ARE BANKS IMMUNE FROM FRAUD?

Fraud occurs when one party misrepresents a fact and induces the other party to act based on bad information. Normally, when a person commits fraud they can be held liable to the person who relies on the bad information for damages incurred based on that reliance.

This is not the case with banks and their borrowers. In Colorado, banks and borrowers are protected from liability for fraud claims and other similar claims by Colorado Revised Statute § 38-10-124 (the “Bank Statute of Frauds”). The Bank Statue of Frauds bars claims brought by a bank or other financial institution as well as claims brought by borrowers to enforce credit agreements in excess of $25,000 unless the claim is based on an obligation contained in a signed writing. In other words, banks and borrowers must express their expectations in writing, or such expectations will likely not be enforceable.

Two simple examples illustrate the implications of the Bank Statute of Frauds:

Bill’s Cycle Shop has a $100,000 line of credit with Dream Bank that by its terms expires on June 1. On May 15, prior to the expiration of the line of credit, Bill talks to his banker at Dream Bank about renewing the line of credit, and the banker tells Bill not to worry – the line of credit will be renewed. Relying on this oral promise, Bill orders new inventory for Bill’s Cycle Shop and intends to pay for it with his line of credit at Dream Bank. Dream Bank refuses to renew the line of credit. When Bill cannot pay for the ordered inventory because his line of credit has expired, Bill does not have any recourse against Dream Bank because his claim is barred by the Bank Statute of Frauds.

Bill’s Cycle Shop applies for a $100,000 loan with Dream Bank. In order to obtain the loan from Dream Bank, Bill provides fraudulent financial statements. Relying on the fraudulent financial statements, Dream Bank enters into a written agreement to loan to Bill’s Cycle Shop $100,000. The terms of Dream Bank’s loan agreement with Bill’s Cycle Shop do not address the bank’s reliance on the financial statements and do not give the bank the ability to rescind the loan agreement or declare a default based on the submission of fraudulent financial statements.

When Dream Bank discovers that Bill’s Cycle Shop submitted fraudulent financial statements, it will not have a claim against Bill’s Cycle Shop under Colorado law. These examples illustrate just how important it is to have well drafted credit agreements. Financial institutions and borrowers must make sure that their complete understanding of the agreement is in writing. Otherwise, they may end up in an agreement that does not reflect their understanding of the transaction.

The Bank Statute of Frauds is a unique “statute of frauds.” The traditional statute of frauds requires that certain agreements must be in writing to be enforceable. For example, agreements that must be in writing include contracts for the sale of land and contracts that cannot, by their terms, be performed within one year. While the traditional statute of frauds does not differ significantly from the Bank Statute of Frauds on its face, it is very easy to avoid the application of the traditional statute of frauds because it has many exceptions. For example, an oral agreement can be enforced despite the lack of a signed writing based on partial performance of the agreement by either party. Also, claims for “fraudulent inducement” (where one party enters into a contract based on the other party’s misrepresentations) are not barred by the traditional statute of frauds. However, unlike the traditional statute of frauds, the Bank Statute of Frauds actually works as a bar to all fraud claims, including fraudulent inducement claims.

Disclaimer: The foregoing discussion is not intended to constitute legal advice but is provided

solely for informational purposes. You should consult with a competent attorney regarding any

of the issues discussed herein.