Covenant of Good Faith and Fair Dealing no help to Borrowers

As a borrower you may find yourself in a situation where you negotiated and entered into a loan agreement but are still denied a loan advance, because your lender just doesn’t feel like it.  Or at least that is the picture that presents itself from your end of the table.  Most likely the lender will point you to language in the loan agreement that states that the lender is allowed to exercise sole discretion in approving or disapproving loans or making any other decision under the loan agreement.

Fuming at the thought of all the wasted cost and time that went into the negotiation and execution of the loan agreement (and your financial homework to get approved for a loan in the first place), you may think to yourself that lenders should not be allowed to jerk innocent businesses around like that.  Unfortunately, if your loan agreement contains the above-mentioned language, there is little you can do after the loan agreement has been executed.

Even though New York law recognizes a covenant of good faith and fair dealing whereby contracting partners are supposed to refrain from unreasonable and arbitrary exercise of contractual terms, such covenant is construed very narrowly and will probably not help the frustrated borrower.  New York courts have held that where the express terms of a loan agreement allow a lender to exercise discretion in the decision to advance a loan, the lender has a right to deny the loan, even if the decision is unreasonable or arbitrary.  Courts have even gone so far as to hold that where a contract allows a lender to act in a certain way and sets no boundaries on the lender’s right to do so, a lender is not prohibited from unreasonably or arbitrarily exercising such right.

Thus, the time to prevent arbitrary and unreasonable decisions by lenders is during the negotiation stage.  Look for any clauses that allow the lender to exercise discretion and try to negotiate these provisions out of the agreement. You may also want to add provisions that state that any necessary consent by the lender “may not be unreasonably withheld” and that rights may only be exercised “acting reasonably.”  While you may not succeed in getting all such language removed (or added), you may be able to scale back the lender’s discretion to a manageable risk you are willing to take.

About Imke Ratschko

Imke Ratschko is a New York Attorney helping small businesses, business owners and entrepreneurs with all things "Small Business Law," such as litigation, contracts, business owner disputes, shareholder and operating agreements, sale or purchase of a business, investors, and starting a business. You can reach her at 212.253.1027.

One comment

  1. Glad you got power back and we’ll hope for a speedy reconnect for the rest out there still without.