Banks Beware When Documenting And Securing Renewal Loans

A complicated set of facts recently led the Tennessee Court of Appeals to a decision that sends a simple message to banks: When documenting a renewal loan, be careful when dealing with the collateral that secured the earlier loan. If a bank learns that a borrower has engaged in fraud to secure a renewal loan after it has released the borrower's guaranty from the earlier loan, a Tennessee court will not rescind the release agreement if the original guarantor was not involved in the fraud. In Healthcare Management Resources, LLC v. Carter, the Court refused to rescind a release agreement between a bank and Party B based on alleged fraud by Party C.

In 2003, a bank entered into a loan agreement with a business that was controlled by three individuals (the sellers). A fourth individual (the guarantor) pledged collateral to secure the loan. In 2004, the sellers transferred ownership of the business to new investors. As part of the change in control transaction, the bank entered