Taking Action When Loan Proceeds Are Used Improperly

Issue/Question

If a customer obtains advances from his business line of credit with the Bank, which he obtained to purchase commercial property, but deposits the proceeds into his personal account and then withdraws the money for personal use, does the Bank need to take action in any way?

Response Summary

Using the proceeds of an advance for an inappropriate purpose may be an event of default, depending on the facts of the matter and the language of the loan documentation. Whether the Bank wishes to treat it as such and to pursue a legal remedy is a business decision for it to make. Under Federal law, however, the Bank will be required to file an SAR, either for the loan fraud committed against it for a use contrary to the Bank Secrecy Act purpose statement.

Response Detail

Depending on the facts of the matter and the language of the loan documentation, the proceeds of the advance may have been used inappropriately.

If the proceeds of the advance from the business line of credit were used by the customer for a personal purpose, the Bank must review the language of the promissory note and loan agreement to determine whether they specify the purpose for which an advance from the line of credit can be made. If the promissory note or loan agreement does not specify such a purpose, the related documentation, such as an application or commitment letter, might still allow a determination to be made as to whether the Bank and the customer had agreed that advances would be limited to a certain purpose.

The Bank must also review the language of the request for the advance to determine whether it identifies the purpose for which the advance is being requested.

Assuming that advances are limited by the loan documentation to the purchase of commercial property and that the borrower requested an advance to be used for that purpose, the use by the borrower of the proceeds of an advance for another unrelated purpose would be an event of default. The language of the promissory note and loan agreement should provide the Bank with remedies when there is a default, including a demand for payment of the outstanding balance of the line in full.

Whether the Bank treats the improper use of the proceeds of an advance as an event of default and seeks a legal remedy against the borrower is a business decision for it to make.

Under Federal regulations, the Bank is also required to file a suspicious activity report (“SAR”) with the Financial Crimes Enforcement Network (“FinCEN”) for, among other things, transactions conducted through the Bank and aggregating $5,000 or more if the Bank knows, suspects, or has reason to suspect that the transaction may involve illegal activity. The Bank may also, at its discretion, file a SAR even if the amount involved is less than the $5,000 threshold [12 CFR §353; FFIEC, Bank Secrecy Act/Anti-Money Laundering Manual, Suspicious Activity Reporting – Overview].

In this case, borrowing money for one purpose and using it for another would be in the nature of loan fraud. Under Federal law, it is a crime to knowingly make a false statement or report for the purpose of influencing in any way the actions of a financial institution whose accounts are insured by the Federal Deposit Insurance Corporation [18 U.S.C. §1014]. Given this violation of the law, a SAR should be filed.

If the line of credit was for more than $10,000 and not secured by real estate, a purpose statement would also have been obtained from the borrower under the requirements of the Bank Secrecy Act [31 CFR §103.33(a)].  If the Bank obtained such a statement and the advance was used for a purpose contrary to the one recited in it, this too would be cause for filing a SAR.

The Bank will have a “safe harbor” under Federal law and be protected from civil liability for all reports of suspicious activity filed with the appropriate authorities. Specifically, the law provides that a bank and its directors, officers, employees, and agents that make a disclosure to the appropriate authorities of any possible violation of law or regulation “shall not be liable to any person under any  law or regulation of the United States, any constitution, law, or regulation of any State or political subdivision of any State, or under any contract or other legally enforceable agreement (including any arbitration agreement), for such disclosure or for any failure to provide notice of such disclosure to the person who is the subject of such disclosure or any other person identified in the disclosure” [12 U.S.C. 5318(g)(3); FFIEC, Bank Secrecy Act/Anti-Money Laundering Manual, Suspicious Activity Reporting – Overview].

In the case of any event of default under a loan agreement, the Bank should seek the advice of outside counsel as to the course of action it should pursue.

This entry was posted on Friday, February 6th, 2015 at 7:58 pm.