United States: Ten Years After Crash, Litigation Continues – Directors Of Bankrupt Holding Company Not Liable To Trustee

Last Updated: September 12 2018
Article by Stephen M. Proctor

The Great Recession of 2008 may seem a distant memory. September 15, 2018 is the 10th anniversary of the Lehman Brothers bankruptcy, the largest bankruptcy in U.S. history, and often seen as the point at which a garden-variety recession turned into the Great Recession, with catastrophic results severely impacting the livelihood of millions.

Litigation resulting from the Great Recession is still ongoing. An example is a recent 7th Circuit Court of Appeals decision in which the officers of a failed bank holding company were found not liable to the company's trustee in bankruptcy for decisions that unsuccessfully tried to rescue the holding company's subsidiary banks. (Elliott D. Levin, as Chapter 7 Trustee for Irwin Financial Corporation v. William I. Miller, Gregory F. Ehlinger, and Thomas D. Washburn, 7th Circuit Court of Appeals, No. 17-1775, August 17, 2018)

Irwin Financial Corporation ("Irwin") was a holding company for two subsidiary banks, Irwin Union Bank and Trust Company (referred to in the decision as "Bank and Trust") and Irwin Union Bank, FSB (referred to as "Savings Bank"). Miller was Irwin's CEO and Ehlinger was its CFO. (The remaining defendant, Washburn, was not involved in the appeal.) These officers answered to Irwin's Board of Directors, which was largely independent. In fact, a supermajority of ten members of Irwin's Board were independent outside directors. After each meeting, the Board held an executive session without Irwin's officers.

In 2007-2008, the early stages of the financial crisis, both subsidiary banks struggled. Federal and state regulators insisted that Irwin had a duty to support its subsidiary banks. Irwin tried hard to do so. As part of its efforts to keep the subsidiary banks afloat, Irwin retained Rodgin Cohen of the law firm of Sullivan & Cromwell. Although not stated in the opinion, Cohen is known as one of the foremost legal experts in bank regulation, suggesting Irwin recognized the severe risks it was facing. Cohen agreed that Irwin should support the banks. The basis of his advice was the "Source of Strength Doctrine", which requires bank holding companies to provide assistance to subsidiaries in financial distress. Irwin's Board committed itself to saving the banks. As will be seen, this commitment, and actions taken consistent with this commitment, was later challenged by Irwin's bankruptcy trustee as a breach of fiduciary duty by Irwin's officers.

The situation worsened. In May 2008, the Chicago Federal Reserve and Indiana Department of Financial Institutions advised Irwin that the Bank and Trust was in trouble. Two months later the bank regulators sent a Memorandum of Understanding to Irwin demanding that Irwin obtain $50 million to support the Bank and Trust by the end of August. In the throes of the financial crisis hitting banks all over the country, this was an impossible demand and Irwin was unable to raise this money.

Irwin continued to try to support the banks through a formal Written Agreement to develop a plan to "improve management" and "maintain sufficient capital." Irwin also tried to tap into funds from TARP (Troubled Asset Relief Program), one of the many alphabet soup programs offered to keep banks solvent during the Great Recession. In November 2008, Irwin submitted a TARP application to the Treasury Department. But, ironically, Irwin's financial condition was almost too weak to justify TARP support to avoid throwing good money after bad.

In December 2008, Irwin injected $14 million into the Bank and Trust. There were positive indications that the Bank and Trust was not so bad as to prevent TARP assistance, although it would be an uphill struggle. The Federal Reserve again pushed for $50 million in additional funds into the Bank and Trust.

Irwin was desperate for TARP assistance and Irwin believed it needed Federal Reserve support for its application. In January 2009, Irwin asked the Federal Reserve what it needed for the Federal Reserve's support. After, several weeks, the Federal Reserve responded that Irwin would need to raise an additional $150 million in capital, an impossible amount, as well as replace its CEO.

In the midst of this bleak situation, Irwin's Board approved the 2009 Tax Allocation Agreement, which was the source of this litigation. As it had since 1999, the Agreement provided that Irwin would file consolidated federal income tax returns. If the banks would have become entitled to a tax refund if they had filed separately, Irwin would transfer the appropriate amount after receiving the refund from the IRS. This was also consistent with regulatory guidance applicable to bank holding companies. Fortuitously, Irwin was expecting a large tax refund to get it through these hard times.

While waiting for the tax refund, there was more bad news. On March 31, 2009, Irwin's accounting firm, Ernst & Young informed Irwin that the Bank and Trust was no longer considered well capitalized and its ability to continue as a going concern was in serious doubt.

In May 2009, the Indiana Department of Financial Institutions, the FDIC and the Chicago Federal Reserve warned the Board's independent directors of the consequences of failing to keep the Bank and Trust adequately capitalized. The Board continued to direct the officers to keep the banks solvent.

In June 2009, Irwin received the long-awaited tax refund. The refund was $76 million and, per the Tax Allocation Agreement, Irwin sent $74 million to the Bank and Trust and the remainder to the Savings Bank.

But, even with the tax refund, Irwin and its banks failed. Both banks closed and Irwin filed for bankruptcy in September 2009.

Levin, the plaintiff in this litigation, was appointed as Irwin's Chapter 7 bankruptcy trustee. As trustee, he was charged with recovering as much as possible for the benefit of Irwin's unsecured creditors.

Levin decided to pursue the officers of Irwin individually based on breach of fiduciary duty. Levin, second-guessing the Board and the officers, claimed that Irwin would have been better off to file bankruptcy before it transferred the refund to the subsidiary banks. Levin claimed that Miller and Ehlinger breached their fiduciary duties by failing to advise the Board of this possibility. The district court judge granted summary judgment to Irwin's officers and Levin appealed.

Judge Sykes, writing for the Court of Appeals, affirmed. First, Judge Sykes found the trustee's theory to be implausible. Levin's complicated scenario involved the officers of Irwin realizing the banks were doomed, investigating the bankruptcy option earlier, realizing that a bankrupt Irwin could probably keep the tax refund, and then advising the Board accordingly to file for bankruptcy before Irwin received the tax refund. Said Judge Sykes, "Color us skeptical."

There was a more fundamental flaw in Levin's theory, in Judge Sykes' view. Officers must follow the lawful instructions of the board, even if they disagree with those instructions. Irwin's Board's instructions were clear and were based on legal and regulatory guidance – first and foremost do everything possible to save the banks. Irwin's bankruptcy would have contradicted and probably destroyed this strategy. Judge Sykes noted, "The officers had no right – much less a duty – to pursue a course of action that directly contradicted the Board's clear instructions."

Consistent with the officers' duty to comply with the Board's instructions, the officers did not have any duty to hire an expert to second-guess the Board's judgment. Levin argued that the Board was persuadable and the officers should have done more to look into using Irwin's bankruptcy as a means to keep the $76 million tax refund. Judge Sykes dismissed this argument as "speculation", returning to the background around which all these events were taking place, namely the financial crisis that threatened, and ultimately destroyed, the banks and state and federal regulators' consistent demands to make every effort to save the banks.

So the trustee's efforts to use a fiduciary duty argument to impose personal liability on Irwin's officers failed. The case illustrates that, while the long, slow recovery from the financial crisis continues, efforts to shift the severe losses resulting from the financial crisis also continue and may still have a long way to go.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions