Opinion ID: 203868
Heading Depth: 2
Heading Rank: 3

Heading: Instrumentality Theory of Lender Liability

Text: Count VIII of plaintiffs' complaint alleged that Sovereign was liable on the basis of an instrumentality theory. Where the theory is recognized, a lender may be held liable under the common-law instrumentality theory when the lender exerts such a degree of control over the borrower that the borrower becomes a mere business conduit for the lender. Krivo Indus. Supply Co. v. Nat'l Distillers & Chem. Corp., 483 F.2d 1098, 1102-07 (5th Cir. 1973), reh'g denied 490 F.2d 916 (5th Cir. 1974); see also Schwan's Sales Enters., Inc. v. Commerce Bank & Trust Co., 397 F.Supp.2d 189, 194 (D.Mass.2005); F.C. Imports, Inc. v. First Nat'l Bank of Boston, N.A., 816 F.Supp. 78, 91-92 (D.P.R. 1993); 1 Lender Liability Law and Litigation § 1.03[4][a] (2009); Lender Liability and Banking Litigation § 6.02 (2009). At least one Massachusetts trial court decision has suggested that under certain circumstances creditors may be held liable under the instrumentality theory. See Healy v. McGhan Med. Corp., No. CA975320, 2001 WL 717110, at  (Mass.Super.Ct. Mar. 29, 2001) (citing F.C. Imports, 816 F.Supp. at 91-92); see also Schwan's Sales, 397 F.Supp.2d at 194 (applying the instrumentality theory in a case governed by Massachusetts law and citing Healy ). But neither the Supreme Judicial Court nor the Appeals Court, as best we can determine, has ever adopted the theory. Even if Massachusetts were to be hospitable to the instrumentality theory, as utilized in some other states, the theory would not apply here. First, plaintiffs suggest a radical alteration to the theory. The instrumentality theory is akin to the piercing of the corporate veil doctrine, and has generally been used by third party creditors seeking to hold a lender liable for the debts of the borrower. See Krivo, 483 F.2d at 1102 (noting, in a suit brought by third party creditors to recover from another creditor on the debts of the borrower, that [o]ne of the most difficult applications of the rule permitting the corporate form to be disregarded arises when one corporation is sought to be held liable for the debts of another corporation ... [on the grounds that] it [has] misuse[d] that corporation by treating it, and by using it, as a mere business conduit for the purposes of the dominant corporation.); see also F.C. Imports, 816 F.Supp. at 91-92 (discussing instrumentality theory in suit brought by wholesale supplier against bank from which a retail seller had borrowed to recover from the bank on debts owed by the seller to the supplier); Healy, 2001 WL 717110, at  (discussing instrumentality theory in the context of an attempt by a third party to recover from a creditor on the basis of debtor's actions). Here, plaintiffs are debtors seeking to use the instrumentality theory to recover damages from their own creditor. They were not in the least misled as to who their creditor was. Plaintiffs point to no cases that recognize this novel application of the instrumentality theory, and there is no indication that such an application would be accepted by the Massachusetts courts. Further, the district court correctly found that, even under the usual theory, the facts alleged by plaintiffs cannot support the conclusion that Sovereign exercised sufficient control over FAMM to give rise to liability. Of course, the mere existence of a creditor-debtor relationship does not by itself give rise to the level of control necessary for liability under the instrumentality theory; if it were otherwise, lenders would rightfully be reluctant to extend credit. Krivo, 483 F.2d at 1104; accord F.C. Imports, 816 F.Supp. at 91; Healy, 2001 WL 717110, at . Indeed, even when the creditor tak[es] an active part in the management of the debtor corporation, this is not by itself sufficient. Krivo, 483 F.2d at 1105; see also Chi. Mill & Lumber Co. v. Boatmen's Bank, 234 F. 41, 43-44, 46 (8th Cir.1916) (finding insufficient control in a case in which a lending bank arranged for its employee to become president of the debtor company in order to protect the bank's interests). To establish liability under the instrumentality theory, courts have required a strong showing that the creditor assumed actual, participatory, total control of the debtor; the facts must unmistakably show[] that the subservient corporation was being used to further the purposes of the dominant corporation and that the subservient corporation in reality had no separate, independent existence of its own. Krivo, 483 F.2d at 1105; see also Schwan's Sales, 397 F.Supp.2d at 195; 1 Lender Liability Law and Litigation, supra, § 1.03[4][a] ([T]he creditor's control and dominance over the borrower [must be] so substantial as to indicate that the effective control of the borrower's operations and affairs rests with the creditor.); Lender Liability and Banking Litigation, supra, § 6.02[3][b][i] ([A] bank may properly share control of, or oversee, a debtor's business so long as it does not totally dominate the debtor's affairs.). Here, plaintiffs have failed to make such a showing. Although Powers and Lee interacted, there is no evidence that Sovereign directed Lee's actions, or that, even if it did, Sovereign had assumed actual, participatory, total control over FAMM's affairs. Indeed, such an inference seems implausible in light of the losses the bank suffered as a result of Lee's actions. Moreover, Ann and Paul Gavin continued to serve as President and Vice President of the company throughout this period, and FAMM had a permanent comptroller starting in March 2002. The district court did not err in granting summary judgment as to plaintiffs' instrumentality theory claim.