Lenders not liable for failing funds

by Kyle Peterson, Affleck Greene McMurtry LLP

If investors borrow money to invest in mutual funds, and the funds do not perform up to expectations, are the lending financial institutions on the hook? This question was the subject of the recent Court of Appeal decision in Baldwin et al. v. Daubrey et al.[1] A number of plaintiffs sought compensation from their financial advisors and the financial institutions that loaned the plaintiffs the money they invested in poorly performing investments. The Ontario Court of Appeal upheld Spence J.’s decision granting summary judgment dismissing the claims against the financial institutions.

The plaintiffs had all purchased mutual funds. Relying on the advice of their financial advisors, they obtained loans from various financial institutions to purchase those mutual funds on margin. All of the loans had margin requirements that required the borrowers to pay down the loan if the underlying investments dropped below a certain value. Unfortunately, the funds did not perform as well as hoped, and the lenders called the loans.

The appeal panel agreed that the action against the lenders should be dismissed, relying upon well-established law that the relationship of lender and borrower is not a fiduciary relationship. Instead it is a typical commercial relationship “in which the interests of the parties are not the same and each party seeks to secure its own interest.” The nature of the relationship between the parties was governed by contracts in which the plaintiffs each acknowledged responsibility for the loans. The court agreed that there was no duty on the lender to advise the investors regarding their investments.

Published November, 2006