Disappointed investors can’t sue bank

December 31, 2008

In a sign of tough times for the real estate development market, investors in a multi-story lakefront condo project are battling with the bank that paid out their investment money to now-bankrupt developers. The disappointed investors who thought they had a money-back guarantee had their lawsuit against Branch Banking and Trust Co. dismissed by a federal judge this month.

The lawsuit centers on a now-vacant condo project that occupies a premier site at Central Virginia’s Smith Mountain Lake, where property sales are dropping faster than the drought-suppressed water level. It’s a turnabout for the popular 20,000-acre lake, where for decades fishing cabins steadily have given way to expensive lakefront dwellings.

The 2008 bankruptcy of the Bridgewater Pointe condominium project at Smith Mountain Lake not only left a prominent 48-unit luxury condo tower standing empty, it clearly left a lot of folks unpaid.

North Carolina’s BB&T can be counted among the disappointed investors. Claiming that it was owed $21 million in unpaid loans, the bank scheduled a public auction of the condo property in April. The auction promptly was cancelled when the development firm filed a Chapter 11 bankruptcy petition.

Then, BB&T was hit with a lawsuit by smaller investors who claimed that the bank had a duty to honor their escrow agreement with the developers.

Under that agreement, the investors’ funds, totaling $750,000, were supposed to be returned if the developers did not sell $1.5 million worth of units by a deadline in 2006. The project fell short of that sales target, but the investors did not get their money back. The investors claim the bank was aware of the escrow deal, but wrongly paid out their money to the developers, who then filed for bankruptcy. The funds are claimed by the development firm as part of its bankruptcy estate.

The problem with the investors’ lawsuit, according to U.S. District Judge Glen E. Conrad, is the investors were not customers of the bank and the bank was not part of the escrow agreement. Conrad dismissed the lawsuit Dec. 5, saying that the plaintiff’s case, if successful, would make a “shambles” of the banking industry.

The case is Scott v. Branch Banking and Trust Co.

“Under plaintiffs’ theory, a bank would assume escrow duties automatically whenever it might become aware that its customer and a third party had entered into some sort of arrangement that included an escrow agreement,” Conrad wrote, rejecting that concept as “unworkable.”

The appropriate way to address the situation would be for the bank’s customer to set up an escrow account with the bank in which funds are specially segregated and the bank formally assumes the duties of an escrow agent, the judge wrote. “This was not done here.”

Granting the bank’s motion to dismiss the lawsuit, Conrad concluded that the bank did not breach any contractual or fiduciary duties to the investors. A lawyer for the investors said an appeal is likely.

Banking lawyers cheered the decision. “I believe the court got it right,” said Joseph E. Spruill III, general counsel for the Virginia Bankers Association. “All too often, when there is a loss like this, … the aggrieved party goes after the deep pockets of the bank.”

“Making banks responsible to non-customers for what their customers do with non-customer money would put the bank deposit system in ‘shambles,’ to borrow Judge Conrad’s characterization,” wrote Spruill in an e-mail comment. He declared the decision “sound from a legal and practical standpoint.”

Roanoke banking lawyer Douglas W. Densmore agreed with the outcome, but he said that the investor’s claims are not novel.

“I think they reflect a common, but mistaken, belief that banks that receive money are obligated to look out for how that money is disposed of. That is not true unless the person is a ‘customer’ of the bank or the bank has otherwise expressly committed itself to protect a third party’s interests,” Densmore commented.

“The lesson for investors relying on escrows to protect their funds is to obtain a copy of the escrow agreement and confirm it with the escrow agent involved,” he said.

Given the economic situation, the claim itself is unsurprising, Densmore said. “I think the case is reflective of the economic circumstances of the times because it involves what obviously is a failed real estate venture, an unfortunately common event these days,” he noted.

Richmond lawyer Alan D. Wingfield, who represented BB&T in the case, also sees the lawsuit as a sign of the times. It represents, as he put it, “efforts of disappointed investors to shift their losses onto banks that provided services to the failed business.”

The plaintiffs were represented by Frederick, Md., lawyer Brian M. Maul, who advised through an assistant that he would have no comment other than, “We plan to appeal.”

Written by Peter Vieth  |  Filed Under Home Page Items, Weekly Update 

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