Since the current cycle of bank failures began in 2008, the FDIC
has authorized suits for director and officer ("D&O")
liability against 427 individuals in connection with 49 failed
banks. Through February 9, 2012, the FDIC has filed 22 lawsuits
against former officers and directors of failed banks, most of
which were instituted within the past year.
Recently, United States District Courts in Atlanta and Chicago have
issued important opinions governing the manner in which these
lawsuits should be handled. In FDIC v. Steven Skow, et
al., a case which arose from the failure of Integrity Bank,
Alpharetta, Georgia ("Integrity"), on August 29,
2008.1 and FDIC v. John M. Saphir, et al., a
case arising out of the failure of Heritage Community Bank,
Glenwood, Illinois ("Heritage"), on February 27,
2009,2 the courts define the legal grounds on which the
FDIC's bank failure claims against D&Os may be litigated,
especially in the early motion stage.
The Integrity and Heritage cases are based on a
familiar set of FDIC allegations and claims in failed bank D&O
lawsuits: the alleged pursuit by directors and officers of failed
banks of an unsustainable growth strategy concentrated on lending
for allegedly high-risk and speculative real estate ventures, which
resulted in substantial losses when the real estate market
collapsed and the bank failed. In these and other lawsuits, the
FDIC has asserted claims for (i) breach of fiduciary duty, (ii)
ordinary negligence under state law, and (iii) gross negligence
under the federal Financial Institutions Reform Recovery and
Enforcement Act of 1989 ("FIRREA").
The director and officer defendants in these recent cases filed
dispositive Rule 12 motions seeking dismissal of all claims. In
Integrity, the FDIC also moved to strike a number of the
defendants' affirmative defenses. In both Integrity
and Heritage, the courts allowed some of the FDIC's
claims to survive dismissal at the pleadings stage, while other
claims and certain affirmative defenses did not.
Claims Based on Ordinary Negligence Should Not Survive the Business Judgment Rule
The defendants in Integrity and Heritage
argued that the business judgment rule barred claims for ordinary
negligence. The Integrity Court addressed the substance of
this argument.
Under Georgia corporate law, as noted by the Integrity Bank
defendants and the court, the business judgment rule "affords
an officer the presumption that he or she acted in good faith, and
absolves the officer of personal liability unless it is established
that he or she engaged in fraud, bad faith or an abuse of
discretion."3 Thus, "allegations amounting to
mere negligence, carelessness or 'lackadaisical
performance' are insufficient as a matter of
law."4 Finding this principle determinative, the
court held that claims against directors and officers for ordinary
negligence, as well as claims for breach of fiduciary duty based on
ordinary negligence, are precluded by the business judgment rule
under Georgia law.5
By precluding claims based on ordinary negligence, the
Integrity ruling confirms that the FDIC should be held to
the higher standard of gross negligence when attempting to prove
liability against failed bank directors and officers. We believe
this is an appropriate decision that should be helpful to directors
and officers of other failed banks, especially in jurisdictions
with bank corporate laws similar to Georgia's. This ruling
should enable more productive discussions with the FDIC before it
files a failed bank D&O lawsuit, discourage similar claims by
the FDIC, and support defendants' motions to dismiss claims
based on ordinary negligence.
Defendants Should File a Motion for Judgment on the
Pleadings, Not Just a Motion to Dismiss for Failure to State a
Claim
The directors and officers in Heritage also moved to
dismiss the FDIC's ordinary negligence claims based on the
business judgment rule.6 The Heritage court
declined to address the merits of the defendants' argument,
however, concluding that the business judgment rule was an
affirmative defense which had yet to be raised because the
defendants had not answered the complaint.7 Accordingly,
the court reasoned, the effect of the affirmative defense on the
FDIC's claims was more appropriately considered on a motion for
judgment on the pleadings.8
Integrity reached a different conclusion, citing Eleventh
Circuit authority that subjects a complaint to dismissal under Rule
12(b)(6) when the allegations, on their face, show that an
affirmative defense bars recovery.9 Given these
differing judicial viewpoints, former directors and officers may
wish to consider filing both a motion for judgment on the pleadings
and a motion under Rule 12(b)(6) when arguing that the business
judgment rule, or any other affirmative defense, precludes the
FDIC's claims.
Exculpatory Provisions in a Bank's Articles of
Incorporation May Not Bar Claims for Gross Negligence Brought by
the FDIC
In addition to relying on Georgia's business judgment rule,
the Integrity Bank defendants argued that exculpatory provisions in
the bank's articles of incorporation precluded claims for
breach of the duty of care and gross negligence under
FIRREA.10 Like many states, Georgia allows companies in
their articles of incorporation to limit or exculpate directors
from liability for the breach of the duty of care, including gross
negligence. In a typical derivative lawsuit brought by a
corporation's shareholders against its directors, defenses
based on these exculpatory provisions are common and often
effective. Even so, the FDIC argued that the exculpatory provision
in the bank's articles of incorporation had no effect because
the lawsuit was not a derivative action and the FDIC, as receiver,
was acting not as a shareholder, but as successor to the
bank.11 The Court in Integrity agreed with the
FDIC.
At the outset, the Integrity Court noted that the express
purpose of FIRREA "was to improve the FDIC's ability to
recover federal funds spent to rescue failed banks" and that
FIRREA "preempts state laws to the extent that those laws
insulate bank directors from personal liability for gross
negligence in an action brought by the FDIC."12 The
court also held that the exculpatory provisions did not preclude
state law fiduciary duty claims for the breach of the duty of care
based on gross negligence.13 The reason, according to
the court, is that the "FDIC [is] primarily serving as an
instrument of the banking industry" when it becomes a receiver
for a failed bank, not as the bank's shareholder or as the
corporation per se.14 The Integrity decision
then proceeded to analyze the allegations in the complaint, in the
light most favorable to the FDIC, and determined that they
sufficiently stated a claim for gross
negligence.15
The Integrity decision on the issue of gross negligence
and exculpatory provisions presents the biggest downside to
D&Os. If other courts adopt this approach, it will be difficult
for defendants to eliminate claims of gross negligence at the early
stage of litigation through motions to dismiss or for judgment on
the pleadings. In future cases, however, defendants may be
well-advised to raise exculpatory provisions as a defense, if only
to preserve the issue for appeal. Defendants also should make every
effort to show the FDIC during its investigation stage, and any
court in the event a complaint is filed, how the FDIC's
allegations do not factually support a claim for gross negligence
in their particular situation.
Affirmative Defenses Based on the Pre-Receivership Conduct of the FDIC in Its Corporate Regulatory Capacity May Not Succeed
The Integrity Bank defendants raised a number of other
affirmative defenses, including estoppel, based on the FDIC's
conduct before the bank failed. Specifically, the defendants argued
that the FDIC's "lax oversight" and
"arbitrary" regulatory constraints contributed to the
bank's failure and that the FDIC neglected or refused to take
appropriate steps to mitigate its damages.16 The court,
however, rejected these arguments, holding that affirmative
defenses based on the FDIC's pre-receivership regulatory
conduct in its corporate capacity must be
stricken.17
The court reasoned that the "FDIC has the authority to serve
in two separate and legally distinct capacities: (1) in its
corporate capacity as an insurer of deposits and regulator of
member banks [Corporate FDIC] and (2) in its receivership capacity
as a receiver of failed banks [Receiver FDIC]."18
Corporate FDIC was not a party to the lawsuit, which was brought by
the FDIC in its capacity as receiver. The court looked to federal
appellate authority recognizing this distinction and holding that
Receiver FDIC cannot be liable for wrongs committed by Corporate
FDIC.19 On the basis of this authority, the court ruled
that affirmative defenses against Corporate FDIC had no bearing on
Receiver FDIC's claims.20 The court, however, did
not strike affirmative defenses based on the post-receivership
conduct of the FDIC in its capacity as receiver.21
Accordingly, defendants should focus any reasonable estoppel-type
defense on the conduct of Receiver FDIC to the extent possible.
Defendants should still raise these affirmative defenses, even as
to Corporate FDIC, to preserve this issue for appeal at least until
appellate courts definitively resolve the issue.
Causation Arguments Based on the Pre-Receivership Conduct of
the FDIC in Its Corporate Capacity Remain Open Issues
The Integrity Bank defendants also raised a causation
"defense," arguing that Corporate FDIC's
pre-receivership conduct in tacitly approving the bank's
business plans and then abruptly downgrading its assets contributed
to the bank's failure.22 Noting that causation is
not technically an affirmative defense, but rather an essential
element of the FDIC's claims, the court found this to be a
murkier question of law than that posed by the FDIC's motion to
strike certain affirmative defenses.23 Hence, the court
determined that the issue warranted additional briefing either at
the summary judgment stage or before trial.24
In passing on this issue, and thus denying the FDIC's motion to
strike, the court also refused to address the FDIC's argument
that the defendants should have impleaded Corporate FDIC if they
intended to contend that its pre-receivership conduct caused the
bank's failure. Because this issue remains unsettled, and given
the FDIC's position, defendants will need to consider whether
to implead Corporate FDIC when arguing that the FDIC helped cause
the bank's failure. More importantly, banks and their boards of
directors should periodically review their business plans, asset
and concentration levels, staffing and experience levels, and risk
tolerances to manage their risks, maintain good regulatory
relations, and prevent these sorts of claims from shareholders, as
well as regulatory enforcement actions while their banks are
operating, and potential claims by the FDIC, as receiver, if their
banks fail.
Conclusion
Failed bank director and officer liability will become more defined
as additional rulings are rendered in the other pending FDIC cases
and upon appellate review. For now, however, the Integrity
and Heritage cases have helped inform the strategy of
former directors and officers facing potential FDIC claims or
actual litigation. More importantly, the Integrity
decision appropriately set the bar higher for FDIC claims based on
ordinary negligence, at least in jurisdictions with law similar to
Georgia, whose corporate law, like many states, is based on the
Model Business Corporation Act. Integrity's precedent
is also significant because Georgia has had 77 bank failures from
2007 through March 9, 2012, more than any other state, making it an
important battleground for failed bank litigation.
Footnotes
1. FDIC, as receiver of Integrity Bank v. Skow, et. al., Civil Action No. 1:11-CV-0111-SCJ (N.D. Ga. Feb. 27, 2012) (Jones, J.). See also Jones Day analysis of this failure and resolution.
2. FDIC, as receiver of Heritage Community Bank v. Saphir, 2011 WL 3876918, No. 10 C 7009 (N.D. Ill. Sept. 1, 2011) (Pallmeyer, J.). See also Jones Day analysis of this failure and resolution.
3. Skow at 16 (quoting Brock Built, LLC v. Blake, 300 Ga. App. 816, 821–822, 686 S.E.2d 425, 430–431 (2009)). Georgia, like a number of other states, follows the Model Business Corporation Act.
4. Id.
5. Id. at 18.
6. Saphir, 2011 WL 3876918, at *1.
7. Id. at *5.
8. Id. The Heritage court did, however, dismiss the FDIC's negligence claims on grounds that they were duplicative of the FDIC's breach of fiduciary duty claims. Id. at *9.
9. Skow at 18 (citing Cottone v. Jenne, 326 F.3d 1352, 1357 (11th Cir. 2003)).
10. Id. at 6.
11. Id. at 9.
12. Id. at 7 (citing Atherton v. FDIC, 519 U.S. 213, 227–229 (1997)).
13. Id. at 12.
14. Id. at 11 (citing FDIC v. Harrison, 735 F.2d 408, 413 (1984)).
15. Id. at 13.
16. Id. at 25.
17. Id. at 26.
18. Id. at 25 (citing Harrison, 735 F.2d at 412).
19. Id.
20. Id. at 26.
21. Id. at 30.
22. Id. at 30.
23. Id. at 31.
24. Id.
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