Over the last two or three years, I have encountered scenarios where the traditional rule – that a relationship between a lender and borrower is an arm’s length transaction – is called into question and creates potential lender liability.
- 1) As real estate development in Florida has grown, developers have increasingly obtained construction loans tied to the value of the property being developed, called “loan-to-value” loans. In these types of loan transactions, the bank lends the developer money up to a certain percentage of the value of property being developed, based upon a formula that is set forth in the loan agreement. As development continues, the value of the property increases by virtue of the improvements to the land and the builder is able to borrow more money based upon the increased value. However, the borrower must also maintain certain debt-to-value ratios or risk triggering a default under the loan agreement. The bank has significant control over the success of the project because its valuations of the project determine how much money the developer can draw at any given time and determines whether the borrower is maintaining a proper loan-to-value ratio. Because lenders have such significant control, it is important that they fairly and accurately value the property. When banks improperly value the property or take actions that negatively impact the value of the property, they can sabotage – even unintentionally – the entire development project and expose themselves to potential lender liability.