by: Peter J. Gallagher (@pjsgallagher)
It seems like I read cases like this every few weeks: A borrower defaults on a loan, tries to work something out with the bank, but the bank for some reason decides not to work out a deal and instead decides to enforce the terms of the underlying loan documents (usually through foreclosure or some other means). The borrower then sues, alleging that the lender acted in bad faith by thinking about working out a deal, and maybe even taking some steps to do so, but eventually deciding not to. Although I have obviously summarized these cases in broad terms and the devil is often in the details, the result is almost always the same – the borrower loses.
The reason for this is simple. The law in New Jersey is well settled that a lender will not generally be deemed to have acted in bad faith when it seeks to enforce the terms of a note or mortgage as written. Stated differently, lenders cannot be barred from enforcing loan and mortgage documents merely because they seek to enforce their express contractual rights. Indeed, “a creditor's duty to act in good faith does not extend to foregoing its right to accelerate upon default or otherwise compromising its contractual rights in order to aid its debtor.” Glenfed Financial Corp. v. Penick Corp. For instance, in Creeger Brick & Building Supply, Inc. v. Mid-State Bank & Trust Co., — a decision cited by the Appellate Division with approval in Glenfed — a Pennsylvania appeals court held:
. . . a lending institution does not violate a separate duty of good faith by adhering to its agreement with the borrower or by enforcing its legal and contractual rights as a creditor. The duty of good faith imposed upon contracting parties does not compel a lender to surrender rights which it has been given by statute or by the terms of its contract. Similarly, it cannot be said that a lender has violated a duty of good faith merely because it has negotiated terms of a loan which are favorable to itself. As such, a lender generally is not liable for harm caused to a borrower by refusing to advance additional funds, release collateral, or assist in obtaining additional loans from third persons. A lending institution also is not required to delay attempts to recover from a guarantor after the principal debtor has defaulted.
Try as borrowers might, New Jersey courts have repeatedly and consistently rejected efforts to hold lenders liable for violating the duty of good faith and fair dealing when those lenders have simply attempted to enforce the terms of their loan agreements.
The latest example of this can be found in the Appellate Division's decision in The Provident Bank v. Interstate Transport, Inc. In that case, plaintiff obtained from defendant a term loan and a loan from its credit line, both of which were secured by a first lien on plaintiff's property. Plaintiff later defaulted on both. After default, it attempted to get a loan from a different lender that would have allowed plaintiff to cure the default. (Plaintiff was essentially going to refinance its debt.) To assist plaintiff in this process, defendant agreed, several times, to extend the maturity date on the two loans.Plaintiff eventually obtained a term sheet from a new lender. Because the new lender required that any new loan be secured by a first lien on plaintiff's personal property, plaintiff sent the term sheet to defendant and defendant indicated that plaintiff could sign it. Some time later, defendant asked plaintiff about the status of the new financing. Plaintiff responded by producing a "commitment letter," but this letter was, the court concluded, little more than a restatement of the term sheet, and not a commitment to provide financing. Thereafter, defendant decided not to extend the maturity dates of the loans any more and moved to collect the debt from plaintiff.
Plaintiff raised as a defense that defendant had breached the duty of good faith and fair dealing by "encouraging" plaintiff to find a new lender and then "abruptly" pulling the plug on this process. The court rejected this argument because of the well-settled law discussed above.
As I mentioned above, this is the same conclusion that countless other New Jersey courts have reached in countless other cases, but that does not stop borrowers from raising this defense, therefore lenders should be aware of it.
[Incidentally, for an example of a rare case where a New Jersey court found that a borrower had at least pled a breach of good faith and fair dealing sufficiently enough to defeat a motion to strike, click here.]