The Standard of Care for a Workout Banker

By Nancy Terrill

How many conversations have you sat through where the parties question what a workout banker did or failed to do? Having spent most of my career as a workout banker, I know that a lender's actions are frequently shaped by banking regulations, by influences behind the scenes at the bank, and by the standard of care to which a workout lender must adhere. Understanding that standard of care is the difference between reading a banker's decisions correctly and assuming the worst.

I have been retained several times as an expert witness in lawsuits over a workout lender's behavior and decisions, usually in the wake of a business failure. These suits often come from guarantors trying to avoid paying under their loan guarantee, or from other creditors trying to pull more funds out of the liquidated estate.

Lenders Get Sued for Acting Too Late, Not Just Too Soon

Most lenders assume a lender-liability claim looks like this: the bank called a default too soon, demanded payment, and the plaintiff argues the bank destroyed the going-concern value of the business. Those cases exist. But many lawsuits claim the opposite, that the bank took aggressive collection action too late.

Those cases frequently involve fraud, where the real bad actor was a management team that was untruthful or improperly withdrew funds once they realized the business was going to fail. The banker then gets sued for not knowing a truth that was deliberately hidden, and for not moving to collect the loan sooner.

The Escalating Steps a Lender Can Take

A central question in these suits is the lender's action, or lack of action, in the face of a default. Each case turns on the exact wording of the loan documents and the specific situation, but the lender's options generally escalate:

• Request compliance with financial or collateral information so the lender can better assess the situation.
• If the loan is monitored under a borrowing base, suspend new advances until the loan is back in compliance with the collateral borrowing base.
• Declare a formal event of default, then continue to lend under a forbearance agreement that requires defined behavior from the borrower within a set time.
• Increase the interest rate or charge a fee for the default.
• Accelerate the loan and demand payment in full, which is usually followed by immediate legal collection activity.

Deciding which step was appropriate, and when, is exactly where hands-on workout experience matters. Engaging an expert witness or turnaround consultant with real depth in working out troubled loans puts you in the best position to judge what the lender should have done and when.

Bankers Rarely Have the Control People Assume

Parties without practical workout experience often assume the lender should have had complete control over the borrower or the collateral. Bankers usually do not have that control. A lender may hold the car titles of an automotive dealership as a way to monitor sales closely, but even that does not stop the dealer from selling a car, keeping the funds, and fraudulently obtaining a replacement title for the new owner. That is not incompetence by the lender. It is fraud by an unscrupulous borrower outmaneuvering the customary standard of care.

Knowing the inner workings of a bank in a workout can drive the right result in these suits. In one case, a plaintiff claimed wrongdoing because a workout banker put collateral proceeds into a bank-controlled depository account rather than applying the funds immediately against the loan. The plaintiff read evil intent into it. The far less nefarious answer is that workout bankers frequently do this to keep funds accessible until the expenses of the case are paid, such as rent, security, and sales commissions. If the lender had applied the funds straight to a loan flagged as non-performing, it would have had real difficulty processing the future advances needed to cover those expenses.

Why the Ivory-Tower Expert Gets It Wrong

Parties in these suits often hire expert witnesses who know banking regulations cold but have never actually worked out a bad loan. These witnesses tend to seize on new loan advances to a financially challenged or insolvent borrower as bad lending practice, and cite OCC underwriting guidelines as their authority. It is case-specific, but in most cases that focus on new advances is not the relevant question.

The relevant measure is new advances net of loan pay-downs, which gives you the dynamic total loan exposure, compared against the true collateral value. Using that formula, the workout lender calculates the likely and worst-case loss on the loan, and manages over time to avoid growing, and ideally to shrink, the expected loss. Advances are one input in that calculation. A lawsuit fixated on that single input misses the entire point of the workout, which is to reduce the potential loss.

Reading a Rising Loss the Right Way

Another common fact pattern is that the lender's estimated loan loss grew over time. An experienced expert knows this happens for one of two reasons: either the collateral assets themselves decreased, because assets physically disappeared or receivable collections were not used to repay debt, or the estimated collateral value fell because of better information, such as an inventory count or an outside appraisal.

That distinction matters. The disappearance of physical assets might have been stopped by earlier action from the bank. A decline in value driven by better knowledge would likely not have changed regardless of when the lender acted. Read this way, the experienced expert's opinion simply identifies the standard of care of a workout lender, and depending on the facts, it may support either the plaintiff or the lender. This kind of forensic financial analysis is what separates a defensible opinion from a convenient one.

The Bottom Line

The logic behind a workout lender's actions, or inaction, is often invisible to non-bankers, yet it may reflect entirely normal standard-of-care behavior driven by banking regulation and internal process. Engaging someone with hands-on experience in bank workout practice helps you understand those influences. In a post-mortem, that same experience can identify where genuine lender liability exists, refute the irrelevant points in the litigation, and keep the court focused on the facts that actually matter.