1. Don't rely on what your banker tells you; get it in writing. Don't make side deals that aren't documented in writing.
A legal doctrine known as the "parol evidence rule" enables lenders to keep any evidence out of court about prior or contemporaneous oral agreements they made with their borrowers if the oral agreement conflicts with the written loan documents. This means that if your lender makes an oral promise to you that is not reflected in the written loan documents, or if your loan documents don't match exactly the agreement you've reached with your lender, then you may not testify in court about the oral promises or statements made to you.
The rule is harsh and is meant to discourage fraud, but the unfortunate result in practice is that it often encourages fraud by lenders. Unscrupulous lenders can induce a borrower to sign a loan agreement by characterizing onerous provisions in the agreement as "mere boilerplate" that will never be enforced. After the borrower signs the agreement based on those statements, the lender can invoke the parol evidence rule and prevent the borrower from testifying about them.
Another problem with oral agreements is that they are worthless if the lending institution fails and is taken over by the federal government. Under the "D'Oench, Duhme doctrine" and related statutory provisions, a failed bank or savings and loan is not bound by an agreement made with its customer unless the agreement is in writing and is approved in the minutes of the institution's board of directors. The odds of your oral agreement being reflected in writing in the minutes of the institution's board of directors' meeting are so remote as to render an oral agreement meaningless.
2. If you get a loan commitment, be sure it is in writing and includes all the terms of the loan.
In many states, special laws known as "statutes of fraud" require loan commitments to be in writing. As a result, it is imperative that, when your lender commits to making a loan, that the commitment be reduced to writing. If you proceed to make your own financial commitments based only on the lender's oral commitment, and the loan is never funded, you may have no recourse against your lender.
A related doctrine involves "agreements to agree." Under this doctrine, a loan commitment that does not include every single term of the loan may be legally invalid because it is merely an agreement to agree rather than a final binding agreement. For example, if a development company spends millions of dollars buying property and preparing to develop it, in reliance on an unenforceable loan commitment, it is out of luck if the lender refuses to fund the loan.
3. Get all important statements by your loan officer confirmed in writing.
Lenders are using the doctrine of "reasonable reliance" to convince courts that a borrower should have known that what a banker promised was so unreasonable the borrower should not be able to recover any damages against the lender for making those statements. The doctrine has unfortunately been stretched to ludicrous lengths.
For example, one court held that a borrower should have known his loan officer's credit limits; therefore, the borrower's reliance on a loan in excess of that limit was unreasonable. Other courts have held that borrowers should have known their loans would have to be approved by a certain committee or board, and that those borrowers were therefore not acting reasonably when they relied on the bankers' statements that the loans would be made.
Courts have not been deterred from applying this doctrine even when they know the borrowers did not actually know their loan officer's credit limit or that higher approval was needed before the loan would be funded. It is therefore important that you not make substantial outlays or otherwise rely on what your banker tells you until you get a final signed loan commitment or, better yet, a fully executed loan agreement.
4. Read every document before signing; if you have any questions, ask.
In the past, courts were lenient about enforcing the strict terms of loan agreements. They understood that not everyone reads, let alone understands, every single word buried in the small print on the back of deeds of trust and mortgages. This was perhaps because they themselves never examined their own loan documents that carefully.
Those days are over. Courts are now strictly enforcing all the terms of the loan documents, no matter how onerous they are, whether the borrower read them or not, and even when the borrower doesn't understand written English.
Borrowers must remember that virtually every clause in a loan document is there for a reason: To protect the lender. Your lender may try to assure you that some provision you question is "just boilerplate that the bank never enforces." However, if that provision will help the bank against you, your bank will enforce it if necessary.
That is why it is so important to read and understand everything in your loan documents. If your deed of trust says that your bank can foreclose if you are one day late in payment and that it can do this without giving you any notice of your default, that is obviously something you should know if you are in the habit of making late payments. If your loan officer assures you that the lender never enforces a troublesome provision, then ask that it be deleted. If your loan officer refuses, be prepared for the worse.
5. If you have any questions about your loan documents or your rights under them, contact a lawyer.
One of the few groups of people more distressing to deal with than bankers are lawyers. Lawyers aren't cheap, especially good ones, and they often seem to create more problems than they solve.
Nevertheless, lawyers can help borrowers avoid some major headaches because they are often the only people other than bankers who can make sense of the minutiae and legalese that usually appear in loan documents. The initial expense of consulting a lawyer for direction through the maze of a complex loan transaction can pay off with fewer problems down the road.
One downside to using a lawyer, either during the loan negotiation or documentation process, is that your bank may later use that fact against you. That is, your bank may claim that because you had someone looking out for your interests, the bank couldn't have taken advantage of you or violated your rights.
6. Never give a lender a security interest in something you can't live without.
Lenders often demand far more security than they need. While this may be a prudent, cautious lending strategy for them, it can prove disastrous for a borrower or guarantor who pledges that security.
For example, a lender may ask for a deed of trust or mortgage on the borrower's property, and a security interest in the receivables or other intangibles of the borrower's business. It may also demand a guarantee of a corporate officer, and a deed of trust on that officer's house to secure the guarantee. In such situations, both the borrower and guarantor are at risk of losing their property if the loan goes into default.
Guarantors must understand that a guarantee is a legally binding agreement that in effect makes the guarantor just as liable as the borrower for repayment of the loan. While most guarantors believe that the lender will come after them only after failing to get satisfaction from the borrower and the borrower's collateral, that is not necessarily so.
Guarantors generally have the right to make the lender proceed first against the borrower, but most standard guarantees today include a waiver of that right. This means that the lender may legally go after the guarantor and his property first, before the lender sues the borrower or forecloses on the borrower's collateral.
It doesn't matter whether the borrower or guarantor is told: "Don't worry--we never foreclose on that--we just need it for bookkeeping," or some other pretense is used to induce the borrower or guarantor to turn over the security. Under the parol evidence rule, neither the borrower nor the guarantor will be able to testify to what the banker said if those statements conflict with the lender's unconditional rights in the loan documents.
7. If your banker tells you something that sounds unusual, check it out.
In years past, the public generally trusted bankers and held them in a certain esteem. Deals were done on a handshake and mutual trust between the lender and borrower was more the rule than the exception.
No more. Today, borrowers must remember that lenders are selling goods and services, just like any other business. When lenders exaggerate or "puff" about what they can or will do, borrowers must take that with the same grain of salt as they do when dealing with a car salesperson or other vendor of goods or services.
This is especially important because of the high standards of conduct being imposed on borrowers by the courts. Courts often treat borrowers as more sophisticated and knowledgeable than they really are; this requires borrowers to be on their toes at all times.
If your loan officer says he or she can do something for you that doesn't sound realistic, try to confirm those statements with the officer's superior. Better yet, don't rely on those statements until whatever the officer promised actually occurs.
8. Be aware of what you're giving up if you sign a jury trial waiver, an arbitration clause or a release.
Lenders today are including jury trial waiver and arbitration clauses in their loan agreements with alarming frequency. A jury trial waiver prevents you from having disputes with your lender decided by a jury, while an arbitration clause prevents you from having your disputes decided by a court.
Both provisions are generally detrimental to borrowers. Juries tend to side with the underdog rather than the institution, and therefore tend to favor borrowers over lenders. It is for this reason that lenders try to keep these claims away from juries or out of the courts altogether.
Another provision to be on the lookout for is a release. After a dispute has arisen or some problem develops in the lending relationship, the lender may realize it acted improperly and try to cover its tracks. It can do this by getting the borrower to release the lender from any liability. If the borrower signs the release, he or she permanently loses any claims against the lender, whether the borrower knew about those claims or not.
Lenders often present releases when they know they have the borrower over a barrel, and the borrower has little choice but to sign to keep a loan. The harder the lender pushes to get the release, generally, the stronger the borrower's claims are.
Because a release results in the permanent loss of what may be substantial rights, you should never sign one unless you are absolutely positive you have no claims against your lender. If you even suspect you may have a claim, you should consult a competent lawyer before agreeing to sign the release.
9. If you suspect your lender has done something improper, do something about it.
A doctrine known as "waiver of the fraud" is being used by lenders to prevent borrowers from prosecuting their claims. Under the doctrine, a borrower who suspects fraud by the lender but who nevertheless continues to accept substantial benefits from the lender (i.e., funding under a line of credit) waives or loses the ability to pursue a fraud claim.
This doctrine makes little sense in practice; worse, it may place the borrower in an impossible dilemma. If you suspect some minor wrongdoing or mistake on your lender's part and you complain out of fear of losing your claims, then you risk the lender's wrath and subsequent termination of your funding. If, on the other hand, you decide to grin and bear it and hope things work out for the best, then you lose your fraud claim if things turn out otherwise.
A related concern for borrowers is the timely pursuit of their claims. "Statutes of limitation" set deadlines for filing various claims. If you are one day late in filing your claim that claim is lost forever.
When these two legal principles are applied together, a real Catch-22 can develop. If you immediately pursue any claims you have, you will retain those claims but will probably lose your funding. If you wait and don't complain, you keep your funding but risk losing your claims. If you find yourself in this dilemma, consult a lawyer for help.
10. Don't ever forget that your banker's allegiance is to the bank and not to you.
Many people like to develop strong personal relationships with the people they do business with. They may foster close friendships with a loan officer or banker, especially in a small town where the branch manager knows everyone and there's only one bank in town.
No matter how close you and your banker become, how many football games you go to together, or how many of his children he names after you, you need to remember that if it's a choice between his head and yours, it will probably be yours. It's unfortunate, but it's "Borrower beware."
A variation of this rule is that just because you treat your lender honestly and fairly, don't expect the same in return. If your banker is up against the wall because of pressure from superiors, regulators or anyone else, your friendship with him will be his last concern. In other words, a certain healthy skepticism should temper your relationship with your banker, no matter how long you two have been doing business together.
While your bank may advertise itself as your "friend" and "trusted advisor" and your banker may assure you he is just that, lending is like any other business. It's a dog-eat-dog world in the lending industry today, and you might just be your lender's next breakfast.