A secured lender’s position appears unassailable on paper. It holds collateral, controls the credit agreement, and can declare default. When a borrower falls into distress, the instinct on both sides of the table is to treat the lender as the party with all the leverage. That instinct is wrong, or at least incomplete. The doctrine of lender liability exists precisely because a lender’s contractual rights, however broad, do not authorize every action a lender might wish to take. When a lender overreaches, it creates exposure and that exposure is a resource for borrowers, debtors, trustees, and the counsel who represent them.

This article examines lender liability from the borrower’s side of the table. It surveys the categories of claims that arise most often in distressed situations, identifies the patterns of lender conduct that give rise to them, and explains why those claims carry real negotiating weight even when they never reach a verdict.

 

The Strategic Value of a Lender Liability Claim

Lender liability is not a single cause of action. It is a collection of contract, tort, and bankruptcy claims that share a common thread: the lender did something it should not have done, or failed to do something it was obligated to do. The potential plaintiffs include the borrower, a bankruptcy trustee, a creditors’ committee, and other creditors with a direct stake in the lender’s conduct.

The practical value of these claims extends well beyond the possibility of a judgment. Lender liability claims are inherently fact-intensive. They are difficult to dismiss at the pleading stage and resistant to summary judgment. That means discovery. And with discovery comes the production of internal communications, loan committee memoranda, and email chains that institutional lenders would strongly prefer to keep private. Add the prospect of a jury trial, and the litigation posture becomes deeply uncomfortable for a lender that expected to enforce its way to a quick resolution.

Lenders know this. They work hard to avoid the conduct that generates these claims in the first place. That risk aversion is an asset for borrower’s counsel. A well-developed lender liability theory, even one that may not ultimately succeed at trial, shifts the dynamics of any restructuring negotiation. It slows enforcement. It extracts concessions. It changes what the lender is willing to accept.

 

Contract Claims

The credit agreement is the starting point, but it does not tell the whole story. Courts routinely find that lenders have obligations that exist alongside the written documents, and some of the strongest borrower claims arise from conduct that lender personnel likely considered unremarkable.

 

The Implied Covenant. Every contract carries an implied covenant of good faith and fair dealing, and that covenant survives a standard anti-waiver clause. A lender that has routinely accepted late payments, declined to enforce covenant ratios, or overlooked reporting deficiencies for multiple quarters cannot pivot to strict enforcement without warning. The shift itself — absent notice, absent a compliance letter, absent any opportunity for the borrower to adjust — can constitute a breach regardless of what the documents technically permit. Oral representations compound the problem. Statements by lender representatives during workout discussions, “we’ll work something out,” or “don’t worry about that for now,” can create enforceable expectations, particularly when made to a borrower in default with limited alternatives.

 

Improper Acceleration. Not every default supports acceleration, and not every acceleration is procedurally proper. A lender that accelerates based on a covenant it has previously waived, or that declares a default without satisfying its own notice and cure provisions, may be in breach independent of any payment failure by the borrower. Every notice of default deserves the same scrutiny a lender’s counsel applied in drafting the remedies section.

 

Collateral Missteps. Lenders make mistakes with their security interests more often than they would like to admit. A mistakenly filed UCC termination statement, a collateral release broader than intended, or a gap in perfection across the different asset tranches of a split-collateral or ABL structure can leave a lender wholly or partially unsecured. These errors do not always surface until someone looks for them. In a distressed engagement, looking for them is not optional.

 

Tort Claims

Contract claims address what the lender agreed to do. Tort claims address how it behaved. The two categories often travel together, but the tort exposure can be the more significant of the two.

 

Control. A lender is not a fiduciary to its borrower. That proposition, however, has a limit. When a lender crosses from creditor to operator by directing management decisions, dictating which creditors to pay, or prescribing which C-Suite targets to conscript, the relationship begins to look like something courts treat differently. The lender that tells a distressed borrower “you will do X” rather than presenting options and stepping back has strayed into territory that generates both fiduciary duty exposure and economic coercion claims. The fact that a borrower welcomed the lender’s involvement does not absolve the lender; the lender’s liability turns on what the lender did, not what the borrower asked for.

 

Economic Coercion. A lender that uses a borrower’s distress to extract terms or payments beyond what its documents permit, or that threatens enforcement action it has no contractual right to take, exposes itself to a duress claim. The question is whether the demand was grounded in the lender’s actual rights or whether it exploited an asymmetry of power to obtain something more.

 

Fraudulent Transfer in Up-Tier Transactions. The liability management exercises that have attracted the most attention in recent years are up-tier transactions (structures in which a majority lender group uses an “open market purchase” or similar provision to create a new super-priority tranche secured by collateral that previously secured the full facility.) Serta[1] addressed the contract question of whether such transactions were permissible; the fraudulent transfer analysis asks something different. Non-participating lenders in these transactions are asserting that the pledge of existing collateral to the new super-senior tranche was made with actual intent to hinder, delay, or defraud them. That litigation is developing across multiple jurisdictions and has found more traction in the fraudulent transfer context than in the contract interpretation context. The legal landscape remains unsettled.

 

Tortious Interference. A lender that tips off a key vendor or customer about a borrower’s financial condition, uses confidential borrower information to influence third parties, or otherwise disrupts the borrower’s existing business relationships may face tortious interference exposure. This is most consequential in operational businesses where lender conduct can destroy going-concern value in ways that harm the entire creditor body.

 

Unfair and Deceptive Trade Practices. In the most egregious cases, state trade protection statutes provide an additional avenue, one that can produce treble damages and attorneys’ fees. The bar is high. Ordinary breach does not reach it. But when a lender’s conduct is genuinely oppressive, the availability of multiplied damages changes the settlement calculus considerably.

 

Bankruptcy Remedies

For debtors and their counsel, the Bankruptcy Code provides targeted mechanisms to address lender misconduct that go beyond compensatory damages.

 

Equitable Subordination. A bankruptcy court can subordinate a lender’s claim below those of other creditors when the lender has engaged in inequitable conduct that harmed other parties in the case. The standard demands more than aggressive enforcement, but courts have not been reluctant to apply it when the facts warrant. The Yellowstone Mountain Club[2] litigation is a vivid illustration. There, the court found the lender’s conduct “so far overreaching and self-serving” as to shock the court’s conscience, and subordinated its claim accordingly.

 

Recharacterization. Where a claim held by an equity sponsor or insider is nominally structured as debt, a trustee or committee may seek to have it recharacterized as equity. The effect is to eliminate the insider’s priority as a creditor and subordinate its recovery to all other claims.

 

Vote Designation. A bankruptcy court can nullify a lender’s vote on a plan of reorganization if that vote was cast in bad faith or for an improper purpose. The threat of designation, particularly against a lender holding a blocking position in a class, can fundamentally shift the dynamics of plan confirmation and force concessions that would otherwise be unavailable.

 

Finding the Leverage

The same conduct that exposes lenders to liability creates opportunity for borrower counsel. Some patterns recur with enough frequency to be worth examining at the outset of any distressed engagement. A lender that accelerated without first issuing a compliance letter, or that pivoted from years of accommodation to strict enforcement without advance notice, has likely created a course-of-dealing problem. A lender whose representatives made oral commitments during workout discussions that were never reduced to writing has created an implied covenant or oral modification issue. A lender whose collateral files contain perfection errors or inadvertent releases may have a materially different secured position than it believes it has. A lender that inserted itself into the borrower’s operational decisions, communicated sensitive borrower information to third parties, or administered the loan in an ad hoc manner without consistent protocols has opened the door to tort exposure at multiple entry points.

Discovery in any lender liability action is likely to be contentious. For lenders, that is a cost. For borrower counsel, it is often the point. A credible lender liability claim (one that survives a motion to dismiss and forces the lender into fact-intensive discovery) changes what the lender is willing to accept, independent of how the case would ultimately be decided on the merits.

 

The Early Advantage

The optimal time to identify lender liability exposure is before the lender has fully exercised its remedies, before the forbearance agreement has been signed, before the chapter 11 petition has been filed, before the record has been made. Counsel who begin mapping the lender’s conduct at the outset of an engagement preserve the most options. Waiting until the lender has already moved leaves less room to work with.

 

The question borrower counsel should be asking at every stage is not only what rights the lender has, but whether it is exercising them, or threatening to exercise them, in a manner that exceeds those rights or otherwise crosses a line the law recognizes. The answer to that question frequently determines who actually holds the leverage.

 

[1] In re Serta Simmons Bedding, LLC, 96 F.4th 599 (5th Cir. 2024).

[2] Credit Suisse v. Official Comm. of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), 415 B.R. 769 (Bankr. D. Mont. 2009)

 

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DISCLAIMER: This article is for informational purposes only and intended for legal professionals. It is NOT legal advice. Maritime law is highly specialized; always consult with or associate with experienced admiralty counsel for specific case matters.