When a Director Has to Go

Scenario

It is not a good day for Edna Summers. As the outside chairman of the $900 million County Savings Bank, she knows a difficult task lies ahead. Several months ago, a longtime board member who owns a real estate development company that had fallen on hard times announced that his business had filed for Chapter 11 status and he himself had declared personal bankruptcy. Because County Savings Bank is the largest and only locally owned bank in this bedroom community, other board members have been very concerned about how these negative events reflect on the bank’s image. Chairman Summers and the bank CEO have been dropping hints that it might be a good idea for this director to resign from the board to separate this unfortunate situation from the bank. So far these hints have fallen on deaf ears and the rest of the board want a more definitive action. Chairman Summers is convinced that this director will not want to give up his seat. She and the CEO have decided to solicit some advice prior to determining their plan of action.

Bank Director posed the previous scenario to two corporate governance experts, George Freibert, chairman of Professional Bank Systems, Louisville, Kentucky, and TK Kerstetter, president of Bank Director. Here are their views on how the Chairman Summers ought to respond to the situation.

BD: Is it the outside CEO’s or the chairman’s responsibility for solving this problem?

Freibert: It’s the board’s responsibility. The CEO is going to have input, but it’s the board’s job. What they need to do is call a couple of board members that are particularly close to this bankrupt director and talk to him. They need to try to convince him that he should resign on his own. This should be done with the understanding that if he doesn’t resign on his own, the board will have no choice but to call a special shareholders meeting in order to force him off the board.
Most of the time, when it is put to them in this manner, the director usually chooses the sensible path and decides to resign because of “personal reasons.”

Kerstetter: I agree, this is clearly the board’s responsibility, with outside director Ms. Summers as chairman of the board taking the lead. This is really no different than if a director was missing too many meetings or leaking information from the boardroom, it would be the chairman’s responsibility, with the support of the board, to seek corrective action. That being said, if the chairman is also CEO, I would enlist some outside board members to help communicate the message that the director in question needs to hear.

BD: Is there any rule or bank regulatory guideline about a director having to resign if he or she declares personal bankruptcy?

Kerstetter: I’m not aware of any regulations on a director declaring personal bankruptcy. However, banks can and should have corporate governance guidelines that can deal with events that would harm the bank’s public image.
Freibert: Regulatory guidance doesn’t require this, but frankly, the examiners would be aghast to find a bank that didn’t make a bankrupt director resign.

Another bank I worked with had a director who they told me was “on temporary leave.” When I probed further about where, exactly, he was, they admitted he was in prison! Only on weekends, they explained. When I asked why they didn’t oust him from the board, they said he “wanted to stay on,” so they let him. At the next shareholder meeting they intended to take him off, but for his sake, they didn’t want to have a special shareholders meeting which would bring more negative publicity.

BD: How do you go about getting a director off a board?

Freibert: It’s very useful to have the bylaws of the institution state that a director can be removed by a majority vote of the board without calling a special shareholders meeting. I would recommend bank boards examine their bylaws and include this language if it doesn’t already exist. This type of change or amendment should be ratified by the shareholders, and it should be examined by bank counsel to ensure the language is legal in whichever state the bank is domiciled in, although I know of no state where it wouldn’t be.

The bottom line is, a bank is a different animal from other types of businesses. It’s a repository of public money and people expect bank directors to be a cut above.

Kerstetter: Getting a director off the board is not as easy as it should be. Obviously if a director has committed a fraudulent act or hurt the institution by some clear action, the regulators can remove a director, or a board for that matter, by a single mandate. Outside of that power, the process a bank has to take can get more involved.
Sometimes the situation will call for a special board meeting, and other times a board can wait and just not let that director in question stand for re-election.

As you can imagine, this process can get ugly if the board is divided, or the director in question is a substantial shareholder. In most cases, the meeting with the chairman, CEO, or some respected board members does the trick.
BD: What can a bank board do to make this process less painful in the future?

Freibert: This situation also makes apparent the need for a comprehensive corporate governance policy. I consistently encourage banks to consider this type of policy, which embodies an ethics policy and a code of conduct for the board. It also covers a myriad of topics that define why a director might be asked to resign from the board, such as bankruptcy, classified loans, Reg O violations, indictment, or if the conduct of the board member is simply not consistent with the role of a bank director.

For example, years, ago, a bank we worked with had a director who ran a very successful liquor business. That was fine until one day he opened up a “gentlemen’s club.” The board explained to him that this type of business wasn’t consistent with being a director of a bank. In this case, he went peacefully.

Kerstetter: I have been accused of being obsessive on the need for boards to adopt governance guidelines, and this scenario is just another example of what a valuable tool the guidelines can be.

If this bank board had corporate governance guidelines (see sidebar), there would be little question what action said director should take when he filed for bankruptcy. These guidelines should be signed by directors annually so there is no mistaking what the board best practices are. You eliminate any misunderstanding, split boards, or shareholder questions about a director’s removal from the board selection slate if you create and approve guidelines. It is a great tool for chairmen of boards, particularly when a CEO is also chairman. It is beyond me why only a low percentage of boards have actually taken the step to create guidelines.

BD: What advice would you give Chairman Summers in this scenario?

Kerstetter: First of all, I would tell Chairman Summers and the CEO to stop hinting around and confront the director on the board’s feelings and potential damage to the bank. If they balk at resigning, it sounds like the board has a consensus that said director shouldn’t stand for re-election.

This case is interesting and very lifelike when you consider that many real estate developers’ companies go bankrupt at one time or another. When I was president of a bank, I started to think it was a “rite of passage” for a developer to go bankrupt at least once.

I do know one bank that handled this situation with a real estate developer director that had fallen on “temporary” hard times in a creative way. Because this director was a very valuable contributor to the board, they asked him to take a leave of absence until his company problems were corrected and they reinstated him several months later. I thought in this bank’s case that it was a good plan due to the small size of the bank and this person’s major contribution to board business.