms—borrowers will latch onto them; and (2) use merger clauses in your commitment letters (e.g., a clause that states all prior discussions “merge” into the letter and will have no further effect).
Treating loan commitments like a contract is also an exercise in clarity. Many borrowers forgo a deep understanding of a loan commitment’s terms and rely instead on how a lender explains the loan to them. And when a lender is unclear or a borrower is confused, preventable litigation can arise.
Example: Refundable Deposits[4]
Joseph Florence applied for a loan from Tri-State Savings and Loan to buy a motel. The bank sent a commitment letter to Florence that required him to pay $7,000 to the bank when he signed the letter. He asked his loan officer about the purpose of that money, and was told that it would cover expenses only if the loan closed. Florence eventually signed the commitment letter.
A short time later, Florence found a better deal with another bank and declined the loan from Tri-State. Tri-State refused to return the $7,000 and Florence sued. He won at trial and the bank appealed.
The First District Court of Appeals ruled in favor of Tri-State by holding that evidence of Florence’s discussion with his loan officer was inadmissible to alter the terms of the commitment letter—a written contract. Even so, the bank incurred litigation costs at trial and on appeal.
The takeaway from this example is the need for consistency between the terms found in loan commitments and the message from commercial lenders.
Takeaways
- Loan commitments are contracts just like notes, mortgages, and loan agreements. Treat them with the same consistency and care.
- Reduce confusion over loan terms by reducing them to writing where possible.
- Ensure a consistent message between lender and the loan commitment before and after signing.
[1]Krukrubo v. Fifth Third Bank, 10th Dist. Franklin No. 07-AP-270, 2007-Ohio-7007, ¶ 13.
[2]Toledo O.J., Inc. v. Fifth Third Bank, 6th Dist. Lucas No. L-01-1039, 2001 Ohio App. LEXIS 3748 (August 24, 2001).
[3]Nat’l City Bank v. Facilities Asset Mgt., 145 Ohio App.3d 240, 762 N.E.2d 1060 (8th Dist.2001).
[4]Florence v. Tri-State S&L Co., 322 N.E.2d 322 (1st Dist.1974).