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In a booming economy, with money flowing freely and banks clamoring for your business, you wouldn't think that the lender-borrower relationship could turn ugly. Yet that's exactly what happened to Roger Jacobs (an entrepreneur whose name has been changed), owner of a small cafe in the ski paradise of Mammoth Mountain, California.
In 1996, Jacobs shopped for funding for his new restaurant at a number of local and national banks. He settled on one that had a history of lending to the hospitality industry. "I felt confident that the loan officer understood my business, and he seemed willing to work with me," says Jacobs.
The restaurant business, especially at a ski resort, can be seasonal. Jacobs would often fall behind in his loan payments in the summer, only to catch up in the winter. "This arrangement was fine for the first few years of the loan," explains Jacobs. "Then the loan officer left and things began to fall apart."
In addition to that officer's departure, a new branch manager came on board, and it was someone who didn't seem interested in making loans to restaurants. Jacobs began receiving letters from the bank threatening foreclosure when he fell behind in his payments in summer 1998. "There was no attempt to understand the cyclical nature of my business; they played it straight by the book," says Jacobs. "I got the distinct impression they were no longer interested in continuing the relationship. I didn't change the way I did business with the bank; the bank changed the way it did business with me."
The bank continued to put pressure on Jacobs, seeking extra collateral and refusing to extend his credit line, so Jacobs had to seek legal assistance to work out the impasse.
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Looking For Trouble
To be sure, banks aren't venture capital firms; they expect to be paid back in a timely manner. However, they must abide by certain lending laws and business practices, and, unfortunately, some cross the line. Others, because of mergers, acquisitions and consolidations, seem to have a revolving-door employment policy, where loan officers come and go with alarming regularity. Jacobs, for example, had to deal with three different loan officers in only four years, and each of them had to be educated about his business's financing needs. Each had his or her own set of lending rules, and Jacobs felt he had to sell them on his business repeatedly to be sure funds would remain available.
During good economic times, businesses are more apt to let their guard down when dealing with their lenders. "It's the time we're less likely to read the small print before signing a loan document, or we accept a loan officer's word on matters that should have been put in writing," says A. Barry Cappello, Jacob's attorney and managing partner at Santa Barbara, California-based Cappello & McCann, a leading borrowers' rights law firm. "It's only later, when the economy slows, the business slumps or a new regime takes over at your bank with a different lending agenda, that you find you've signed away your rights and the lender holds all the power."
A loan can go sour for a number of reasons, but sometimes it is the lender that makes things worse. Some signs of lender liability include:
requiring increased accounts receivable or collateral without sufficient justification;
refusing to advance the amount available as promised under a loan; and
suddenly reducing credit lines or changing loan terms without warning and demanding certain performance levels that weren't clearly specified in the loan documents.
So how can you protect yourself from lender misconduct? Cappello offers a few simple rules.
First, recognize that we are no longer a "my handshake is my word" society. A handshake or a verbal promise meant something years ago. No longer. Get all lender promises in writing. Lenders have been working hard at the state level to better protect themselves from borrower lawsuits. Nearly every state has passed a legal doctrine called the parol evidence rule, which allows a lender to keep evidence of oral agreements out of court if a borrower decides to sue.
"Let's say a borrower is troubled by a clause in the loan documents and hesitates signing the documents," says Cappello. "To push the deal through, the loan officer says, 'Don't worry, that's only a bunch of legalese written for lawyers. It's never enforced.' Because of the parol evidence rule, the lender has the ability to deny that the statement was ever made, and the borrower cannot argue the fact in court."
The parol evidence rule also covers promises made prior to funding the loan. Imagine you get a call from a loan officer saying your loan was approved and the funds will be available within two weeks. If you relied on that statement to purchase equipment and hire workers in anticipation of the capital infusion, you would have no legal recourse if the lender reneged on the promise.
If a lender really wants to wiggle out of a loan commitment, it can use so-called "reasonable reliance" rules. Using them, lenders can argue in court that borrowers should have known the lender's credit limits, lending policies and chain-of-approval process, and that's why an oral loan promise by a loan officer should not be taken seriously.
Cappello cautions borrowers not to feel pressured into signing documents they haven't read carefully. "Loan officers often rush the borrower at closing, shoving page after page of loan documents in front of the borrower to sign," says Cappello. "After coming this far, borrowers have a tendency to want to get the process over with. This can be a big mistake." The courts have put the responsibility of fully understanding the loan documents before signing squarely on the shoulders of borrowers.
Ask the lender to send you the documents in advance so you and your lawyer can review them thoroughly. "A commercial loan is much more complicated than a personal loan," says Tom Thomas, partner with Thomas & Culp LLP, a law firm in Dallas. "And for many new entrepreneurs, the only experience they've had with lending is obtaining a mortgage for their home. Business loan documents contain sophisticated wording that protects lenders. The business owner needs to have a lawyer acquainted with lending law review the documents and delete troublesome clauses."
A personal guarantee clause is particularly onerous. Entrepreneurs are often asked to put up personal assets (such as a home, a boat, a vacation home, etc.) as collateral. "If you agree to use your home as collateral for your business loan, be prepared to lose it if the loan is called," warns Cappello. "If the lender says, 'Don't worry, we would never seize personal collateral,' don't believe it. Under the parol evidence rule, a lender's verbal assurance means nothing."
Another popular loan document clause is one that waives the borrower's right to a jury trial and forces disputes to be settled with binding arbitration. "For more routine matters, this is OK," says Thomas. "But for complex disputes, resolution in court makes more sense for the borrower. For one, who selects the arbitrator or panel of arbitrators? If they get a steady stream of business from the lender, can they really be neutral? Second, history has proven that juries are more likely to side with borrowers than with a large, heartless bank. Waiving your right to a jury trial takes away that advantage."
When a lender knows it has stepped over the line, it may ask the borrower to sign a waiver, releasing it from liability for previous misconduct. In return, it might agree to grant the borrower more attractive loan terms. Be wary of these releases, says Cappello. "Compare what you are gaining by signing the release with what you may be potentially losing. Once you sign that paper, you are foregoing your right to ever seek legal recourse for the bank's misconduct."
Finally, create a paper trail of your dealings with your lender. "If a lender promises something over the phone, follow up the conversation by sending the lender a written confirmation of what was said," notes Cappello. "If you have been allowed to skip a few payments and catch up later in the year, write the lender a letter thanking it for enabling you to do so. This establishes a history of business dealings with the lender and can come in handy if you must renegotiate terms with the lender or in worst-case scenarios, take the lender to court."
Jacobs is fortunate because he's a good record-keeper. He's hoping to use his records to persuade his lender to agree to new terms that will save his restaurant while making the new bank management happy.
"Everything is negotiable when it comes to business loans," says Thomas. "A lot depends on how bad the bank wants your new or continued business."
The bottom line, both attorneys agree, is to always be vigilant about the relationship with your lender, in good times and in bad. Otherwise, you can easily leave your business exposed to undue risk.
|Interview potential backup bankers in your community. Even if you're on good terms with your lender now, you never know when you might need a new one fast.|
- Cappello and McCann, (805) 564-2444, www.cappellomccann.com.