Recent regulatory activity against directors and officers of failed banks has highlighted the consequences of a director's failure to meet his or her standard of care. As of August 4, the FDIC has authorized lawsuits against 294 directors and officers and is presently seeking $7.222 billion in recoveries in connection with failed banks. Directors targeted in such lawsuits face potentially significant personal losses and the inevitable emotional stress accompanying the defense of one's past actions. In today's distressed banking environment, the risk of lawsuit, and emotional and financial toll such lawsuit brings, seems especially real. Nonetheless, directors who avoid conflicts of interest and act deliberately and on a fully informed basis should sleep soundly. The FDIC has stated that it "will not bring civil suits against directors and officers who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable business judgments on a fully informed basis and after proper deliberation." Schiff Hardin attorneys have worked closely with banks and their boards, providing customized strategic advisory services to help directors fulfill their fiduciary duties and meet their standard of care. We offer the following lessons for bank directors based on our many engagements with banks and a review of the FDIC's lawsuits filed to date.

Lesson #1 — Ignore your regulator at your peril

A common thread among all of the FDIC's cases against directors is a failure to heed regulators' warnings, concerns or guidance. For instance, in FDIC as Receiver of Corn Belt Bank and Trust Company v. Stark, et al., Case Number 3:11-cv-03060-JBM-BGC (U.S. District Court for the Central District of Illinois Filed March 1, 2011), the FDIC alleged that the bank and, by extension, its directors, failed to "address recurring criticisms by examiners regarding imprudent lending practices, including the failure to properly underwrite, manage and administer existing credit relationships." The FDIC's complaint goes on to describe an "action plan" adopted by the Corn Belt Bank's board of directors in response to an examination that was not implemented, and two subsequent Memoranda of Understanding issued by the FDIC and Corn Belt Bank's state regulator. Even if directors and executives at Corn Belt Bank believed they had a strong business case for pursuing an alternate path, the directors' and officers' failure to address issues noted by examiners will strongly support the FDIC's claim of gross negligence (or in some states, negligence) or a breach of the duty of care. Banks and their boards must demonstrate to their regulators a shared concern about problems identified in bank examinations and a commitment and capacity to address such problems.

Lesson #2 — If It's Not Documented, It Didn't Happen

Given how potentially damning a failure to act in the face of regulatory criticism can be, directors and officers must have a written record of activity — such as detailed board minutes, evidence of frequent board meetings, internal reports and reports from professional advisors — to be able to demonstrate that regulatory input was acted on. Such documentation can be time intensive. In a crisis, directors and officers may have difficulty prioritizing tasks and finding time to appropriately document their actions and reasoning. Professional advisors in this environment can provide real value to directors and officers by helping them manage, prioritize and document activities and reasoning responding to regulatory concerns.

Lesson #3 — Get a Handle on Your Bank's Loan Portfolio

Good loans gone bad will not result in director liability. Rather, a failure of the lending process, or lack thereof, which may or may not cause bad lending, will lead to director liability. A plaintiff may show that bank directors were negligent or breached their duty of care by failing to establish and follow lending procedures. It stands to reason, therefore, that establishing an independent, objective and sophisticated loan underwriting and review process is critical. Portfolio review is an ongoing process. Directors should regularly review their bank's lending procedures, identify weaknesses and seek to correct them. Lending decisions, including decisions to refinance, should be based on a realistic appraisal of a bank's existing loan portfolio. In many instances, it may make sense to obtain an independent credit risk assessment in order to have a realistic understanding of the bank's financial situation and lending capacity.

Lesson #4 — It's Not Just About Relationships

A corollary to Lesson #3 is that the decision whether to lend or not cannot be based solely on a relationship. Perceived self-dealing is a common thread in many of the FDIC's lawsuits. If proven, it's a clear breach of the fiduciary duty of loyalty. So, while a bank should have strong ties with its community, some of which may be established through its directors, lending decisions should be made only on the basis of a thorough credit analysis. Conflicts of interest, such as officers with loan origination responsibility and underwriting authority or loans to related parties, should be identified and eliminated.

Lesson #5 — Directors Must Exercise Oversight of Bank Management

While responsibility for the day-to-day operation of a bank rests with its management, directors are responsible for making sure that management does its job. Directors will be held accountable for a bank's failure to respond to regulatory concerns. Therefore, directors must be actively engaged in the oversight of their bank's affairs — particularly in a distressed situation. Directors should demand from management action plans responsive to examiners' concerns. If management fails to respond, or its plans appear incomplete, directors should not hesitate to engage experienced, independent professionals to assist them in their inquiry and oversight and, potentially, replace non-responsive officers and managers.

Lesson #6 — Prepare for the Worst

Should a bank fail, directors face the very real possibility of being named in a lawsuit by the FDIC. Defending such suits will not be cheap, and the directors' failed bank will not have money available to indemnify them. Effective D&O insurance is crucial. Unfortunately, many D&O policies have exclusions that can leave directors without coverage when their bank fails. Directors should engage knowledgeable counsel to review their D&O policies and identify areas of weakness.