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2© OnCourse Learning
Chapter 22 Learning Objectives
Understand how parties to real estate finance transactions can be held liable for their actions
Understand the structure of agency relationships within real estate finance
Understand that there are agency costs associated with preventing parties from acting solely in their own interest and against the interests of others
Understand how insufficient agency costs allow wealth transfers
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Lenders’ Legal Liability
Lenders may be subject to liability in two areas: Violation of state or federal laws regulating certain activities
Violation of contractual obligations involving loan arrangements
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Federal Laws Regulating Hazardous Waste
Comprehensive Environmental Response, Compensation, and Liability Act of 1980 (CERCLA) Liability under CERCLA – strict, retroactive, and joint and several
Strict liability – a charged party may not offer as a defense a claim that its actions were not in violation of any law prior to CERCLA
Joint and several liability – each potentially liable party can be made to bear the entire cost of cleanup even if several parties may have been responsible for the contamination
Superfund Amendments and Reauthorization Act of 1986 (SARA)
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Hazardous Waste
Potentially responsible parties (PRPs) for contaminated properties: Current owners / operators of a facility
Owners / operators at the time of discharge
Generators of the hazardous substance or parties arranging for disposal
Transporters of the hazardous waste
Secured-Lender exemption – a PRP owner or operator does not include a lender that holds a mortgage or deed-of-trust on a property as security for a note Lenders may lose this exemption if they foreclose on the contaminated property
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Lender Defenses
Lender claims to not be a PRP
Contamination resulted solely from an act of God, act of war, or omission by a third party
Claims to be an innocent landowner with no knowledge of contamination
Initial Judicial Decision United States v. Mirable (1985) – involved three lenders with
secured interest in a property United States v. Maryland Bank and Trust Company (1986) –
involved a secured lender that foreclosed on a property and took title through a sheriff’s sale
Guidice v. BFG Electroplating Co (1989) – court recognition of option values related to the CERCLA legislation
Fleet Factors Corporation (1990) – lenders liability extended further
Bergsoe Metal Corporation (1990) – addressed the issue of lender control of business activities
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April 1992 EPA Regulation
Rules allowing lenders to foreclose and not be liable: Actions prior to security interest
Periodic monitoring and/or inspection
Involvement from inspection results
Requiring borrower compliance
Restructuring the loan arrangement
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April 1992 EPA Regulation
Rules allowing lenders to foreclose and not be liable: Requiring additional rent or interest
Exercising any rights the lender may have under the law or any warranties, covenants, conditions, or promises
Providing financial or administrative advice
In 1994 an appeals court invalidated the 1992 EPA regulation
Congress Acts Asset Conservation, Lender Liability and Deposit
Insurance Protection Act of 1996 – part of the spending bill for 1997; provision that codified the 1992 EPA rule
Under the act “participating in the management” term included participating in the operations and ability to engage in several other activities and retain the secured lender exemption
Allows a lender to foreclose on a property, sell, wind up operations and undertake a response action under CERCLA without losing its exemption
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Other Lender Regulations
Comprehensive Drug Abuse Prevention and Control Act of 1970 allows confiscation of property used in illegal drug activity The danger for the lender is the greatest when it forecloses on a property that has been
used to support illegal drug transaction
The lender must use due diligence defense
Other Lender Regulations Uniform Commercial Code (UCC) which specifies rights
and obligations of contracting parties Two primary areas of lender behavior that can give
rise to liability Nonperformance of oral commitments Failure to extend credit beyond a certain date
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Liability from Lender/Borrower Relationship Oral commitments for Extension of Credit
The following contracts must be in writing in order to be enforced:Agreements that cannot be performed with 1 year
Promises to answer for the debts of another (surety contracts)
Promises made in consideration of marriage
Agreements relating to real property
Contracts exceeding $500 for sale of goods
Contracts by executors
Termination of demand notes without notification
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Other Theories of Lender Liability
Prima facie tort
Promissory fraud
Nondisclosure fraud and breach of fiduciary duty Breach of contract
Duress and lender control
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Liability to Third Parties: Bankruptcy and Agency Costs Agency law - another area of the law where the lender may become liable
to third parties If lender undertakes sufficient control for the operations of the creditor’s business
(assumes the role of principal)
Bankruptcy law and the cramdown process Cramdown – the ability, under the law, to force restructuring of the debt owned by the
developer
Ethics, fraud and agency costs Agency relationships have legal and ethical implications
Agency costs – costs incurred to make sure that the agent acts only in the principal’s interests