Financially troubled builder Kennedy Homes sued the parent company of Harris Bank on Tuesday, accusing Harris of making accounting errors that constituted fraud and pushed the South Barrington-based company into insolvency.
The suit, filed in Cook County Circuit Court, says that the Bank of Montreal, Harris’ parent, miscalculated the balance of funds available to Kennedy, causing the builder to overdraw its line of credit by more than $11 million.
The suit says that, through Harris, Bank of Montreal in 2003 set up a $40 million revolving construction loan agreement — at one point expanded to $95 million — and recruited other banks to commit fixed amounts to it.
In making the loans, Bank of Montreal created a complex formula based on land values, construction costs and other factors, to calculate lender fees and the funds available to Kennedy. Kennedy drew on this line to build subdivisions around the Chicago region.
The suit says that in 2006 Kennedy raised concerns about the accuracy of the formula, and that Bank of Montreal officials said they had investigated and corrected it. However, in 2007, according to the suit, the bank told the builder that errors in the formula had inflated the amount of funds available to it, leading Kennedy to overdraw its account by a significant amount.
The errors rendered Kennedy insolvent and incapable of securing further financing, the suit says.
In recent weeks, Kennedy has admitted to financial pressures. Last month it laid off 20 employees, or 60 percent of its staff, and Bill Gronow, a partner, said it intended to complete all homes under construction and eventually resume full operations.
Harris Bank declined to comment on the litigation. Kennedy Homes attorney Aldo Botti declined to elaborate on the suit, which seeks damages of $100 million.
“This [kind of lawsuit] is something that’s going to get a lot more common,” said industry consultant John Burns, based in Irvine, Calif., as builders spar with lenders over the declining value of their principal asset, which is land.
“If the borrower is over their cap, the bank has the right to ask the borrower for money,” he said. “But the borrower might completely disagree with the appraisal. And so you have a lawsuit.”
Anthony Sabino, professor of law at St. John’s University in Queens, N.Y., pointed out, however, that fraud would be difficult to prove.
“You have to prove intent — that I want to cheat you,” he said, adding that he generally sees the suit as a way for the borrower to buy time.
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On the other hand, “the borrower could have a substantial argument if it largely turns on the accuracy of the lender’s calculations and its ability to document them,” said Ronald Mann, a professor of law at Columbia University Law School in New York who specializes in commercial finance.
Either way, the suit reflects the tumult in housing, said Katherine Porter, an associate professor of law at the University of Iowa.
“The last time we saw a wave of lawsuits in which businesses claimed that lenders caused their downfall was in the late 1980s,” when real estate and energy companies went under in Texas, she said.
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