A loan agreement or mortgage is just like any other contract. If there is a breach, the lender can be sued, just as the buyer can be sued if there is a default. The law requires the lender to act fairly and in good faith towards the borrower, which becomes a point of contention when the purpose for which the monies were to be used goes south. Lenders can jump too early in enforcing rights under the loan agreement, including improperly or prematurely declaring default and seizing property. If a borrower such as a builder is damaged because he cannot continue or finish the project, then the lender can be sued and held liable for money damages and the cost of obtaining another loan to finish the job.
Lenders and borrowers owe nothing to each other when negotiating and entering into a loan agreement, since they are presumed to be acting at arms length in a business transaction. However, if a lender becomes too closely involved in the borrower’s business, a fiduciary relationship can arise which leads to lender liability. If a lender gets too involved in timetables for the use of loan proceeds, and allows a departure from the exact terms of the loan agreement, it can be held liable when things go awry.
A recent example is when lenders sold interest rate hedges known as “swaps” to a commercial borrower, as part of a large adjustable rate loan using the borrower’s collateral. The swaps were not part of the loan. Rather, the lender would approach the borrower after the loan was made, and convince him to buy a swap which the lender said would protect the borrower if interest rates rose. The problem was that the lender did not disclose that it would be disastrous if interest rates fell and land/building values declined. Of course, that is exactly what occurred all over the country. When the borrower could not pay the higher monthly installment and defaulted, the lender tried to foreclose and seize the property. The borrower defended on the ground that the lender had a fiduciary duty to the borrower, and was guilty of deception in selling the swaps, knowing what would occur in the event of a reversal of rates and value. The borrower also counter-sued the lender for money damages and to keep the property, and won.