by By MICHAEL CORKERY
The Wall Street Journal
The Wall Street Journal
As lenders rush to curtail their real estate exposure and preserve sorely needed capital, they are triggering lawsuits from builders that say the banks have unfairly cut off their construction financing, stopped their projects midstream and forced their companies to the brink of bankruptcy.
“Lender-liability lawsuits are coming. It’s only just beginning,” said Michael Hackard, a lawyer in Sacramento, Calif., who focuses on real-estate law. “There are going to be builders who argue that the lender forced me into insolvency by not acting in good faith.”
Developer John Thomas said he had nearly finished building a 222-unit condominium and hotel project in Stockton, Calif., when his lender, First Banks Inc.’s Missouri-based First Bank, wouldn’t release the final $6 million from his $40 million construction loan.
The bank indicated on “multiple occasions” that it would finish funding the loan, but never did, according to a lawsuit Thomas’s company, Regent Hotel LLC, filed against First Bank in Superior Court in Sacramento County. As a result, Thomas’ lawyer said, liens have piled up against the project, the condo units haven’t been completed, and the hotel has been taken over by a receiver.
“In our view, the bank took a healthy project and destroyed it,” said the lawyer, Matthew Quint. “It’s our belief that they had no legal grounds and no legitimate practical concerns for refusing to continue funding it.” First Bank’s lawyer declined to comment.
The clampdown on construction financing comes as banks face intense pressure from regulators and shareholders to reduce their real estate exposure.
Regional and small banks have been reeling amid fears that they face potentially crippling real estate-related losses.
Tuesday, KeyCorp, a major lender to home builders, reported a $1.13 billion loss, saying its second-quarter results were “adversely affected” by higher loan losses related to its efforts to “aggressively reduce its exposure to the residential properties segment of its commercial real estate construction loan portfolio.”
The bank’s provision for loan losses in the second quarter was $647 million, up from $187 million in the previous quarter.
The courts may be a builder’s last resort against a bank. The legal disputes are turning heated as banks go after the builders’ personal assets and family fortunes to recoup losses from soured housing developments. The banks are enforcing personal guarantees that many builders signed to arrange the loans.
Lender-liability lawsuits were relatively common during the real estate bust in the 1990s. Back then, before foreclosing, some lenders often would effectively take control of troubled projects and force many developers to follow their management advice. That gave developers an opening to sue the banks – with success in many cases.
“When the project didn’t work, the developer would blame the bank when the bank moved to foreclose,” said Leonard Boxer, head of the real estate practice at the New York law firm Stroock & Stroock & Lavan LLP. “The banks learned their lesson in the 1990s. That’s why lenders are cautious today.”
During this downturn, some banks have been more willing to pull out of projects instead of getting involved to fix them.
J.P. Eliopulos Enterprises Inc., a home builder in the hard-hit housing market of California’s Antelope Valley, north of Los Angeles, is suing IndyMac Bancorp Inc. which is now under federal control.
The suit alleges that the lender failed to act in good faith when it launched an extensive audit of the builder’s large housing project and then ordered an appraisal, delaying the development, according to a lawsuit the company filed in Los Angeles County Superior Court in April.
The bank appraisal in December 2007 valued the project, the approximately 900-acre Joshua Ranch Development, at $17 million, down from an appraised value of $82 million in May of that year, said Andrew Eliopulos, the company’s president and chief executive.
The bank estimated it would take about 18 years to sell 539 houses on the property, Eliopulos said. “That’s insane,” he said.
“I told them your appraisal is flawed. This bank is in trouble, and it just wants out.”
He said the bank had been pursuing personal guarantees that he, his wife and his 81-year-old mother signed when the builder took out the loans. IndyMac had been requiring that the builder pay the difference between the property’s $17 million appraised value and the $27 million loan balance, or pay off the loan in full, he said.
David Barr, a spokesman for the Federal Deposit Insurance Corp., which now controls the bank, declined to comment on the Eliopulos lawsuit, but said “the FDIC is currently reviewing all defense of litigation that was pending against IndyMac when it was closed.”
It isn’t clear whether IndyMac will enforce the guarantees against the Eliopulos clan. FDIC Chairwoman Sheila Bair said her agency was conducting a “case-by-case review” of the bank’s construction loans.
Eliopulos has joined about 30 California builders who have been meeting in recent weeks to discuss ways to push back against the banks. They are considering contacting state lawmakers and even Congress for help.
“If banks want to get out of residential lending, that’s fine; let’s sit down and figure it out,” said Mick Pattinson, another group member and chief executive of builder Barratt American, based in Carlsbad, Calif. “But that isn’t being done. The rug is literally being pulled from under us and games are being played.”
Pattinson said Bank of America Corp. froze his $100 million credit line for seven months, while ordering a new appraisal of his properties. During that time, Pattinson said, his company paid down its credit line by $30 million, but then stopped making payments in March when Pattinson said he realized the bank was never going to unfreeze the loan.
A Bank of America spokeswoman declined to comment on Pattinson’s situation.
Pattinson said that “after seven months, this country boy figured they weren’t going to allow us to use the credit line. I said, ‘No functioning line, no interest.’”
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