Issues in lending: Tips for managing commercial banking litigation

RMA Journal, The, March, 2002 by Richard A. Clarke

Banks are in the business of gathering deposits, ma king loans, and providing a broad array of services. Sometimes, however, bank management must turn its attention to commercial banking litigation. Although inevitable, litigation has not been a prime area of senior management focus even with the development of strong problem loan resolution (workout) units beginning in the late 1980s.

As the country works its way through another business downturn, it is a good time to consider the manner in which litigation is managed at your institution. What follows are suggested practices based on my experience gained over a 30-year career.

Suggested Practices

1. Maintain strong business oversight for each actual or potential litigation matter. Do not simply send a case out to a law firm and hope for a favorable outcome. Inevitably, costs will escalate, and many of the following additional suggestions may not be followed, such as early judicious settlement. Some large banks use in-house lawyers to supervise the litigation process, but this often leads to impractical penny-pinching and incredibly inefficient bureaucratic processes.

2. Use external counsel for the actual litigation effort, and choose litigators who like to litigate. Business overseers should be the ones to decide when to settle, not busy attorneys who like to schmooze and/or are so backlogged that they can't go to court in a timely fashion.

3. Give serious thought to replacing original closing attorneys with a fresh team and viewpoint, and never award litigation business on a basis other than sheer competence. Having an approved list of outside litigators provides management control, yet permits workout officers to make the final selection. This type of process leads to better service, lower costs, and more cohesive teamwork. You will soon see how the less effective law firms fall quickly by the wayside, assuming you have a strong and competent workout unit.

4. While cost control is very important, don't get carried away with the expense budgeting process. Use law firms with reasonable rates and low overhead, but don't impose overly restrictive budgets that are acceptable only to the less effective firms in your area.

5. Never offer settlements of nuisance suits, as you only encourage more.

6. Don't over-negotiate with uncooperative borrowers seeking excessive amounts and/or who refuse to disclose their true assets in writing.

7. Conversely, settle suits quickly when the bank has real culpability, based on the weighted probability of various possible outcomes. Good attorneys are excellent handicappers, but always add 10% to their estimates of probable success.

8. Never adjust your settlement offer based on the amount of your expected legal fees, as both sides must pay similar expenses and, besides, you can afford to pay while your opponents are usually less well heeled. Similarly, remember that you can usually afford to lose the case, while the debtor has home and hearth on the line.

9. Avoid litigation, but do not fear it. Understand that judges and juries today are not hostile to the lender. These constituencies got sick and tired of the hordes of sleazy debtors trying to get off the hook by any possible means following the last credit crunch in the early 1990s. Contrary to prevailing bank thinking, I have found that juries in these matters exercise tremendous group wisdom and fairness for both parties. (Some 30% of the time, I have been retained by debtors who were treated unfairly by their lender.)

10. Consider filing your own bankruptcy petition as opposed to engaging in lengthy civil litigation that sometimes leads to the bankruptcy courts anyhow, much later and after considerable civil litigation expense. Be aware that this may not be the first-choice strategy offered by counsel, but nevertheless can be the best course of action under certain circumstances.

11. Do not threaten criminal prosecution to collect a civil debt. Just do it if you have strong proof of a criminal act. Repayment negotiations are always more productive as part of a sentencing hearing when the borrower's alternative is four years at Leavenworth! Maintain strong relations with the authorities and encourage them to put your matter to the top of the pile. Use attorneys who have such relationships as well, but who also know how to file criminal charges directly, if needed, to move the process along.

12. Keep a separate expense (legal and other) ledger in your loan department so that you can provide the court with a proper accounting of recoverable expenses that will certainly follow if you pay attention to these principles of legal expense management.

13. Most important, train your lenders to play by the rules so that you don't get into the legal soup in the first place. Explain to them that even the appearance of lender impropriety will foster expensive and time-consuming lawsuits even if you ultimately prevail. Sloppy lending practices also provide "smoke screen" or "red herring" defenses for debtors' counsel.