On September 18, 2020, the Illinois Appellate Court, First Division, decided Metropolitan Capital Bank and Trust v. Feiner, 2020 IL. App (1st) 190895. It was a case in which the lender was suing the defendant for common law fraud and conspiracy to commit fraud. That the defendant committed fraud in the loan underwriting process wasn’t at issue. What was at issue was whether the lender was justified in relying solely upon the defendant’s fraudulent statements or had a duty to dig deeper. And that is where the Illinois Uniform Commercial Code became relevant.
Failure to review UCC filings leads to loss for lender
The case facts
In 2014, various entities controlled by the defendant borrowed $4.5M from the lender. Later, there were four defaults on the loan and, finally, a fifth default. It was during the negotiations over the fifth default that the misrepresentations occurred.
The lender was willing to modify the loan terms for the fifth time if the defendant were to became a party to the loan documents and provide additional unencumbered collateral to support the credit facility. In response, the defendant pledged his interest in two Delaware limited liability companies. The cash flow generated by the LLCs was supposed to service the debt. The lender set up a separate account into which distributions from the LLCs were to flow.
But no funds flowed into the account. It was at this point that the lender discovered that the collateral the defendant offered and the lender accepted had previously been pledged to another entity. Lacking access to that collateral and having been deceived by the defendant, the lender sued the defendant for fraud.
In critiquing whether the lender acted reasonably the court reviewed the circumstances surrounding the fifth renewal of the credit facility. As to the applicable rule of law, the court stated that when considering whether a party justifiably relied on the veracity of a party’s statements, all of the circumstances surrounding the transaction, including the parties’ relative knowledge of the facts, as well as any opportunity it had to investigate the facts has to be considered. An evaluation of a party’s justifiable reliance included not only those facts actually known, but also those facts that could have been learned through the exercise of ordinary prudence.
When the fifth modification of the loan was being considered, the lender obtained a personal financial statement from the defendant. The financial statement disclosed three debts owed to an entity named SLG Limited Partnership but not the defendant’s pledge to SLG of the same collateral he was offering the lender. As part of the process of underwriting the fifth modification, and to verify the information disclosed in the financial statement, the lender ordered a tax, lien, and judgment search.
At trial, a senior vice president of the lender testified it was not the lender’s practice to review each UCC filing. The review was limited to just those filings that the borrower or the borrower’s counsel said were against an asset of the borrower.
How did the court rule?
The appellate court sustained the trial court’s determination that the lender could not establish that it justifiably relied on the defendant’s false assertions that the offered collateral was unencumbered because public documentation was available that refuted those assertions. It said, “…[the lender] should not have simply relied on [the defendant’s] representations regarding the status of the pledged collateral”. So despite the obvious fraud, judgment was for the defendant.
What’s the point?
UCC searches contain valuable information for lenders. Used correctly, they can assist lenders in avoiding costly errors. Ignoring what an adequate review of the filings disclosed by a UCC search could reveal is a recipe for unfortunate consequences.
Need help with public records searches?
Lien Solutions has the expertise to perform the proper due diligence with your public record search to ensure your assets are secured. Give one of our experts a call at 1-800-833-5778, option 3 to get started today.
This piece is authored by Michael Weissman, Of Counsel at Levin Ginsburg
Michael L. Weissman is an attorney in Chicago who has served as Executive Vice President and General Counsel of a banking group, as an adjunct professor at a law school, as a FINRA arbitrator, as an educational trainer in the United States and overseas, as chairman of a leading legal educational organization in Illinois, and as an expert witness in commercial lending cases. Weissman is a winner of the 2018 Addis Hull Award of the Illinois Institute for Continuing Legal Education for speaking, writing, and governance. He serves as a consultant to Wolters Kluwer Lien Solutions and The Risk Management Association.