Maryland Legal Alert for Financial Services

On January 23, 2019, the United States District Court for the District of Maryland, following trial, entered judgement in favor of a lender for over $1.3 million against two individuals who had signed “bad boy” guaranties in connection with a loan to a group of nursing home entities. Notably, the court also awarded $200,000 in punitive damages against one of the guarantor defendants for having signed and submitted false borrowing certificates on behalf of the borrowers to the lender. 

In July 2015, a non-bank lender extended a $9 million revolving line of credit loan that was secured by the borrowers’ accounts receivable. The two individuals who controlled the borrowers guarantied repayment of the loan. Liability under the guaranties only would be triggered upon the occurrence of certain “bad acts”, specifically if the borrowers improperly filed for bankruptcy, colluded with other creditors to cause an involuntary bankruptcy, “and” engaged in a fraudulent act “or other illegal action” in connection with the loan. The borrowers’ covenanted in their loan documents that they would timely pay all taxes. Also, the borrowers agreed to deposit all receipts only into an account at a designated bank that had entered into a deposit account control agreement with the lender.

In December 2016, the lender discovered through a field audit that the borrowers were delinquent in the payment of federal withholding taxes even though borrowing certificates signed by the guarantor who managed the operation represented that the borrowers were current on the payment of taxes. The lender also discovered that funds were being diverted from the agreed upon control account into accounts at banks with which the lender did not have a control agreement. The lender called the loan, realized on its collateral and thereafter sued the guarantors for breach of their guaranties, conversion of collateral and, in the case of the guarantor who signed the borrowing certificates, for fraud. The lender requested an award of punitive damages on its fraud claim.

In ruling for the lender on its claims, the court addressed the guarantors’ argument that their guaranties were not breached because their terms literally required all three of the “bad acts” to have occurred before liability would attach. After reviewing Maryland cases that have held that the use of the word “and” may under the circumstances be understood as “or” and noting that the guarantors’ interpretation of the guaranties would be illogical and permit the borrowers to “commit flagrant acts of fraud”, the court rejected the argument and ruled that the guarantors breached their guaranties. In addition, the court found that the guarantor had committed fraud when he signed false borrowing certificates after observing that the guarantor was a “sophisticated businessman with years of experience in the healthcare industry” and that if he did not read the borrowing certificates before signing them, he was “grossly irresponsible” and demonstrated a “reckless indifference to the truth.”

The court’s award of punitive damages should send a strong message to those who are responsible for submitting borrowing certificates to a lender that their liability for nonpayment of a loan can be much greater than the amount due if the certificates contain false representations. Please contact Lawrence Coppel for more on this topic.