September 28, 2011
In This Issue:
- Bank Held Accountable for Lack of Vigilance in Identify Theft Case
- Replacement Doctrine Affords Lender Priority Over Intervening Mechanics' Liens
- SBA Issues New SOP; SBA SOP Seminar on October 13
- Welcome to New Lending Attorney Nicole N. Soraruf
Bank Held Accountable for Lack of Vigilance in Identify Theft Case
In this era of cyber crime, victims of identity theft increasingly are seeking judicial intervention to determine the responsibility of various parties for their losses. In a recent case in Michigan, a federal court found a bank responsible for a commercial customer’s losses in a “phishing” attack.
This case involved a metal-fabricating company that maintained numerous commercial banking accounts at Comerica Bank. The services agreement between Experi-Metal and the bank permitted electronic wire transfers from two of the accounts. Only two such wire transfers had ever been implemented from those accounts over the most recent five-year period.
On January 22, 2009, the wire transfer history drastically changed. In the morning, Experi-Metal’s controller received a “phishing” e-mail. The e-mail purported to be from Comerica Bank and asked Experi-Metal to confirm its account information. The controller provided the requested information, thereby giving the criminal third party immediate online access to Experi-Metal’s accounts. Over the course of the next six hours, the identity thief executed more than 90 fraudulent payment orders totaling more than $5.6 million. The destinations of the transfers were to “suspicious” locations, including Russia and Estonia. Most of the transfers were book transfers from employee savings accounts that had no funds at the beginning of the day, resulting in an overdraft of about $5 million.
Experi-Metal sued Comerica for approximately $560,000 in stolen funds that it was not able to recover. It relied on the provisions of the Michigan Uniform Commercial Code to argue that the wire transfers were not payment orders of the company. The court was tasked with deciding whether Comerica acted in good faith in accepting the payment orders. If the bank had acted in good faith, its acceptance of the payment orders would have been justified.
The test of whether a bank acted in good faith requires proof that the bank acted (1) with “honesty in fact”, and (2) within “reasonable commercial standards of fair dealing.” The court determined that Comerica had passed the “pure of heart and empty head” standard of the honesty-in-fact prong. The more difficult question was whether Comerica had acted within reasonable commercial standards. Significantly, the court found no evidence that industry standards required a bank the size of Comerica to provide fraud monitoring services to its commercial customers.
However, the court found that Comerica’s expert witness, who admitted to lack of experience with Internet banking systems and “phishing” issues, was not qualified to opine on whether the bank had responded within a reasonable time to shut down the fraudulent transfers. Considering all of the circumstances, including the volume and frequency of the transfers, the limited prior history of wire transfers, the suspicious destinations of the transfers, and the bank’s admitted knowledge of prior and current phishing attempts, the court determined that Comerica should have detected and stopped the fraudulent activity sooner. Accordingly, Comerica was found liable for the $560,000 loss.
This case is cited as Experi-Metal, Inc. v. Comerica Bank (E.D. Mich. 06/13/11).
Replacement Doctrine Affords Lender Priority Over Intervening Mechanics' Liens
An Arizona court recently applied the doctrine of replacement in deciding that a lender had a priority position vis-à-vis the holders of two intervening mechanics’ liens.
In August 2005, Karl Conover acquired vacant land, financing the purchase with a loan from Real Estate Equity Lending, Inc. (REEL) in the amount of $825,000. The deed of trust securing the promissory note evidencing this loan was recorded August 30, 2005. Conover later subdivided the property and conveyed it to his LLC. The LLC contracted with Premier Grading and Utilities, LLC and its subcontractor, Continental Lighting and Contracting, Inc., to make improvements to the property.
In September 2007, the LLC refinanced the loan with REEL pursuant to a new note in the amount of $1 million, secured by a new deed of trust recorded September 5, 2007. The new loan was used in part to fully discharge the original debt, which had an outstanding balance of $803,125.08. The LLC refinanced the property with REEL a third time in 2008. In February and May 2008, Premier and Continental respectively recorded notices of claims for mechanics’ liens.
The LLC defaulted on the 2007 and 2008 notes and REEL sold the property pursuant to its power of sale under the deeds of trust. Premier and Continental then each initiated mechanics’ lien foreclosure actions. The trial court granted summary judgment to Premier and Continental, holding the mechanics’ liens had priority. REEL appealed, arguing, among other things, that its lien had priority over the mechanics’ liens by virtue of the doctrines of equitable subrogation and replacement.
Under the doctrine of equitable subrogation, if proceeds from a loan are used to discharge outstanding obligations under an earlier deed of trust, the deed of trust securing the new loan is deemed to be substituted into the priority position of the earlier deed of trust, and is afforded priority over liens subsequent to the lien of the earlier deed of trust. The court noted that for equitable subrogation to apply “the second loan must be made by a different lender than the holder of the first deed of trust, because, by definition, one cannot be subrogated to one’s own previous deed of trust.” In this case, the second loan was refinanced with the same lender. As such, REEL’s lien could not have priority based on the equitable subrogation doctrine.
The court next turned to the applicability of the doctrine of replacement, which “allows a senior lender that discharges its mortgage of record and records a replacement mortgage to keep its priority as against the holder of an intervening interest in the property.” Finding no Arizona law on point, the court looked to the Restatement (Third) of Property (Mortgages) and to the law of other jurisdictions for guidance. Ultimately the court adopted the Restatement approach, holding “that where a senior lien is released of record and, as part of the same transaction, is replaced with a new lien, the latter retains the same priority as its predecessor, except to the extent that any change in the terms of the security document or the underlying debt it secures is materially prejudicial to a junior lienholder’s interest in the real property.” In this case, the court said, REEL’s 2007 deed of trust assumed the priority of the initial deed of trust it replaced, but only to the extent of $803,125.08, which was the outstanding balance of the original debt replaced. Premier and Continental gained priority over REEL to the extent of the increase over that amount.
While Premier and Continental argued that replacement did not apply in this case because REEL’s initial mortgage and the refinancing loan involved different debtors (Conover and his LLC), the court found that “a change in borrowers is not a determinative factor in deciding whether replacement should apply.”
This case is cited as Continental Lighting & Contracting, Inc. v. Premier Grading & Utilities, LLC, et al., No. 2 CA-CV 2010-0109 (Ariz. Ct. App. 05/31/11). .
SBA Issues New SOP 50 10 5(D) Effective October 1, 2011
On September 15, 2011, the SBA published its most recent edition of the Lender and Development Company Loan Programs of the U.S. Small Business Administration, SOP 50 10 5(D).
Each year, the SBA updates the program to address issues that have arisen over the course of the year. This year’s version focuses on change of ownership, franchises, fee and agents, creditworthiness and life insurance requirements. In addition, there has been a major overhaul of the asset based CAPlines program, which includes working capital and contract CAPlines, and a section on the Community Adjustment and Investment Program. This new SOP 50 10 5(D) is effective October 1, 2011. The SOP includes updates and changes on:
- Maximum Loan Amounts
- EPC/OC Structure
- Change of Ownership
- Prohibitions Regarding Debt in Principal’s Names
- Interest Rate Changes
- Packaging Services Fees
- Extraordinary Servicing Fees
- Lender Service Providers
- Franchises
- Leased Space
- Credit Elsewhere Requirements
- Life Insurance
- Eligibility and Prior Loss
- Lender Preference Prohibition and Piggy Back Structure
- Changes to Authorization Requests for SBA Loans Approved on a Non-Delegated Basis
- Mandatory E-Tran Filings for Lenders with Delegated Authority
- Changes to the CapLine Programs
- OREO Transactions
- Flood Insurance for Condominium Projects
For a more complete explanation of the changes:
- Go to the article "Summary of SBA New SOP 50 10 5(D) Changes," and
- Attend our seminar "What Lenders Need to Know About The New SBA SOP 50 10 5(D)" on Thursday, October 13 at 11:30 am.
Welcome Nicole N. Soraruf
The Commercial Lending group is pleased to welcome Nicole N. Soraruf to the firm as an associate in the lending and real estate groups.
Nicole has just moved to Silver Spring from Baltimore, where she clerked for the Honorable Michael J. Finifter of the Baltimore County Circuit Court. She received her law degree summa cum laude from the University of Baltimore Law School and her undergraduate degree in political science from Hobart and William Smith Colleges. For more information about Nicole, visit Nicole Soraruf.
