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A Caution to Borrowers Seeking to Prove Informal Loan Modifications

Lerch, Early & Brewer's Real Estate Law Update

A recent Virginia case provides a cautionary lesson to borrowers who might rely on a course of dealing with a lender to prove a modification of loan terms contrary to those specified in a written loan agreement. In the case of Wachovia, N.A. v. Preston Lake Home L.L.C., 2010 WL 4530103 (W.D. Va.), Wachovia, entered into two separate loan agreements (“Loan Agreements”) with Preston Lake Homes, L.L.C. in 2006 for $20 million in financing for the acquisition and development of a real estate project in Rockingham County. The Loan Agreements provided for a two-year term, but permitted the bank to grant a six to twelve month extension at its sole discretion.

The Loan Agreements required repayment of $4.75 million on or before March 31, 2008. In January 2007, the parties made a written modification of the agreements to provide for Wachovia’s funding of an additional $3 million so that Preston Lake could undertake more extensive improvements to the site. Significantly, however, the maturity date of the loans was not modified. Thereafter, in January 2008, Preston Lake requested a payment extension that would expire in July of that year. Wachovia gave verbal assurances that the extension could be worked out, but a formal written extension was not produced. Nevertheless, Preston Lake alleged that it relied on these assurances in spending an additional $1 million in improvements, rather than applying those funds to the loans. In March 2008, Preston Lake did not make its scheduled payment under the Loan Agreements. Wachovia did not demand payment or declare a default. It did, however, however, refuse to fully fund further disbursement requests to Preston.

Wachovia continued to assure Preston Lake that it would extend and renew the Loan Agreements. However, no written modification of the Loan Agreements was ever executed. In February 2009, Wachovia sent its first written notice of default, and finally delivered a formal demand for payment in December 2009. Preston Lake did not repay the loans.

Wachovia sued Preston Lake for payment of the loans. Preston Lake counterclaimed, alleging numerous breaches of the Loan Agreements by Wachovia, breach of fiduciary duty, and fraud. Preston Lake argued that Wachovia’s failure to comply with the strict terms of the Loan Agreements by waiving late fees and acquiescing in late payments proved that the parties had modified the Loan Agreements. In the alternative, it claimed that Wachovia never intended to extend the loans but fraudulently induced Preston Lake to continue making loan payments by giving verbal assurances of loan extensions. Finally, it asserted that Wachovia exercised undue control over Preston Lake’s affairs, making it a de facto partner who owed a fiduciary due to Preston Lake. Preston Lake sought consequential and punitive damages for its claims.

In considering Preston Lake’s nine counterclaims for breach of contract, the court found that most of its allegations were factually supported in the counterclaim pleadings. Accordingly, it denied Wachovia’s motion to dismiss eight of those counterclaims and allowed them to go forward at trial. It did, however, agree to dismiss Preston Lake’s claim that Wachovia breached the Loan Agreements by failing to exercise its option to extend the loans. The court pointed to the clear language of the Loan Agreements that provided that any extensions would be at the bank’s sole discretion, and that any modifications must be reduced to writing. It found that the implied obligation of good faith and fair dealing under Virginia law did not alter the express bargain of the parties set forth in the terms of the Loan Agreements, and refused to otherwise impose an obligation to require Wachovia to extend the loans.

Similarly, the court dismissed Preston Lake’s claims that Wachovia had exercised improper control over it, thus evolving their lender-creditor relationship into a fiduciary partner-to-partner relationship. The court noted that the debtor-creditor legal relationship did not in itself impose any fiduciary duties on the bank and that the factual allegations of Wachovia’s “control” over Preston Lake did not overstep the bounds of the customary debtor-creditor relationship. Further, the court dismissed Preston Lake’s claims of both constructive and actual fraud (namely, that Wachovia fraudulently induced Preston to spend its own funds on the project when it had no intention of extending the loans), finding that Preston Lake expended the funds for its own benefit and that any loan payments which Preston Lake made were contractually required, rather than fraudulently obtained. Finally, the court dismissed Preston Lake’s claims for consequential and punitive damages because the express terms of the Loan Agreements contained a waiver of all such damages.

The lesson learned from Wachovia v. Preston Lake is that Virginia law will respect the strict terms of written loan agreements. If the parties have stipulated that modifications may be made only in writing, the court will respect that agreement. Similarly, the law will not restrict or influence a bank’s exercise of its “sole discretion” if the written loan terms confer such a prerogative on the bank. Accordingly, borrowers are warned to resist the lure of verbal promises and assurances to modify contrary loan terms, even with lenders who seem complacent or cooperative. All modifications are advised to be reduced to written agreements.

This content is for your information only and is not intended to constitute legal advice. Please consult your attorney before acting on any information contained here.

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