The Illinois Credit Agreement Act

The Illinois Credit Agreement Act – Sword or Shield in Disputes Among Participating Lenders?

The decline of the commercial real estate market created an inverse trend in number of inter-creditor disputes concerning commercial acquisition and construction loans.  While creditors have always wrangled over the carcass of failed real estate deals, a disturbing new trend has emerged—participating lenders are growing ever more aggressive in their attempts to unwind decisions made long ago to extend credit and to hang their liability on the necks of their business partners.
 
I have been working with others at the Firm on just such a matter.  Several years ago, when the market was flush and lines of credit freely granted, our client, a major financial institution, engaged another financial institution to participate in a commercial acquisition and development loan.  The project was funded in 2006, and by all accounts each lender was optimistic as to the likelihood of success.  So much so that they overlooked a mistake in the participation agreement—namely that the document was internally inconsistent as to whether all parties would participate on a pro rata basis at the outset, or if there was a funding threshold in place.  At the closing, each lender funded the credit on a pro rata basis, consistent with the negotiated terms of the deal.
 
Fast forward four years.  The commercial real estate market tanked, the borrower defaulted, and the value of the collateral decreased by half.  The rational expectation of the lead lender was that each of the participating lender would accept the corresponding pro rata share of the proceeds from the sale of the collateral, lick its wounds, and walk away.  Not so.
 
In an unusual twist, the participating lender sued the lead lender alleging that the participation agreement was breached because it included a term that was not consistent with the parties’ agreement or the structure of the transaction.  After the lead lender asserted a counter-claim for reformation, the participating lender sought dismissal of the counterclaim pursuant to the Illinois Credit Agreements Act.  That powerful but not-very-well-understood Act precludes any claim or defense by a debtor based on a credit agreement that is not reduced to writing and signed by the parties to be charged.  The purpose of the Act is to prevent costly litigation for financial institutions that have advanced funds when recovery efforts are met with meritless defenses of fraud, estoppel and waiver.
 
While the Act has always been a favorite tool in the arsenal to we use to assist clients combating legal and equitable claims made by borrowers, this was the first time we have seen a lender attempt to use it against another lender.  The general theory behind the motion was that since the lead lender was obligated to pass through amounts paid by the borrower under the note, the lender was a “debtor” as defined by the Act.
On behalf of our client, we argued that the participating bank’s theory was an improper and incorrect reading of the Act.  The trial court agreed and determined that our client did not meet the definition of “debtor” because, among other reasons, it acted as the lead lender in the transaction.
 
This experience teaches the importance of understanding the contours of the Act, and, of course, hiring counsel familiar with its various nuances.
 
For more information on the Illinois Credit Agreement Act, please contact Jessica Scheller.