Community Development Bank Loses Suit Brought by Borrower

The troubled Los Angeles Community Development Bank on Friday lost the first of several lawsuits filed by former borrowers, a blow that could signal millions of dollars in taxpayer losses and further damage to the publicly funded lender.

In a decision issued Friday, Superior Court Judge William J. Birney found the bank breached its contractual responsibility to its borrower and “directly caused the total loss” of Summit Industries, a manufacturer of counter tops and sinks. Birney awarded $7.2 million plus interest to Summit’s president, Lindsey Austin.

Austin’s lawsuit alleged the bank bungled his $2.2-million loan, damaging his business, then abruptly and improperly pulled the plug on him after indicating they would help the company work its way back to health. The bank countersued Austin, spending more than $1 million on attorneys and receiver fees to pursue him. They also sought a receiver who shut down a second business Austin launched after Summit failed--an action later reversed by a judge as improper.

“I feel vindicated,” Austin said Friday. “What they did to me was wrong and now it’s been proven in a court of law. I finally got justice.”

Birney called the consequences of the bank’s conduct “disastrous.”

The bank vowed to appeal the ruling. The bank’s attorney, Bonifacio Bonny Garcia, blasted the judge’s decision, saying Birney “ignored California law to rule that LACDB acted in bad faith.” The bank’s counsel had argued an open-and-shut case of a borrower who defaulted on his loan.

“The bank had a right to do what it did, and that is to enforce its contract,” he said.

Added Bank CEO William Chu: “We strongly believed all along that we were going to prevail.”

While the bank’s insurance policy covers its steep legal fees in the case, it does not cover the judgment because it is capped at $1 million. Nor will it protect the lender from damages that could result from pending or future litigation.

The thin insurance coverage is yet another sign of early problems now taking a toll on the bank, created in the wake of the 1992 riots to revitalize the city’s most blighted pockets and funded with $430 million from the U.S. Department of Housing and Urban Development.

Struggling to get up and running with a largely inexperienced staff, the bank placed early bets on a string of large deals that soured, at times violating its own policies in the process.

The ruling comes seven months after the bank’s biggest loan, to a South Central dairy, soured. That deal alone cost the bank $20 million, depleting loan loss reserves and driving the bank’s default rate up to a third of its portfolio. Chu took the reins of the institution in January and vowed to continue reforms, and the bank has agreed to stricter city oversight.

But the gap in insurance coverage means litigation losses must be paid directly from the bank’s shrinking pool of federal grant money--its only source of reserves for bad loans.

“That is a crime. That’s federal money given to the city . . . that the bank has just wasted,” said Roberto Barragan, president of the Valley Economic Development Center, a community lender that also packages loans for the bank.

Barragan called on the bank to bring in an independent third party to review all loans in default or litigation.

“The fact that they’ve lost their first case indicates they have some very serious exposure going forward,” he said.

Chu said he found the insurance coverage lacking when he came on board in January and is shopping around for a broader policy, although “it’s not an easy task because they know there’s a pending loss.”

Bank officials said they plan to study the matter of where the money would come from to pay a judgment if an appeal fails.

The city’s Community Development Department oversees the bank because the city’s social service grants are on the hook if the bank fails to pay back the bulk of its federal funding. Barker Khorasanee, director of the department’s financial management division, said it is possible the bank will not be allowed to use the federal grant money to pay for litigation losses. The issue will have to be raised with HUD, he said.

City Councilman Mike Feuer has sought a report from the bank--due later this month--on how oversight could be improved. While he said the litigation caused concern, and the bank will undoubtedly pay for it with taxpayer money, “it’s going to take a lot of lawsuits before any general fund implications would result from this.”

Two other lawsuits against the bank are pending, with one scheduled for trial in July.

The five-week Summit trial in Los Angeles Superior Court in Norwalk offered an in-depth look at the way the 4-year-old bank conducted business in its early years.

According to testimony and court records, the problems began even before the bank funded the loan. In a move that Summit’s attorney, Robert S. Lewin, called grossly negligent, the bank failed to ensure it had first dibs on all of Summit’s assets before funding the loan. The bank was buying out another lender, who sold Summit’s assets twice.

The ensuing months-long battle among lenders scared away customers, hurting sales, Austin alleged. Furthermore, he said, the money the bank used to settle the disagreement came out of Summit’s loan proceeds, leaving him undercapitalized.

Bank executives then made verbal promises to Austin that if he moved his company into the empowerment zone--the area served by the bank--they would work with him on bringing payments up to date.

But when Austin did lease a location in the zone in July 1997, the bank abruptly pulled the plug anyway, the suit alleged. Summit’s manufacturing facility was in Mexico, operating as a maquiladora, and the bank’s action caused Mexican authorities to immediately seize his assets there.

Bank records and testimony show the bank was fully aware that Summit’s manufacturing operations were in Mexico. But when Austin sued the bank, it countersued Austin for fraud, saying he had surreptitiously taken assets south of the border.

The countersuit against Austin also destroyed a second company he launched after Summit failed. That company--San Diego-based Shasta Home Products Inc.--was returned to Austin in a separate ruling by a judge who said the receivership was improper. But by then the company was ruined.

“We’ve ruined our children’s credit, and our credit. I can’t even open up a checking account,” said Austin, whose home water and phone services were cut off during the trial.

The issue at trial was not whether Summit Industries had defaulted on its loan--it agreed that it had--but whether the bank breached its contract, acted negligently, and fell below the industry’s standard of care in dealing with its borrower.

The judge considered only the breach of contract claim, dismissing five others.

Garcia, the bank’s lawyer, said the judge’s ruling will scare community lenders away from working out problem loans.

Lewin, Summit’s attorney, said Friday’s decision “sets a framework” for other pending cases. He is also representing former borrower George L. Akers, who has sued the bank for fraud and breach of contract regarding its treatment of his former company, Trinity Knitworks.

Akers sat in on the five-week trial daily.

“I cried with Lin,” Akers said of his reaction to the ruling. “He got his name back. All the money in the world won’t pay for that.”