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Houston:389124v1

AMERICAN COLLEGE OF REAL ESTATE LAWYERS MARCH 23, 1990

DISCUSSION OF LENDER'S STRATEGY AND PITFALLS

By SANFORD A. WEINER VINSON & ELKINS HOUSTON, TEXAS

© 1990 VINSON & ELKINS

Houston:389124v1

TABLE OF CONTENTS

TAB A – HYPOTHETICAL FACT SITUATION

TAB B – SPEECH OUTLINE

I. USURY ISSUES................................................................................................................. 1

II. PARTNERSHIP LAW ISSUES........................................................................................ 10

III. BANK TYING ACT ISSUES........................................................................................... 13

IV. GUARANTY ISSUES ...................................................................................................... 13

V. CONFLICT OF LAWS ISSUES....................................................................................... 16

VI. LENDER LIABILITY ISSUES........................................................................................ 18

VII. PERMANENT LENDER'S PITFALLS AND STRATEGY............................................ 25

VIII. CONSTRUCTION LENDER'S PITFALLS AND STRATEGY ..................................... 30

IX. ACKNOWLEDGMENTS................................................................................................. 35

Houston:389124v1

DISCUSSION OF LENDER'S STRATEGY AND PITFALLS

By SANFORD A. WEINER VINSON & ELKINS HOUSTON, TEXAS

© 1990 VINSON & ELKINS

I. USURY ISSUES

A. Life's 40% Contingent Interest.

1. Life's 40% contingent interest could be structured in a number of ways, including:

a Additional interest, denominated as such and provided for in the promissory note, equal to 40% of the net cash flow, capital transactions proceeds and appraisal surplus (i.e., excess of fair market value over debt upon maturity).

b. A 40% interest in a limited partnership, general partnership or joint venture, with the Borrower (or the other partners in Borrower) being the 60% partner. Life could be admitted as a 40% limited partner in the existing limited partnership, or Borrower could convey the project to a newly formed partnership or joint venture between Borrower and Life.

c. Creation of a net profit interest evidenced by a separate document.

2. If the 40% contingent interest is in the form of a partnership or joint venture interest, or a separate net profits interest agreement, which is granted to Life at the time the permanent loan is closed, remains the property of Life until the project is sold and is not subject to limitation on the amount of money which can be received thereunder, the 40% interest should be valued at the time it is received. Sandell, Inc. v. Bailey, 28 Cal. Rptr. 413 (Cal. Ct. App. 1963), cert. denied, 374 U.S. 831 (1963); Price v. Gulf Atlantic Life Ins. Co., 621 S.W.2d 185 (Tex. Civ. App.--Texarkana 1981, writ ref'd n.r.e.). If the 40% contingent interest is valued at the inception of the permanent loan, the value of the contingent interest (or the excess of the value over the amount paid for it by Life) will likely be considered interest with respect to the permanent loan and spread over the term of the permanent loan (the full stated term or, in the case of acceleration or prepayment, the actual term).

3. If the 40% contingent interest is merely interest, denominated as such and provided for in the promissory note, there should be no need to value, ab initio, the right to receive that interest. See Thompson v. Hague, 430 S.W.2d 293 (Tex. Civ. App.--Ft. Worth 1968, no writ). Rather than having the value of the 40% contingent interest treated as interest at the

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inception of the loan, the actual amounts paid as interest will be treated as interest for usury purposes if, as and when received.

4. If the promissory note contains no "lid" (limiting the total of the fixed interest and contingent interest to the maximum amount of interest permitted by applicable law), and no usury savings/rebate provision (obligating the lender to rebate excessive interest), arguably the lender has contracted for usurious interest by accepting the promissory note. However, where the lender is to receive something of contingent, speculative or unascertainable value, and the fixed interest is significantly less than the applicable usury ceiling, numerous cases have held that the contingent interest does not cause the loan to be usurious. See, e.g., Thomassen v. Carr, 250 Cal. App. 2d 341, 58 Cal. Rptr. 297 (1967); Beavers v Taylor, 434 S.W.2d 230 (Tex. Civ. App.--Waco 1968, writ ref'd n.r.e.); Wagner v. Austin Sav. & Ln. Assn., 525 S.W.2d 724 (Tex. Civ. App.--Beaumont 1975, no writ). See also Restatement of Contracts, Section 527 (1932). The more cautious practice in states such as Texas is to include both a "lid" and a savings/rebate paragraph.

5. If Life's 40% contingent interest is provided for in the promissory note and denominated as additional interest therein, and the fixed rate is significantly less than the applicable usury ceiling, Life should not be viewed as having contracted for usurious interest by accepting the promissory note and closing the loan. However, Life should be careful not to charge (demand) or receive, as fixed and contingent interest, an amount greater than what Life could have received if the promissory had provided for fixed interest equal to the applicable usury ceiling. See W.E. Grace Mfg. Co. v. Levin, 506 S.W.2d 580 (Tex. 1974).

6. Conclusion: Assuming that the 40% contingent interest is included in the promissory note and denominated as interest therein, the fixed interest rate is significantly below the applicable usury ceiling, and the note includes both "lid" and usury/savings language, Life's right to receive the 40% contingent interest should not present a usury problem for Life. However, Life has contractually agreed to limit its return and has given up the possibility (however remote) to "make a killing" on this deal.

7. Some Additional Source Material.

a. Annotation, 16 A.L.R. 3d 475 (1967), Agreement for Share in Earnings of Or Income From Property In Lieu of, Or In Addition To, Interest As Usurious.

b. Annotation, 81 A.L.R. 2d 1280 (1962), Payments Under (Ostensibly) Independent Contract As Usury.

c. Roegge, Talbot & Zinman, Real Estate Equity Investments and the Institutional Lender: Nothing Ventured, Nothing Gained, 39 Fordham L. Rev. 579 (1971).


d. Hershman, Usury and "New Look" In Real Estate Financing, 4 Real Prop. Prob. & Tr. J. 315 (1969).

e. Weiner, Usury Considerations in Equity Participation Loans, Vol. 23, No. 2 of the Newsletter of the State Bar of Texas Real Estate, Probate and Trust Law Section (1985).

f. Cooke, Equity Participation in Texas: A Lender's Dream or a Usurious Nightmare?, 34 Sw. L. J. 877 (1980).

g. Hackerman, The Application of Texas Usury Laws to Equity Participation Agreements, 48 Tex. L. Rev. 925 (1970).

h. Barton and Morrison, Equity Participation Arrangements Between Institutional Lenders and Real Estate Developers, 12 St. Mary's L. J. 929 (1981).

i. Respress, Equity Participation in Real Estate Finance, 7 N.C. Central L. J. 387 (1976).

B. Interim's 10% Partnership Interest.

1. Arguably, the 10% partnership interest should be treated as a commitment fee. Generally, bona fide commitment fees are not considered as interest. See Sintenis, Current Treatment of the Non-Refundable Commitment Fee and Related Problems, 86 Banking L.J. 590 (1969); Gonzales County Sav. & Ln. Assn. v. Freeman, 534 S.W.2d 903 (Tex. 1976). However, if the commitment is issued a few days prior to closing the construction loan, and the admission of Interim as a partner does not occur until the construction loan is closed (or shortly prior thereto), it is unlikely that Interim will prevail on treating the 10% limited partnership interest as a bona fide commitment fee.

2. The partnership interest should be valued at the time it is received and that value should be treated as interest spread over the term of the construction loan. See paragraph I.A.2., supra. See paragraph I.B.4., infra, regarding the problem of acceleration.

3. The value of the 10% limited partnership interest is a fact question. Assuming that none of the other partners have a preference return, valuation of the 10% partnership interest will appear relatively simple to a typical juror. If $3,000,000 was paid in by 30 limited partners for what initially was a 50% interest in the partnership, the 100% interest in the partnership should be worth $6,000,000 and a 10% interest worth $600,000. Even if the $6,000,000 is considered diluted by adding an additional 10% sharing ratio (thereby causing the $6,000,000 value to be divided among 110 sharing points, rather than 100 sharing points), the value of the partnership interest will at least on the surface appear to be $545,454. If the other limited partners have a preference return, valuation is more complicated and harder for a typical juror to understand, particularly when complicated mathematical formulae are used. Expert witnesses as to valuation will give conflicting, technically-oriented


testimony which will further confuse a typical juror. Even attributing zero value to the general partners' initial 50% interest in the partnership (due to a preference return to the limited partners), the value of Interim's 10% limited partnership interest should be $300,000 ($272,727 on a diluted basis). A typical juror may find it difficult to understand why the general partners are doing the deal if their partnership interests have zero value.

4. The value of the partnership interest obtained by Interim should be spread over the term of the construction loan. Tanner Dev. Co. v. Ferguson, 561 S.W.2d 777 (Tex. 1977); McConnell v. Merrill, Lynch, Pierce, Fenner & Smith, 21 Cal.3d 365, 146 Cal. Rptr. 371, 578 P.2d 1375 (1978). Thus, if the value of the partnership interest, together with interest denominated as such and any other consideration deemed interest under applicable law, does not exceed the usury ceiling for the full stated term of the loan, based on the principal balance from time to time outstanding, Interim's receipt of the 10% limited partnership interest should not create a usury problem, absent prepayment and acceleration.

a. Even if the value of the partnership interest could be spread over the expected term of the loan, prepayment by Borrower or acceleration by Interim could result in a shorter actual loan term such that, for the actual period the funds are outstanding, the value of the partnership interest could not be "absorbed" without exceeding the applicable usury ceiling. In a construction loan this is a particular problem because the term of the loan is relatively short and the outstanding principal balance is relatively small in the early months.

b. For example, assume that Contractor seeks Chapter 11 protection six months after the loan is closed, the usury ceiling is 18% per annum, the weighted average outstanding principal balance during that time period is $3,000,000 and the fixed interest has been a constant 11% per annum. Thus, Interim's "spreading room" is only is 7% per annum on $3,000,000 for six months, or $105,000.

c. If Interim were to accelerate maturity of the construction loan at the end of six months, and if the value of the partnership interest is $600,000, Interim will have to rebate $495,000 to avoid charging or receiving usurious interest, even if the construction loan would not have been usurious had it gone its full term and the full $9,000,000 had been advanced. Interim may believe that a value of $300,000 is more realistic than the $600,000 value Borrower would no doubt be proposing for Interim's 10% limited partnership interest. If the value of Interim's limited partnership interest is only $300,000, the rebate will be only $195,000. But if Interim accelerates maturity of the construction loan, Interim will have to make the rebate before Interim knows what the jury will find as the value of the partnership interest. In light of the severe penalties for


violating the usury law, Interim should be very cautions in determining the amount of the rebate; it could be quite expensive to guess wrong about what the jury's fact finding will be.

d. The calculations set forth above assume that the value of the partnership interest will not be treated as a front-end discount. Front-end cash payments will normally be treated as front-end discounts to determine a "true principal amount" for spreading computation purposes. See Tanner Dev. Co. v. Ferguson, supra; Nevels v. Harris, 129 Tex. 190, 102 S.W.2d 1046, 109 A.L.R. 1464 (1937). But see Band Realty Co. v. North Brewster, Inc., 37 N.Y.2d 460, 373 N.Y.S.2d 97, 325 N.E.2d 316 (1975). Logically, the value of the partnership interest, which is not the equivalent of a cash payment by Borrower to Interim, should not be treated as a front-end discount even though it is treated as interest with respect to the loan. However, precedent on this issue is virtually non-existent and what little case law exists may deal with thinly disguised attempts to obtain front-end cash payments. See, e.g., Commerce Sav. Assn. v. GGE Management Co., 539 S.W.2d 71 (Tex. Civ. App.--Houston [1st Dist.] 1976), modf'd and aff'd, 543 S.W.2d 862 (Tex. 1976) (involving lender's profit on the "flipping" of property to the borrower). If the value of the partnership interest is treated as a front-end discount, the usury problem is exacerbated and the amount of the necessary rebate will be greater.

e. A typical usury savings/rebate paragraph will permit the lender to make the rebate by crediting the excessive amount on the principal balance of the loan at the time of acceleration or prepayment (rather than writing a separate check to the defaulting borrower). See also Tex. Rev. Civ. Stat. Ann. art. 5069-1.07(a), dealing with spreading of interest on Texas real estate loans and requiring a rebate in the case of prepayment; the statute is silent about the obligation (and the right) to make a rebate in the context of acceleration. Whether Interim has to write a check or has to take a reduction in the principal balance at the time of acceleration, Interim is facing the prospect of a loss of $495,000 merely from this rebate if it accelerates at the end of six months based on these numbers (including the $600,000 value for the partnership interest it received). Interim's analysis of whether to insist upon the $1,000,000 completion deposit should be tempered by the prospect of writing off approximately half that amount merely to avoid usury penalties even if Borrower were willing and able to pay the loan in full upon acceleration. The longer the loan remains outstanding, and the more money that is advanced on the loan, Interim's potential usury problem and/or rebate obligation will become less.


f. If Interim does not make the rebate, Interim may suffer severe usury penalties. Based on the numbers set forth above, including an 18% per annum usury ceiling, the total interest received by Interim during the first six months of the construction loan is $765,000 ($165,000 of interest denominated as such and $600,000 of value attributable to the partnership interest). The maximum amount which Interim could have received during this six month period based on an 18% per annum usury ceiling is $270,000. Thus, the interest received during the six month period is more than double the amount permitted by law. Under Tex. Rev. Civ. Stat. Ann. art. 5069-1.06, if Interim made no rebate Interim would not only forfeit three times the usurious portion of the interest received (the penalty for exceeding the usury ceiling) and reasonable attorneys' fees, but also forfeit principal (the penalty for exceeding double the usury ceiling). In addition, the loan would be an "unlawful debt" for RICO purposes. 18 U.S.C. § 1961 (6). The $765,000 figure is the equivalent of 51% per annum on the $3,000,000 average outstanding principal balance for a six month period. If Interim made a rebate of $195,000, gambling that its 10% limited partnership interest was worth only $300,000, and the jury later found the value to be $600,000, the total interest received by Interim after giving effect to the $195,000 rebate would still be $570,000, more than double the lawful amount.

g. Because the value of the partnership interest was determined at the inception of the loan, the fact that the problems of Contractor, Inc. and its concrete subcontractor and Tenant Corporation may have made Interim's partnership interest virtually worthless does not give Interim any relief from its usury problem. Furthermore, the author has been unable to locate any case which has permitted a lender to make a rebate, or to pay usury penalties, in property other than cash. Accordingly, Interim cannot merely give back its partnership interest and solve its serious usury problem.

C. Proposed Management Fee to Life Management.

1. Under the collateral advantage doctrine, if, as a condition of a loan, the Borrower is required to purchase property from the lender at more than its fair market value, or sell property to the lender at less than its fair market value, the difference may be considered interest on the loan. C.C. Slaughter Co. v. Eller, 196 S.W. 704 (Tex. Civ. App.--Amarillo 1917, writ ref'd). See also Mission Hills Dev. Corp. v. Western Small Business Inv. Co., 260 Cal. App. 2d 923, 67 Cal. Rptr. 505 (1968).

2. There are numerous cases holding that a profitable collateral transaction will not render the loan usurious if the collateral transaction is independent of the loan and supported by independent consideration. See, e.g., Boyd v. Head, 443 P.2d 473 (Idaho 1968); Freedom Oil Works Co. v. Williams,


152 A. 741 (Pa. 1930). However, this ultimately depends upon a fact question.

3. Because Life is requiring Borrower to use Life Management, it is highly unlikely that a judge or jury will find the transactions independent. Accordingly, the issue will be whether Borrower is required to pay more for Life Management's services than their fair market value. Presumably fair market value could be determined by comparing the fees charged by unrelated third parties for similar services.

4. Assuming that Life Management's fees are within the ballpark of independent contract management companies, this aspect should not create a usury problem. However, the possible differential between the fees charged and the "fair market value" of those fees needs to be taken into account in determining how much Life can receive with respect to its 40% contingent interest in the project.

D. Life's Proposed Option to Purchase.

1. The usury analysis is similar to that of the proposed management fee to Life Management and the 10% limited partnership interest to Interim. The issue will be: what is the value of an option to purchase the project when the purchase price is fair market value? This is a fact question.

2. The fact that Life is demanding the option as a condition to not terminating the commitment suggests that it has some value.

3. The option to purchase may also create a clog on Borrower's equity of redemption.

E. Interim's Proposed Cross-Collateralization with Good Loan.

1. A lender who requires, as a condition to making a loan to a borrower (or extending the term of a loan to a borrower), that the borrower assume a third party's debt (as distinguished from a requirement that the borrower pay another one of the borrower's own debts), must include the amount of the third party's debt in the interest computation. Alamo Lumber Co. v. Gold, 661 S.W.2d 926 (Tex. 1983); Laid Rite, Inc. v. Texas Industries, Inc., 512 S.W.2d 384 (Tex. Civ. App.--Ft. Worth 1974, no writ). See Annotation, Usury: Effect of Borrower's Agreement to Pay, Guarantee, or Secure Some Other Debt Owed to or By Lender, 31 A.L.R. 3d 763 (1970). The Alamo Lumber problem is not unique to Texas.

2. Alamo Lumber dealt with a requirement that a borrower assume an existing debt of a third party to the lender. It did not deal with the requirement that the borrower guarantee a pre-existing debt of a third party. Nor did it deal with a requirement that a borrower pledge collateral to secure a pre-existing debt of a third party to the lender. Applying the Alamo Lumber holding to the guarantee and cross-collateralization situations would be extensions of the Alamo Lumber doctrine which have not yet been specifically addressed at least by the Texas courts. Arguably, guaranteeing a debt or pledging collateral to secure a debt can be


distinguished from assuming a debt if for no other reason on the basis of the subrogation rights of the guarantor or pledgor.

3. If the cross-collateralization is not distinguishable from an assumption, and if Interim requires Good Partnership to give a second lien on Good Partnership's property as security for Borrower's construction loan as a condition to giving a one-year extension of the maturity of the Good Loan, the full amount of the construction loan would be additional interest on the $2,000,000 Good Loan, thereby creating enormous usury penalties on the Good Loan, including forfeiture of principal. The Good Loan would also be an "unlawful debt" for RICO proposes.

4. If the Alamo Lumber doctrine were extended to cross-collateralization, Interim could avoid contracting for usurious interest by mathematically limiting the amount of the construction loan which is secured by Good Partnership's collateral. Obviously, the loan documents relating to the extension of the Good Loan would have to deal with the possibility of prepayment or acceleration of maturity of the Good Loan. This would have the effect of reducing the amount of Borrower's debt which could be secured by Good Partnership's property. The key issue is how much of Borrower's debt is secured by Good Partnership's property. The "safe harbor" amount is determined by a mathematical formula which is not always easy to describe. That formula is particularly difficult to describe when the Good Loan bears interest at a variable interest rate.

5. The lender's request that a Borrower assume a third party's debt in connection with the extension of the Borrower's loan did not constitute charging usurious interest at least where the lender actually did renew the Borrower's loan notwithstanding the Borrower's refusal to go along with the request. Dodson v. Citizens State Bank of Dalhart, 701 S.W.2d 89 (Tex. App.--Amarillo 1986, no writ). Accordingly, Interim's demand that Good Partnership give Interim a second lien on its property as security for Borrower's construction loan, as a condition to extending the maturity of the Good Loan, should not create a usury problem, at least if Interim in fact does extend the maturity of the Good Loan in the face of Good Partnership's refusal to go along with this proposal.

6. Even though the requirement that Good Partnership give a lien on its property to secure the Borrower's construction loan may create a usury problem under Alamo Lumber, Interim's requirement that Able and Baker pledge their respective general partnership interests in Good Partnership as collateral for their guaranty of lien-free completion of Borrower's project should not create a usury problem. Nor should any requirement that Bubba Developer pledge his own collateral to secure performance of his guaranty create any usury problem. Requiring a borrower to pay his own undisputed prior obligation to the lender, as part of the consideration for a new loan, does not render the loan usurious. See, e.g., Dorfman v. Smith, 517 S.W.2d 562 (Tex. Civ. App.--Houston [14th Dist.] 1974, no writ). Likewise, a lender's requirement, as a condition to the approval of a new


loan, that an existing personal loan to the proposed guarantor of the new loan be paid off does not establish usury so long as the lender does not require the borrower or any other guarantor of the new loan to pay off the first guarantor's existing loan. Stephens v. First Bank & Trust of Richardson, 540 S.W.2d 572 (Tex. Civ. App.--Waco 1976, writ ref'd n.r.e.). Logically, requiring a Borrower to provide collateral to secure his existing obligation, or requiring a guarantor to provide collateral to secure his existing guarantee, should not be viewed as an Alamo Lumber problem. The Borrower or guarantor is not being required to pay or agree to pay more than he was already obligated for.

F. Summary of Usury Concerns.

1. Life's right to receive a 40% contingent interest in the project's upside, at least if it is denominated as interest in the promissory note and subject to an overall usury "lid", should not cause Life to change its negotiating position vis-a-vis Borrower. Likewise, increasing the interest rate on its loan should not create a problem so long as the fixed interest rate, together with the contingent interest and other consideration, do not cause the loan to exceed the applicable usury ceiling. Furthermore, the elimination of the non-recourse nature of the permanent loan should not be viewed as a usury concern. Although the general partners (as well as the limited partnership itself) would be exposing all of their assets, and not merely the project itself, to satisfy the permanent loan, they are not being required to assume debt of a third party. Viewed properly, the elimination of the non-recourse nature of the permanent loan merely changes the pool of assets available to satisfy that loan, but does not increase the amount of debt for which Borrower or its general partners will be held liable. See Sunbelt Service Corp. v. Vandenburg, 774 S.W.2d 815 (Tex. App.--El Paso 1989, writ denied).

2. The requirements that Borrower use Life Management and give Life the option to purchase the project for fair market value create additional interest on the permanent loan. These requirements, in and of themselves, should not create a usury problem that should concern Life at this time.

3. Interim's receipt of the 10% limited partnership interest creates a serious usury problem if the loan is prepaid or Interim accelerates maturity. This usury problem exacerbates Interim's other problems and gives Borrower a significant negotiating position because Interim's alternatives are either (i) make an effective rebate of approximately $500,000 or (ii) risk severe usury penalties for failure to make the rebate. Obviously, the value of the limited partnership interest is a question of fact, and Interim should not expect favorable treatment from a jury on this fact question.

4. Interim's demand on Good Partnership that it give a second lien on its property as security for Borrower's construction loan as a condition to Interim's extending the maturity of the Good Loan, creates a severe usury problem with respect to the Good Loan if the Alamo Lumber doctrine is

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extended to the cross-collateralization situation (and not limited to the situation of an assumption of a third party's debt). Interim would be well-advised to withdraw this demand and agree to extend the maturity of the Good Loan without the requirement of cross-collateralization.

II. PARTNERSHIP LAW ISSUES

A. Interim's Proposed Cross-Collaterialization with Good Loan.

1. Uniform Limited Partnership Act ("ULPA") § 9 provides that a general partner has all the rights and powers and is subject to all of the restrictions of a general partner in a general partnership

except that without the written consent or ratification of the specific act by all the limited partners, a general partner or all of the general partners have no authority to: . . . (d) Possess partnership property, or assign their rights in specific partnership property, for other than a partnership purpose, . . .

2. Revised Uniform Limited Partnership Act ("RULPA") § 403 provides that except as otherwise provided in the partnership agreement a general partner in a limited partnership has the rights and powers and is subject to the restrictions of a partner in a general partnership.

3. Uniform Partnership Act ("UPA") § 25 provides that a general partner has no right to possess specific partnership property for any purpose other than partnership purposes without the consent of all of the other partners.

4. Conclusion: Unless the partnership agreement of Good Partnership specifically provides for the pledging of its property to secure the debt of Borrower, Able and Baker lack the authority to give Interim a second lien on Good Partnership's property to secure Borrower's construction loan without the consent of all of the limited partners.

B. Pledge by Able and Baker of Their General Partnership Interests.

1. ULPA § 19 states that a limited partner's interest is assignable. It does not make the interest of a general partner assignable. ULPA § 9 provides that except with the written consent of the specific act by all of the limited partners a general partner cannot admit another person as a general partner. Furthermore, under ULPA § 20 the "retirement" of a general partner dissolves the limited partnership unless the business is continued by the remaining general partners under a right to do so stated in the certificate or with the consent of all of the partners.

2. RULPA § 401 provides that additional general partners may be admitted "as provided in writing in the partnership agreement or, if the partnership agreement does not provide in writing for the admission of additional general partners, with the written consent of all partners."

3. RULPA § 702 provides that, unless the partnership agreement otherwise provides, a partnership interest is assignable. This is not limited to merely

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a limited partnership interest. The assignment entitles the assignee to be allocated income, gain, loss, deduction, credit or similar items and to receive distributions to which the assignor was entitled, to the extent that these items are assigned, but until the assignee becomes a partner the assignor continues to be a partner and to have the voting rights associated with being a partner. However, on the assignment by a general partner of all of the general partner's rights as a general partner, the general partner's status as a general partner may be terminated by the affirmative vote of a majority in interest of the limited partners.

4. It is unlikely that Interim wants to be and have all of the liabilities of the general partner of Good Partnership. Interim may not have regulatory authority to act as a general partner of a limited partnership such as this. Being a general partner may create equitable subordination problems in the event of a bankruptcy or insolvency of Good Partnership. Being a general partner of Good Partnership would make Interim an "insider" under the Bankruptcy Code with respect to Good Partnership.

5. Conclusion: If Interim wants access to some of the equity in Good Partnership's assets, the least dangerous way to gain that access, albeit very limited access, is to require Able and Baker, in connection with the workout of Borrower's construction loan (and not as a condition to extending Good Partnership's loan), to pledge to Interim Able's and Baker's right to receive 99% of the distributions to be made to the general partners pursuant to the partnership agreement of Good Partnership. It does not give Interim access to all of the equity in Good Partnership's property. Indeed, Able and Baker collectively may own only a 5% interest in Good Partnership.

C. Interim's Status as a Limited Partner in Borrower.

1. ULPA § 13 provides, in relevant part, as follows:

a. A limited partner also may loan money to and transact other business with the partnership, and, unless he is also a general partner, receive on account of resulting claims against the partnership, with general creditors, a pro-rata share of the assets. No limited partner shall in respect to any such claim

(1) receive or hold as collateral security any partnership property, or

(2) receive from a general partner or the partnership any payment, conveyance, or release from liability, if at the time the assets of the partnership are not sufficient to discharge partnership liabilities to persons not claiming as general or limited partners.

b. The receiving of collateral security, or a payment, conveyance or release in violation of the provisions of paragraph (1) is a fraud on the creditors of the partnership.

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The juxtaposition of the language "if at the time the assets of the partnership are not sufficient" has caused some commentators to question whether that language modifies both subsection (a) and subsection (b) or only subsection (b). Generally courts have held that if the partnership was not insolvent and was not rendered insolvent at the time the lien on partnership assets was granted to the limited partner-creditor, the limited partner's lien is permitted. Hughes v. Dash, 309 F.2d 1 (5th Cir. 1962); A.T.E. Financial Services, Inc. v. Corson, 268 A.2d 73 (N.J. Ch. Div. 1970). See also Kravotil and Werner, Fixing-Up the Old Jalopy - the Modern Limited Partnership Under the ULPA, 50 St. John's L. Rev. 51 (1975). Because the partnership owned the land free of debt and the lien in favor of Interim is to secure only the funds advanced for development of the project, Borrower should be viewed as not being insolvent or rendered insolvent by the granting of the lien.

2. RULPA § 107 provides as follows:

Except as provided in the partnership agreement, a partner may lend money to and transact other business with the limited partnership and, subject to other applicable law, has the same rights and obligations with respect thereto as a person who is not a partner.

RULPA § 805 provides that, upon winding up of a limited partnership, the first priority of distribution of assets is to creditors of the partnership, including partner-creditors. Thus, under RULPA, subject to any limitations stated in the partnership agreement (which presumably Interim reviewed carefully before it closed the construction loan), Interim could obtain a lien on Borrower's assets (the project) and not be subject to the pro-rata sharing on liquidation provided in ULPA § 23 (or the subordination imposed in UPA § 40, which subordinates partner-creditors to other creditors in order of priority of payment upon dissolution of the partnership).

3. UPA § 21 creates certain fiduciary obligations upon general partners in a general partnership. There is no comparable statutory duty of loyalty by limited partners to other limited partners, general partners or the limited partnership itself.

4. The taking of a 10% limited partnership interest by Interim should not make Interim an "insider" under the Bankruptcy Code.

5. Conclusion: Interim's status as a limited partner should not preclude Interim from taking and enforcing a lien on the project, should not subject it to any fiduciary obligation to the partnership arising out of the partnership statutes, and should not cause Interim to be an "insider" under the Bankruptcy Code. But see discussion at paragraph VI F.3.C., infra.

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III. BANK TYING ACT ISSUES

A. The Bank Tying Act, 12 U.S.C. § 1972 (1) et seq., and comparable (albeit not identical) language in 12 U.S.C. § 1464(q) applicable to savings associations, generally prohibit a bank or savings association from conditioning an extension of credit upon the requirement that the customer provide some additional property, service or credit to the lender other than that which is usually provided in connection with a loan, or is consistent with "traditional banking practice". Among other remedies provided by these statutes, a person who is injured in its business or property by reason of a violation of the typing statute may file suit in the federal district courts and may recover three times the amount of damages sustained by him and the cost of suit, including reasonably attorneys' fees. Civil penalties of $1,000 per day for violations may be assessed against persons participating in the conduct of the affairs of the bank, such as officers, directors, employees and agents.

B. A lender trying creative solutions to a loan workout may find itself doing something which does not constitute "traditional banking practice", thereby subjecting itself to potential liability under the tying acts. What constitutes "traditional banking practice" is frequently a fact-intensive question. In a trial, the borrower and the lender may each put on expert witnesses as to what does and does not constitute a "traditional banking practice". The trier of fact may have broad discretion as to whether any particular act constitutes a "traditional banking practice".

C. Requiring Good Partnership to pledge its assets to shore-up the collateral shortfall on Borrower's construction loan may violate the tying acts as a requirement "that the customer [Good Partnership] provide additional credit . . . to such association [Interim] . . . other than those related to and usually provided in connection with a similar loan, . . ." U.S.C. § 1464(q)(1)(B).

D. The requirement that Borrower give a 10% limited partnership interest to Interim may likewise constitute a requirement "that the customer [Borrower] provide additional . . . property . . . to such association [Interim] . . . other than those related to and usually provided in connection with a similar loan, . . ." 12 U.S.C. § 1464(q)(1)(B).

E. If Interim had required Borrower to use its wholly-owned management company (as Life is indicating it will require), Interim may be in violation of 12 U.S.C. § 1464(q)(1)(A) for requiring "that the customer shall obtain additional . . . service from such association, or from any service corporation or affiliate of such association, other than a loan, . . .".

F. If Contractor, Inc. were an affiliate of Interim (an unlikely situation), Borrower may allege a violation of 12 U.S.C. § 1464(q)(1)(A) and (C) based on an allegation that Interim required Borrower to obtain construction services from an affiliate of Interim and that Borrower not obtain construction services from a competitor of Contractor, Inc. (i.e., Developer Construction Company).

IV. GUARANTY ISSUES

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A. Traditionally guarantors were considered the favorites of the law, and anything done by a lender (or other beneficiary of a guaranty agreement) which altered the risk of the guarantor might have the effect of releasing or otherwise excusing the guarantor from performance under the guaranty agreement.

B. Modern guaranty agreements typically contain lengthy provisions attempting to waive the benefit of the protections afforded by the common law to a guarantor and making clear that a guarantor has personal liability notwithstanding the occurrence of the types of events which traditionally may have released the guarantor from liability. The guarantor's obligation under a modern guaranty agreement generally is equivalent to that of a primary obligor, albeit subject to traditional rights of subrogation (unless those rights are expressly waived). Modern case law increasingly recognizes and gives effect to these waivers, at least where the guarantor is a sophisticated business person represented by counsel.

C. So long as Developer remains a general partner of Borrower, any workout proposal will require Developer's joinder, including a ratification of his all-inclusive guaranty. If Developer is removed as a general partner in Borrower, as a result of the demands of Life, Able and Baker or the limited partners, it is likely that Developer insist upon receiving a complete release of liability. Furthermore, if Developer is removed as a general partner in Borrower, it is likely that the value of Developer's guaranty will be less than originally anticipated.

D. Able and Baker guaranteed only lien-free completion of the project, not payment of principal and interest or performance of other obligations of the Borrower. A completion guaranty would typically provide, as one of the conditions to the guarantor's liability, that the construction lender advance funds pursuant to and subject to all of the terms and conditions in the construction loan agreement.

1. Able and Baker will claim that their liability under the completion guaranty is released if Interim refuses to advance further funds for construction.

2. Interim will answer that it is complying with the terms and conditions of the construction loan agreement, one of which requires a completion deposit when it is apparent (or at least if in the judgment [good faith judgment, reasonable judgment, sole discretion] of Interim [and the independent supervising architect] it appears) that the unadvanced portion of the construction line items in the budget are insufficient to complete construction of the project. Accordingly, Interim will argue that Interim is advancing funds in accordance with the construction loan agreement but, under the facts presented, the construction loan agreement expressly permits Interim to withhold further advances until the completion deposit is made.

3. Able and Baker's next response is that, in light of Interim's "insistence" that Contractors, Inc. be used as the general contractor and Interim's "refusal to allow" Borrower to obtain a payment and performance bonds, and the fact that the present "imbalance" in the budget (i.e., inability to

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complete the project with the remaining construction funds) is due to the bankruptcy of Contractor, Inc. and its concrete subcontractor, Interim should not be permitted to rely on the completion deposit paragraph to permit Interim to both (i) refuse to advance funds until the $1,000,000 completion deposit is provided and (ii) insist that Able and Baker cause construction to be completed lien-free. Able's and Baker's argument may be based on theories of estoppel, duty of good faith and fair dealing, "Catch 22" or chutzpah.

4. Able and Baker may also contend that their completion guaranty should be released based upon the general contractual principle that it is inequitable for a party [Interim] to insist on the satisfaction of a condition [lien-free completion] if that party [Interim] has made it impossible for the condition to be achieved.

5. Unless their guaranty agreement specifically covers the obligation to make the completion deposit as and when required pursuant to the construction loan agreement, Able and Baker may also argue that they have no liability under their guaranty agreement until Interim has advanced all of the funds budgeted for construction under the construction loan agreement. But that argument may merely delay the day of reckoning for Able and Baker.

E. Able and Baker may take a totally different approach based on an argument that the value of the collateral is now more than sufficient to satisfy the existing construction loan balance, especially in light of the fact that the land, worth $3,000,000 alone and paid for out of the limited partners' capital contributions, is part of the collateral. Under this approach, Able and Baker may contend that if Interim were to foreclose now Interim would suffer no loss. By delaying foreclosure the value of the collateral in relationship to the loan balance may decline. So long as Interim is "made whole" out of the foreclosure proceeds, Interim should have no claim against Able and Baker on their completion guaranty. See Coleman v. FDIC, 762 S.W.2d 243 (Tex. App.--El Paso 1988, writ granted) (guarantors of a loan secured by real property argued that the FDIC wrongfully delayed its foreclosure, that the collateral values declined during the delay, that this delay created a deficiency and that the delay was a breach of the FDIC's duty of good faith to the guarantors, thereby releasing the guarantors from liability for the deficiency). Obviously, the limited partners would be most unhappy with Able and Baker for encouraging Interim to foreclose, especially in light of the fact that Able and Baker received their 10% partnership interest in Borrower at least in part as consideration for arranging the limited partners' investment in Borrower.

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V. CONFLICT OF LAWS ISSUES

A. Restatement (Second) of Conflict of Law (1971).

1. Restatement (Second) of Conflict of Law (1971) (cited herein as "Restatement/Conflict") § 187 provides, in relevant part, that the law of the state chosen by the parties to govern their contractual rights and duties will be applied . . . unless either

a. the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties choice, or

b. application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.

2. Restatement/Conflict § 188 provides, in relevant part, as follows:

a. The rights and duties of the parties with respect to an issue in contract are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the transaction and the parties under the principles stated in § 6.

b. In the absence of an effective choice of law by the parties (see § 187), the contacts to be taken into account in applying the principles of § 6 to determine the law applicable to an issue include:

(1) the place of contracting,

(2) the place of negotiation of the contract,

(3) the place of performance,

(4) the location of the subject matter of the contract, and

(5) the domicile, residence, nationality, place of incorporation and place of business of the parties.

These contacts are to be evaluated according to their relative importance with respect to the particular issue.

3. Restatement/Conflict § 195 provides in relevant part as follows:

The validity of a contract for the repayment of money lent and the rights created thereby are determined, in the absence of an effective choice of law by the parties, by the local law of the state where the contract requires that repayment be made, unless, with respect to the particular issue, some other state has a more significant relationship under the principles stated in § 6 to the transaction and the parties, in which event the local law of the other state will be applied.

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4. Restatement/Conflict § 203 provides as follows:

The validity of a contract will be sustained against the charge of usury if it provides for a rate of interest that is permissible in a state to which the contract has a substantial relationship and is not greatly in excess of the rate permitted by the general usury law of the state of the otherwise applicable law under the rule of § 188.

5. Restatement/Conflict § 145 provides as follows:

a. The rights and liabilities of the parties with respect to an issue in tort are determined by the local law of the state which, with respect to that issue, has the most significant relationship to the occurrence and the parties under the principles stated in § 6.

b. Contacts to be taken into account in applying the principles of § 6 to determine the law application to an issue include:

(1) the place where the injury occurred,

(2) the place where the conduct causing the injury occurred,

(3) the domicil, residence, nationality, place of incorporation and place of business of the parties, and

(4) the place where the relationship, if any, between the parties is centered.

These contacts are to be evaluated according to their relative importance with respect to the particular issue.

B. Construction Loan.

1. If Interim is located in Texas, Borrower is a Texas limited partnership whose general partners are located in Texas and the project is located in Texas, Texas law will govern the relationship between Borrower and Interim.

2. If Interim is located in a state with no usury ceiling on loans such as this, Interim's usury problem will be solved by 12 U.S.C. § 1730g(a) which permits an insured savings institution to charge interest "at the rate allowed by the laws of the state . . . where such institution is located, . . ." Gavey Properties/762 v. First Financial Sav. & Loan Ass'n, 845 F.2d 519 (5th Cir. 1988). See also Marquette Nat'l Bank v. First of Omaha Service Corp., 439 U.S. 299, 99 S. Ct. 540, 58 L. Ed. 2d 534 (1978) (dealing with 12 U.S.C. § 85 which is applicable to national banks). 12 U.S.C. § 1831d contains comparable language; it relates to state banks, insured savings banks, insured mutual savings banks and insured branches of foreign banks.

3. If Interim is not located in Texas, Interim will have to contend with Section 9.03 of the Texas Savings and Loan Act, Tex. Rev. Civ. Stat. Ann. art. 852a which provides as follows:

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Any contract made by any foreign association with any citizen of this State shall be deemed and considered a Texas contract and shall be construed by all courts of this State according to the laws of this State.

C. Permanent Loan.

1. The permanent loan commitment provides for New York law to govern the commitment as well as all of the loan documents (except the deed of trust).

2. Nothing in the hypothetical fact situation suggests a contact with New York. None of the parties are located in or are organized under the laws of the state of New York. The closest contact to New York is Life which is a Connecticut corporation headquartered in Hartford.

3. Many lender liability claims are based on tort theories. Even if a court were to uphold the validity of the New York choice of law provision in the permanent loan commitment as to issues of contractual interpretation and breach of contract, the court may nevertheless apply Texas law to the determination of whether Life has engaged in fraud, duress and interference with contractual relationships, which are commonly espoused tort-based theories in the world of lender liability.

4. Even as to contractual-based issues, the court may refuse to give effect to the New York choice of law provision under Restatement/Conflict § 187 either due to an absence of a substantial relationship to the parties or the transaction or because doing so may be contrary to a fundamental policy of the State of Texas. DeSantis v. Wackenhut Corp., 31 Tex. Sup. Ct. J. 616 (July 13, 1988) (motion for rehearing pending).

5. Application of Texas law is all the more likely because Borrower, its general partners, the project and all (or a significant portion of) the limited partners are located in Texas, and Life will no doubt have some operations in Texas. Certainly the suit against Life will be brought in Texas.

VI. LENDER LIABILITY ISSUES

A. Lender liability cases tend to involve complex facts and the results tend to be fact-specific. The case law has developed rapidly over the past decade and there has been a plethora of law review articles, newsletters and loose leaf services dealing with the subject. This outline will not address these issues in depth, and will include citations to only a handful of the cases and commentaries.

B. Theories of lender liability are limited only by the imagination of borrowers, guarantors, limited partners and their attorneys. Commonly used theories include: breach of contract; breach of fiduciary duty; breach of duty of good faith and fair dealing; fraud; duress; tortious interference; control of the Borrower; and negligence in processing, making or administering the loan. The theories are often overlapping and interrelated and are based on similar facts. Different courts sometimes use different theories to reach the same result on the same set of facts.

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C. Lender liability is sometimes predicated, in whole or in part, on violation of statutes such as the bank and savings association tying acts discussed in Article III, supra, RICO (Racketeering Influenced Corrupt Organization Act, 18 U.S.C. §§ 1961-68), state deceptive trade practice acts such as the Texas Deceptive Trade Practices-Consumer Protection Act, Tex. Bus. & Com. Code Ann. §§ 17.41-17.63, and the Uniform Commercial Code. Usury claims are often raised in lender liability cases. Often the facts necessary to establish a violation of a statute may also establish one of the common law theories. Alternatively, facts which may not fit neatly within the requirements of a statute may nevertheless be sufficient to satisfy one of the common law theories of liability.

D. Many of the lender liability theories are based in tort, not in contract. The distinction may have importance in terms of applicable statutes of limitations, conflict of law rules and the availability of attorneys' fees and exemplary or punitive damages.

E. Jurors, or the general public, may react negatively just to the accusations against the lender. For example, jurors may develop a particular reaction when told that a savings association is accused of fraud, duress, tortious interference, lack of good faith and violation of usury, racketeering and deceptive trade practice legislation. Some financial institutions (or at least their officers and directors) may be sensitive to merely being publicly accused of that type of conduct.

F. Some Lender Liability Theories Possibly Applicable to These Facts.

1. Duress.

a. Restatement (Second) of Contracts § 176 (1981) provides, in relevant part, that:

(1) A threat is improper if . . .

(d) the threat is a breach of the duty of good faith and fair dealing under a contract with the recipient.

(2) A threat is improper if the resulting exchange is not on fair terms, and . . .

(c) what is threatened is otherwise a use of power for illegal ends.

b. With respect to the Good Loan, Good Partnership may contend that Interim's implicit threat to not extend the maturity of its loan for an additional year unless it gives Interim a second lien on its assets as security for Borrower's troubled construction loan, constitutes duress. While Interim may otherwise have no obligation to extend the maturity of the Good Loan, its expressed willingness to do so conditioned on the granting of the second lien to secure Borrower's construction loan indicates that Interim is willing (and has presumably made the decision that it would be prudent to) extend the maturity of the Good Loan.

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c. Interim's demand for the $1,000,000 completion deposit should not constitute duress if it is authorized under the construction loan documents and Interim can clearly establish that $1,000,000 is the correct amount. But factual findings by the jury on other issues could be used to also establish duress.

d. Life's threat to terminate its commitment unless Bubba is removed as the general partner of Borrower and Life is given an option to buy Borrower's project at fair market value upon completion of construction, and Life's requirement of the use of Life Management to manage the project, may constitute duress, particularly in light of the fact that Life had no right to insist upon those matters as a condition to leaving its commitment in effect (as distinguished from increasing the dollar amount of and changing the terms and conditions of its commitment).

2. Breach of fiduciary duty/duty of good faith and fair dealing.

a. Generally the relationship between a borrower and a lender is a debtor-creditor relationship and does not create a fiduciary duty between the lender and the borrower. In Re Letterman Bros. Energy Securities Litigation, 799 F.2d 967 (5th Cir. 1986); In Re W.T. Grant Co., 699 F.2d 599 (2nd Cir. 1983); and Dennison State Bank v. Medeira, 640 P.2d 1235 (Kan. 1982). But see Commercial Cotton Co. v. United California Bank, 163 Cal. App. 3d 511, 209 Cal. Rptr. 551 (Ct. of App. 1985) ("quasi-fiduciary" duty exists between a bank and its depositor). See also Annotation, Existence of Fiduciary Relationship Between Bank and Depositor or Customer so as to Impose Duty of Disclosure Upon Bank, 70 A.L.R. 3d 1344 (1976).

b. A lender's participation in the control of the borrower's business may impose certain duties of good faith and fair dealing. See discussion in paragraph VI.F.3., infra.

c. Borrower may argue that other factors, in addition to the mere debtor-creditor relationship, establish a fiduciary relationship:

(1) Interim is a partner in Borrower. But neither the ULPA nor the RULPA create a fiduciary duty of a limited partner to the partnership, and RULPA § 107 permits a partner to deal with the partnership as if it were a non-partner creditor. See discussion at paragraph II.C., supra.

(2) Jimmy Johnson is a partner in Johnson & Ryan, the limited partnership's attorneys, as well as a director of Interim. The hypothetical facts do not indicate that Johnson & Ryan represented Interim, that Jimmy Johnson was personally involved in (or knew about) the firm's representation of Borrower, or that Jimmy Johnson was personally involved

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as a director in any of Interim's decision-making regarding Borrower's construction loan.

d. Uniform Commercial Code § 1-203 provides that "Every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement." Uniform Commercial Code § 1-201(19) defines "good faith" as "honesty in fact in the conduct or transaction concerned".

e. Although it is not in a borrower/lender context, LaSara Grain Co. v. First Nat. Bank of Mercedes, 673 S.W.2d 558 (Tex. 1984), dealt with a bank's duty of good faith in the context of honoring a check presented for payment. The court adopted the so-called "actual belief" test of good faith: "[the] test for good faith is the actual belief of the party in question, not the reasonableness of that belief." Id. at 563. This subjective test for good faith could expand potential lender liability exposure.

f. The common law of the state may not negate a general duty of good faith (at least outside specific statutory contexts or special relationships). In English v. Fischer, 660 S.W.2d 521 (Tex. 1983), the Texas Supreme Court refused to impose an implied covenant of good faith where a lender had refused to allow a borrower to use fire insurance proceeds to rebuild.

This concept is contrary to our well-reasoned and long-established adversary system which has served us ably in Texas for almost 150 years. Our system permits parties who have a dispute over a contract to present their case to an impartial tribunal for a determination of the agreement as made by the parties and embodied in the contract itself. To adopt the laudatory sounding theory of "good faith and fair dealing" would place a party under the onerous threat of treble damages should he seek to compel his adversary to perform according to the contract terms as agreed upon by the parties. The novel concept advocated by the courts below would abolish our system of government according to settled rules of law and let each case be decided upon what might seem "fair and in good faith" by each fact finder.

Id. at 522. It should be noted that the Texas Supreme Court has applied a duty of good faith and fair dealing between an insurer and its insured. Arnold v. Nat. County Mutual Fire Ins. Co., 725 S.W.2d 165 (Tex. 1987).

g. Courts often recite that acceleration is a harsh remedy and impose limitations on a lender's right to accelerate a loan. See Patterson, Good Faith, Lender Liability and Discretionary Acceleration: of Llewellyn, Wittgenstein, and the Uniform Commercial Code, 68 Tex. L. Rev. 169 (1989). Uniform Commercial Code § 1-208 permits a lender to exercise his right to accelerate maturity or require additional collateral "at will" or "when he deems himself insecure" "only if he in good faith believes that the prospect of payment or performance is impaired." In characterizing the then existing Texas case law, the court in State Nat. Bank of El Paso v. Farah Mfg. Co. 678 S.W.2d 661 (Tex. App.--El Paso 1984, writ

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dism'd by agr.) (cited herein as "Farah"), stated that "Acceleration clauses are not to be used offensively such as for the commercial advantage of the creditor. They do not permit acceleration when the facts make its use unjust or oppressive." Id. at 685. Interim's acceleration of maturity, or threat to do so, if the $1,000,000 completion deposit is not made by Borrower maybe the fulcrum a court to create a special duty of good faith and fair dealing in exercising acceleration options and then find a violation of that duty.

3. Lender control.

a. Some courts have found lenders liable, under an implied duty of good faith and fair dealing or a fiduciary duty or other theories, where the lender has exercised control over the borrower's business. Generally, in order to establish this fiduciary duty the lender must become deeply involved in the management of Borrower's business, almost on a day-to-day basis. See, e.g., Krivo Ind. Supply Co. v. Nat. Distillers and Chemical Corp., 483 F.2d 1098 (5th Cir. 1973), reh'g denied, 490 F.2d 916 (5th Cir. 1974) ("actual, participatory, total control of the debtor [by lender]" may impose fiduciary duty); In Re American Lumber Co., 7 Bankr. 519 (Bankr. D.C. Minn. 1979).

b. Control over the borrower's finances may create a fiduciary duty to continue funding the borrower's operations. See K.M.C. Co. v. Irving Trust Co., 757 F.2d 752 (6th Cir. 1985).

c. A lender's recommendation that a borrower hire a particular person or company (at least if it is unrelated to the lender) has been held insufficient in and of itself to constitute a domination of the borrower, even though the bank threatened to call its outstanding loans if the borrower failed to comply. In Re Prima Co., 98 F.2d 952 (7th Cir. 1938).

d. In Farah, supra, the lenders' threat to call the loan if William Farah were elected chief executive officer and threats regarding the election of certain unacceptable directors, subjected the lender to liability under theories of fraud, duress and tortious interference. The case involves bad facts, including representatives of the lender making threats to take certain actions which the lender group had not yet decided it would take.

e. A lender's participation in the day-to-day management and control of the borrower may also subject the lender to liability in tort or in contract for claims against the borrower, either under a theory that the lender and borrower were joint venturers or that the borrower was an agent or instrumentality of the lender. See, e.g., A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285 (Minn. 1981);

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and Conner v. Great Western Sav. & Loan Ass'n, 69 Cal. 2d 850, 447 P.2d 609, 73 Cal. Rptr. 369 (Cal. 1968).

f. Borrower's allegation here will be that (w) Life insisted that Borrower lease the space to Tenant Corporation, rather than the competing tenant, (x) Interim refused to allow Borrower to use Developer Construction Company, (y) Interim insisted that Borrower use Contractor, Inc., and (z) Interim refused to allow Borrower to obtain performance and completion bonds.

(1) Interim may have had very legitimate reasons for refusing to allow Developer Construction Company to be the general contractor. It may have lacked adequate capital. It may have been inexperienced in constructing buildings such as this. Interim may have been concerned about the "coziness" of having Bubba's wholly-owned company act as general contractor and the resulting absence of the usual "checks and balances" between the developer and the general contractor.

(2) Interim recommended that Borrower use Contractor, Inc. Interim did not require that Contractor, Inc. be used.

(3) Interim did not prohibit Borrower from obtaining performance and completion bonds. Nor did Interim recommend that performance and completion bonds not be obtained. Interim merely declined to fund the cost of the bonds and did not require that bonds be obtained. Frequently developers will not obtain bonds unless they are required by the construction lender.

(4) Life had a legitimate interest in knowing who the tenant of 25% of the space would be, and the financial strength of that tenant.

(5) There is no indication in the facts that Interim knew of the potential financial problems of Contractor, Inc. or its concrete subcontractor. Nor do the facts indicate that either Contractor, Inc. or the concrete subcontractor was owned by Interim or Interim's controlling shareholders, directors or officers, or that either Contractor, Inc. or the concrete subcontractor was in debt to Interim and needed the profit (or at least the cash flow) from this job to pay off existing debts to Interim. Although the facts do mention that Contractor, Inc. had built other projects financed by Interim, the facts indicate that those projects had been successfully built and there is no indication that either Contractor, Inc. or the concrete subcontractor needed the funds from this project to complete (or at least pay off potential mechanics' lien claimants from) a prior project

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financed by Interim. If the facts were different, the legal result perhaps might be different.

(6) There is no indication in the facts that Life knew of the undisclosed liabilities of Tenant Corporation, or that Life was itself a creditor of Tenant Corporation with special access to financial information regarding Tenant Corporation, or that Life or any of its controlling shareholders, directors or officers had any financial interest in Tenant Corporation. Nor is there any indication in the facts that Borrower urged Life to approve the other proposed tenant (rather than Tenant Corporation), or that the other proposal was any better for Borrower. The only distinction between the two proposals was that Tenant Corporation "appeared to be financially stronger". Finally, there is no indication that Borrower asked Life to analyze the financial strength of each of the proposed tenants. We can only assume from these facts that Borrower obtained unaudited financial statements from each proposed tenant, reviewed those financial statements and then forwarded them to Life along with the two proposals.

(7) There is no indication in the facts that either Interim or Life had represented, directly to Borrower or through their advertising, that they would provide financial advice to Borrower as part of their services in connection with the loans, based on their financial expertise. If Borrower could establish that representations such as this were made by Interim and by Life, perhaps Interim and Life would be subject to at least a higher duty of care in investigating and evaluating the financial condition of Contractor, Inc. and its subcontractors and Tenant Corporation. If it could then be established that (i) Interim should have known of the potential financial problems of Contractor, Inc.'s concrete subcontractor and the resulting financial problems it would create for Contractor, Inc., and (ii) Life should have known of the potential financial problems of Tenant Corporation, Borrower may be able to use these breaches of duty, relating to attempts by the lenders to control Borrower's business, either defensively (to enjoin Interim's acceleration) or offensively (to sue Interim and Life for damages).

(8) All of the distinctions described herein may be of no consequence in the eyes of a typical juror who knows only that the bankruptcy problem of the general contractor selected by Interim has been the main cause of the problem, including the $1,000,000 cost overrun, and that the

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bankruptcy problem of the tenant selected by Life may preclude Borrower from easily qualifying for the last $1,000,000 funding.

g. If Interim attempts to take control of the project and complete the development, even assuming that the construction loan documents expressly permit this, Interim may be held to a high standard of care as a mortgagee in possession. Accordingly, even if the actions theretofore taken by Interim were insufficient to create a fiduciary duty or a duty of care, Interim's undertaking to complete the project may create significant new liabilities.

4. Tortious Interference. Life's insistence on the ouster of Bubba Developer as general partner of Borrower could constitute tortious interference in Borrower's relationship with its general partner. See Farah, supra.

VII. PERMANENT LENDER'S PITFALLS AND STRATEGY

A. What Does Life Really Want?

1. The threshold question is whether Life has a burning desire to make the loan. If so, Life should take steps to increase the likelihood that the building will be completed and that the permanent loan will be closed. If Life really wants this permanent loan, Life could, inter alia, (i) increase its dollar commitment, (ii) eliminate the 60% occupancy condition to the funding of the last $1,000,000, (iii) extend the period of the commitment (i.e., the period of time during which Borrower must meet the conditions to funding), and (iv) eliminate the $900,000 holdback for tenant improvements and brokerage commissions.

2. If Life does not have a burning desire to make the loan, but is willing to make the loan on the terms and conditions in the commitment and the tri-party agreement, Life should take a more passive role and not attempt to modify the permanent loan commitment.

3. Life should keep in mind that the main problem in this fact situation is the bankruptcy of Contractor, Inc. and its concrete subcontractor in the middle of construction of the building. Completion of the building is a condition precedent to Life's obligation to close the permanent loan.

B. Life's Approval Rights.

1. The permanent loan commitment gives Life the right to approve plans, contractors, budgets and leases. All of these are items of legitimate business concern to a permanent lender making a non-recourse loan secured by a building and a stream of rental payments. A prudent permanent lender with no contingent interest in the project's upside would have valid reasons to want these approval rights.

2. The only control Life exercised was insinuating that a lease to the competing tenant may be rejected for purposes of satisfying the 60% lease-up condition of the permanent commitment. Life never

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actually rejected the other tenant, although it insinuated that a lease to the other tenant would be rejected.

a. Life obviously preferred for Borrower to lease to Tenant Corporation because Tenant Corporation appeared to be financially stronger. In fact, debts which had not been disclosed to Borrower during the course of lease negotiations led to Tenant's Corporation's Chapter 11 filing.

b. There is no indication in the facts that Life knew of the other debts which had not been disclosed or that Life was a creditor of (or otherwise financially interested in) Tenant Corporation. If Life did know of the other debts and failed to make Borrower aware of the other debts, the result may be different. Generally speaking, a lender should not have, and the right to approve a tenant should not impose on the lender, a duty to independently investigate the creditworthiness of a proposed tenant. Rather, it should be Borrower's responsibility to do the credit checks and submit information to Life to permit Life to approve or disapprove the proposed tenant based upon the financial information submitted by Borrower. But see discussion at paragraph VI.F.3.f., supra, regarding duties Life may have assumed if it had represented to Borrower that Life was providing expert financial advice as part of its services in connection with the loan, or it if had been asked to do a financial analysis of the two competing tenants.

c. Although the facts presented here resulted in Life de facto selecting between two competing tenants, Life was, at most, exercising its right to approve or disapprove any proposed leases.

d. The facts indicate that Life did not respond formally approving or rejecting either of the two proposals. Any formal response could have included appropriate disclaimer language reflecting the limited role of Life's review and requiring that the tenant selected not be the subject to any bankruptcy proceeding at the time its lease was being used to satisfy the 60% occupancy requirement.

3. There is no indication in the facts that Tenant Corporation's financial problem is the primary cause of Borrower's immediate crisis. Nor is there any indication that Borrower had to modify the building or order special purpose (or more expensive) tenant finish items to satisfy the requirements of Tenant Corporation, thereby increasing the cost of construction.

4. If all four floors of the proposed building are of equal size, Borrower can qualify for the 60% occupancy achievement level without the first floor space leased to Tenant Corporation. Obviously, it will be more difficult to do so without counting that space toward the 60% achievement level.

5. Borrower and Interim will want, as part of the workout proposal, for Life to confirm that the bankruptcy of Tenant Corporation will not cause

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Tenant Corporation's lease to be disqualified from counting toward the 60% occupancy achievement level. Life should resist agreeing to this at least until Tenant Corporation has assumed or rejected the lease under Section 365 of the Bankruptcy Code and some determination is made regarding the ability of Tenant Corporation to pay the rent. The harder issue for Life is whether to approve the lease if Tenant Corporation has assumed the lease in its bankruptcy proceeding but its financial condition is weak. Life is then in an unfortunate dilemma.

a. If Life then confirms that Tenant Corporation's lease will count toward the 60% achievement level, 25% of the space will be leased to a tenant whose financial condition, and therefore ability to pay rent, is at best questionable. Will Life later be precluded from accelerating or foreclosing on its permanent loan if Borrower's inability to make monthly payments is due to Tenant Corporation's inability to pay rent?

b. If Life refuses to accept Tenant Corporation's lease as counting toward the 60% occupancy requirement, after having dropped "strong hints" that Tenant Corporation (as opposed to the competing tenant) was the better financial risk, Life will appear to be acting unfairly in the eyes of a typical juror.

C. Terminating the Commitment.

1. Life should not threaten to terminate the commitment unless (i) the commitment clearly specifies conditions under which termination is permitted at this stage, (ii) those conditions exist, (iii) those conditions are in fact the reason for Life's desire to terminate the commitment and (iv) Life has decided to terminate the commitment because of those reasons.

2. Life should not dictate who the general partner of Borrower will be, particularly if the commitment does not expressly authorize Life to have a voice in that matter. Life should not interfere in the relationship among the partners in borrower. Life may be liable for damages caused by the new general partner. See Farah, supra.

3. A lender should not threaten to take an action unless the lender has the right to take that action and intends to take that action. Farah, supra.,

4. Using the threat of termination of the commitment to extract an option to purchase the project subjects Life to potential liability for duress (among other theories). In addition, the option to purchase could be construed as a clog on Borrower's equity of redemption and therefore be unenforceable.

D. Requirement of Using Life Management.

1. A permanent lender, especially in the context of a non-recourse loan, has a legitimate interest in knowing that the collateral is being properly managed. Having the right to approve the property manager should not, in and of itself, be viewed as being in control of the Borrower.

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2. Requiring the Borrower to use an affiliate of the lender to manage the project goes beyond the lender's right to merely approve the property management company.

a. Having an affiliate of the lender operating the day-to-day business of the project, which is the only asset of the Borrower, may subject Life to a risk of equitable subordination vis-a-vis other creditors of Borrower or otherwise becoming liable for the debts of Borrower. This could be particularly risky if in fact Life Management used rental income first to service Life's permanent loan at the expense of not paying trade creditors or withholding taxes. It appears less risky if Life Management merely causes the net cash flow to be applied first toward Life's permanent loan before servicing debt which, by its very terms, is expressly subordinate to Life's first lien permanent loan.

b. By requiring that Life Management manage the project, Life may be assuming liabilities and may be subject to a standard of care similar to that of a mortgagee in possession inasmuch as an affiliate of the mortgagee is essentially in possession of the project, running the day-to-day business of the only asset of Borrower.

E. Renegotiating the Commitment Letter.

1. Increasing its dollar commitment to the project clearly increases Life's risk. It is attempting to obtain more compensation for the increased risk through increasing the interest rate. Life is also attempting to hedge its increased risk by eliminating the non-recourse nature of the permanent loan.

2. Eliminating the non-recourse nature of the permanent loan helps, from a financial point of view, only to the extent that the other assets of the general partners are sufficient to service the increased debt (or at least pay a deficiency following foreclosure in an amount no less that the increased debt).

3. In light of the fact that Life already is entitled to 40% of the upside potential of the project, any increase in the fixed interest rate reduces the value of the 40% contingent interest and "nets" only an additional 60% of the increased interest rate for Life.

F. Misc. The usury partnership law, bank tying act and guarantor issues discussed, supra, should not cause Life to deviate from what would otherwise be the sound course of action.

G. Summary of Life's Strategy.

1. Life should increase its dollar commitment or waive (or modify) the lease-up contingency or holdback provisions only if (i) it has a strong desire to make the loan and perceives a risk that the loan will not be delivered to it without increasing the commitment and waiving the other requirements, (ii) the net increase in the interest rate (taking into account

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the fact that any increase in the fixed rate will decrease the value of Life's 40% contingent interest) represents an adequate reward for the increased risk, and (iii) either through elimination of the non-recourse nature of the loan (in whole or in part) or the addition of other guaranties and/or additional collateral the increase in the risk resulting from the increase in the loan amount can be adequately hedged.

2. Life could make lower risk concessions to Borrower and Interim by extending the time period for completing construction and permitting Interim to retain a second lien in the amount of the cost overruns. But Life will want to make sure that the second lien is subordinate in lien and in payment.

3. Obtaining the personal liability of Developer and Brokerage Corp. for all (or at least the additional amount) of the permanent loan may not add much in the way of assets available to service the debt or satisfy a deficiency claim. However, it is likely to increase the attention level of Developer and Brokerage Corp. and cause them to focus more of their energies (and steer more potential tenants) to the project as compared with other projects in which they may own an interest and on which they have no personal liability.

4. Life should not require that Borrower use Life Management to manage the project. Life should merely have the right to approve an independent property management company selected by Borrower.

5. Life should not demand that Bubba be removed as the general partner. Life should not demand an option to buy the project at fair market value.

6. Life should not threaten to terminate its commitment or make other threats to do anything which it does not actually have the right to do at the time of the threat and which it fully intends to do. Life would be better served by waiting to determine whether the conditions to its obligation to fund have been met within the time period provided in the commitment letter and the tri-party agreement, rather than relying on the theory of anticipatory breach to terminate its commitment without giving Borrower an opportunity to satisfy the conditions within the appropriate time period.

7. If (i) Life's files indicate that it had represented that financial advice was part of the services to be rendered in connection with the loan, or that it had been asked to or had agreed to analyze the financial condition of Tenant Corporation, (ii) the lease is assumed in the bankruptcy, (iii) Life is requested to do so by Borrower and Interim, and (iv) it appears that Life's refusal to so commit is the last major condition to Borrower's working out the construction loan, Life should commit to count Tenant Corporation's lease toward the 60% occupancy requirement. Otherwise, Life should agree to count Tenant Corporation's lease toward the 60% occupancy requirement only if Tenant Corporation's financial condition is substantially the same as that set forth in the financial statements submitted by Borrower to Life.

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VIII. CONSTRUCTION LENDER'S PITFALLS AND STRATEGY

A. Interim's Objectives.

1. Interim's prime objective is to see construction completed, the conditions to funding of the permanent loan satisfied, and Interim's loan paid in full.

2. A secondary (and at this point in time very minor) objective of Interim is to realize some benefit from its 10% limited partnership interest in Borrower.

3. Even if its ultimate objectives might be achieved, Interim does not want, at any point in time, to have advanced more under its construction loan than the value of its collateral at that point in time. Interim wants to make sure that the unadvanced funds are sufficient to complete the project and qualify for funding of the permanent loan within the time period provided in the permanent loan commitment and the tri-party agreement.

4. If Interim must advance more money than the Life will fund at the permanent loan closing, Interim wants to provide a mechanism for eventually getting the excess repaid.

B. Alternatives Available to Interim.

1. Refuse to fund any further amounts until the Borrower makes the $1,000,000 completion deposit.

2. In lieu of requiring the $1,000,000 completion deposit, require additional collateral to secure the $1,000,000 potential shortfall (or at least performance of the guaranties).

3. Require an increase in the permanent loan, or at least a waiver of the 60% occupancy requirement to the last $1,000,000 of funding, to assure that sufficient funds will be available upon completion of construction to take out interim's Loan. In lieu of insisting on a complete waiver of the 60% occupancy requirement, Interim may insist on Life's agreement to count Tenant Corporation's lease toward the 60% threshold, regardless of whether Tenant Corporation emerges from bankruptcy or rejects the lease. In addition, require an extension of time for Borrower to complete construction and satisfy the other conditions of the permanent loan commitment. A typical construction lender wants to limit its risk to one risk: that construction cannot be completed within the time period and for the amount to be funded pursuant to the permanent loan commitment.

4. Accelerate, foreclose and sue for a deficiency if the amount bid at the foreclosure sale is not sufficient to pay the loan in full.

5. Attempt to complete the project, without foreclosing, pursuant to its right to complete contained in the construction loan agreement.

6. Seek appointment of a receiver. This is not feasible in fact situations such as this. A receiver will only slow down the process.

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7. Proceed with funding the construction loan to at least reach the objective of having the building completed in time to qualify for funding of the $9,000,000 first advance under the permanent loan. This should be coupled with a requirement that Life agree to permit a second lien in favor of Interim to secure the cost overrun and that the Borrower, Bubba Developer and, if possible, Able and Baker have full personal liability on the second lien loan.

C. Identify the Parties with Potential Conflicting Points of View: Interim; Life; Borrower; Bubba Developer; Brokerage Corp., Able and Baker; limited partners in Borrower; Good Partnership; limited partners in Good Partnership; Contractor, Inc; Contractor, Inc.'s subcontractors and suppliers and their subcontractors and suppliers; Tenant Corporation; and Johnson & Ryan, Jimmy Johnson and the partners in Johnson & Ryan who are limited partners in Borrower.

D. Special Problems of Multiplicity of Parties.

1. As a general rule, the ability to resolve an issue is inversely proportionate to the number of parties who have conflicting interests in the manner in which the issue gets resolved.

2. The demands of one group of interested parties may be mutually exclusive of the needs of another conflicting party.

3. Different parties have different economic investments and risks. For example, under these facts only Interim and the limited partners of Borrower have any money actually invested in the project to date. However, Developer has exposure under guaranty of payment and performance and Able and Baker have exposure under their guaranty of lien-free completion.

4. Real or imagined grievances by one group against another group of interested parties may preclude ultimate resolution of the issue. For example, Able and Baker, the limited partners and Life want Bubba Developer removed as the general partner of the Borrower. But Bubba Developer may be the person best capable of achieving completion of development of the project. Furthermore, Developer has a clear economic incentive to complete development of the project because of Developer's guarantee of payment and performance and Developer's 35% general partnership interest in Borrower.

5. Some parties may be entitled to special protections which give them leverage. For example, under the laws of many states mechanics and materialmen have statutory liens on the project.

E. Analyzing Interim's Principal Problem.

1. The Contractor, Inc. and its concrete subcontractor are in Chapter 11.

a. A general contractor operating under bankruptcy court protection is unlikely to be able to effectively complete construction. Therefore, it will be necessary to get a new general contractor.

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b. Inevitably mechanics' and materialmen's liens will have been filed against the project, and the combined M and M lien claims will exceed the amount of the retainage to date.

c. The cost of completing construction with a new general contractor will inevitably be more than the unadvanced construction line items in the budget, especially taking into account amounts which may be necessary to settle M and M lien claims.

2. Special timing problems.

a. Delays associated with Contractor, Inc.'s bankruptcy may prevent completion of construction within the time period provided in the permanent loan commitment and the tri-party agreement.

b. Delays in construction may delay Borrower's leasing program, particularly with smaller tenants who do not want to commit to a building until they can see what it actually looks like.

c. Inability to deliver completed space may relieve some tenants (who have already signed leases) from their obligation to lease the space.

d. In highly competitive markets, competing developers will emphasize to prospective tenants that they should avoid leasing from a "failed project".

3. The value of the project (land and partially completed building) may be less than the amount of the debt. This is particularly so taking into account the M and M lien claims and the fact that potential purchasers of the land may not want to complete the exact same building and may be uncomfortable with the quality of existing construction given the financial problems of Contractor, Inc. and its concrete subcontractor. Furthermore, time delays in recommencing construction may cause physical deterioration of construction done to date, including vandalism.

4. Shoring up Interim's collateral position.

a. The best way for any construction lender to shore up its collateral position in this situation is to require and obtain a completion deposit.

b. In lieu of a completion deposit, Interim should seek additional collateral from Developer, Able and Baker, and/or the limited partners.

c. The limited partners are unlikely to provide any additional collateral, especially in light of the fact that they perceive that they are the only parties who have invested any hard cash in the project. They are unlikely to "appreciate" the fact that Interim has invested a significant amount of cash in the project, albeit subject to its legal right to be repaid.

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d. Requiring cross-collateralization by Good Partnership. This idea should be abandoned immediately. See discussion of Alamo Lumber usury problem, partnership issues and Bank Tying Act issues, supra. In addition, see discussion of fraudulent transfer issues in outline on Bankruptcy Considerations in Workouts.

5. Special problems of acceleration of the construction loan.

a. Interim's ultimate leverage is to accelerate maturity of the construction loan and foreclose if Borrower does not come up with the completion deposit.

b. Interim will not want to run the risks associated with completing the project itself while Borrower owns the project.

c. Acceleration is threatened due to the need for a completion deposit to cover cost overruns caused by the financial problems of Contractor, Inc., who Interim recommended that Borrower use. Even if the recommendation of Contractor, Inc. does not expose Interim to liability for damages, a judge or jury may nevertheless find that it is inequitable to allow Interim to accelerate maturity in this situation. See discussion at paragraphs IV.D.3 and VI.F.2.g., supra. Furthermore, due to fact questions that need to be resolved, a court will likely be willing to restrain or enjoin a foreclosure pending the resolution of the issue of whether Interim rightfully accelerated. The delay in resolving the issue adversely affects all parties and the project.

F. Summary of Recommendations to Interim.

1. Carefully analyze whether the cost overrun is really $1,000,000. Don't demand a completion deposit larger than is justified. But don't move forward with funding completion if the real cost overrun is so large that Interim is "throwing good money after bad". Part of this analysis involves a de novo determination of what the project will really be worth upon completion. That value may be lower than originally estimated.

2. Do not require that Good Partnership give a second lien on its assets to secure Borrower's construction loan as a condition to extending the maturity of the Good Loan. Withdraw that request and offer to extend the maturity of the Good Loan on all of the same terms without any requirement of cross-collateralization.

3. Do not require Able and Baker to pledge their general partnership interests in Good Partnership as security for payment of Borrower's construction loan or performance of Able's and Baker's completion guaranty. At most, require Able and Baker to pledge their rights to 99% of the distributions to be received by them as general partners, solely as collateral for their existing completion guaranty (or as security for the second lien note evidencing the cost overrun).

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4. Attempt to get Life to increase the amount of the permanent loan or at least remove the 60% occupancy condition to the funding of the last $1,000,000. At a minimum, get Life to agree that Tenant Corporation's lease will count toward the 60% threshold if and when Tenant Corporation assumes the lease. In addition, get an extension of time to complete construction. Also, get Life's approval of the new general contractor and revised budgets, as well as any other item which requires Life's approval and has changed from the circumstances existing at the time the tri-party agreement was executed. Insist that Life permit a second lien to evidence the portion of the revised construction loan which exceeds the amount to be funded by Life pursuant to the permanent loan commitment.

5. Attempt to get whatever additional collateral Developer can and will provide, being careful not to insist upon additional collateral the present value of which is less than the legal fees necessary to properly document and perfect, or which creates other problems (such as the second lien on Good Partnership's assets).

6. Attempt to get as large a completion deposit (or alternative collateral) as Borrower can and will provide.

7. Do not accelerate maturity of the Loan.

a. Acceleration will trigger a rebate obligation under the usury savings/rebate provision or a very serious usury violation. The size of the rebate depends on what the jury ultimately finds the value of the 10% limited partnership interest to be.

b. Accelerating maturity will undoubtedly trigger suits for damages by Borrower, Bubba Developer, Able, Baker, Brokerage Corp., limited partners and perhaps others directly or indirectly interested in the completion of the project.

c. Acceleration may be the fulcrum for application of theories of breach of duty of good faith and fair dealing, duress or other lender liability theories.

8. Do not attempt to complete construction prior to accelerating and foreclosing, while Borrower still owns the project. The potential liability exposure is too great.

9. Proceed with funding of the construction loan to reach completion in time to qualify for the $9,000,000 funding under the permanent loan commitment. Require Borrower and Bubba Developer, and, if possible, Able and Baker, to have personal liability on the second lien loan evidencing the cost overrun.

10. Prepare to establish a reserve against, or otherwise "write down", the loan due to questions regarding the ability to fully collect the loan.

11. Instruct Jimmy Johnson not to participate in any actions taken by the Board of Directors of Interim relating to this loan.

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12. Review the files very carefully. Cure any defects which may exist in perfection of liens and security interests.

13. In documenting the workout get ratifications of guaranties, releases from liability, endorsements to the Mortgagee's title policy and opinions of Borrower's counsel.

14. Make sure that any director, officer or employee of Interim who may have personal animosities toward Borrower or any of its general or limited partners is removed from direct responsibility for the workout. Preferably, appoint a workout specialist to handle the negotiations, with the original loan officer available for consultation and for meeting, along with the workout specialist, with representatives of the Borrower so long as the original loan officer does not have animosity and is not trying to justify past actions.

15. Confirm all meetings and telephone conversations with letters or at least memos to the file. All communications with representatives of the Borrower, whether written or oral, should be carefully worded to avoid threats to take actions which are not permitted under the loan documents or which would be illegal, to avoid threats to take actions which Interim has not decided (through its appropriate committees) to actually take, and to avoid language which will cause a typical juror to believe that Interim is mean, vindictive or generally not nice.

16. Don't lose sight of the primary objective of Interim: to get the building built and the loan (or at least as much thereof as possible) paid off.

17. If litigation is inevitable, Interim should file suit to collect the debt and enforce the guaranties. Get "first crack" at the jury. But, avoid litigation if at all possible.

IX. ACKNOWLEDGMENTS

The author wishes to acknowledge the assistance of his partners, Frank F. Smith, Jr., Walter B. Stuart, IV and Philip D. Weller for their advice, Randall K. Howard for his advice, and the assistance of his legal assistant, Charlene E. Hudgins, and his secretary, Carole Kubsch, in connection with the preparation of this outline.

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BIOGRAPHICAL SKETCH - SANFORD A. WEINER

Sanford A. Weiner is a graduate of the University of Texas at Austin (1968) and Harvard Law School (1971). Sandy is a partner in the Houston office of Vinson & Elkins specializing in the areas of real estate financing, acquisitions and dispositions, development and partnership/joint venture relationships, as well as usury issues relating to business transactions. He is currently an adjunct professor of real estate finance at the University of Houston College of Law, has been a guest lecturer at University of Texas School of Law, and has been a frequent lecturer on usury law, foreclosures and workouts, commercial mortgage lending and various other aspects of real estate law with Practising Law Institute, State Bar of Texas Advanced Real Estate Law Course, Texas Mortgage Lending Institute, Southwestern Legal Foundation and Houston Bar Association. He is a member of the American, Texas and Houston Bar Associations, the American College of Real Estate Lawyers, the Texas Academy of Real Estate, Probate and Trust Lawyers and the Houston Real Estate Lawyers Council.

american college of real estate lawyers · american college of real estate lawyers march 23, 1990...

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