November 16, 2014
Authored by: Jay Krystinik and Keith Aurzada
Lenders are frequently confronted with questionable lender-liability claims not only from borrowers (usually in connection with collection or foreclosure procedures) but also from property managers unable to recover from borrowers. Claims property managers assert directly against lenders include those for breach of oral or written contract, fraud, and unjust enrichment (particularly if the lender has foreclosed its interest in the borrower’s property). Lenders can hedge against the risk of claims by property managers through a variety of methods, both pre- and post-borrower default.
As part of origination (or any subsequent review of the borrower’s property management agreement), the lender should ensure that the property management agreement clearly defines that the property manager can turn solely to the borrower for satisfaction of the property manager’s fees and expenses. Thorough property management agreements will also cap expenses the property manager is allowed to incur absent approval, which can help avoid successful assertion of contractor liens.
The lender can also obtain a three-party subordination agreement among the lender, borrower and property manager that subordinates the property manager’s rights to those of the lender and allows the lender to, among other things, (i) seize rents immediately upon default, and (ii) terminate the property management agreement and appoint its own property manager. Termination of the property manager and appointment of the lender’s desired property manager is preferred to the lender directing the actions of the borrower’s property manager, as a lender should take care to avoid a direct relationship with the borrower’s property manager.
Post-default, the lender should send a reservation of rights letter that defines the parties’ relationships and limits a property manager’s authority. This is particularly true where a property manager has exceeded the scope of mere management and may have undertaken an ownership role at a property or asserted liens against the property, potentially relying on credit support from a lender for repayment of expenses.
Lenders should also consider seeking a court-appointed receiver to operate the property and act as a buffer. The court can grant a receiver the authority to terminate the existing property manager and appoint a new property manager, often of the lender’s choosing. Because a receiver is cloaked with a certain level of immunity (although acts of gross negligence or wilful misconduct are often excepted), a receivership offers a prudent method through which a lender can eliminate a troublesome property manager. A receivership also offers a lender a trial period during which the lender can examine the performance of a property manager of the lender’s choosing that it may decide to retain following foreclosure or a receivership sale. For example, Bryan Cave has extensive experience in obtaining receivers, as well as drafting and revising property management agreements, all of which can protect a lender before meritless claims are asserted.
In the event that a property manager asserts claims directly against a lender, such claims are commonly derivative of claims properly held by the borrower (the property manager’s principal) and, if based in contract, are often not properly memorialized. For example, among other successfully asserted defenses, Bryan Cave has obtained summary dismissal of property manager’s claims against lenders due to (i) failure to comply with the statute of frauds (which requires certain contracts to be in writing); (ii) lack of privity between the lender and the property manager; and (iii) the property manager’s lack of standing to assert the principal’s claims. Although unpaid property managers will always try to look to a deep pocket for recompense, judicious planning can reduce the risk and merit of any such claims.