Chapter 22
Liability, Agency Problems,
Fraud, And Ethics in Real
Estate Finance
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Chapter 22 Learning Objectives
 Understand how parties to real estate finance
transactions can be held liable for their actions
 Understand the structure of agency relationships
within real estate finance
 Understand that there are agency costs associated
with preventing parties from acting solely in their own
interest and against the interests of others
 Understand how insufficient agency costs allow wealth
transfers
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Lenders’ Legal Liability
 Lenders may be subject to liability in two areas:
 Violation of state or federal laws regulating certain activities
 Violation of contractual obligations involving loan
arrangements
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Federal Laws Regulating Hazardous Waste
 Comprehensive Environmental Response, Compensation,
and Liability Act of 1980 (CERCLA)
 Liability under CERCLA – strict, retroactive, and joint and several
 Strict liability – a charged party may not offer as a defense a claim
that its actions were not in violation of any law prior to CERCLA
 Joint and several liability – each potentially liable party can be
made to bear the entire cost of cleanup even if several parties
may have been responsible for the contamination
 Superfund Amendments and Reauthorization Act of 1986
(SARA)
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Hazardous Waste
 Potentially responsible parties (PRPs) for contaminated
properties:
 Current owners / operators of a facility
 Owners / operators at the time of discharge
 Generators of the hazardous substance or parties arranging for disposal
 Transporters of the hazardous waste
 Secured-Lender exemption – a PRP owner or operator does not
include a lender that holds a mortgage or deed-of-trust on a
property as security for a note
 Lenders may lose this exemption if they foreclose on the contaminated
property
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Lender Defenses
 Lender claims to not be a PRP
 Contamination resulted solely from an act of God, act
of war, or omission by a third party
 Claims to be an innocent landowner with no
knowledge of contamination
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Initial Judicial Decision
 United States v. Mirable (1985) – involved three lenders
with secured interest in a property
 United States v. Maryland Bank and Trust Company (1986)
– involved a secured lender that foreclosed on a property
and took title through a sheriff’s sale
 Guidice v. BFG Electroplating Co (1989) – court recognition
of option values related to the CERCLA legislation
 Fleet Factors Corporation (1990) – lenders liability
extended further
 Bergsoe Metal Corporation (1990) – addressed the issue of
lender control of business activities
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April 1992 EPA Regulation
 Rules allowing lenders to foreclose and not be liable:
 Actions prior to security interest
 Periodic monitoring and/or inspection
 Involvement from inspection results
 Requiring borrower compliance
 Restructuring the loan arrangement
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April 1992 EPA Regulation
 Rules allowing lenders to foreclose and not be liable:
 Requiring additional rent or interest
 Exercising any rights the lender may have under the law or
any warranties, covenants, conditions, or promises
 Providing financial or administrative advice
 In 1994 an appeals court invalidated the 1992 EPA
regulation
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Congress Acts
 Asset Conservation, Lender Liability and Deposit Insurance
Protection Act of 1996 – part of the spending bill for 1997;
provision that codified the 1992 EPA rule
 Under the act “participating in the management” term
included participating in the operations and ability to
engage in several other activities and retain the secured
lender exemption
 Allows a lender to foreclose on a property, sell, wind up
operations and undertake a response action under CERCLA
without losing its exemption
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Other Lender Regulations
 Comprehensive Drug Abuse Prevention and Control
Act of 1970 allows confiscation of property used in
illegal drug activity
 The danger for the lender is the greatest when it forecloses
on a property that has been used to support illegal drug
transaction
 The lender must use due diligence defense
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Other Lender Regulations
 Uniform Commercial Code (UCC) which specifies rights
and obligations of contracting parties
 Two primary areas of lender behavior that can give
rise to liability
 Nonperformance of oral commitments
 Failure to extend credit beyond a certain date
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Liability from Lender/Borrower
Relationship
 Oral commitments for Extension of Credit
 The following contracts must be in writing in order to be
enforced:
Agreements that cannot be performed with 1 year
Promises to answer for the debts of another (surety contracts)
Promises made in consideration of marriage
Agreements relating to real property
Contracts exceeding $500 for sale of goods
Contracts by executors
 Termination of demand notes without notification
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Other Theories of Lender Liability
 Prima facie tort
 Promissory fraud
 Nondisclosure fraud and breach of fiduciary duty
 Breach of contract
 Duress and lender control
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Liability to Third Parties: Bankruptcy
and Agency Costs
 Agency law - another area of the law where the lender
may become liable to third parties
 If lender undertakes sufficient control for the operations of the
creditor’s business (assumes the role of principal)
 Bankruptcy law and the cramdown process
 Cramdown – the ability, under the law, to force restructuring of
the debt owned by the developer
 Ethics, fraud and agency costs
 Agency relationships have legal and ethical implications
 Agency costs – costs incurred to make sure that the agent acts
only in the principal’s interests
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