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NY Court of Appeals Rules Lender Reliance on Borrower Financial Representations without Independent Investigation is not Unreasonable
Gilbert D. Porter, Sue P. Murphy
An almost universal feature of commercial loan agreements is the inclusion of representations and warranties regarding the financial statements and condition of the borrower. A recent case examined whether under New York law, sophisticated lenders can reasonably rely upon such representations in asserting claims of fraud instead of being required to make an independent investigation into the books and records of the borrower.
In DDJ Management LLC, et al v. Rhone Group L.L.C.,1 the New York Court of Appeals held that lenders may maintain claims against two groups of investment funds and their affiliates for fraud after the plaintiffs,2 the agent and lenders under a credit agreement lost a total of $40 million in loans they made to a company controlled by such investment funds. The court held that lenders could reasonably rely upon representations and warranties contained in the loan documents, in which the borrower provided assurances that its financial statements were accurate and that nothing therein was materially misleading. The court found that by including such representations, the lenders made a “significant effort” to protect themselves against the possibility of false financial statements and therefore did not require that lenders independently investigate the financial condition of borrower. This came much to the relief of lenders who typically bargain for and rely upon such representations, as the appellate court overtturned a lower court decision which would have required sophisticated lenders to independently investigate the books and records of their borrowers in order to sustain a fraud claim against them.
Published in the September 2010 issue of Pratt’s Journal of Bankruptcy Law. Copyright 2010 ALEX eSOLUTIONS, INC. 1-800-572-2797. Reprinted by permission. To read the full article click on the PDF linked below.
1 DDJ Mgmt., LLC v. Rhone Group L.L.C., 2010 NY LEXIS 1182 (N.Y. 2010).
2 The plaintiffs in the case are the agent DDJ Management LLC and lenders DDJ Total Return Loan Fund, L.P., GMAM Investment Funds Trust II and Arlie Opportunity Master Fund, LTD.