May 2014 Legal Briefs

• Keeping customers happy

Keeping customers happy

By Mary Beth Guard

The hottest song on the Billboard charts these days is a little ditty by the artist Pharrell. With a catchy beat and a tune that makes you want to get up and dance, the lyrics encourage listeners to clap their hands if they’re happy. As you deliver products and services to your customers, it’s wise to always strive to do it in a way that is designed to elicit a positive response. While they may not leave the bank clapping their hands and dancing around, let’s hope they do at least have positive thoughts and favorable impressions.

The fact is, happy customers are important for three reasons. The first is retention. If a customer is satisfied with the way you have handled his business, he’s not likely to be seeking out another financial institution to do business with unless they’re offering something you’re not.

The second is that in the age of social media, customers have a louder voice than ever with which to express their displeasure and share their negative experiences. The old rule used to be something to the effect that an unsatisfied customer would tell anywhere from 8 to 20 others about what he believes you did wrong. Now that some folks have hundreds (even thousands!) of Facebook friends and Twitter followers, it takes mere seconds for a customer’s displeasure to be broadcast around the globe.

We’ve witnessed some high profile examples of this recently. The New York City Police Department suffered a social media disaster when it launched a Twitter campaign asking people to post pics of themselves interacting with officers. Folks responded to the request, but not with the types of pictures the NYPD had in mind, but instead with what appeared to be photographic evidence of various cases of police brutality! The resulting black eye the city received can only be described by the hashtags #epicfail, #fiasco and #headswillroll. The reality is, even if your bank isn’t active on social media networks and hasn’t attempted any outreach, you can still get creamed in the Twitterverse or on planet Facebook if you tick off the wrong person or business. It’s an online free-for-all where the first amendment goes a long way to protect those who have grievances to air. Grievance reduction and mitigation is therefore more important than ever these days.

Which brings us to the third reason customer happiness matters: litigation reduction. I’m going to make a bold statement here: as a general rule, happy customers are not going to sue you. Conversely, make a customer unhappy enough and he’ll trot down to the local lawyer to investigate ways to “make you pay.”

I had just been listening to “Happy” on my iPad before flipping on the TV in the wee hours this morning. My mental channel changed from blissful thoughts to a big “Uh oh” when I realized the commercial airing on the tube was precisely the sort we feared and predicted when the Dodd Frank mortgage rules were being developed. In a somber voice, the announcer was exhorting viewers to call the law office of “who knows who” if they were having trouble paying their home loan because they might have been the victim of predatory or illegal lending practices. Through his grave tone and message, he conjured up the image of a knight in shining armor galloping up on his horse to save the day – or at least save the house.

This edition of Legal Briefs helps you understand the most common scenarios under which you are likely to end up in litigation brought by your customers, with the hope being that by understanding the underlying causes, you can reduce or eliminate them.

Typically, most lawsuits against banks can be divided roughly into two categories. 1) The customer suffers a disappointment due to a disconnect between expectation and reality. This often comes down to poor communication. 2) Self-preservation. In this scenario, the bank has usually sued the customer first to collect on a debt or to otherwise enforce a duty or obligation under a contract or otherwise. The customer then seeks to defend himself – and get the better end of the lawsuit, by pressing a counterclaim against the bank or by raising certain defenses against the bank’s action.

An example of the first category came up recently in conversation with a friend who is a bank examiner. Her widowed mother, Lana, is in her 80s and has managed her finances extremely well throughout her life. Although her earnings were always modest, smart investments and wise money management have allowed her to amass a small fortune. She purchased a CD at her bank the other day and misread the APY, which led her to mistakenly believe she would be earning a rate of 4.10%. Certainly, during her lifetime, she had achieved that type of rate and many much, much larger rates on previous CDs, so it wasn’t inconceivable or irrational – except that in the interest rate environment we are in, it simply wasn’t what was being offered. The real APY was .041%.

When Lana told her daughter about the rate on her CD, her daughter had two thoughts: either mom is totally wrong about this, or I need to take off tomorrow and go deposit some money in that bank. Upon asking for the supporting documentation, she found the real rate and broke the news to her mom. Lana was upset, not just because the rate was so low. Not just because she hadn’t paid sufficient attention to what she was purchasing. But also because she had exclaimed to the bank employee “I’m so pleased to be getting this great rate – 4.1%! I am really happy about this.” And the bank employee had said nothing to correct her. Gee, what do you think? Unfair or deceptive act or practice, perhaps? A plaintiff’s attorney would be more than happy to describe the bank employee’s action (inaction) that way on behalf of the elderly widow lady.

In terms of the types of causes of action that can be brought by disappointed customers, let’s begin, in this edition, by looking at breach of contract, which is the number one theory of bank liability, both in frequency of cases and in the total dollar amount of verdicts rendered.

In contract law 101, you learn that there are five elements of a contractual relationship. It is crucial for all bankers to understand these five elements so that you will know whether your actions and representations have created a binding, enforceable contract between the bank and your borrower. After all, a customer can’t successfully sue for breach of contract if there was never a contract! But what constitutes a contract can be different from what many laymen assume.

Five basic elements are necessary to form a binding contract. These are 1) legal capacity; 2) intent; 3) agreement on the terms; 4) offer and acceptance; and 5) consideration. If any of these five elements is lacking there will not be a contract:

Element No. 1. The parties must have legal capacity to contract. From the bank’s side, this means the loan officer dealing with the parties must have the authority (or at least the apparent authority) to bind the bank. From the other side of the transaction, the borrower must be legally competent to bind himself as borrower (or to bind the person he is acting for, as borrower) and must not be under any legal disability.

Some examples of legal disability, incapacity or lack of authority to contract, and/or inability of the person to fully understand what he is doing, are the following:

a) Because of injury, illness or other condition a person is either temporarily or permanently impaired in his ability to understand the terms of the contract. (Perhaps someone feels sick, is in extreme pain, and/or is on strong medication and for that reason is not able to focus adequately on what he is signing. Also consider the drunk who temporarily is unable to understand what he is doing, or the grieving widow who is so overcome by emotion that she is incapable of focusing on the terms of the documents she is being asked to sign. A loan closing should probably be delayed if a person shows up for a loan closing under any of these circumstances.)

b) A minor–under 18 (who by law is not legally able to bind himself to a contract, except in very limited circumstances);

c) A secretary or other non-executive employee of a corporation, who by his/her position does not have enough authority to bind the company to the transaction.

d) A person of diminished capacity, for whose person or property a guardian or custodian has been appointed. (Remember that a person who is obviously “not all there” may not be legally capable of making a contract either, even if no guardian or custodian has been appointed. For example, an elderly person may be starting to slip mentally. The issue is whether person has enough awareness to understand what he is signing and the legal effect of it?)

Where there is any doubt, a lender would be wise to make notes of what its officer said and the ways in which the person’s responses demonstrated clear understanding. Having a slightly impaired person’s relatives there to explain things (and as witnesses) may also be helpful, because they would be most familiar with the person’s limitations, what is “normal” for this person, and whether he/she is having a “good day” or “bad day.” It is hard to prove affirmatively, after the fact, that a person who obviously had some impairment at the time of the transaction was, nevertheless, sharp enough to be legally bound by your loan agreement. Document your evidence in such a case, or back off.

Element No. 2. There must be intent by both parties to enter into a contract at the particular point in time. In legal terms this is called “mutual assent.” Both parties must somehow demonstrate an intent to contract. (Verbally they state, “I agree,” or “It’s a deal,” or they sign an agreement.)

(The issue of whether both parties intended to form a contract particularly arises when people are arguing over whether they had a verbal agreement or not. When there isn’t any written agreement, the party who “changes his mind” often tries to get out of what he agreed to by saying he never agreed, or he didn’t understand, or he was just discussing the terms. On the other hand, a person who wants a transaction to go forward, but didn’t get any written agreement signed, will often argue that there was a verbal agreement and that he relied on it. In both cases, a jury will tend to bend over backwards in favor of the customer, and against the bank.)

The issue of “no intent” normally can’t arise after there is already a signed written contract. (However, at one rather infamous failed bank, some commercial borrowers later alleged that they were asked to sign blank guaranty forms or blank promissory notes and never intended to consent to what was later filled out on those forms.)

This is important: If you give a customer plenty of time to read over forms before signing them, this helps to cut down on the (usually weak) argument that the customer didn’t know what he was signing, or felt pressured to sign without being given time to read it. Perhaps, in closing a loan, the loan officer could improve the customer’s comprehension and avoid future problems by 1) asking if the customer understands the documents; 2) giving him the opportunity to ask any questions about the transaction; and even 3) offering to give him (or his adviser) a copy of the documents to review before the loan closing.)

Element No. 3. Reaching agreement on all of the material terms. Sometimes this is called a “meeting of the minds.” If the parties have not agreed to all the material terms (haven’t finished agreeing on the major points where they were apart), there usually cannot be an enforceable contract (although sometimes there is).

In some cases, a court will supply the “open” terms (provisions not stated). It may be that there has been an established “pattern of dealing” between the parties, or that there are certain “customary practices in the industry” that form part of the background against which an agreement is made. If so, these matters that the parties would have understood as part of the deal can be used to supplement what the parties have stated in writing, to clarify any issues on which the contract is silent.)

Element No. 4. Offer and Acceptance. Sometimes, no contract is formed because there is an offer and then, instead of an acceptance, there is a counter offer. A loan officer might agree to make the borrower a loan of $10,000 for a term of two years with an interest rate of 10%. What if the borrower responds by saying he accepts the bank’s generous proposal, but subject to the understanding that the term of the loan will be three years. The applicant has made a “counter-offer,” and there is no contract unless the bank goes along with the applicant’s proposed provision that the loan will be for three years instead of two. (What each of the parties separately is proposing does not line up yet with what the other party is willing to do.)

Element No. 5. Finally, there must be “consideration” in order for a contract to be valid. Consideration means “something of value” that is given or exchanged between parties to the contract. For example, the bank offers to loan the borrower money. In exchange for receiving that money, the borrower agrees to pay interest to the bank, along with repaying the principal. Thus, both parties have given valuable promises that amount to consideration.

Some Examples of Consideration.

Following are examples of consideration in a banking context:

a) Borrower moves his accounts to the lender’s request;

b) Borrower terminates other relationships (or other loan applications) with other lenders; or

c) A large fee is paid and the bank does not expressly state that it was simply to compensate the bank for investigating the possibility of making a loan. (The larger the fee, the more likely a court will find it was a fee to lock down a loan commitment. Most borrowers would not pay a large fee merely for an investigation.)

It is also possible for there to be liability under verbal agreements, in some instances. Thus, a bank should recognize that its communications with customers (conversations, letters, and actions) can sometimes form a contract (or an amendment to an existing contract) on which the bank may be held liable.

It is a popular misconception that there can’t be a contract without a signed piece of paper. This is false. Oral contracts are more difficult to prove in court than written agreements, but if proven they are equally binding. It’s possible for a contract to be formed entirely by verbal promises. Title 15, O. S., Section 134, states: “All contracts may be oral, except such as are specially required by statute to be in writing.”

What contracts must be in writing? Under 15 O.S. Section 136, (1) an agreement that “is not to be performed within a year from the making thereof” must be in writing (so some loan agreements for a term not to exceed one year could be oral); (2) most guaranty agreements must be in writing (but see some exceptions in 15 O.S. Sections 324 and 325); and (3) most contracts affecting title to real estate must be in writing. Contracts that are formed by internet (if that’s the way parties intend to agree) would be considered “in writing.” In particular, e-mail communications with a customer can form a contract or an amendment.

Generally, a judge or jury would not be too impressed by a bank’s argument that there can’t be a verbal agreement with its customer “because banks never do that.” In reality, banks make a lot of verbal agreements with their borrowers–for example, agreeing to accept a late payment if it is made by a certain date, or giving the debtor permission to sell collateral and apply the proceeds to the loan.

In 1989, at the request of the OBA, Oklahoma passed a law to reduce the number of suits alleging the existence of a verbal loan agreement.15 O. S. Section 140 states that no borrower or lender may sue on a credit agreement having a principal amount greater than $15,000 unless that agreement is in writing. Therefore, a borrower cannot sue to enforce an alleged verbal agreement to lend more than $15,000.

Sometimes, the best proof that a contract was actually intended is the fact that partial performance has already been rendered. This approach considers the conduct of the parties as being further evidence of what they agreed upon.

For example, if it’s true that a banker didn’t really tell the customer to go ahead and write a check to a dealer to buy a new car, and then to come into the bank later to paper up the loan, (1) why did the customer write a $20,000 check to the car dealer (without having any money in his account), and (2) why did the banker pay that check?

The following definition of “implied contract” appears in 15 O.S. Section 133: “An implied contract is one, the existence and terms of which are manifested by conduct.”

Ever heard the phrase “Attempted Reversal of a Course of Dealing”? It refers to another theory of liability that often comes into play. Here’s how: Occasionally, the parties to a contract will depart from the strict terms of their contract, engaging in conduct different from what the contract requires. If this occurs repeatedly, the lender and the borrower may establish a “course of dealing” that is contrary to the written terms of the loan agreement. Essentially, this pattern amounts to a subsequent verbal amendment to a written agreement.

Before an established course of dealing can be reversed or terminated, the lender should give reasonable notice, so that the customer can take steps to limit any damage that might occur by the lender’s sudden reversal or termination of that practice. When the customer has come to rely on an established course of dealing, the bank could be held liable for damages suffered as a result of any sudden change.

Common examples of conduct which gives rise to a “course of dealing” are (1) repeated acceptance of late payments or (2) repeated payment of overdrafts on the borrower’s checking account. Some cases in Oklahoma have compelled a lender to accept a late payment and to reinstate a loan, where the lender (without warning) changed its previous loose policy on accepting late payments. A similar argument can be made that a customer is damaged if a bank suddenly starts bouncing a customer’s checks, where before the bank was quite liberal in paying overdrafts.

Also watch out for situations where your contract has given you certain rights (such as the right to impose late fees) and after an extended period of time without ever having enforced that contract term, you decide to start enforcing it. If you don’t provide advance notice before your change in practices, the customer is not going to have the ability to make arrangements for your “new world order” and may suffer consequential damages. Then, guess what? Your customer is not going to be “happy.”

I think it helps to use some examples. As stated earlier, it is impossible to breach a contract until there is a contract. Once you have a binding contract with your borrower, suits for breach of contract can arise under various factual patterns. Examples are:

1) Refusal to advance funds (where advances are mandatory, such as with a construction loan);

2) Failure to negotiate or establish in good faith what the open terms of the contract should be; and

3) Wrongfully determining (whether frivolously, arbitrarily, erroneously, or even maliciously) that certain required prior steps for funding (called “conditions precedent”) aren’t met.

And don’t count on squirming out of a loan commitment simply because the amount of the loan would exceed your bank’s lending limit. Some cases have held that an agreement by a bank to lend an amount of money which exceeds its legal lending limit is illegal and therefore unenforceable, but many courts have instead ruled in favor of the borrowers, finding that the regulatory restriction on how large a loan can prudently be made does not interfere with a binding contractual commitment to make a loan in excess of that amount.

Courts have held that a commitment to lend in excess of the lending limit was binding and enforceable because the bank can always avoid the lending limit problem by selling loan participations. (Also, a customer usually is not in a position to know what a bank’s lending limit is, and reasonably would expect the bank to be able to close whatever size of loan the bank commits itself to make.)

Another aspect of liability that can arise under a contract is a breach of the duty to act in good faith. Parties to a contract are obligated to deal with each other in good faith. Courts have generally stated that every contract contains the implied requirement of good faith and fair dealing.

What is good faith? The U.C.C. defines it as “honesty in fact in the conduct or transaction concerned.” 12A O.S. Section 1-201(19). And the U.C.C. specifically states that a party is not permitted to waive good faith performance.

The issues of (1) acceleration of a debt, (2) exercising a “due on demand” provision, and (3) terminating a line of credit, are closely related to each other, involving concepts of reasonableness, fair dealing, and adequate warning. These concepts, if ignored, can result in lender liability.

Be especially careful in accelerating a loan! A special duty to act in good faith is involved when the contract contains a provision that allows the lender to accelerate a debt either “at will” or “if it deems itself insecure.” Under the U.C.C. a lender may only accelerate a debt under such a provision if it believes in good faith that the prospect of payment is impaired.

If a lender decides that its prospect of repayment is impaired, its basis for forming this belief must be reasonable. (The bank should ask, “Are we acting the same way we would with other borrowers?”)

Let’s face it. Some customers are more likeable than others. Some will rub you the wrong way. But we aren’t running a personality contest here and it is imperative that you be objective about facts and circumstances. In some situations a bank may be tempted to react emotionally, taking adverse action based on strong suspicion or a very negative rumor, without having complete information. But instead of over-reacting, the bank should first turn the situation around, asking, “What if what I believe to be true is not correct? Is there some way I could be misinterpreting the circumstances? Is there something else I need to check to verify what I am hearing, or what appears to be true?”

When uncertain, a bank should investigate more carefully the truth or falsity of the information it is considering. Provide the benefit of the doubt to the customer, where possible. This approach requires a bank to imagine how the facts would look from the jury’s point of view.

The issue of good faith is especially important whenever the lender is exercising discretion. Of special concern are the delicate issues of when (or if) to make further advances on a loan, when (or if) to terminate a line of credit, when (or if) to repossess collateral, and whether to give prior notice of repossession of the collateral or of the termination of the line of credit. At all of these times it is important for the lender to act in good faith.

Danger zone: demand clauses in commercial loan agreements. The best advice concerning putting a “due on demand” provision in a commercial loan agreement is, “Don’t do it.” In the past, demand promissory notes were used frequently for commercial loans, but courts have frowned on this practice. Because a bank knows that the borrower’s business is dependent upon borrowed funds to continue operations, a sudden, unannounced withdrawal of funding is almost always unreasonable. It can trigger the failure of the business.

Use a carefully-tailored loan agreement, not a demand note. A contractual provision allowing a bank to call a loan due without warning, for any reason or no reason, gives a lender an unreasonable amount of power over the debtor, and is almost never necessary from a lending standpoint. A lender can reasonably address its legitimate concerns by negotiating certain “covenants” and “events of default” that will be part of the loan agreement. These provisions allow the lender to call the loan in specific situations that have been carefully defined in advance and are understood by both the borrower and the lender.

When an “event of default” occurs, the lender typically is required by the loan agreement to give notice to the borrower, who then has a certain number of days to cure the default. If the borrower does not eliminate the default within that time period (or make adequate progress toward curing it), the lender can then call the loan due.

“Covenants” of the debtor (promises to do or refrain from doing certain things), “representations and warranties” (certain matters that the debtor swears are true and which, if untrue, would be grounds for calling the loan due), and other events of default (for example, filing bankruptcy, failing to pay taxes, or failing to have adequate liquidity to pay bills) are rules stated up front that tell everyone exactly what kinds of behavior the lender will expect and what it will not tolerate. If the borrower can avoid violating these points, its loan will not be accelerated.

It is prudent, in most circumstances, for the lender to give the borrower advance notice of his intent to terminate a line of credit, so that the borrower will have an opportunity to seek financing elsewhere. (Although the borrower’s problems may make it impossible for him to obtain other financing, as a matter of fairness the bank should at least give him a chance to look elsewhere–particularly if the bank’s position is well secured and the bank can stand the delay in taking action.)

Instead of threatening a company about changes in management personnel or trying to exercise veto power over major business decisions, the parties instead can agree that if the company’s income or capital falls below mutually defined minimums, or other pre-defined problems arise, the bank can call a default. (This approach does not attempt to control the company’s “methods” or “choices,” so long as the company can achieve desirable financial outcomes.)