Should Bank Directors Approve Loans?

Following several lawsuits where the Federal Deposit Insurance Corp. sued directors of failed banks who serve on the loan committee, Bank Director decided to ask bank attorneys for their insight on whether directors should be involved in approving loans. It turns out there are a variety of opinions on this. Some think the FDIC’s lawsuits clearly point to the hazards of bank directors getting involved in loan decisions. Others say with a prudent approach, directors need to be involved in a way that shows their due diligence and expertise.

Q. Should directors be directly involved in approving loans, and what are the important liability issues to keep in mind?

Harold-Reichwald.jpgNo. Given recent experience with the FDIC, directors who served on a directors’ loan committee and actually approved loans (as opposed to a mere recommendation) are being singled out for allegations of liability while other non-loan committee directors get a pass. A theory of liability being espoused by the FDIC is that directors’ loan committee members acted in a quasi-executive role when approving loans and hence should be treated differently with perhaps a standard of care of mere negligence, not gross negligence.

—Hal Reichwald, Manatt, Phelps & Phillips, LLP

Heath-Tarbert.jpgTo involve directors in directly approving individual loans that are not to insiders or are otherwise routine can needlessly conflate the role of directors with that of management. As the institution grows in size, such a practice is a recipe for diminished—rather than enhanced—corporate governance. What is critically important, however, is that every director become confident that the bank’s overall lending and credit policies are sound in substance and in practice.

—Heath Tarbert, Weil, Gotshal & Manges LLP

Chip-MacDonald.jpgMany loans require director approval to comply with Regulation O and securities exchange corporate governance rules, among other things. It is customary bank practice to require director approval of larger credits. Board or director loan committee consideration of loan requests are the first line of risk control and corporate governance, and properly conducted, provide better assurance of compliance with laws and bank policies, including credit quality and asset concentrations. Loan decisions are subject to the business judgment rule and generally should not be second-guessed by the courts. The recent Integrity Bank decision that held directors cannot be liable for negligence should be very helpful in limiting liability in this area.

—Chip MacDonald, Jones Day

Jonathan-Wegner.jpgState law often drives whether or not directors are required to be involved in large loan approvals, but the reality is that—whether required by law or not—bank directors often do become involved in approving loans. If you’re engaged in approving loans, the most important thing to understand is that you are going to have a Monday-morning quarterback looking over what you’ve done, so it is crucial that you strictly adhere to your bank’s lending and risk management policies, as well as any laws or regulations applicable to your bank’s loans (such as loan limits or transactions with affiliates). If a loan goes bad that complies with law and fits within your bank’s policy parameters, chances are regulators will find something to blame besides your decision to authorize the loan.

—Jonathan Wegner, Baird Holm, LLP

Mark-Nuccio.jpgIn light of the FDIC’s publicized lawsuits against former directors of failed banks, it has become fashionable to suggest that directors curtail their involvement in lending decisions that are not specifically required by law. In my mind, that’s like throwing the baby out with the bath water. Directors would be unwise to eschew responsibility for a business unit that is the key revenue driver for most banks. Directors first need to focus on establishing sound credit and risk policies appropriate for the size and complexity of their organization. Those policies should delineate when a board level loan committee is required and what it should do. A recent spate of lawsuits by the FDIC against directors involved in lending approvals is probably more about shaking a recovery out of a directors & officers insurer than it is about trying to take personal assets away from bank directors.

—Mark Nuccio, Ropes & Gray LLP

Kathryn-Knudson.jpgWhile directors should have a significant role in establishing loan policies and procedures, especially from a risk management perspective, they should not have additional potential liability from “approving” loans. This is particularly true when the director has no specific loan underwriting training and his or her involvement with a given loan may be a 5- to 15-minute presentation by the bank’s senior loan officer. It is still appropriate for directors to have factual input. For example, at the directors’ loan committee meeting, if a director has information concerning a borrower that may not have been available to the lending team, the director should tell the team. The lending team still makes the ultimate decision. Moreover, the directors should verify with the lending team (and have documented) that the loan meets all of the legal and risk appetite parameters set forth in the bank’s loan policy.

—Kathryn Knudson, Bryan Cave LLP

Kelsey Weaver