A recent bench trial in the Cobb county Superior Court pitting a real estate developer David Pearson and several related entities against Delta Community Credit Union (“DCCU”) resulted in Pearson being awarded a lender liability judgment in the amount of $75 million. A copy of the Final Order and Judgment is available online here. Pearson initially obtained credit from Delta Community Credit Union in early 2009 when one of his entities (“Gettysburg”) refinanced a $2,025,000 loan on an office park located in Cobb County, Georgia. DCCU obtained an appraisal showing a value of $4,800,000.
Following the Gettysburg loan, Pearson sought additional financing in the form of a $30 million credit facility for the purpose of buying distressed real estate in Florida and metropolitan Atlanta (the “Master Credit Facility”). The Master Credit Facility was set up in conjunction with a formula referred to as the “Pearson Matrix” that required a certain loan to value ratio and first lien position for any real estate acquisition that Pearson might use the funding for. In addition to the Master Credit Facility, DCCU also extended a line of credit (the “LOC”) that eventually grew to $9,900,000 secured by existing real property pledged by Pearson’s affiliates.
Pearson attempted to utilize the Mater Credit Facility to purchase a number of properties in Florida. At the same time he was trying to acquire that portfolio he was also seeking to purchase the note on a project in Florida called Nature Walk for $8.1 million. Nature Walk fronts on Highway 395, less than a mile from the beach, and is adjacent to the Watercolors Project, Sea Grove Community, and the community of Seaside. He hoped to free up availability under the LOC to purchase Nature Walk by moving the other unrelated properties into the Master Credit Facility.
During the time that Pearson was looking to purchase Nature Walk, DCCU became very concerned about the quality of the appraisals previously obtained on the Georgia and Florida properties the secured both the Gettysburg loan as well as the LOC. On February 10, 2010, DCCU informed Pearson that all of the valuations for both the Georgia and Florida Properties had been rejected by an independent third-party reviewer. The reasons for the third-party reviewers’ rejections of the appraisals included: (1) USPAP violations for failure to reconcile sales of the subject property for the prior three years; (2) improper application of valuation methodologies; (3) insufficient adjustments to sales and rent comparables; (4) improper selections of sales and rent comparables; (5) insufficient accounting for current market conditions; (6) errors in proper zoning identification and reporting; (7) lack of historical operating data; (8) errors in vacancy rate calculations; and (9) errors and omissions regarding statistics and absorption data. Pearson was also informed that DCCU would be engaging new appraisers to reappraise the properties and that once completed, these appraisals would also be submitted for independent third-party review.
The relationship between Pearson and DCCU deteriorated with the result that Pearson was never able to consummate the Nature Walk transaction. DCCU declared Pearson to be in default for various reasons including the fact that Pearson used almost $5 million of the loan proceeds to invest in the stock market instead of purchasing real property. Pearson eventually brought suit against DCCU seeking damages for the alleged breach of contract. The trial itself was a bench trial conducted over 14 days. The court for the most part resolved disagreements over the competing factual claims of the parties in favor of Pearson. Although the opinion is 131 pages long one can get the sense of where things are headed in just the first few pages of the opinion when you read the following references:
- the court refers to Pearson as a “successful real estate developer” who used “conservative” investment strategies,
- DCCU is a $4 billion dollar institution and one of the largest credit unions in the nation,
- Pearson negotiated a “unique and advantageous loan commitment” with DCCU,
- Because Pearson was looking to buy deeply discounted properties it was anticipated an “unrealized gain would be created at the time of purchase” that would capitalize on the unprecedented “deleveraging” that began in late 2008.
The Georgia Court of Appeals recently issued a very favorable ruling for banks that have purchased loans from the FDIC. In the case of KENSINGTON PARTNERS, LLC et al. v. BEAL BANK NEVADA, the guarantors argued that the purchaser of a $7 million loan from the FDIC did not possess a valid assignment from the FDIC. The original loan had been extended by BankFirst in 2006. BankFirst subsequently failed and the FDIC sold the loan to Beal Bank Nevada.
The record established that the FDIC sold the loan and all related documents, including the guaranties and the court rejected the argument put forth by the guarantors. In a helpful comment, the court noted that even if the assignment from the FDIC had not referenced the guaranties, under Georgia law, the assignment of the note carried with it the assignment of the guaranties. The guarantors also argued that there were genuine issues of fact concerning the amounts owed under the note.
The court rejected these arguments as well based on evidence from the FDIC loan portfolio manager accounting for the loan balance from its inception. The case is typical of some of the lender liability litigation that lenders are having to grapple with right now as well heeled borrowers and guarantors attempt to put off the day of reckoning. The litigation can be lengthy and expensive and the loan obligors are seeking to use that to extract a settlement form the lender that is favorable to the obligors.
Lenders seeking to collect against loan obligors that have sufficient assets to cover the loan should enter into collection activities with realistic expectations about the time and cost involved. Bank counsel’s awareness of typical or new lender liability theories is also vital to a successful collection effort.
One of the unique aspects of the current real estate downturn has been the large number of disputes over participation agreements. While these disputes have occurred in the past, the current downturn has produced more and varied disputes, especially disputes between originating banks and participating banks, than we have previously seen even during other challenging times.
As a result, the various form participation agreements and the standard terms contained in those agreements have undergone considerable scrutiny both inside and outside of litigation. Many Bryan Cave lawyers, including Jerry Blanchard, Bill Custer, or Jennifer Dempsey, have advised numerous banks on all aspects of these agreements and have represented parties in a number of these disputes including:
- Representing originating/lead banks in disputes brought by participant banks regarding the administration of the loan.
- Representing participant banks in disputes with originating/lead banks regarding the administration of the loan.
- Enforcing provisions requiring the repurchase of a participant bank’s interest in a loan by an originating bank as a result of the originating bank’s fraud.
- Representing groups of up to 60 loan participants in collection actions against borrowers.
- Providing general advice regarding questions about the interpretation of loan participation agreements.
- Providing advice when the lead position in a loan participation was assigned by the FDIC as Receiver to a third party under circumstances where the validity of the transfer was in question or the assignee was a non-bank with markedly different standards of administration.
- Providing advice on the effect of receiverships and loss share arrangements on participation agreements.
- Providing advice on the forced removal of lead banks.
The attorneys at Bryan Cave are here to help you with your questions regarding loan participations, whether your bank serves as the originating bank or as a participant bank.
In the event you have a dispute involving any of the above, or merely want to discuss your questions with an attorney, please call Jerry Blanchard, Bill Custer, or Jennifer Dempsey at (404) 572-6600. They will be happy to discuss your questions with you to help you better understand your options.
On February 9, 2010, a federal district court in Macon, Georgia issued a noteworthy decision in a dispute over a participation agreement finding the lead bank to have breached the agreement and ordering the lead bank to repurchase an interest from a participating bank.
The case of Sun American Bank v. Fairfield Financial Services, Inc. involved a claim by Sun American that Fairfield Financial had breached its obligations under a loan participation agreement involving a condominium project in north Florida. Sun American contended that Fairfield Financial had breached the agreement by failing to disclose to participants in a timely manner the downgrades in its credit relationship with the borrower and of circumstances that were likely to have a material, adverse effect on the loan. Sun American sought to compel Fairfield Financial to repurchase its interest in the loan as a remedy for the breach.
Judge Ashley Royal, of the United States District Court for the Middle District of Georgia, granted summary judgment in favor of Sun American finding that Fairfield Financial had failed to meet its disclosure obligations to the participants. Judge Royal noted that the disclosure requirement with respect to credit downgrades was particularly important given that the lead bank possessed substantial information regarding the borrower’s affairs that was not available to Sun American as a participant bank.