During the interval between the date when a loan commitment letter is issued and the date when a loan is closed, lenders often discover that one or more of the parties to their prospective loan transaction has become subject to a civil judgment or involved in a pending lawsuit.  When that situation occurs, lenders need to determine whether the existence of the pending lawsuit or judgment: (1) is a basis not to make the loan, (2) requires a modification of the terms of the loan, and/or (3) requires additional documentation in the loan file to justify the lending decisions being made.  In making these determinations, lenders should first focus on gathering the relevant facts and then obtaining the advice of counsel in the jurisdiction(s) at issue.

Prudent decisions are based on having a good understanding of the facts.  When lenders investigate the facts of the lawsuit or judgment at issue, they should work closely with their underwriting staff, search vendor and borrower and ask appropriate questions that will help them gain a fuller understanding of the nature of the problem. For example:

1. Is there a judgment, a pending lawsuit, or just an asserted claim?
2. What court is involved?
3. Who are the named defendants, and what are their relationships to the proposed transaction (e.g., seller, guarantor, borrower)?
4. When was the lawsuit filed (or the judgment entered)?
5. What is the amount of money in dispute, and is there any other form or judicial relief being requested by the plaintiff (such as a declaratory judgment or injunction)?
6. Has there been any execution proceedings on the judgment, and, if so, against whom?
7. Does the defendant have legal counsel?
8. If there is a lawsuit that is still pending, what defenses have been asserted, and what is their chance of success?
9. If the judgment is old, is there a chance that it has been paid in full but inadvertently left unsatisfied by the judgment creditor?
10. Is there insurance or indemnification available to cover the claim at issue, and, if so, has the appropriate insurer/ indemnitor been notified and what was the insurer's/indemnitor's response? 

Once the lender has obtained answers to the relevant questions, it should confer with qualified legal counsel and ask her or him additional questions relating to the practical and legal effects of the lawsuit or judgment at issue, such as:

1. Will the judgment at issue be senior to the mortgages, pledge agreements and/or UCC liens that will serve as security for the lender's prospective loan if it proceeds with the transaction?
2. Should the lender require that the defendant resolve the claim with the plaintiff as a condition to proceeding with the loan, on the theory that the claim is a material adverse change in the borrower's circumstances that was discovered after the commitment letter was issued (or on some other theory)?
3. Is there a material risk that, as a result of the legal fees, discovery responses, and other costs and time commitments that the lawsuit may incur, the lawsuit will become an undue strain on the cash flows and/or management of the borrower and increase the risk that the proposed loan will default?
4. If the defendant in the lawsuit or judgment is selling a business or assets to the borrower, is there a risk that the borrower will be held liable for the judgment (either as a result of successor liability theories, allegedly fraudulent transfers, or the like)?
5. If the judgment is old, has it lost its priority over newer liens by operation of law, and is there a risk that its priority will be renewed?
6. Should the lender require a letter from the defendant's attorney explaining the circumstances, potential risks and likely outcomes?
7. Is the lender's collateral protected by an indemnity provision, and, if so, does the proposed indemnitor have sufficient assets to fund a defense and indemnification of the defendant? Moreover, if the proposed indemnitor is the seller in the proposed transaction, should some of the loan proceeds be escrowed until the claim is resolved?
8. Does the litigation call into question the authority of the officers, directors, members or shareholders of the borrower to execute the loan documents on the borrower's behalf?
9. If the loan in question is an SBA loan being processed through general processing, is the lender required to advise the SBA of the existence of the litigation or judgment?

Lenders should always be sure to ask their counsel about any potential lender liability issues that might arise with regard to these situations.  They should also ensure that their counsel is familiar with any contractual obligations contained in the commitment letter for the loan at issue.  By asking the right questions, obtaining appropriate legal advice, and maintaining proper loan documentation, lenders can put themselves in the best position to find a way to close their loans in circumstances where litigation is pending or prior judgments exist.

For more information on issues arising from litigation in the context of commercial financing transactions, please contact Jeff at 215-542-7070 or at jfeldman@starfieldsmith.com.