Most written agreements in Ohio can be changed verbally, including loans.[i] As a result, nearly all loan documents contain terms that forbid verbal changes to them. But can a lender and borrower verbally agree to waive a non-verbal-modification clause? Yes, in the right circumstances, which is one of the biggest causes of lawsuits and lender liability for Ohio’s community banks and credit unions.[ii]
According to Ohio’s appellate courts, borrowers and lenders can verbally waive their written agreement to bar verbal changes to loan documents.[iii] In fact, they needn’t express that waiver verbally, for a lender may modify a loan’s term simply through its actions (i.e., an implied change).[iv] In other words, borrowers and lenders can change a loan’s enforceable written terms just by acting as though they’ve changed. And where the parties disagree about whether a change occurred, a judge or jury will decide if the lender’s actions were consistent with that non-written change—a far departure from written words in loan documents that so many financial institutions rely on.[v] But like most risk, Ohio’s financial institutions can manage the risk of verbal changes by establishing and following strong policy. Even so, it’s first important to recognize how verbal changes usually arise.
Verbal changes to loans often occur when a financial institution is unintentionally unclear about a loan’s status. That vagueness can take many forms, even those that come from the desire to help: e.g., acting inconsistently with the loan’s written terms by waiving fees, disregarding breached negative covenants, or assisting a borrower without proper safeguards. Verbal changes—or at least the argument for them—can also occur simply because of human nature.
Many borrowers, both commercial and consumer, view a lender’s loan officers, workout specialists, and service representatives as their personal voice within the institution, and to some extent they are. So, for example, where a borrower asks its loan officer to waive its annual debt-service coverage covenant in June and the officer promises to seek approval from the institution, no response or a negative response in November might create issues.
And some injuries from verbal or implied changes to loans are self-inflicted. Even the smallest financial institutions speak with multiple voices, and where those voices are inconsistent, a loan’s status and terms can become unclear. Rarely a lender-liability case is filed without an allegation that one representative made a promise that another refused to honor. For example, where a workout specialist denies a request to modify a loan to interest-only payments for six months and loan officer verbally approves the same request (or leads the borrower to believe that its request will be approved), a defense or claim concerning verbal modification can arise.
Despite those risks, verbal-modification claims and defenses are rarely successful, but that belies the danger for financial institutions: disputing those claims and defenses can add years to loan enforcement and thousands in avoidable costs and fees. As a result, prevention is vital.
Consistency and knowledge are often the means to avoiding unintended verbal changes to loan terms. Training employees who interact with borrowers to thoroughly grasp the major written terms of the loans they service can prevent future issues. Knowing, for example, when a negative covenant applies to one loan but not to another can prevent disputes that give rise to litigation or regulatory issues.
Likewise, presenting a consistent message can prevent avoidable future losses. Are your lenders aware of all communication between the institution and the borrowers about a troubled debt? Verbal changes and liability can arise, for example, where a loan officer leads a troubled borrower to believe its loan will be modified under favorable terms, the borrower forgoes other borrowing opportunities in response, and then special assets (without knowledge of the officer’s communication) files a lawsuit. Policies that enforce good note taking and case review can prevent those unfortunate situations—particularly where communication becomes more electronic and informal (e.g., texting).
In the end, use the written word to combat the verbal: ensure all changes are written—even those that are common, like waivers. A brief written note confirming that a waiver of a quarterly financial disclosure was one time only can be just as valuable from a lender-liability perspective as a pre-workout agreement that memorializes a loan’s current terms and status.
[i] See Third Fed. S&L Ass'n of Cleveland v. Formanik, 8th Dist. Cuyahoga No. 103649, 2016-Ohio-7478.
[ii] See Wells Fargo Bank v. Smith, 11th Dist. Trumbull No. 2010-T-0051, 2012-Ohio-1672.
[iv] See City of St. Marys v. Auglaize County Bd. of Comm'rs, 115 Ohio St.3d 387, 2007-Ohio-5026, 875 N.E.2d 561.
[v] See Third Fed. S&L Ass'n of Cleveland v. Formanik, 8th Dist. Cuyahoga No. 103649, 2016-Ohio-7478.