When a commercial enterprise is looking to purchase or improve a property, it needs financing to pay for the project. Often, the enterprise will use the property it is purchasing as collateral. The last thing the lender wants is to create an additional liability to itself in property that is meant to secure the loan. But creative counsel for individuals and corporations injured in a calamity at the property, such as a fire or a flood, are doing precisely that.
In this context, a third party, such as a tenant of the borrower, typically seeks to establish liability. Oftentimes a lending institution will have one of its employees or someone else of its choosing inspect the property to ensure that the property is worth the value of the financing. This is especially true in the case of properties that are being improved and need to be inspected several times as improvements are made. Those injured in a calamity – sometimes years or even decades after the inspections occurred – may attempt to claim that the lender-conducted inspections were done improperly and led to harmful conditions. In addition, some lenders will have financing setup in such a way that the more profitable the commercial property is, the more interest collected on the financing. Creative plaintiffs' attorneys may argue that by sharing in the profits, the lender now is an owner and has responsibility for the condition of the property. However, there are ways in which a lender can protect itself from this potential liability.
In general, in most jurisdictions, a lender who performs inspections of the mortgaged property does so for its own benefit and not the benefit of the borrower or anyone else. This general rule appears to bar lawsuits against a lender, but there are several exceptions to this rule. First, depending upon what the parties may agree to do, an argument could be made that the lender has taken on an obligation by conducting the inspections. Second, an argument has been made – with some success – that by performing the inspections, the lender had an obligation to do perform them correctly. If the inspections were conducted improperly and that caused harm to the borrower or others, the lender should be liable for the same. Finally, the argument has been made that if the lender has some type of interest in the property, such as receiving a portion of the rents or additional interest if the investment property does well, the lender has an obligation to ensure that the property is properly maintained as an owner of the property. If the property is not properly maintains, the lender becomes liable for any harm to others as a result.
There are several things lenders can do to limit or eliminate potential liability under these circumstances. A lender should state within the applicable loan agreement clearly and unequivocally that any inspections it performs or has performed on its behalf are for its benefit alone, and that the borrower, or anyone else, is not entitled to rely upon those inspections. Fortunately, in some jurisdictions this is presumed unless stated to the contrary in the loan agreement. This may be clarified by stating in the agreement that the inspection is only being done to determine the value of the property and not to determine if the property is up to code or otherwise properly maintained.
In addition, lenders should be cautious to ensure that any inspections are conducted only for their own benefit. One way to do so is to use clear language in the mortgage agreement. Another equally crucial role is who performs the property inspections. While a lender certainly wants to make sure the property is worth what they are led to believe, if an expert is used to perform the inspections who also has expertise in other areas, such as engineering, fire codes or building codes, borrowers may claim that they relied on that expert to insure the property was up to snuff in the inspector's specific area of expertise.
It is also important that the person conducting the inspection documents any actions he or she takes in order to make it clear that he or she is inspecting strictly to determine the value of the property. This is especially important in projects where multiple inspections occur or the inspections occur over time as progress in made on the project. Finally, inspectors must know what it is they are required to do and limit themselves only to that task. Any action beyond that task could be used in an effort to show that the inspector played a role beyond a mere valuator. Inspectors should not advise the borrower as to potential issues at the property and should make it clear that the borrower should be doing its own inspections for other issues beyond the value of the property.
For projects already completed, to the extent the steps listed above have been followed, any documentation regarding the project must be preserved in the unlikely event that calamity strikes years or perhaps even decades after the inspections occur. Documentation and preservation is key to ensuring that what was done can be proven in the event that the actual inspectors or others involved cannot be found years later.
Lenders need to be careful when they send out someone to inspect a property for the purposes of ensuring value and use as collateral. The steps detailed above should be followed to prevent this collateral from becoming a liability to the lender. The last thing any lender wants when they finance a property and use that property as collateral to secure the financing is for that collateral to become a significant liability should calamity strike.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
