How Can a Lender Breach a Loan Contract?

Loan agreements are simply contracts between a lender and a borrower, spelling out the obligations of each party. Violating those obligations amounts to breach of contract. It's common to hear about breaches on the borrower side -- failure to repay the loan being the most obvious -- but lenders can also breach a loan contract in a number of ways.

A lender's primary duty under a loan contract is to provide money to the borrower according to the terms of the agreement, while the borrower's primary duty is to pay that money back. When a lender fails to supply the required funds, it's in breach of contract. Imagine showing up for the closing on a house and discovering that your mortgage lender simply didn't deliver the money as promised. That's a breach. Failure to fund also occurs in situations where the lender disperses funds over a period of time, as with a construction loan. As long as borrowers fulfill their own obligations to receive the next portion of the money, the lender is in breach if it fails to deliver.

Loan contracts often give lenders the right to "call" a loan -- that is, require full payment immediately -- if the borrower violates its terms. The language in the contract that allows this is called an acceleration clause. Mortgage contracts, for example, might have acceleration clauses that kick in if the borrower misses too many payments, fails to insure the home or doesn't live there. However, if a lender tries to accelerate improperly, calling the loan even though the borrower has held up her end of the bargain, that's a breach of contract. Even if acceleration is justified, it may still be a breach of contract if it isn't carried out according to the terms of the agreement -- for example, a lender foreclosing on a home without notifying the borrower of the acceleration.

Courts have found lenders to be in breach of contract for failing to fulfill promises made to the borrowers while the loan was being negotiated, even if those promises didn't make it into the final loan contract. For example, in a precedent-setting case from 1991, cattle ranchers had taken out a loan on a promise from the lenders that they could take 10 to 20 years to repay. The final loan agreement, however, said payment could be required within a year -- something the ranchers were told was a "formality" that wouldn't be enforced. The lender then demanded repayment in a year, and the ranchers sued. The court sided with the ranchers, who argued that they never would have taken out the loan under a one-year repayment. The court ruled that the oral promises were enforceable despite contradicting the written contract.

Loan agreements may include provisions allowing the borrowers to refinance or restructure the loan -- to take advantage of lower interest rates, for example, or to extend the repayment period. If the lender denies a refinancing or restructuring that should be allowed under the agreement, that's a breach of contract. A breach can also occur when the lender fails to provide sufficient notice of changes in the loan terms, even when such changes are allowed by the contract. An example would be changing the interest rate on an adjustable-rate loan. The lender may have the right to raise the rate, but the contract will usually require it to notify the borrower before doing so.