The Borrowers Fail to Mention Material Facts

By Dan Harkey

Real-life Example:

In this real-life example, a borrower withholds crucial information in a proposed loan transaction, leading to a complex and potentially risky situation. The lender's due diligence uncovers the full extent of the borrower's financial obligations, highlighting the importance of transparency and thorough investigation in financial transactions.

This example concerns a super complex and audacious proposed loan transaction in which a borrower withholds many material facts. In retrospect, this borrower possessed sneakiness, deviousness, and dishonest traits. The transaction has too many moving parts to verify each problem thoroughly.

The mortgage broker states…

“My client needs a loan to pay various judgments, liens, and tax obligations.? He has a ton of equity in his real estate and is probably worth more than 10-20 million dollars.? Would he ever default?? I will obtain an application for your review.”

The prudent lender responded….

A couple of weeks later, after the lender’s underwriting department has conducted due diligence, the broker/lender, responsible for facilitating the transaction and ensuring all necessary information is provided, responds to the borrower’s agent.

·?????????????? As a potential lender, we have meticulously conducted due diligence on this transaction. Our comprehensive background search on the borrower and the borrower’s operating company and our thorough check of court records revealed a more complex situation than initially presented.

·?????????????? Our thorough due diligence process should reassure all concerned about our commitment to uncovering all potential transaction risks.

·?????????????? What was initially represented as a few judgments, liens, and tax obligations has unexpectedly transformed into an immensely complex underwriting exercise.? “A few turned out to be a few too many.” This unexpected turn of events should underscore the importance of being prepared for surprises in the lending process.

·?????????????? The example has three parties:

·????? the primary borrowers who own at least 15 pieces of real estate,

·????? a company owned and actively operated by the borrower or a close family member,

·????? a newly formed company started and operated by a closely related borrower party, which is not part of this loan request.

·?????????????? The borrower also has a business enterprise with many judgments and liens, separate from the borrower’s judgments as an individual.

·?????????????? This borrower has many prime real estate pieces, some free and clear.? The equity to borrow against appears to be more than adequate.

·?????????????? The borrower has a significant financial burden of about 2 million dollars of state and federal personal tax arrearages and judgments.

·?????????????? The borrower has a Lis Pendens recorded on numerous properties, and lenders are using his individual properties as a source of repayment. There are also multiple defaults on large pieces of leased business equipment that he has personally guaranteed. No new loans or conveyance are possible unless these obligations are satisfied because they are all a matter of public record.

·?????????????? The operating company, owned by the borrower separately from the individual, also has 2 million dollars of civil judgments and liens. The company has not paid California employment taxes for almost two years.

·?????????????? The company has also defaulted on lease payments for multiple pieces of large equipment, which the borrower personally guaranteed.

·?????????????? ??The defaults of some equipment leases had personal guarantees; therefore, the judgment becomes an individual obligation of an estimated $300,000.

·?????????????? The borrower and the borrower’s lawyer argue that business debts cannot be attached to the individual or his unrelated real estate holdings.? Therefore, a title insurer must insure these new real estate loans.

·?????????????? The borrower tends not to pay vendor service providers in his business, resulting in litigation.? There are multiple civil judgments against the company.

·?????????????? A borrower-related party has started a new company in the same line of work.? The new company took over all active customer accounts.? The operational buildings and the equipment used in the latest industry are the same.? However, even the new company continues to default on equipment payments owed by the old company.? It appears, although not verified that the borrower is attempting to take his defaulting company, with two million in debt, into insolvency without bankruptcy or paying creditors.

·?????????????? The new company would take over the business accounts and operate a functioning enterprise with a projected profit.? The intent is that all tax obligations, judgments, liens, and tax obligations remain in the old insolvent company.

·?????????????? All arrears in taxes, judgments, and liens of the old operating company would disappear in insolvency.

·?????????????? While one may consider the underhanded maneuvers a brilliant estate planning scheme, the loan request was declined for apparent legal and ethical reasons. The borrower's actions, including the attempt to transfer liabilities to a new company and the history of defaults and litigation, raised serious concerns about the borrower's financial responsibility and the potential for future defaults.

·?????????????? The broker/lender perceives that there will be future litigation since the new operating company defaults on equipment leases, all with personal guarantees leading back to the borrowers as individuals. This perception underscores the need for thorough risk assessment in such transactions, ensuring that we are always prepared and proactive, especially when potential future litigation is a concern.

In conclusion, this case is a stark reminder of the risks and complexities involved in loan transactions, especially when borrowers withhold material facts. It underscores the critical importance of thorough due diligence and the potential consequences of unethical or deceptive behavior in financial transactions. This is a cautionary tale and a call to vigilance for all involved, emphasizing ethical conduct in all financial dealings.

Thank You

Dan Harkey

Educator and Private Money Lending Consultant

949 533 8315??? [email protected]

Visit www.danharkey.com

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