Dangers of Loan Commitments

During the normal course of business, loan commitments are issued by banks to a wide array of businesses. Loan commitments typically provide a conditional commitment to loan a fixed amount of money, at a specified interest rate for a contemplated project. During the real estate boom, many of these loan commitments were issued by banks for commercial real estate development projects.

Unfortunately for such a ubiquitous tool, both the issuing bank and its customer often do not clearly understand or thoroughly consider the legal consequences flowing from the issuance of a loan commitment. The commitment’s terms and conditions are critical to determining whether the bank is obligated to proceed with funding the loan. The lender may believe that the terms and conditions give it sufficient basis to later deny the loan, while the borrower often views the commitment as obligating the lender to make the loan. Many times the “fine print” of the commitment is ignored, and the parties proceed to negotiate and consummate deals based on their sometimes inaccurate understanding of the loan commitment’s terms. (One of Denny Hecker’s claims is that his bankruptcy was caused by Chrysler Credit failing to follow through on a loan commitment.)

For both banks and borrowers, these divergent views can create unintended problems and resulting legal consequences. In Town Bank v. City Real Estate Development, LLC, 2009 WI App 160, the Wisconsin Court of Appeals addressed some of these issues in a very common fact scenario. On May 27, 2004, Town Bank issued to City Real Estate Development, LLC (“Developer”) a loan commitment (“Commitment”) for the development of a condominium project in Milwaukee. Under the terms of the Commitment, Town Bank agreed to provide the Developer with financing in two phases. In the first phase, Town Bank was to loan the Developer $2.5 million to acquire a building, complete demolition, engineer the project, remove asbestos and marketing. In the second phase, Town Bank was to extend the Developer an additional $6.5 million to construct condominium units as presales dictated.

The Commitment contained a number of standard terms and conditions, including that the Developer grant Town Bank a first priority lien on the real estate, fixtures and other assets and provide Town Bank with an assignment of rents, leases and developer’s contracts. In addition, the Commitment contained a provision mandating a $900,000 equity injection by the Developer. Finally, the Commitment would terminate on June 25, 2004, if a credit agreement had not been signed.

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