Consider the following questions: Does a debt or equity investor typically owe a fiduciary duty to other shareholders or to the entity itself? Is a debt investor liable for anything beyond breach of contract and running afoul of a smattering of commercial lending laws? If you answered no, you would be correct—in most cases. Despite your good intuition, recent developments in the law raise the possibility of additional liability for commercial lenders.
Furthermore, consider that the profile of a commercial lender has changed. In days past, this was likely a traditional bank. However, as borrowers look for more options in accessing capital, private credit funds have become a viable alternative to banks. In an industry that has undergone substantial transformation, navigating the intricacies of lender liability in different jurisdictions is crucial.
In Delaware, a loan is typically seen as an arm’s length transaction with no fiduciary duties attached. Likewise, shareholders generally do not owe such duty to each other or to the entity in which they have invested. Yet in Skye Mineral Investors, LLC v. DXS Capital (U.S.) Limited, 2020 WL 881544 (Del.Ch., 2020), the court notes that even a minority shareholder, with only a 27 percent stake in the business, can be a fiduciary if it possesses sufficient control. In this case the minority shareholder was able to block new security interests, issuances of shares, mergers, and other substantial transactions. Ultimately, the lesson arising from the case is that that when blocking rights allow even a minority investor to channel the corporation into a particular decision, these blocking rights may contribute to an inference of control. Other Delaware cases suggest that lenders need to avoid “stacking” no more controls than necessary and be mindful of how much control they exercise.
Turning to New York, we find that courts may be hesitant to upset the traditional no-fiduciary rule for lenders. For instance, in Roswell Capital Partners LLC v. Alternative Const. Technologies, 638 F.Supp.2d 360 (S.D.N.Y., 2009), the U.S. District Court for the Southern District of New York applied New York law to allude to the possibility of an implied fiduciary duty for lenders. The key question here is whether a relationship between a lender and borrower is special enough to warrant implied fiduciary duties. To answer this question, courts in New York, like those in Delaware, embark on a fact-intensive analysis, focusing on the nature and use of control mechanisms. And while no court applying New York law has found sufficient indices of control, the Roswell Capital court suggests such a finding is certainly possible.
Like in New York, Texas courts have held that there is generally no fiduciary duty between lenders and borrowers. But that may not always be the case. In Salek v. SunTrust Mortgage, Inc., 2018 WL 3756887 (S.D. Tex. 2018), we get a useful discussion of the rules of the road in Texas with respect to lenders and their possible fiduciary duties. Although in that case the court rejected the plaintiff’s fiduciary duties claims, it reasoned that when there exists a special relationship between a borrower and lender, it comes down to extraneous facts and conduct “such as excessive lender control over, or influence in, the borrower's business activities.” Once again, the forms and exercise of control make all the difference.
Navigating lender liability is fact-intensive and the jurisdiction matters immensely. In our upcoming article, When an Arm’s Length Isn’t Long Enough: Implied Fiduciary Duty & Lender Liability, to be published in the ABA Commercial & Business Litigation Committee’s newsletter, we will more closely explore and examine the emerging contours of lender liability in Delaware, New York, and Texas, and note actionable takeaways so lenders can sidestep such additional liability.
