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FDIC-R professional liability lawsuits: A call for uniformity

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Abstract

This article examines the US Federal Deposit Insurance Corporation’s (FDIC) efforts to pursue the former directors and officers of failed banks (the ‘Directors and Officers’) for damages. The FDIC, in its capacity as receiver of a failed bank, has the authority to pursue professionals that it believes acted tortiously and contributed to a bank’s losses. With over 500 US banks failing since February 2007, the FDIC has investigated and pursued many such professionals. This article focuses on: the unclear standards of liability to which one group of professionals – Directors and Officers – are held in these FDIC investigations and subsequent lawsuits, the disparate application of those standards by courts, and the negative consequences of the lack of a clear and uniform standard of liability for Directors and Officers. This article concludes that the creation of a uniform statutory gross negligence standard would allow the FDIC to effectively pursue the most culpable Directors and Officers, while eliminating the fear of liability for well-informed business decisions that has driven qualified Directors and Officers out of the banking industry.

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Notes

  1. The S&L Crisis occurred during the 1980s, with repercussions lasting well into the 1990s, and involved the closure by the Resolution Trust Corporation of 747 savings and loan institutions.

  2. It is a popular misconception that the cost of a failed bank is borne by taxpayers. In actuality, it is borne by the Deposit Insurance Fund, which itself is funded by banks (see FDIC, 2015b). Note, however, that the Deposit Insurance Fund has a line of credit with the Treasury but has not drawn on it during this wave of bank failures.

  3. According to the FDIC, ‘[a]s receiver for a failed financial institution, the FDIC may sue professionals who caused losses to the institution in order to maximize recoveries. These individuals can include officers and directors, attorneys, accountants, appraisers, brokers, or others. Professional liability claims also include direct claims against insurance carriers such as fidelity bond carriers and title insurance companies’ (FDIC, 2015c).

  4. While this article will focus on Lawsuits against directors and officers, the FDIC-R has also sued professionals such as law firms and accountants.

  5. Because of the federal government’s ‘too big to fail’ approach to bailing out financial institutions, it was primarily community banks that were left to collapse under the weight of the worldwide economic meltdown. Directors and Officers of banks that survived the Great Recession because of bailout relief have not had to face investigation, while their community bank counterparts that did not receive government assistance have frequently been the targets of the FDIC-R.

  6. For example, there have been situations where the FDIC-R has gone after certain Directors and Officers but not others based apparently on depth of pockets.

  7. The business judgment rule is defined and analyzed in under ‘Issues regarding standard of liability – Business judgment rule’, infra.

  8. The fallacy of the FDIC-R’s all-too-common position that a bank failure necessarily indicates tortious conduct by Directors and Officers is made apparent when taken to its logical conclusion. If it is true that bank failures necessarily indicate tortious conduct by Directors and Officers, then bank failure statistics tell us that from 2004 to 2007 no Directors and Officers acted in a sufficiently tortious manner to cause a bank failure; yet beginning in February 2007, over 500 sets of Directors and Officers across the country suddenly decided to violate their legal standards of care and cause their respective banks – many of which had recently received composite ratings of 1 or 2 from regulators – to fail in rapid succession.

  9. Pursuant to the terms of the loss-share agreement, the FDIC-R has, in some situations, reimbursed the purchasing bank for some portion of that bank’s losses incurred on the failed bank’s loans.

  10. The Order of Investigation, typically signed by the FDIC’s Acting Deputy General Counsel of its Litigation and Resolutions Branch, is issued pursuant to 12 U.S.C. § 1818(n) and 12 U.S.C. § 1821(d)(2)(I), which provide for subpoena power.

  11. Pursuant to 12 C.F.R. § 308.146, ‘[t]he person conducting the investigation may obtain the assistance of counsel or others from both within and outside the FDIC’.

  12. Pursuant to 12 C.F.R. § 308.147, ‘[i]n-formation and documents obtained by the FDIC in the course of such investigations shall not be disclosed’.

  13. Pursuant to 12 C.F.R. § 308.146, ‘[t]he person designated to conduct [an] investigation shall have the power … to issue subpoenas and subpoenas duces tecum and to apply for their enforcement to the United States District Court for the judicial district or the United States court in any territory in which the main office of the bank, institution, or affiliate is located or in which the witness resides or conducts business’.

  14. Pursuant to 12 C.F.R. § 308.146, ‘[t]he person designated to conduct [an] investigation shall have the power, among other things … to take and preserve testimony under oath’.

  15. Because many D&O insurance policies contain exclusions for intentional conduct, the FDIC-R – which often relies on the corpus of the insurance policy to pay a substantial part of its damages or settlement demand – rarely alleges such intentional conduct.

  16. Early on in their Investigations into the present wave of bank failures, the FDIC-R would often accept solely the proceeds of Directors’ and Officers’ D&O insurance policies in satisfaction of its claims. However, the FDIC-R has since changed its practice and now generally seeks to require personal contributions from Directors and Officers in addition to the proceeds of relevant insurance policies.

  17. The officers were the former President/CEO of IndyMac’s Homebuilders Division, the former Chief Lending Officer of the Homebuilders Division and the former Chief Compliance Officer of the Homebuilders Division (LaCroix, 2012).

  18. But see infra ‘Interstate inconsistencies - Disparate application to directors and officers’.

  19. ‘The business judgment rule operates to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments’ (Binks v. DSL.net, Inc., 2010).

  20. ‘The business judgment rule protects bank directors from being guarantors on loans made by banks’ (RTC v. Norris, 1993).

  21. The Florida statute provides, in pertinent part, that a director’s alleged misconduct must rise to the level of ‘conscious disregard for the best interest of the corporation, or willful misconduct’ (see FDIC v. Price, 2012 (quoting Fla. Stat. § 607.0831(I)(b)(4))).

  22. Finding that business judgment rule was a rebuttable presumption that directors acted ‘on an informed basis, in good faith, and with the honest belief that the course taken was in the best interest of the corporation’, but that the FDIC successfully pled around this presumption by alleging that the directors failed to exercise due care in carrying out their duties.

  23. The Illinois Banking Act, for example, provides:

    By the affirmative vote of the holders of at least two-thirds of the outstanding shares of stock of a State bank, such vote occurring at any annual or special meeting of shareholders held pursuant to this Act or occurring pursuant to the waiver provisions of Section 43 of this Act, a State bank may establish that a director is not personally liable to the bank or its shareholders for monetary damages for a breach of the director’s fiduciary duty; provided, however, that such provision may not eliminate or limit the liability of a director for any of the following:

    (1) An act or omission that is grossly negligent.

    (2) A breach of the director’s duty of loyalty to the bank or its shareholders.

    (3) Acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law.

    (4) A transaction from which the director derived an improper personal benefit.

    (5) An act or omission occurring before the effective date of the provision authorized by this subsection. (205 ILCS 5/39)

  24. ‘[Defendants] have the burden of proof of the affirmative defense’ (Premier Capital Mgmt, LLC v. Cohen, 2008).

  25. The court in FDIC v. Spangler quoted Stamp v. Touche Ross & Co., 263 Ill. App. 3d 1010 (1st Dist. 1993), for the proposition that ‘[t]he [business judgment] rule does not shield directors who fail to exercise due care in their management of the corporation’.

  26. FDIC v. Rippy (2015) concluded that, while the defendants ‘failed to address deficiencies outlined in examination reports issued by the FDIC and NCCB …. those same reports repeatedly awarded [the bank] ratings of “2” in the CAMELS categories’ and thus, ‘[i]n the face of this contradiction, we find that there is insufficient evidence that the [defendants] acted wantonly or with reckless indifference’.

  27. Compare FDIC v. Gravee, 966 F. Supp. 622, 636 (N.D. Ill. 1997) (gross negligence has been defined as ‘very great negligence’, but something less than willful, wanton and reckless conduct) with RTC v. Franz, 909 F. Supp. 1128, 1140–41 (N.D. Ill. 1995) (‘[d]efining gross negligence as recklessness is consistent with horn book law’ as well as Illinois case law).

  28. ‘Gross negligence has been defined as “very great negligence” but something less than willful, wanton and reckless conduct’.

  29. The idea that a claim attacking the wisdom of a judgment is clearly distinguishable from a claim attacking the process by which the judgment was made is untenable. It also overlooks the fact that considerations such as what information to consider and the impact of a given piece of information on a final judgment are, in and of themselves, business judgments. Further, this ruling throws plaintiffs such as the FDIC-R a softball by allowing them to sidestep the business judgment rule by simply pleading that any piece of information was overlooked and that, therefore, the judgment was not based on the exercise of ordinary care. Thus, if a bank director makes a business decision to consider, for example, nine pieces of information pursuant to approving a loan, the FDIC-R need only allege that the director should have also considered – and failed to consider – a tenth piece of information in order to circumvent the business judgment rule.

  30. Utilizing the Restatement definition of recklessness is consistent with the current practices of many jurisdictions. See, for example, Stefan v. Olson, 497 Fed. App’x 568, 581 (6th Cir. 2012) (Ohio law has defined recklessness in light of the Restatement (Second) of Torts § 500); Cincinnati Ins. Co. v. Markey Builders, Inc., No. 15-cv-00062, 2015 US Dist. LEXIS 103492, at *6–7 (M.D. Pa. 7 August 2015) (Pennsylvania courts have consistently applied the Restatement (Second) of Torts definition of recklessness); Cupp v. United States, No. CV 512-005, 2014 US Dist. LEXIS 164216, at *12 (S.D. Ga. 24 November 2014) (Texas courts employ the definition of recklessness supplied by the Restatement (Second) of Torts); Masuo v. Galan, 455 B.R. 214, 223 (Bankr. D. Idaho 2011) ([o]ther Idaho decisions look to the Restatement (Second) of Torts’ definition of recklessness); DeCormier v. Harley-Davidson Motor Co. Group, 446 S.W.3d 668, 671 (Mo. 2014) ([t]he definition of ‘recklessness’ in the Restatement (Second) of Torts has been long utilized in Missouri cases); Schumacher v. Schumacher, 676 N.W. 2d 685, 692 (Minn. Ct. App. 2004) ([t]he Iowa Supreme Court recently applied the recklessness standard found in the Restatement (Second) of Torts).

  31. While utilizing the Restatement definition of recklessness would not achieve perfect uniformity throughout the country (as each state may apply the definition in its own way), it will at least provide a common starting point for determining the standard to which Directors and Officers will be held.

References

  • 1st Valley Credit Union v. Bland (2010) No. 10-1597, 2010 U.S. Dist. LEXIS 144739, at *23 (C.D. Cal. 20 December 2010).

  • AABD (American Association of Bank Directors) (2014) AABD survey results on measuring bank director fear of personal liability are not good news, http://aabd.org/aabd-survey-results-measuring-bank-director-fear-personal-liability-good-news./, accessed 9 April 2014.

  • Binks v. DSL.net, Inc. (2010) No. 2823-VCN, 2010 Del. Ch. LEXIS 98, at *20 (Del. Ch. 29 April 2010).

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  • FDIC (2015b) The deposit insurance fund, https://www.fdic.gov/deposit/insurance/, accessed 26 January 2016.

  • FDIC (2015c) Professional liability lawsuits, https://www.fdic.gov/bank/individual/failed/pls/, accessed 26 January 2016.

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Acknowledgements

The authors thank Jill O’Neill for her assistance with this article.

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Correspondence to Joshua Nichols.

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To date, the authors have defended more than 100 directors and officers of troubled and failed banks against FDIC claims in excess of $400 million.

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Nichols, J., Lending, R., O'Rourke, D. et al. FDIC-R professional liability lawsuits: A call for uniformity. Int J Discl Gov 13, 204–220 (2016). https://doi.org/10.1057/jdg.2016.1

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