Lender’s Breach of a Construction Loan Results in Awarding of Economic Damages to Builder
The Arizona Court of Appeals affirms that a construction financing agreement is a binding commitment, and breaching that agreement can make the lender liable for the borrower’s lost profits.
The financial distresses of the Great Recession led to a
wide variety of conflicts between construction lenders and builders. In many
cases, the lender had the upper hand, with few options for builders who lost
their financing in mid-project. But in at least one case, a lenders arbitrary
termination of a construction loan agreement backfired.
In early 2007, a predecessor of Great Western Bank¹ made an acquisition and development (A&D) loan to a builder-developer, Cedar
Ridge Investments, to purchase Flagstaff-area real estate and develop it as
a residential subdivision. Separately, the bank entered into an agreement with
Cedar Ridge to make construction loans, on a case-by-case basis, for the homes
to be built in the subdivision. Both loans were guaranteed by Cedar Ridges
parent company and its principals.
In July 2008, as development of the project was nearing
completion and Cedar Ridge was preparing to obtain building permits for the
homes, Great Western Bank decided to stop making construction loans in Arizona
and told Cedar Ridge that it was pulling out of their agreement.
Cedar Ridge was unable to get alternate financing, could
not build and sell homes and, thus, could not generate cash to service its A&D
loan. Great Western foreclosed, sold the property to another developer, and sued
the guarantors for the remaining $2.6 million loan balance.
At trial, the guarantors argued that the unpaid loan
balance should be offset by lost profits caused by Great Westerns breach of
their loan agreement, which they further argued constituted anticipatory
repudiation and breach of the implied covenant of good faith and fair dealing.
Great Western claimed that the construction loan
agreement was just a guidance line, under which the bank could choose to make or not make loans to build the homes at Cedar Ridge.
Win for the Builder
In the end, the trial court rejected the banks
guidance line argument, noting that the agreement (titled Loan Agreement)
obligated the bank to make the Loans to Borrower and required Cedar Ridge to
accept such Loans. Also, the agreement allowed the bank to withdraw only if
the borrower defaulted a moot point, as the bank never made a loan on which
Cedar Ridge could default.
The trial court concluded that:
Great Western breached the loan agreement;
Great Westerns breach prevented Cedar Ridge
from building and selling homes and using the proceeds to retire the A&D loan;
Great Western had no valid reason for
terminating the loan agreement, as Cedar Ridge was not in default and was
prepared to begin construction.
Further, the trial court found that, if the bank had not
breached the agreement, Cedar Ridge would have made a profit of between $2.8
million and $3.5 million. As that figure exceeded the outstanding balance on the
A&D loan, the guarantors liability under the guaranty would have been reduced
Great Western Bank appealed, unsuccessfully. The Arizona
Court of Appeals upheld the trial courts ruling in all respects, sending a
harsh warning to lenders and providing good news to borrowers who find
themselves in a comparable situation:
See also: The Court of Appeals opinion in
Great Western Bank
v. LJC Development, et al.