Equitable Subordination - Chapter 28 - Lender Liability

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§ 28.01 Overview

Equitable subordination is a doctrine that allows bankruptcy courts
to subordinate the claims of one creditor when that creditor engages in
inequitable conduct that either gives the creditor an unfair advantage or
injures other creditors. That inequitable conduct can be a lender's
exercise of improper control over the borrower, a breach of fiduciary
duty, or fraud.

Only the bankruptcy trustee or current creditors of the debtor can
invoke the doctrine. Nevertheless, the doctrine serves as a powerful
incentive to lenders to treat both the borrower and other creditors fairly.
This is especially true in cases where there are insufficient assets or
when the misconduct is especially glaring. In either instance, the lender
may not be allowed to recover at all on its debt.

§ 28.02 General Principles

The doctrine of equitable subordination is based on estoppel, and has
been recognized by bankruptcy courts for years;1 it was codified in the
Bankruptcy Code in 1978.2 The bankruptcy court sitting as a court of
equity is empowered to invalidate a lender's security interest, require the
lender to return collateral to the debtor, and classify the lender's claims
as subordinated ones, which are paid after the claims of other creditors.

There are three requirements that must be met before equitable
subordination will be ordered:

Part I WHERE PROBLEMS ARISE

Chapter 1:   INTRODUCTION
§ 1.01   Overview
§ 1.02   Suggestions for Lenders
§ 1.03   Suggestions for Borrowers
Chapter 2:   LOAN APPLICATIONS
§ 2.01   Overview
§ 2.01A Predatory Lending
§ 2.02   Processing of Loan Applications
§ 2.03   Failure to Obtain Insurance
§ 2.04   False Statements on Loan Applications
Chapter 3:   LOAN COMMITMENTS
§ 3.01   Overview
§ 3.02   Binding Loan Commitments
§ 3.03   Written Commitments
§ 3.04   Oral Commitments
§ 3.05   Addition of Conditions After Acceptance
§ 3.06   Enforcement of Commitment by Lender
§ 3.07   Commitment Fees
Chapter 4:   CONTENTS OF LOAN DOCUMENTS
§ 4.01   Overview
§ 4.02   Acceleration Clauses
§ 4.03   Jury Trial Waivers
§ 4.04   Arbitration Clauses
§ 4.05   Dragnet Clauses
§ 4.06   Prepayment Penalty Provisions
Chapter 5:   GUARANTEES
§ 5.01   Overview
§ 5.02   Enforceability of Guarantees
§ 5.03   Duties Owed to Guarantors
§ 5.04   The Duty to Disclose and the Duty of Good Faith
§ 5.05   Guarantors' Rights
§ 5.06   Right of Subrogation and Anti-Deficiency Rights
§ 5.07   "True" Guarantors
§ 5.08   Exoneration of Guarantors
Chapter 6:   ADMINISTRATION OF LOANS
§ 6.01   Overview
§ 6.02   Refusal to Disburse Funds
§ 6.03   Line of Credit
§ 6.04   Construction Loans
§ 6.05   Crop Loans
§ 6.06   Termination of Funding
§ 6.07   Revoking Line of Credit
§ 6.08   Calculation of Rates and Charges
§ 6.09   Interest Rates
§ 6.10   Other Charges
§ 6.11   Loan Participations
§ 6.12   Letters of Credit
§ 6.13   Finance Leases
Chapter 7:   CONFLICTS OF INTEREST
§ 7.01   Overview
§ 7.02   Duty of Confidentiality
§ 7.03   Duty to Disclose
§ 7.04   Use of Confidential Information for Lender's Benefit
§ 7.05   Responding to Requests for Credit References
§ 7.06   Conflicting Duties
Chapter 8:   DEFAULT AND ACCELERATION
§ 8.01   Overview
§ 8.02   Notice of Default
§ 8.03   Improper Declaration of Default
§ 8.04 "Technical" Default Versus "Material" Breach
§ 8.05   Inadequate Notice
§ 8.06   Demand Notes
§ 8.07   Cases Upholding Right to Immediate Payment upon Demand
§ 8.08   Cases Requiring Good Faith and Reasonable Notice
§ 8.09   Improper Acceleration
§ 8.10   Deviating from Established Course of Dealing and Waiver
Chapter 9:   LOAN WORKOUTS AND SETTLEMENT NEGOTIATIONS
§ 9.01   Overview
§ 9.02   Good Faith Negotiations
§ 9.03   Standstill and Forbearance Agreements
§ 9.04   Releases of Liability and Waivers
§ 9.05   Breach of Workout or Settlement Agreement
Chapter 10:   FORECLOSURE AND REPOSSESSION
§ 10.01   Overview
§ 10.02   Foreclosure of Real Property
§ 10.03   Notice and Sale
§ 10.04   Environmental Concerns
§ 10.05   Right to Recover Deficiency
§ 10.06   Wrongful Foreclosure
§ 10.06A Miscellaneous Concerns
§ 10.07   Repossession of Personal Property
§ 10.08   Notice of Sale and Disposition of Property
§ 10.09   Commercially Unreasonable Sales
§ 10.10   Wrongful Repossession
§ 10.11   Mixed Collateral
§ 10.12   Right of Offset
Chapter 10A: ENFORCEMENT ISSUES AND FOREIGN LENDERS
§ 10A.01 Overview
§ 10A.02 The Foreign Sovereign Immunities Act

Part II   COMMON LAW THEORIES OF LIABILITY

Chapter 11:   INTRODUCTION
Chapter 12:   BREACH OF CONTRACT
§ 12.01   Overview
§ 12.02   Breach of Contract— General Principles
§ 12.03   Written Contracts and Statutes of Frauds
§ 12.04   Oral Contracts and Parol Evidence Rule
§ 12.05   Loan Commitments
§ 12.06   Damages for Breach of Contract
§ 12.07   Promissory Estoppel
§ 12.08   Specific Performance
Chapter 13:   BREACH OF COVENANT OF GOOD FAITH AND FAIR DEALING
§ 13.01   Overview
§ 13.02   General Principles
§ 13.03   Bad Faith Breach
§ 13.04   Recovery in Contract
§ 13.05   Recovery in Tort
§ 13.06   Duty of Good Faith
§ 13.07   Cases in Which Duty Recognized
§ 13.08   Cases in Which No Duty Found
Chapter 14:   BREACH OF FIDUCIARY DUTY
§ 14.01   Overview
§ 14.02   General Principles
§ 14.03   Public Policies at Stake
§ 14.04   When Fiduciary Relationship Will Arise
§ 14.05   Lender's Role as Financial Advisor
§ 14.06   Lender's Role as Borrower's Agent
§ 14.07   Lender's Control Over Borrower
§ 14.07A Lender's Role as Seller
§ 14.08   Other Situations
§ 14.09   Nullification of Fiduciary Relationship
§ 14.10   Fiduciary Duties
§ 14.11   Breach of Fiduciary Duties
§ 14.12   Self-Dealing and Overreaching
§ 14.13   Using One Borrower to Cover Another Borrower's Debt
§ 14.14   Tricking the Borrower
§ 14.15   Exploiting Confidential Information
§ 14.16   Failure to Disclose/Constructive Fraud
§ 14.17   Other Breaches
§ 14.18   Termination of Fiduciary Relationship
Chapter 15:   FRAUD
§ 15.01   Overview
§ 15.02   Types of Fraud
§ 15.03   Intentional Misrepresentation
§ 15.04   Statement of Fact
§ 15.05   Justifiable Reliance
§ 15.06   Examples
§ 15.07   Negligent Misrepresentation
§ 15.08   Nondisclosure and Concealment
§ 15.09   False Promises
§ 15.10   Common Fraudulent Practices
§ 15.11   Promises to Induce Benefits
§ 15.12   False or Groundless Threats
§ 15.13   Misrepresenting the Effect of Documents
§ 15.14   Improper Advice
§ 15.15   Other Practices
§ 15.16   Remedies for Fraud
§ 15.17   Recovery of Damages
§ 15.18   Rescission
§ 15.19   Fraudulent Conveyances
§ 15.20   Bankruptcy Fraud
Chapter 16:   IMPROPER CONTROL
§ 16.01   Overview
§ 16.02   General Principles
§ 16.03   Acts Constituting Improper Control
§ 16.04   Interference with Right to Govern
§ 16.05   Running Day-to-Day Operations
§ 16.06   Takeover of Troubled Borrower
§ 16.07   Joint Business with Borrower
§ 16.08   Checklist of Control Factors
§ 16.09   Ramifications of Improper Control
§ 16.10   Special Bankruptcy Concerns
§ 16.11   Special Environmental Concerns
§ 16.11A Special Labor Concerns
§ 16.12   Control Theories
§ 16.13   Fiduciary Relationship
§ 16.14   Alter Ego and Instrumentality
§ 16.15   Agency
§ 16.16   Joint Venture and Partnership
§ 16.17   Other Theories
§ 16.18   Common Defenses
Chapter 17:   INTERFERENCE
§ 17.01   Overview
§ 17.02   General Principles
§ 17.03   Interference with Contract
§ 17.04   Interference with Prospective Economic Advantage
§ 17.05   Interference with Right of Corporate Governance
§ 17.06   Common Defenses
Chapter 18:   NEGLIGENCE
§ 18.01   Overview
§ 18.02   General Principles
§ 18.03   Common Negligent Practices
§ 18.04   Processing of Loan Applications
§ 18.05   Appraisals
§ 18.06   Failure to Obtain Insurance
§ 18.07   Administration of Loans
§ 18.08   Disbursement of Funds
§ 18.09   Supervision of Construction Loans
§ 18.10   Responding to Credit Inquiries
§ 18.11   Gross Negligence
Chapter 19:   DURESS
§ 19.01   Overview
§ 19.02   General Principles
§ 19.03   Duress as Affirmative Tort
§ 19.04   Duress as Defense to Contract or Basis for Rescission
Chapter 20:   CONVERSION
§ 20.01   Overview
§ 20.02   General Principles
§ 20.03   Common Applications of Theory
§ 20.04   Wrongful Repossession
§ 20.05   Wrongful Offset
§ 20.06   Refusal to Return Deposit
§ 20.07   Other Applications
Chapter 21:   MISCELLANEOUS THEORIES
§ 21.01   Overview
§ 21.02   Defamation and Related Torts
§ 21.03   Actionable Conduct
§ 21.04   Defenses to Claim
§ 21.05   Infliction of Emotional Distress
§ 21.06   Actionable Conduct
§ 21.07   Defenses to Claim
§ 21.08   Prima Facie Tort
§ 21.09   Unjust Enrichment
§ 21.10   Equitable Estoppel
§ 21.11   Intrusion
Chapter 22:   VICARIOUS AND JOINT LIABILITY
§ 22.01   Overview
§ 22.02   Conspiracy
§ 22.03   Aiding and Abetting
§ 22.04   Inducing and Participating in Breach of Fiduciary Duty
§ 22.05   Colluding with Disloyal Fiduciary
§ 22.06   Other Theories

PART III   STATUTORY THEORIES OF LIABILITY

Chapter 23:   INTRODUCTION
Chapter 24:   FEDERAL LAWS
§ 24.01   Overview
§ 24.02   RICO
§ 24.03   General Principles
§ 24.04   Use of RICO by Borrowers Against Lenders
§ 24.05   Securities Laws
§ 24.06   CERCLA and Other Environmental Laws
§ 24.07   Anti-Tying Provisions of Bank Holding Act
§ 24.08   Tax Laws
§ 24.09   Equal Credit Opportunity and Anti-Discrimination Laws
§ 24.10   Truth-in-Lending Laws
§ 24.10A Usury and the National Bank Act
§ 24.11   Labor and Miscellaneous Other Laws
§24.12   RESPA
Chapter 25:   STATE LAWS
§ 25.01   Overview
§ 25.02   Consumer Protection Laws
§ 25.03   Prohibitions Against Usury
§ 25.04   Environmental Laws
§ 25.05   Miscellaneous

PART IV BANKRUPTCY CONCERNS

Chapter 26:   INTRODUCTION
Chapter 27:   PRE-FILING CONSIDERATIONS FOR THE BORROWER
§ 27.01   Overview
§ 27.02   Benefits to Borrower
§ 27.03   Risks to Borrower
§ 27.04   Other Concerns
Chapter 28:   EQUITABLE SUBORDINATION
§ 28.01   Overview
§ 28.02   General Principles
§ 28.03   Fraud and Inequitable Conduct by Lender
§ 28.04   Lender Control
Chapter 29:   PREFERENCES
§ 29.01   Overview
§ 29.02   General Principles
§ 29.03   "Insider" Liability
§ 29.04   Exceptions to Avoidance Power
§ 29.05   Application to Lenders
Chapter 30:   FRAUDULENT TRANSFERS
§ 30.01   Overview
§ 30.02   General Principles
§ 30.02   Application to Lenders
Chapter 30A:   MISCELLANEOUS ISSUES
§ 30A.01 Overview
§ 30A.02 Judicial Abuse

PART V   LAWSUITS AGAINST FAILING OR FAILED FINANCIAL INSTITUTIONS

Chapter 31:   INTRODUCTION
Chapter 32:   AVAILABILITY OF LENDER LIABILITY CLAIMS AND DEFENSES IN LITIGATION WITH THE FEDERAL GOVERNMENT
§ 32.01   Overview
§ 32.02   Impediments to Lender Liability Claims and Defenses
§ 32.03   D'Oench, Duhme Doctrine
§ 32.04   12 U.S.C. § 1823(e)
§ 32.05   Combined Effects of D'Oench, Duhme and § 1823(e)
§ 32.06   Federal Holder-in-Due-Course Doctrine
§ 32.07   Failure to Exhaust Administrative Claims Process and Other Issues
§ 32.08   Borrower's Strategies to Avoid Impediments

APPENDICES
Appendix A   Fact Pattern for Sample Complaint
Appendix B   Sample Complaint
Appendix C   Sample Request for Production of Documents
Appendix D   Sample Interrogatories
Appendix E   Sample Jury Instructions
Appendix F   Truth in Lending Act
Appendix G   Equal Credit Opportunity Act
Appendix H   Fair Debt Collection Practices Act

Table of Cases General
Table of Cases (Federal Jurisdiction)
Table of Cases (State Jurisdiction)
Table of Statues, Rules, and Regulations
Table of Authorities
Index

About the Author:
A. Barry Cappello, Managing Partner, of the Santa Barbara law firm of Cappello & Noël, LLP. Mr. Cappello, who founded the firm in 1977, is recognized as one of the nation's leading trial lawyers and authorities on complex commercial litigation specializing in lender liability. He has represented both large and small businesses against most of the nation’s major banks in litigation nationwide. His practice also involves class actions against lenders and other large corporations, bad faith insurance litigation and other complex business and tort litigation matters.

A fierce advocate for his clients, Mr. Cappello has been described by California Lawyer magazine as “Santa Barbara’s Resident Barracuda,” a reputation Cappello does not dispute. He has successfully tried jury trials with total verdicts in excess of $300 million and negotiated more than $1 billion in settlements and workouts for his clients.

Mr. Cappello has contributed numerous articles on complex business litigation, lender liability andadvanced trial techniques to business, legal, accounting and trade publications. Publications include Trial, The Daily Journal, The National Law Journal, Small Business Advisor and The Commercial Real Estate Journal. Mr. Cappello speaks to legal and business audiences around the country.

Before entering private practice, Mr. Cappello served a seven-year tenure as City Attorney of Santa Barbara. He was the chief litigator against the oil companies that caused the massive 1969 Santa Barbara Channel oil spill. The disaster and the ensuing litigation awakened the nation's conscious to the dangers to our environment and the tragic consequences if not protected. The case was settled in 1974 shortly before trial for $9.45 million, considered a huge sum at the time.

Prior to being appointed City Attorney of Santa Barbara, he was Assistant District Attorney and Chief Trial Deputy in the Santa Barbara County District Attorney's Office. Mr. Cappello also served as a Deputy Attorney General for the State of California assigned to the Special Trials and Investigations Division. Mr. Cappello prosecuted numerous murder, business crime and major felony cases.

Mr. Cappello has been listed in Best Lawyers in America since 1992 and in Who's Who in America. He was named a “Super Lawyer” in 2007 - 2009, and he was selected as one of the Top 100 Trial Attorneys in California for 2007 by the American Trial Lawyers Association.

Equitable Subordination - Chapter 28 - Lender Liability - 4th Edition