One feature of the legal system that often affects banks is the class action.

Class actions let people sue as a class if all have the same claim, and the court awards the lawyers their fee from the defendant as part of the settlement.

An offshoot of the class action is the derivative suit, in which the defendant, if it loses, is forced to reimburse a company for its losses rather than pay individual claimants. Again, legal fees are paid by the defendant, so those who sue on behalf of their company are not deterred by cost.

Recently the number of class actions has been soaring. And in each case, the defendant faces losing both a lot of money and its good reputation.

Community bankers in particular say class actions -- often related to the Community Reinvestment Act -- take up an inordinate amount of their time.

Why are there so many? One reason is that we have so many lawyers. By gambling on a legal action, they could win a big award. And the worst they can do is waste their time. Rarely does a court impose fines or assess court fees on a lawyer for filing a frivolous suit.

So lawyers have worked with clients to develop cases that range from serious infringements of customer and stockholder rights to the tiniest examples of bank mistakes, like printing information incorrectly on a credit card description letter.

How can bankers handle the problem of excess litigation?

First, as attorney Bernard J. Karol of the New York firm of Carter, Ledyard and Milburn pointed out in this newspaper recently, managers need to anticipate that disappointed customers and investors may sue. Thus they should spell out objectives and liabilities in the written agreement that initiates something like a portfolio management agreement.

In addition a bank must respond to nuisance suits with the tenet "never give in to blackmail."

Even if you feel that the cost of defending the bank will vastly exceed the cost of settling, it is worth it to fight if your cause is just. For if your bank gains a reputation as an easy mark for lawyers, the cases filed against you will multiply.

It is similar to the cases in which borrowers come in and say, "I know someone who took a Chapter 11 bankruptcy and cut his obligation to the bank in half. Why don't we reduce the amount I have to pay back so we can save the hassle of legal action in our case?"

To this, any sane banker will respond, "You borrowed the money, and as long as your firm is viable your obligation stands." Once a bank starts negotiating on credits with a customer who can pay his debts, though he be under duress, it becomes an easy mark for renegotiations by every other borrower who learns what has happened.

In the end, of course, the bank must honestly believe that its policies and its actions in a case have been above reproach.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.