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It’s not often that a borrower blames the bank for causing him to default on a loan.
It’s even less common for a borrower to sue the bank in federal court—as a St. Mary Parish oilfield services company did in 2016—and win a hefty $2 million judgement.
Throw in the fact that the defendant in the case is the venerable Hancock Whitney Bank—which was operating in Louisiana as Whitney Bank at the time of the loan—and you’ve got the story of a lender liability lawsuit that’s raising eyebrows in legal circles and making the banking industry nervous.
“The issues in this case are of importance to the entire banking industry in the state,” reads a brief filed by the Louisiana Bankers Association with the U.S. Fifth Circuit Court of Appeals in support of Hancock Whitney. “The present action threatens … the stability of the industry.”
The present action is a case involving the now-idle SMI Companies Global, which was based in Centerville in St. Mary Parish and specialized in fabricating heavy steel products for the energy and petrochemical industries.
In 2015, Whitney issued a specialized $900,000 line of credit to SMI to help the company fulfill a $2 million contract with Halliburton Corp. for eight, 17,500-gallon oilfield storage tanks, worth some $256,000 each, court documents show.
SMI and Whitney already had an established relationship; SMI had a $1.5 million operating line of credit dating back to 2012. So when SMI owner Vaughn Lane, a crusty Vietnam veteran, went to his longtime Whitney banker for the second line of credit, it wasn’t a terribly hard sell.
Granted, SMI wasn’t in the best financial shape, a fact the bank was aware of at the time, according to court documents. But Lane had a good working relationship with Whitney. More importantly, the $900,000 loan was tied to Halliburton’s creditworthiness, which was solid, not SMI’s financials, according to the trial judge’s ruling in the case.
But almost immediately after Halliburton inked the deal with SMI, the Houston-based corporation put the project on hold for nearly 10 months. By the time it was ready to order the first tank in March 2016, SMI had nearly maxed out the $900,000 line of credit and had just one month before it had to pay off the loan in full.
Lane met with his bankers and they agreed to extend the loan for 90 days—from April until July. Everyone knew it wasn’t enough time to complete the Halliburton project but it was better than nothing and—this is important—the bankers verbally agreed to work with Lane and told him they’d try to extend the line of credit.
Throughout May and June, SMI ramped up production. By July, all eight tanks were in some form of production and two had been completed and delivered, for which SMI—and in turn Whitney—were paid $491,000. But time was running out on the loan maturity date and SMI still didn’t have enough cash to pay the balance.
In the meantime, SMI had drawn down all the available funds from its original, $1.5 million line of credit, and that maturity date was also approaching in July. The company’s overall financial situation was bleak, however, made worse by the slump in the energy services sector due to the drop in oil prices.
On July 3, both loans came due. According to court documents, Lane pleaded his case with his bankers, arguing that—at least as far as the $900,000 loan was concerned—the only way he could repay the balance was to complete the Halliburton job, which meant he needed another extension. Initially, his bankers gave him verbal assurances and started to work out a plan that would extend the credit and enable him to pay it off as funds became available, according to Lane’s testimony during the trial.
But after just a few weeks and without warning, Whitney turned the case over to its collections department and cut off all communication between Lane and his bankers in the commercial lending department. The plan they’d been trying to negotiate was off.
As a result, SMI was unable to complete the Halliburton deal and was forced to permanently close its doors. Some 80 employees lost their jobs, though a group of them have since formed a new company, SMI International.
In October 2016, Whitney sued SMI and Lane for the unpaid balance on the two loans plus interest and attorneys’ fees, which totaled more than $1.2 million. SMI countersued, alleging breach of contract, negligent misrepresentation, tortious interference with SMI’s business relationships and breach of duty to negotiate in good faith, as well as several other claims it would later drop.
The case went to trial in September 2018. After three days of testimony, U.S. Magistrate Judge Patrick Hanna issued a split ruling that amounted to a major victory for SMI and a black eye for the bank.
The judge found SMI liable for defaulting on the original, $1.5 million loan and ordered the company to pay the unpaid balance. But on the second, $900,000 loan, Hanna found the bank liable for breach of contract by “failing to fund the Halliburton project to completion.”
In his ruling, the judge noted that the “brief, three-month extension” Whitney had granted SMI between April and July 2016 “made no sense whatsoever in the context since Halliburton had delayed the start of the project by 10 months. … The bank knew the tanks could not be completed by the new maturity date.”
He also blamed the bank’s collection efforts for ruining SMI’s relationship with its customers, including Halliburton, which ultimately led to the company’s demise.
Hanna gave credence in his ruling to a theory espoused at trial by Lane’s expert witness, Kentucky financial consultant Tim Finn, who attempted to make sense of why the bank would apparently sabotage its own customer by calling a loan that was funding a job that—if completed—would enable the loan to be paid off.
Finn theorized that SMI was the unfortunate victim of a strategic decision made by Whitney at the corporate level to move away from energy sector loans due to unfavorable market conditions at the time.
“A corporate decision to cease lending to oil and gas services companies would explain the bank’s change in course,” Hanna wrote in his opinion, citing Finn. “However this change without any notice, evaluation or recognition of the Halliburton line of credit was a not a commercially reasonable standard of fair dealing and was a breach of contract …”
Hannah determined Whitney’s actions were responsible for forcing Vaughn to idle SMI Global, the value of which he assessed at some $3.5 million. Thus, the $1.2 million SMI owed Whitney on the first loan was negated by the $3.5 million Whitney owed SMI for messing up on the second.
The result was a more than $2 million judgment against the bank. Earlier this month, Whitney filed a lengthy appeal.
“No rational lender would ever assume such a broad obligation. … When the loan matured Whitney acted within its contractual rights to demand payment.”
ATTORNEYS FOR HANCOCK WHITNEY BANK, in an appeals filing with the U.S. Fifth Circuit Court of Appeals
In its appellate brief, Whitney’s attorneys argue that SMI was a customer in deep financial straits that defaulted on two nearly identical loans—both lines of credit on which had been extended, once each—and was maxed out.
More specifically, the bank argues that Hanna made a couple of key errors in his ruling. One was in misinterpreting the terms of the $900,000 loan agreement, which Whitney says was never tied to completion of the Halliburton project.
“Nowhere in the loan document does Whitney promise to fund SMI’s project through completion; nor did Whitney agree to fund the Halliburton project in excess of $900,000,” the brief states.
Whitney argues that Hanna—and Lane for that matter—interpreted a “prefatory purpose statement” as a binding loan term that obligated Whitney to fund the loan beyond its contractual maturity date, rendering the date meaningless.
Why, Whitney argues, would the $900,000 loan have a maturity date at all if it was to remain open-ended until the storage tanks were all completed and delivered?
“No rational lender would ever assume such a broad obligation,” Whitney’s brief states. “What if the Halliburton project was delayed for a year? Two years? Five years? Under the trial court’s judgement Loan 2’s maturity would have been repeatedly extended, perhaps indefinitely. … When the loan matured Whitney acted within its contractual rights to demand payment.”
Whitney’s attorneys also argue that Hanna erred in holding Whitney liable for the verbal assurances and offers made to Lane by his Whitney bankers in the summer of 2016 that they would try to work with him. A 1989 state law requires any such communications must be agreed to in writing.
As for Finn’s theory that SMI was an unfortunate victim of a change in Whitney’s corporate-level lending strategy, Whitney’s attorneys dismiss the notion as “speculative opinions” regarding “alleged ‘macro’ bank decisions.”
Whitney is asking the Fifth Circuit to reverse the lower court’s decision.
So what are the odds that it might?
Chris Odinet, a Baton Rouge native and associate professor at the University of Oklahoma College of Law, says it’s hard to predict. The Fifth Circuit is conservative, meaning it would tend to look closely at the wording in the original loan document and base its ruling off of the language in the contract.
“Does that mean they side with the bank? I can’t say,” Odinet says. “But I think it would be more in line with their past rulings to look to the four corners of the loan contract rather than to exercise any judicial policy making—but you never know.”
The Louisiana Banking Association isn’t taking any chances. On Feb. 19, the industry association filed a “friend of the court” brief in support of Whitney, arguing that the 1989 state law—the Louisiana Credit Agreement Statute—protects banks against claims not based on a written agreement. Until the law was passed, lender liability suits were common and were frequently based on alleged oral agreements and hand-shake deals, which “caused instability and had a chilling effect on economic growth,” the LBA brief reads.
It continues: “The LCA Statute and the way it has been applied over the past 30 years have provided stability and certainty which has enabled banks operating in Louisiana to make loans and contribute to our economic growth. … The LCA Statute has provided a bright-line rule of when a valid credit agreement exists … a finding by this court that alternative theories of recovery are permissible based on an alleged oral agreement … would render the statute meaningless and undermine the protection it provides.”
There’s no telling when the Fifth Circuit will rule. Sometimes it takes months, if not longer. But the LBA’s involvement speaks to a level of concern about the situation, and makes it worth watching from a legal and banking perspective, Odinet says.
“The fact that the LBA is getting involved tells you something about their level of worry,” he says. “They’re worried the district court’s decision would get upheld and concerned about what that would mean for lenders more broadly in the Fifth Circuit states of Texas, Louisiana and Mississippi.”
