Supreme Court Permits Suit by Developer against Lender

Earlier this month, the Supreme Court allowed a developer to maintain its suit against a lender for defaulting upon its loan commitment.

In the case of Basic Capital Management, Inc., et al. v. Dynex Commercial, Inc., ___ S.W.3d ___ (Tex. 2011)(4/1/11), the lender required real estate developer to form single asset entities (SABREs) to finance a multimillion dollar loan commitment for several projects. After the lender provided some credit but then refused further financing, the corporations which owned and managed the SABREs sued. They claimed that they incurred an increase in financing costs when they had to obtain loans elsewhere at higher interest rates, and they also claimed that they lost profits on developments they could not complete.

The jury rendered a substantial verdict for the developer. But the trial court granted a judgment for the lender, based in part on the lender’s claim that the developer was not an entity which lender promised to finance. Rather, the funding would go to the SABREs which the developer would create for each deal. The Supreme Court disagreed: “We hold that the corporate owners of [the SABREs] were third-party beneficiaries of the commitment, and that consequential damages for the lender’s breach of the commitment were foreseeable.”

“‘A third party may recover on a contract made between other parties only if the parties intended to secure some benefit to that third party, and only if the contracting parties entered into the contract directly for the third party’s benefit.'” As “a general proposition, a corporate parent is not a third-party beneficiary of its subsidiary’s contract merely by virtue of their relationship.” But here, the lender “knew that the purpose of the Commitment was to secure future financing” for the corporate owners. The lender knew one plaintiff managed investment trusts, and the lender required the SABREs for its own benefit. The Commitment “‘clearly and fully spelled out’ the benefit to” the corporate owners. And a corporate owner signed the note with lender. Footnote 24 said: The “contracting parties’ intention, which is of controlling importance, must be ascertained from their agreement ‘in the light of the attending circumstances.'”

The developer sought lost profits as consequential damages. “‘They are not recoverable unless the parties contemplated at the time they made the contract that such damages would be a probable result of the breach.'” A “general knowledge of a prospective borrower’s business does not give a lender reason to foresee the probable results of its refusal to make the loan.” But the borrower need not prove that “at the time the commitment was made, not only the nature of the borrower’s intended use of the money, but the specific venture in which the borrower intended to engage.” Rather, to “be liable for the consequential damages resulting from a breach of a loan commitment, the lender must have known, at the time the commitment was made, the nature of the borrower’s intended use of the loan proceeds but not the details of the intended venture.” Here, there was no question that the lender knew of the purpose of the financing Commitment. In addition, the lender “knew that if market conditions changed and interest rates rose, its refusal to honor the Commitment would leave [plaintiff] having to arrange less favorable financing. . . . [Moreover,] we cannot infer from [plaintiff’s] ability to arrange for alternate financing in a few instances that it could always do so, and nothing in the record supports such a counterintuitive proposition.” So, here, the developer could recover damages for increased interest rates and lost profits.