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Print articleShifting Winds? Two N.C. Courts Uphold Fiduciary Duty Claims Against Banks
March, 2013 - Bryan G. Scott
For the first time ever, North Carolina’s Business Court and Court of Appeals both upheld fiduciary duty claims against banks in late 2012. Debtors frequently employ such claims in an attempt to shift liability for failed projects to their lenders or to pressure lenders to settle problem loans in the wake of the financial downturn. Despite their ubiquity, breach of fiduciary duty claims had proven elusive for borrowers before October 2012. With two victories notched in their belt, however, it is likely that borrowers and their counsel will approach these claims with renewed vigor in 2013 and for the foreseeable future.
I. Fiduciary Duties in North Carolina
In North Carolina, a fiduciary duty arises when “there has been a special confidence reposed in one who in equity and good conscience is bound to act in good faith and with due regard to the interests of the one reposing confidence.” Curl v. Key, 311 N.C. 259, 264, 316 S.E.2d 272, 275 (1984). In the banking context, however, North Carolina’s courts have held repeatedly that an ordinary debtor-creditor relationship generally does not give rise to such a “special confidence,” and our courts have consistently resisted debtors’ attempts to cast particular facts as showing more than a mere debtor-creditor relationship. See, e.g., Wells Fargo Bank, N.A. v. Vandorn, 2012 NCBC 6 (N.C. Super. Ct. January 17, 2012) (lendees alleged only an ordinary lender-borrower relationship where lender became involved only after lendees had located the lot, formed the intent to purchase, formed a company to purchase, and approached the lender about financing the transaction); Peak Coastal Ventures, LLC v. SunTrust Bank, 2011 NCBC 13 (N.C. Super. Ct. May 5, 2011) (lender’s knowledge of a lendee’s business plan was mere due diligence and insufficient to create a fiduciary relationship); Allran v. Branch Banking and Trust Corp., 2011 NCBC 21 (N.C. Super. Ct. July 6, 2011) (documents produced by lender were industry standard and thus lendee had alleged merely an ordinary debtor-creditor relationship); Branch Banking and Trust Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992) (lendees failed to allege a fiduciary relationship or reliance where they sought financial advice from private sources). None of these cases, however, went so far as to say that a borrower could never successfully sue a lender for breach of fiduciary duty, and attorneys and banks were left to ponder what set of facts might create the requisite “special relationship.”
II. WNC Holdings, LLC v. Alliance Bank & Trust Co.
The Business Court first answered this question in October 2012 in WNC Holdings, LLC v. Alliance Bank & Trust Co., 2012 NCBC 50 (N.C. Super. Ct. Oct. 2, 2012). The WNC Holdingscase involved a lender’s motion to dismiss a number of claims, including breach of fiduciary duty, brought by its borrower on a failed real estate development. The Business Court denied the lender’s motion to dismiss the fiduciary duty claim, finding that the bank had assumed a dual role as both lender and financial advisor in the development of the property. The second, advisory role gave rise to a special relationship beyond the ordinary debtor-creditor relationship.
As set forth in the debtors’ complaint, the borrower in WNC Holdings sought an acquisition and development loan from the bank for a residential subdivision. In accordance with its underwriting guidelines, the bank contracted with an independent appraiser for an appraisal of the property. The debtors alleged that the bank also had a pro forma financial feasibility statement prepared for the borrowers in order to move the project forward and have the borrowers borrow the development money from the bank. The feasibility statement is typically prepared by a borrower, not the lender.
Thereafter, the bank extended credit for the acquisition and development of the property. Later, the bank evidently developed reason to question the initial appraisal value and ordered a new appraisal. The new appraisal reflected a value of approximately one third of the original appraised value. Based on the new appraisal, the bank demanded the borrower sign renewal notes and supply additional collateral for the loan. The bank allegedly did not notify the borrower of the overvaluation in the first appraisal or the reduced value in the second appraisal, but the loan officer assured the borrower that the project was still financially feasible and drew up another financial pro forma on the borrower’s behalf.
The project was evidently unsuccessful, and the borrower and guarantors ultimately sued the bank on a host of claims related to the allegedly misleading appraisal and representations. At the heart of their claims, the debtors alleged that the initial appraisal overvalued the property, that they relied on the bank’s diligence in reviewing the appraisal and the bank’s alleged misrepresentations, and that the debtors would not have borrowed from the bank had they known of the errors in the first appraisal. At the time of the lawsuit, the borrowers were current on their payments and had not defaulted under the loan documents.
The bank moved to dismiss a number of the debtors’ claims, including their claim for alleged breach of fiduciary duty. The bank argued that the documentation filed on behalf of the loan, the inspections of the project, and any financial advice rendered were part of the bank’s due diligence in a normal arms-length transaction. In contrast, the debtors argued that their allegations detailed more than a mere debtor-creditor relationship because the bank acted as a financial and development advisor and completed financial feasibility pro forma statements on behalf of the borrower. Taking the allegations of the complaint as true, as it was required to do at the motion to dismiss stage, the Business Court agreed with the debtors.
The court noted that the debtors contended the bank acted not just as a lender, but also as a financial and development advisor for the project. The court focused on the fact that the bank had reviewed and suggested changes to the borrower’s property development agreements, performed inspections of the property and development, and completed financial feasibility pro forma statements that are traditionally completed by the debtor. Those allegations, the court said, distinguished the WNC Holdings case from other cases and alleged conduct that exceeded mere creditor knowledge of the debtor’s business plan and were sufficient to establish a fiduciary relationship. Because the debtors alleged the bank breached this relationship by failing to disclose the defective appraisal, the court ruled that the debtors had adequately stated a claim in the complaint for breach of fiduciary duty and denied the bank’s motion to dismiss that claim.
III. Dallaire v. Bank of America, N.A.
Just two months later, the North Carolina Court of Appeals reached a similar result on different facts. In Dallaire v. Bank of America, N.A., No. COA12-626 (N.C. Ct. App. Dec. 18, 2012) (slip op.), the Court of Appeals overturned summary judgment in favor of the bank for alleged breach of fiduciary duty arising from the lender’s representations in a mortgage refinance.
The borrowers’ home in Dallaire was subject to three liens, a first and second deed of trust in favor of the defendant bank, and a third deed of trust held by another lender. In an earlier Chapter 7 bankruptcy, the borrowers had been relieved from personal liability on the three mortgage liens. Later, the borrowers responded to a solicitation from the defendant bank for a mortgage refinance. The borrowers alleged they fully informed the bank’s agent of the three liens and their bankruptcy, and the agent repeatedly assured them that a new refinancing loan would have first priority status and, further, that they should increase the amount of the loan to pay off two cars as well. The bank ordered a “title search” from a subsidiary that showed the three liens, and analysis by a title agency reported that the liens were discharged. Notably, the bank did not have an attorney review the information, but instead handled the full refinance process itself.
When the borrowers later attempted to sell their home, their title search revealed that what had been the third priority lien of the other lender now had first priority status, followed by the new refinance loan. The borrowers sued the bank for a host of claims arising from its alleged misrepresentation, including a claim for breach of fiduciary duty.
The trial court granted summary judgment for the bank, no doubt relying on the bevy of prior cases refusing to find a fiduciary duty on the part of banks. Without citing the recentWNC Holdings opinion, the Court of Appeals reversed the trial court’s decision. The borrowers argued on appeal that special circumstances were present to give rise to a fiduciary duty where the facts suggested the bank advised the borrowers that a first priority lien was possible and being provided. The borrowers alleged they openly discussed their circumstances with the bank and were assured they could obtain a first priority loan. Those facts distinguished the Dallaire case from others in which the borrower had relied on outside counsel and advice in addition to the representations of the lender. As a result, the Court of Appeals held that there was a fact question as to whether the parties’ interaction before signing the loan gave rise to a fiduciary relationship. Specifically, the court held that a question of fact existed as to whether the bank sought to give legal advice to the borrowers as to loan priority and stated that, when a bank provides a customer with a service beyond that inherent in the creditor-debtor relationship, it must do so reasonably and with care. The court remanded the case to superior court for trial.
IV. Takeaways for North Carolina Lenders
While the recent opinions in WNC Holdings and Dallaire appear to be the first reported cases in North Carolina upholding a borrower’s claim against a bank for alleged breach of fiduciary duty, the results in those cases are not especially groundbreaking. Most attorneys who follow this issue have assumed from earlier cases that such a claim would be upheld given the right set of facts. And in that regard, it is helpful that both courts took pains to distinguish the facts of earlier opinions and reiterate the general rule that an ordinary debtor-creditor relationship does not create a fiduciary relationship.
WNC Holdings and Dallaire are important, however, as a reminder to banks and their counsel of the importance of walking the line between extending credit on the one hand and what can, on the other hand, be characterized as offering services outside the traditional debtor-creditor relationship. It is now clear the courts will not permit banks to venture into offering financial or legal advice without creating a fiduciary relationship. While that rule is easily stated, it is not always so black and white in practice. Proper training to educate loan officers and other front line staff is key. Loan officers at community banks, in particular, must successfully juggle close relationships, intimate knowledge of a borrower’s business, and the desire to close a deal with the bank’s interest in avoiding the type of “special relationship” that can establish a fiduciary duty. It is important that loan officers avoid trying to actively “sell” the development or business deal to the client and that they instead focus on meeting underwriting requirements and extending credit once the borrower has made its own business decision to move forward.
Bank employees must also be circumspect in their representations and in providing materials to borrowers. While providing appraisals, environmental studies or other due diligence documents to a borrower have not, by themselves, been held to create a fiduciary duty, providing those documents in a situation where it is clear the borrower is relying on them is problematic. And it goes without saying that bankers should now be extremely hesitant to offer opinions on loan priority, to complete financial feasibility statements for borrowers, or to perform other analysis of the borrower’s business plan other than for the bank’s own internal purposes. Bank employees should instruct all borrowers to consult legal counsel or outside advisors with questions.
The recent success in WNC Holdings and Dallaire will undoubtedly embolden borrowers and their counsel to assert fiduciary duty claims against banks with renewed vigor. These claims are highly factual and can be difficult to assess without expensive discovery and briefing at the summary judgment stage. Banks should be proactive in addressing this challenge by taking time today to educate their employees and update policies to mitigate the risk.
I. Fiduciary Duties in North Carolina
In North Carolina, a fiduciary duty arises when “there has been a special confidence reposed in one who in equity and good conscience is bound to act in good faith and with due regard to the interests of the one reposing confidence.” Curl v. Key, 311 N.C. 259, 264, 316 S.E.2d 272, 275 (1984). In the banking context, however, North Carolina’s courts have held repeatedly that an ordinary debtor-creditor relationship generally does not give rise to such a “special confidence,” and our courts have consistently resisted debtors’ attempts to cast particular facts as showing more than a mere debtor-creditor relationship. See, e.g., Wells Fargo Bank, N.A. v. Vandorn, 2012 NCBC 6 (N.C. Super. Ct. January 17, 2012) (lendees alleged only an ordinary lender-borrower relationship where lender became involved only after lendees had located the lot, formed the intent to purchase, formed a company to purchase, and approached the lender about financing the transaction); Peak Coastal Ventures, LLC v. SunTrust Bank, 2011 NCBC 13 (N.C. Super. Ct. May 5, 2011) (lender’s knowledge of a lendee’s business plan was mere due diligence and insufficient to create a fiduciary relationship); Allran v. Branch Banking and Trust Corp., 2011 NCBC 21 (N.C. Super. Ct. July 6, 2011) (documents produced by lender were industry standard and thus lendee had alleged merely an ordinary debtor-creditor relationship); Branch Banking and Trust Co. v. Thompson, 107 N.C. App. 53, 61, 418 S.E.2d 694, 699 (1992) (lendees failed to allege a fiduciary relationship or reliance where they sought financial advice from private sources). None of these cases, however, went so far as to say that a borrower could never successfully sue a lender for breach of fiduciary duty, and attorneys and banks were left to ponder what set of facts might create the requisite “special relationship.”
II. WNC Holdings, LLC v. Alliance Bank & Trust Co.
The Business Court first answered this question in October 2012 in WNC Holdings, LLC v. Alliance Bank & Trust Co., 2012 NCBC 50 (N.C. Super. Ct. Oct. 2, 2012). The WNC Holdingscase involved a lender’s motion to dismiss a number of claims, including breach of fiduciary duty, brought by its borrower on a failed real estate development. The Business Court denied the lender’s motion to dismiss the fiduciary duty claim, finding that the bank had assumed a dual role as both lender and financial advisor in the development of the property. The second, advisory role gave rise to a special relationship beyond the ordinary debtor-creditor relationship.
As set forth in the debtors’ complaint, the borrower in WNC Holdings sought an acquisition and development loan from the bank for a residential subdivision. In accordance with its underwriting guidelines, the bank contracted with an independent appraiser for an appraisal of the property. The debtors alleged that the bank also had a pro forma financial feasibility statement prepared for the borrowers in order to move the project forward and have the borrowers borrow the development money from the bank. The feasibility statement is typically prepared by a borrower, not the lender.
Thereafter, the bank extended credit for the acquisition and development of the property. Later, the bank evidently developed reason to question the initial appraisal value and ordered a new appraisal. The new appraisal reflected a value of approximately one third of the original appraised value. Based on the new appraisal, the bank demanded the borrower sign renewal notes and supply additional collateral for the loan. The bank allegedly did not notify the borrower of the overvaluation in the first appraisal or the reduced value in the second appraisal, but the loan officer assured the borrower that the project was still financially feasible and drew up another financial pro forma on the borrower’s behalf.
The project was evidently unsuccessful, and the borrower and guarantors ultimately sued the bank on a host of claims related to the allegedly misleading appraisal and representations. At the heart of their claims, the debtors alleged that the initial appraisal overvalued the property, that they relied on the bank’s diligence in reviewing the appraisal and the bank’s alleged misrepresentations, and that the debtors would not have borrowed from the bank had they known of the errors in the first appraisal. At the time of the lawsuit, the borrowers were current on their payments and had not defaulted under the loan documents.
The bank moved to dismiss a number of the debtors’ claims, including their claim for alleged breach of fiduciary duty. The bank argued that the documentation filed on behalf of the loan, the inspections of the project, and any financial advice rendered were part of the bank’s due diligence in a normal arms-length transaction. In contrast, the debtors argued that their allegations detailed more than a mere debtor-creditor relationship because the bank acted as a financial and development advisor and completed financial feasibility pro forma statements on behalf of the borrower. Taking the allegations of the complaint as true, as it was required to do at the motion to dismiss stage, the Business Court agreed with the debtors.
The court noted that the debtors contended the bank acted not just as a lender, but also as a financial and development advisor for the project. The court focused on the fact that the bank had reviewed and suggested changes to the borrower’s property development agreements, performed inspections of the property and development, and completed financial feasibility pro forma statements that are traditionally completed by the debtor. Those allegations, the court said, distinguished the WNC Holdings case from other cases and alleged conduct that exceeded mere creditor knowledge of the debtor’s business plan and were sufficient to establish a fiduciary relationship. Because the debtors alleged the bank breached this relationship by failing to disclose the defective appraisal, the court ruled that the debtors had adequately stated a claim in the complaint for breach of fiduciary duty and denied the bank’s motion to dismiss that claim.
III. Dallaire v. Bank of America, N.A.
Just two months later, the North Carolina Court of Appeals reached a similar result on different facts. In Dallaire v. Bank of America, N.A., No. COA12-626 (N.C. Ct. App. Dec. 18, 2012) (slip op.), the Court of Appeals overturned summary judgment in favor of the bank for alleged breach of fiduciary duty arising from the lender’s representations in a mortgage refinance.
The borrowers’ home in Dallaire was subject to three liens, a first and second deed of trust in favor of the defendant bank, and a third deed of trust held by another lender. In an earlier Chapter 7 bankruptcy, the borrowers had been relieved from personal liability on the three mortgage liens. Later, the borrowers responded to a solicitation from the defendant bank for a mortgage refinance. The borrowers alleged they fully informed the bank’s agent of the three liens and their bankruptcy, and the agent repeatedly assured them that a new refinancing loan would have first priority status and, further, that they should increase the amount of the loan to pay off two cars as well. The bank ordered a “title search” from a subsidiary that showed the three liens, and analysis by a title agency reported that the liens were discharged. Notably, the bank did not have an attorney review the information, but instead handled the full refinance process itself.
When the borrowers later attempted to sell their home, their title search revealed that what had been the third priority lien of the other lender now had first priority status, followed by the new refinance loan. The borrowers sued the bank for a host of claims arising from its alleged misrepresentation, including a claim for breach of fiduciary duty.
The trial court granted summary judgment for the bank, no doubt relying on the bevy of prior cases refusing to find a fiduciary duty on the part of banks. Without citing the recentWNC Holdings opinion, the Court of Appeals reversed the trial court’s decision. The borrowers argued on appeal that special circumstances were present to give rise to a fiduciary duty where the facts suggested the bank advised the borrowers that a first priority lien was possible and being provided. The borrowers alleged they openly discussed their circumstances with the bank and were assured they could obtain a first priority loan. Those facts distinguished the Dallaire case from others in which the borrower had relied on outside counsel and advice in addition to the representations of the lender. As a result, the Court of Appeals held that there was a fact question as to whether the parties’ interaction before signing the loan gave rise to a fiduciary relationship. Specifically, the court held that a question of fact existed as to whether the bank sought to give legal advice to the borrowers as to loan priority and stated that, when a bank provides a customer with a service beyond that inherent in the creditor-debtor relationship, it must do so reasonably and with care. The court remanded the case to superior court for trial.
IV. Takeaways for North Carolina Lenders
While the recent opinions in WNC Holdings and Dallaire appear to be the first reported cases in North Carolina upholding a borrower’s claim against a bank for alleged breach of fiduciary duty, the results in those cases are not especially groundbreaking. Most attorneys who follow this issue have assumed from earlier cases that such a claim would be upheld given the right set of facts. And in that regard, it is helpful that both courts took pains to distinguish the facts of earlier opinions and reiterate the general rule that an ordinary debtor-creditor relationship does not create a fiduciary relationship.
WNC Holdings and Dallaire are important, however, as a reminder to banks and their counsel of the importance of walking the line between extending credit on the one hand and what can, on the other hand, be characterized as offering services outside the traditional debtor-creditor relationship. It is now clear the courts will not permit banks to venture into offering financial or legal advice without creating a fiduciary relationship. While that rule is easily stated, it is not always so black and white in practice. Proper training to educate loan officers and other front line staff is key. Loan officers at community banks, in particular, must successfully juggle close relationships, intimate knowledge of a borrower’s business, and the desire to close a deal with the bank’s interest in avoiding the type of “special relationship” that can establish a fiduciary duty. It is important that loan officers avoid trying to actively “sell” the development or business deal to the client and that they instead focus on meeting underwriting requirements and extending credit once the borrower has made its own business decision to move forward.
Bank employees must also be circumspect in their representations and in providing materials to borrowers. While providing appraisals, environmental studies or other due diligence documents to a borrower have not, by themselves, been held to create a fiduciary duty, providing those documents in a situation where it is clear the borrower is relying on them is problematic. And it goes without saying that bankers should now be extremely hesitant to offer opinions on loan priority, to complete financial feasibility statements for borrowers, or to perform other analysis of the borrower’s business plan other than for the bank’s own internal purposes. Bank employees should instruct all borrowers to consult legal counsel or outside advisors with questions.
The recent success in WNC Holdings and Dallaire will undoubtedly embolden borrowers and their counsel to assert fiduciary duty claims against banks with renewed vigor. These claims are highly factual and can be difficult to assess without expensive discovery and briefing at the summary judgment stage. Banks should be proactive in addressing this challenge by taking time today to educate their employees and update policies to mitigate the risk.
