Loan Participation Bank Owed No Duties to the Borrower

Loan Participation Bank Owed No Duties to the Borrower

      A recent decision from Judge Hale of the Western District of Kentucky makes clear that a bank participating in a loan participation did not owe any duties to the borrower.  On that basis allegations of lender liability were dismissed.  Hurd Family Partnership, L.P. v. Farmers Bank, Civ. Act. No. 3:13-CV-485-DJH, 2016 WL 1030146 (W.D. Ky. March 10, 2016).

      The Hurd Family Partnership, L.P. was a minority shareholder in Freedom Holdings, Inc., which in turn owed Florida Gaming Corporation, it indirectly owning Jai-Alai gambling operations in Florida.  In order to close on options in Florida Gaming, Collett, the 84% owner of Freedom Holdings, sought to borrow $1.3 million from King Southern Bank.  While the opinion is not clear on this point, it implies that while Freedom was the maker on the note the funds were used to buy FGC stock in Collett’s name, i.e., corporate assets were used to fund a shareholder asset.

      Being concerned as to possible conflicts (Jim King, the owner of King Southern Bank, also owed the CPA firm that did work for Freedom), King solicited Farmers to participate in the loan.  Eventually Farmers would provide $650,000 while its affiliate Leitchfield Deposit Bank would provide the balance of $650,000.  Still, even as Farmers/Leitchfield provided all of the funding:

King Southern directly interacted with the Colletts and negotiated the terms of a loan.  In contrast, Farmers Bank “never negotiated this loan with [Collett] or Freedom Holding.  All negotiations were done with King Southern.”

Ultimately:

In other words, King Southern “dealt with the customer, closed the loan, and distributed the proceeds to the customer,” while Farmers funded the loan.

      The loan closed in 2008 with a maturity date of March, 2009, a date that King Southern would extend to March 2010.  At that time the loan was refinanced with Farmers as the lender; King Southern was out of the mix.  That loan was in turn refinanced in June 2012, Collett providing a guaranty. The loan ultimately went into default and the collateral was worthless.

     At that juncture the Hurd Partnership filed suit against Farmers “claiming that Farmers had a duty to determine that the loans were properly used for Freedom Holding’s corporate purposes.”  2016 WL 1030146, *2.  It was also alleged that Freedom’s board had not properly approved the loan and that it was ultra vires.

    The court would hold that these assertions, even if true, would not create a cause of action against Farmers as there was no duty to violate.  Rather, “it cannot be said that Farmers owed the Partnership any duty.” Id. at *3.

      Focusing on the nature of a participation agreement, it was observed that:

A participation agreement occurs when “two or more banks join a loan with each bank lending a portion of the amount to the borrower.”  Participation agreements assign “an interest in an intangible right,” constitute a “contract that prescribes duties of servicing the loan,” and can create agency relationships.  When the lending bank and participating banks sign a participation agreement, the lending bank often executes and delivers a simple document, called the “certificate of participation,” to the participating bank.  Importantly, a true participation agreement does not create a debtor-creditor relationship between the lending and participating banks; the lending bank does not promise to pay off a debt, it simply promises to remit the participating bank’s share of the borrower’s repayments.  Put another way, participation agreements are not themselves loans. They are contractual arrangements where a third party provides funds to a lender so the lender can execute a loan with a borrower. Id. (citations omitted).

      From there, it was determined that Farmers owed no fiduciary duty to either the Hurd Partnership or Freedom, and on the basis the case failed. 

Perhaps the Partnership has some legitimate complaint about how the Freedom Holding loan was handled.  But Farmers is not the proper target for the partnership’s ire.  There was no contractual relationship between the Partnership and Farmers, and so Farmers owed the Partnership no special duty.  Summary judgment is appropriate.  Id. at *5.