Lender’s Breach of a Construction Loan Results in Awarding of Economic Damages to Builder

The financial distresses of the Great Recession led to a wide variety of conflicts between construction lenders and builders. In many cases, the lender had the upper hand, with few options for builders who lost their financing in mid-project. But in at least one case, a lender’s arbitrary termination of a construction loan agreement backfired.

In early 2007, a predecessor of Great Western Bank¹ made an acquisition and development (A&D) loan to a builder-developer, Cedar Ridge Investments, to purchase Flagstaff-area real estate and develop it as a residential subdivision. Separately, the bank entered into an agreement with Cedar Ridge to make construction loans, on a case-by-case basis, for the homes to be built in the subdivision. Both loans were guaranteed by Cedar Ridge’s parent company and its principals.

Loan Termination. In July 2008, as development of the project was nearing completion and Cedar Ridge was preparing to obtain building permits for the homes, Great Western Bank decided to stop making construction loans in Arizona and told Cedar Ridge that it was pulling out of their agreement.

Cedar Ridge was unable to get alternate financing, could not build and sell homes and, thus, could not generate cash to service its A&D loan. Great Western foreclosed, sold the property to another developer, and sued the guarantors for the remaining $2.6 million loan balance.
At trial, the guarantors argued that the unpaid loan balance should be offset by lost profits caused by Great Western’s breach of their loan agreement, which they further argued constituted “anticipatory repudiation” and breach of the implied covenant of good faith and fair dealing.

Great Western claimed that the construction loan agreement was just a “guidance line,” under which the bank could choose to make – or not make – loans to build the homes at Cedar Ridge.

Win for the Builder. In the end, the trial court rejected the bank’s “guidance line” argument, noting that the agreement (titled “Loan Agreement”) obligated the bank to “make the Loans to Borrower” and required Cedar Ridge to “accept such Loans.” Also, the agreement allowed the bank to withdraw only if the borrower defaulted – a moot point, as the bank never made a loan on which Cedar Ridge could default.

The trial court concluded that:

• Great Western breached the loan agreement;

• Great Western’s breach prevented Cedar Ridge from building and selling homes and using the proceeds to retire the A&D loan; and

• Great Western had no valid reason for terminating the loan agreement, as Cedar Ridge was not in default and was prepared to begin construction.
  

Further, the trial court found that, if the bank had not breached the agreement, Cedar Ridge would have made a profit of between $2.8 million and $3.5 million. As that figure exceeded the outstanding balance on the A&D loan, the guarantors’ liability under the guaranty would have been reduced to zero.

Great Western Bank appealed, unsuccessfully. The Arizona Court of Appeals upheld the trial court’s ruling in all respects, sending a harsh warning to lenders and providing good news to borrowers who find themselves in a comparable situation:

• A lender’s breach of a loan agreement can result in lost profits and other economic damages to the borrower.

• Lost profits can be used to offset a loan deficiency and a guarantor’s liability.