United States: NY Court: Lender Owes No Duty of Disclosure to Borrower’s Investors

A New York trial court has ruled that a lender cannot be held liable for fraudulent misrepresentation and failure to disclose information where plaintiff-investors failed to meet their own duty of conducting due diligence prior to investing in a company.

The court specifically determined that the lender owes no duty of disclosure to the borrower’s investors. See Jebran v. LaSalle Business Credit, LLC, No. 601757/2005 (N.Y. Sup. Ct. Jan. 17, 2006).

The case arose when investors in Invatech Corporation ("Invatech") sued LaSalle Business Credit, LLC ("LaSalle") —Invatech’s senior lender—to recover the amount of their investments claiming fraudulent misrepresentation and breach of a duty to disclose information. LaSalle filed a motion to dismiss.

Invatech and LaSalle had entered into a Loan Agreement in early 2000, under which LaSalle and other lenders established a $20 million credit facility for Invatech and its subsidiaries, with LaSalle chosen as the designated lenders’ agent. As collateral, LaSalle retained a lien on most of Invatech’s assets.

By early 2002, Invatech’s financial status waned and it breached the Loan Agreement. In April, Invatech and LaSalle entered into an Amendment to the Loan Agreement, waiving all of Invatech’s defaults and relaxing certain of the financial requirements. Subsequently, Invatech prepared identical Subordinated Loan and Security Agreements ("Subordinated Agreements") and distributed them to potential subordinated lenders, including the plaintiffs.

Under these Subordinated Agreements, the plaintiffs were granted a "first priority security in and lien on" the proceeds of three suits in which Invatech was the plaintiff. The plaintiffs entered into the Subordinated Agreements, and loaned Invatech a total amount of $900,000. Thereafter, Invatech defaulted under the new Loan Agreement, and LaSalle agreed to waive such defaults in December 2002.

The plaintiffs’ security interests under the Subordinated Agreements were subordinate to Invatech’s debt to LaSalle, and when two of the suits that constituted the basis of the plaintiffs’ collateral settled, LaSalle retained the settlement amounts. Invatech eventually filed for chapter 11 bankruptcy protection in October 2003.

In their suit against LaSalle, the plaintiffs contended that LaSalle conspired with Invatech to defraud them by approving the Subordinated Agreements, which represented that Invatech "was not in default of … any of its obligations." The plaintiffs asserted that the language contained in the Subordinated Agreements was incomplete and misleading because Invatech would have been in default but for LaSalle’s waiver.

The plaintiffs further asserted that they reasonably relied on such representations of Invatech’s lack of defaults when they decided to loan money to Invatech, and would not have loaned such funds had they known of Invatech’s true financial status and history of defaults. The plaintiffs also requested that the court grant them leave to amend the second amended complaint to add claims against LaSalle for, among other things, aiding and abetting fraud.

In defense, LaSalle asserted that no underlying fraud existed; that LaSalle never made representations to the plaintiffs; and that reliance on the language in the Subordinated Agreements was not justified because of the plaintiffs’ ability to access Invatech’s financial information.

Addressing LaSalle’s motion to dismiss, the Supreme Court for the State of New York, County of New York, noted that the allegedly misleading statement in the Subordinated Agreements was not false because Invatech was not in default at the time the parties executed the agreements. The court determined that the plaintiffs had a "duty to exercise ordinary diligence and conduct an independent appraisal of the risk they were assuming" and as such, could not complain that they were "induced to enter into the transaction by misrepresentations" (citing Abrahami v. UPC Constr. Co., 224 A.D.2d 231 (N.Y. App. Div. 1996)).

The court also held that LaSalle’s consent to the terms of the Subordinated Agreements did not constitute "substantial assistance" and thus could not support a claim for aiding and abetting fraud (relying on the holding in Albion Alliance Mezzanine Fund, L.P. v. State Street Bank and Trust Co., 8 Misc.3d 264 (N.Y. Sup. Ct. 2003) aff’d. 2 A.D.3d 162 (N.Y. App. Div. 2003), wherein the Albion court held that a bank’s mere acceptance of a loan repayment despite knowledge of the debtor’s wrongful conduct does not rise to the level of aiding and abetting fraud).

The court concluded that a bank’s superior knowledge regarding its borrower does not create a duty to disclose information to the borrower’s investors.

This article is presented for informational purposes only and is not intended to constitute legal advice.