20 October 2010
Recent court decisions have brought to the forefront the issue of an administrative agent’s potential liability in situations where a borrower has acted egregiously. While such decisions have not dramatically changed the landscape for administrative agent liability, or necessitated any changes to typical contract language, they serve as a reminder that all entities acting as an administrative agent should be aware of the potential limitations of exculpation and non-reliance language.
Courts have traditionally upheld exculpation clauses that provide that an administrative agent is not liable to lenders for the actions of a borrower. This is especially true in cases where non-reliance language pursuant to which a lender specifically represents that it has not relied upon an administrative agent or any other lender and that it has made its own appraisal of the borrower was included. However, such clauses may not fully protect an administrative agent if the agent is found to have “peculiar knowledge” regarding the borrower or its business, which would include information that was obtained as a result of the agent’s unique position in the transaction or a special relationship the agent had with the borrower.
Pursuant to the peculiar knowledge exception, notwithstanding a disclaimer in an exculpation clause, a lender is not precluded from claiming reliance on a party’s alleged misrepresentations if the allegedly misrepresented facts are peculiarly within that party’s knowledge. An administrative agent should therefore carefully consider whether it has such peculiar knowledge, and whether the other lenders in the transaction have sufficient access to such information from other sources. In such instances, administrative agents may want to consider disclosing such information in order to avoid any potential liability.
In fact, if an administrative agent’s unique position in a transaction, or its special relationship with a borrower, entitles the agent to obtain crucial information that is not readily available to other lenders, it may have an affirmative duty to disclose such knowledge under the “special facts” doctrine. This doctrine recognizes a party’s duty to disclose if one party’s superior knowledge of essential facts would make the transaction inherently unfair without the disclosure of such facts. Although any such determination would need to be based on the specific circumstances of a particular transaction and the specific relationships of the parties, an administrative agent that is ultimately found to have had knowledge of special facts could potentially be liable for failing to disclose alleged fraud by the borrower. Such liability may, however, be mitigated or avoided if the lenders alleging fraud are sophisticated lenders that could have verified the alleged misrepresentations on their own, but failed to do so. Despite such a possible defense, however, it remains important for administrative agents to be mindful of such doctrine and the potential duty to disclose information that it may have.
The effectiveness of exculpation and non-reliance language in a contract will also be limited in situations where a plaintiff lender is able to establish an administrative agent’s liability for aiding and abetting fraud. In order to hold an administrative agent liable on such a theory, a plaintiff lender must be able to establish, among other things, that the administrative agent had knowledge of a fraud that was being committed. Such knowledge can be established either by proving the administrative agent had actual knowledge of such fraud or based on a “conscious avoidance” theory. With respect to actual knowledge, such knowledge can be established either by direct evidence or based on a strong inference of fraudulent intent (although it has been established that the raising of “red flags” alone may not be sufficient to give rise to such strong inference). With respect to conscious avoidance, an administrative agent can be found to have consciously avoided knowledge of a fraud if it realized the probability of fraud, but refrained from confirming it in order to later deny knowledge. Therefore, administrative agents should be mindful that if fraudulent behavior is suspected, liability cannot be avoided by merely turning a blind eye or actively avoiding information it would rather not know.
Therefore, while exculpation and non-reliance language is often upheld and effective, all administrative agents should be aware of the potential limitations of such provisions and should take appropriate precautions to avoid liability if borrowers are suspected of fraudulent activity.
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