In March, jurors were asked to decide to what extent an Eastern Kentucky community bank had been damaged when the defendant bank breached four Participation Agreements. The case was Citizens National Bank of Paintsville v. MCNB Bank and Trust Company, No. 7:12-102, U.S. District Court, Eastern District of Kentucky, Pikeville Division. After deliberating less than two hours, the jury awarded 100% of the damages claimed by Citizens National Bank (“CNB”) in the amount of $1,412,650.64. M&P represented CNB from the very beginning of the lawsuit and was assisted at trial by Russell Davis of Baird & Baird PSC in Pikeville.
Banks have a lending limit on loans made to a single borrower. If a lending limit is exceeded, a bank will sell a portion of the loan to another bank via “a loan participation.” Banks typically agree to participate in the loan in proportion to the amount of the loan principal they provide. In this case, MCNB (Weston, West Virginia) sold portions of four hotel construction loans to CNB, which paid $5.9 million for its share of the loans via four Participation Agreements.
The borrowers made payments for several years, but MCNB eventually decided it no longer wanted to participate with CNB. Ultimately, MCNB unilaterally wire transferred $5.3 million to CNB, claiming that this terminated the Participation Agreements because it represented CNB’s percentage share of the principal amount of the loans remaining unpaid. CNB disputed MCNB’s right to terminate and filed suit in August 2012 to recover damages for breach of contract.
Federal Judge Karen Caldwell ruled that MCNB had breached its contracts with CNB and ordered a jury trial on damages only. The first issue at trial was how to value the future stream of payments. CNB used a formula to discount the anticipated future stream to a present value and offered evidence that its formula was appropriate to address any uncertainties.
The second issue was a mitigation-of-damages defense by MCNB. CNB invested the money MCNB wired to it in an account at the Federal Reserve (the account to be used by the banks, per the agreements), which paid daily interest at a rate adjusted as the Fed raised and lowered rates.
MCNB argued that this account was too conservative, and that CNB should have invested the $5.3 million in “mortgage-backed securities” (“MBS”). MCNB claimed that if these funds had been invested in this manner, CNB would have earned enough to fully offset its lost interest. CNB countered that there were no guarantees how much such MBS would earn; its regulators warned against buying too many of them; it already had more than it wanted; and a rise in interest rates could adversely affect the MBS’ market value.
After hearing the evidence, the jury adopted CNB’s damages calculation and rejected MCNB’s mitigation-of damages defense.
There are several important lessons from the verdict. First, the case only reached the jury because CNB’s Participation Agreements were written to prohibit a unilateral termination by MCNB, which highlights the importance of well-written bank contracts. Second, the jury was shown a number of CNB’s internal policies (including its investment policy and liquidity policy), which demonstrates the importance of appropriate, well-written policies. Third, M&P’s experience is that juries have little sympathy for banks perceived as acting improperly, and, for this reason, if ever in the shoes of the defendant bank, you need to evaluate thoroughly what might represent a fair settlement and the risks of going before a jury.
by M. Thurman Senn
M. Thurman Senn’s practice concentrates on banking and finance law, bankruptcy, foreclosure, commercial litigation and arbitration.