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Lenders Liability Risks

liability-risksThere once was a time was when all a banker had to worry about in dealing with a loan was collecting it. Now you have to worry about whether you will get a lawsuit for not making the loan and even for making it. “What is my likelihood of getting sued if I lend this money?” This is the question more and more bankers are having to ask themselves these days. “How can I keep from getting sued or paying for it if I am?” Is another question to ask and probably the more important one.

Definition

Before we discuss the ramifications of this issue, perhaps we had better define it first. Lenders Liability is the exposure to legal action that might be taken against its lending officer, a financial institution, his/her officers and directors for their involvement in the lending function. There are three types of Lender Liability a bank could be involved in: Pure, Managerial, and Ownership. Pure Lender Liability results from the lending process itself. Managerial Lender Liability results in the real or alleged partial or total management of a borrower’s company. Ownership Lender Liability results when the bank actually takes a business over and tries to run it before reselling. Each type requires special handling.

In Pure Lending Liability, the bank need to be aware of the implied warranties of the lending function, possible fiduciary responsibilities, the doctrine of Tortuous Interference, implied contract, and discrimination, just to name a few. Managerial Lending Liability is concerned with the actual involvement of the bank in the borrower’s affairs. If the managerial relationship was formed under duress, or wrongful control, or failed to catch an environmental problem, there may be some serious liability. With Ownership Lending Liability, the bank takes on all the liability of an operator of the business it decides to run. Without proper forethought, this action could be disastrous.

Insurance Protection

Insurance protection is often the cheapest and most effective way of handling the financial burden of Lenders Liability. The Commercial General Liability policy, properly endorsed, is the banker’s first line of defense. You need to be sure you have Personal Injury (not to be confused with Bodily Injury) Liability covered by your policy at a bare minimum. Directors and Officers Liability policies provide some protection as well for the directors and officers, and in most cases the Bankers Professional Liability coverage will provide protection for the bank. Be careful, most insurance companies are now separating the Lenders Liability coverage from the BPL coverage at lower limits. Other exclusions and limitations may apply as well. Environmental Liability is also a major consideration, and insurance policies should be purchased if the bank has any idea that an exposure exists (see special note below).

Procedural Controls

In addition to insurance protection, there are several procedures every bank should implement. The following is a partial list of procedural controls that will help you control your exposure.

  1. Always give proper notice.
  2. Never “fib” or “stretch the truth” in answering credit inquiries, especially about borrowers whose credit is not good.
  3. In a workout situation, be careful of making threats; they could backfire on you.
  4. Honor any financial commitments given especially if such commitments are evidenced in writing.
  5. Avoid any involvement in the management of the borrower’s business.
  6. Be sure that all written memos to the loan file are objective, unemotional and accurate.
  7. In loan “workout” situations, loan officers should consult (or transfer to) loan “workout” officers and legal counsel on procedures and negotiations.
  8. Be very careful in suing on a deficiency, as the counterclaim could be far more expensive.
  9. Be very careful in your attitude with the borrower. Avoid an arrogant attitude at all costs.
  10. All loan documents should be carefully drafted and the procedures outlines therein followed carefully.
  11. Give loan officers specific training regarding lender liability issues.
  12. Environmental loss control procedures will be dealt with below.
Discrimination & Sexual Harassment

Make sure your loan officers are clear on how to treat the issues of Race, Religion, Gender, and National Origin. The Courts are very sensitive to these issues and penalties for non-compliance with the laws and regulations in these areas can be severe.

It should be obvious but don’t try to get “a date” with your potential borrower. Anything that could be construed as a sexual advance could land you a major lawsuit. This is the kind of thing lawyers live for!

Special Note-Environmental Problems

Environmental Lenders’ Liability has added a completely new wrinkle to the Lenders’ Liability arena. The EPA’s “Secured Lenders’ Exemption” has been overturned in the Appeals Courts, making banks once again highly susceptible to EPA enforced clean-ups and liability for pollution. The FDIC is now requiring all banks to have in place an Environmental Risk Program (FIL-14-93) and will look for compliance during the next examination.

Conclusion

The subject of Lenders Liability is a far more complex one to be dealt with in a short newsletter, and it is certainly worthy of extensive study. The courts are continuing to define Lenders’ Liability, and, as a result, you will have to continue to update and monitor your exposures through an ongoing Risk Management Program. With a little time and effort you should be able to manage this exposure very well indeed.

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