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Good Fences, Good Neighbors: The Lender and its Investment Banking Affiliate
Lending & Restructuring Alert
October 2004
Authors: Paul A. Rubin

A recent New York appellate decision serves as a compelling reminder that a lender and its investment banking affiliate ("IBA") should operate independently and refrain from exchanging information regarding a common client. The court held that the broad scope of services that the IBA was required to provide under its advisory agreement, coupled with an alleged close working relationship between the lender and the IBA, could effectively impose fiduciary duties and duties of disclosure upon the IBA. As financial institutions struggle to position themselves in a fiercely competitive market, now offering customers "onestop shopping," the message of this case is most timely.


In this case, a lender extended a $25 million line of credit to certain borrowers under a credit agreement, which required the borrowers to maintain specific net worth levels and satisfy other financial covenants. During the parties' lending relationship spanning more than 25 years, the lender had allegedly waived these types of covenants in the past. Later, under a separate advisory agreement, the borrowers retained the lender's IBA as their financial advisor and broker for a proposed acquisition. The borrowers claimed that the lender and IBA aggressively encouraged them to consummate the transaction so as to earn fees. The borrowers intended to use the line of credit to pay for the transaction costs incurred in connection with the acquisition, and to write off those expenses if the transaction did not close. The borrowers ultimately decided to terminate the acquisition, and wrote-off the transaction costs, allegedly in reliance on prior assurances from the lender that it would waive certain covenants in the credit agreement so as not to affect the borrowers' access to credit. But after the borrowers canceled the proposed transaction, the lender froze the line of credit, and notified the borrowers that they were in default of the credit agreement. Th e New York state trial court dismissed the various claims asserted by the borrowers against the lender and the IBA.

The Appellate Court Reinstated the Borrowers' Claims

The court acknowledged that the advisory agreement between the borrowers and the IBA left the borrowers with ultimate decision-making responsibility regarding the acquisition. The court also noted the allegation of the close working relationship between the lender and its IBA, and the broad language of the advisory agreement that required the IBA to counsel the borrower as to the advisability of the proposed transaction. Accordingly, the court held that the borrowers' complaint, alleging that the IBA knew but did not advise the borrower that the lender would freeze the credit line instead of waiving covenants if the deal did not close, stated a claim for breach of the advisory agreement. The court also held that the IBA may have owed and breached fiduciary duties to the borrowers. Reinstating other claims against the lender and the IBA, the appellate court went so far as to hold that the borrowers may pursue a claim for unjust enrichment seeking return of the monies that the defendants received as interest, fees and other charges in connection with the failed acquisition.

The Implications

It is not far-fetched for a borrower to believe that a lender and investment bank operating under the same corporate umbrella work closely together and share information regarding common clients. This case demonstrates that if an acquisition goes sour and the borrower sues the lender and its IBA, the borrower's mere allegation of a close working relationship between the defendants, coupled with a broadly-worded retention agreement, may open the door to protracted litigation. Language in loan documents barring oral modifications and waivers, which typically protects against lender liability claims, may be trumped by language in the investment banker's retention agreement that can create contractual obligations and fiduciary duties to disclose what actions the lender may take with respect to the borrower.

Though cross-marketing may provide a competitive advantage in the current market, maintaining separation between the lending and investment banking operations is advisable to avoid liability.

For more information on these or other lending issues, please contact Paul Rubin at or at (212) 592-1448.

Copyright ©2004 Herrick, Feinstein LLP. Lender's Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.