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Should Banks Settle When They are Hit with an M&A Lawsuit?

April 4, 2014

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In virtually every transaction involving a publicly traded entity these days, a purported shareholder class action challenging the fairness of the merger has become almost inevitable. While these actions ostensibly seek monetary relief, such as an increase in the merger consideration, most of them ultimately settle on terms that call for some additional disclosures to the shareholders in advance of the vote on the transaction, and, of course, an attorneys fee award for the plaintiffs’ lawyers.  There are two primary reasons for these settlements.  First, the risk, however small, of having a large transaction enjoined or otherwise disrupted is often seen as outweighing the relatively minimal nature of the settlement relief.  Second, a settlement is not without its benefits, as, once approved by the Court, the settling defendants can obtain a full and complete release of any claims that were or could have been brought by the shareholders in connection with the merger transaction.  So long as these two dynamics remain in place, the settlement of the majority of these merger and acquisition cases will continue to be the norm. The Courts, however, particularly in Delaware, have begun to show a healthy skepticism about the plaintiffs lawyers’ application for fees in these cases.  Ultimately, it will be the plaintiffs lawyers’ ability to obtain a profitable fee award that will determine the extent to which these cases remain so prevalent.

An abbreviated version of this response was first published on BankDirector.com.

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FDIC Sues Former Officers and Directors of Two Failed Georgia Banks in October 2012

December 10, 2012

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As has been noted on this blog before, the State of Georgia has the dubious distinction of leading the nation in the number of failed financial institutions. In the month of October 2012, the number of lawsuits against former officers and directors of those failed institutions increased by two (2).

In the first lawsuit, filed on October 17, 2012, the FDIC brought suit in its capacity as Receiver for American United Bank of Lawrenceville, Georgia against two former officers and 6 former directors of the bank. (A copy of the complaint can be found here.)  In that suit, the FDIC alleged both ordinary negligence and gross negligence in connection with the management of the lending function of the bank. The FDIC alleged that the failure of American United caused a loss to the Federal Deposit Insurance Fund in the amount of $45.2 million, and, through alleged damages in the lawsuit, seeks to recover an amount in excess of $7.3 million.

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D&O Carrier Seeks Denial of Coverage Against Former Directors of Failed Bank

May 1, 2012

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On March 30, 2012, Progressive Casualty Insurance Company filed an action naming as defendants the FDIC as Receiver of Omni National Bank, as well as the former officers and directors of Omni whom the FDIC had previously sued.  The Complaint asserts a claim for declaratory judgment that Progressive is not obligated to cover any of the claims asserted by the FDIC against the former directors and officers in the Omni litigation.  This action is significant in that it raises a number of coverage issues which former directors and officers of failed banks may see raised by their own D&O insurance carriers, and the presence or absence of D&O coverage is a critical factor considered by the FDIC in determining whether to bring an action seeking any kind of recovery.

Progressive had underwritten a director and officer liability policy for the directors and officers of Omni with a total policy limit of $10 million.  The policy did not contain any exclusion which would directly exclude coverage for any action brought by a governmental or regulatory agency such as the FDIC (a so called “regulatory exclusion”).  Nonetheless, apparently after having received notice of the claim by the FDIC, Progressive denied coverage on a number of separate bases, which now form the basis of the declaratory judgment lawsuit.

First, Progressive alleged that coverage for the former directors and officers of Omni was barred by the insured v. insured exclusion contained in the policy.  An insured v. insured exclusion is a common feature of a directors and officers liability policy, and essentially provides that any claim brought by, on behalf of, or at the behest of any insured company or insured person under the policy against insured persons under that same policy are not covered.  Progressive alleges that, because the FDIC steps into the shoes and succeeds to all the rights and privileges of the Bank, and brought the action against the directors and officers in its capacity as Receiver for the Bank, the insured v. insured exclusion is triggered and therefore no coverage is available.  Whether a standard insured v. insured exclusion in fact bars coverage for an action by the FDIC against former officers and directors is an important question, and is certainly debatable.

Next, Progressive alleges that, because unpaid unrecoverable loan losses are carved out from the definition of “loss” under the policy, there is no coverage for the losses alleged in the FDIC’s complaint against the former Omni directors and officers.  Progressive alleges that the FDIC’s complaint is specifically based on $24.5 million in losses that the bank suffered on over 200 loans.

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FDIC Sues Former Directors and Officers of Omni National Bank

April 3, 2012

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On March 16, 2012, the FDIC, in its capacity as Receiver for the failed Omni National Bank, brought a lawsuit in the Northern District of Georgia against several former officers, some of whom had also served as directors, of the Bank seeking to recover over $24.5 million in losses the bank suffered on over 200 Community Development Lending Division (“CDLD”) loans on low income residential properties.  The Complaint also seeks to recover an additional $12.6 million in what it contends were wasteful expenditures on low income Other Real Estate Owned (“OREO”) properties. A copy of the FDIC’s complaint is available here.

Omni National Bank of Atlanta, Georgia was closed by the regulators on March 27, 2009.  This lawsuit was brought almost exactly three years later, which is the operative statute of limitations.

Most of the defendants named in the Complaint were former CDLD officers, who are alleged to have approved the loans at issue in the Complaint despite alleged “numerous, repeated and obvious violations of the Bank’s loan policies and procedures, banking regulations and prudent and sound lending practices.”  The violations alleged include violations of loan to one borrower limits through the use of straw borrowers, violations of loan to value limits, failure to obtain appraisals prior to funding, lack of required borrower equity or down payment, insufficient borrower credit scores or repayment ability, and other improprieties.  The Complaint also includes claims against more senior former executives, including the former CEO and President of the Bank, based on their alleged failure to supervise the CDLD lending function, their alleged previous knowledge of misconduct and other “red flags” of problems in the CDLD lending program, and their alleged authorization of certain OREO expenditures described below.

The Complaint also asserts claims for alleged wasteful OREO expenditures after September 15, 2008.  This claim is made against a former vice president, who was responsible for management of OREO.  FDIC alleges that, instead of liquidating the additional OREO properties “as is” to conserve remaining capital, this defendant expended over $12.6 million to maintain, rehabilitate, renovate, and/or improve the additional OREO properties.  The Complaint alleges that these expenditures further depleted the Bank’s already deficient capital and hastened the Bank’s failure.

As with previous complaints, this Complaint continues to allege claims under both simple negligence and gross negligence theories, despite the holding of a federal court in the Integrity Bank case in Georgia that simple negligence claims are not available against former directors and officers of a failed bank under Georgia law.

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FDIC Brings Suit Against Former Directors and Officers of Freedom Bank of Georgia

March 22, 2012

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On March 2, 2012, the FDIC, in its capacity as receiver for Freedom Bank of Georgia, brought suit against twelve (12) former directors and officers of the Bank, many of whom served on the bank’s Loan Committee.  The complaint alleges that, because of the defendants’ misconduct, the FDIC, as receiver, is entitled to recover at least $11,050,623.  Interestingly, Freedom was closed by the Georgia Department of Banking & Finance on March 6, 2009, thus the FDIC’s lawsuit was filed almost exactly three (3) years from the date that the bank went into receivership, which is the applicable statute of limitations. A copy of the FDIC’s complaint is available here.

The FDIC’s damage claim is based on losses from twenty-one (21) commercial real estate and acquisition development and construction loans which were approved by the bank from May 16, 2005 through June 20, 2007.  The complaint alleges an undifferentiated laundry list of problems related to these loans, including, but not limited to, a lack of internal control in the loan policy limiting the amount of such loans, the absence of a requirement in the loan policy to conduct the global cash flow analysis of all contingent liabilities for the bank’s borrowers and guarantors, inadequate due diligence market research for loans outside the bank’s geographic area, insufficient analysis of ability to repay, failing to secure adequate collateral, incomplete or inadequate appraisals, and failing to ensure appropriate loan to value ratios.

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FDIC Weighs in on Director and Officer Removal of Bank Documents

Following the failure of over 400 financial institutions since the beginning of 2008, the FDIC has clarified its expectations with respect to collection and retention of bank documents by directors and officers of troubled or failing financial institutions for the purpose of explaining or defending their conduct. The FDIC’s Financial Institution Letter (FIL) released today sets forth the FDIC’s position that “[d]irectors and officers of troubled or failing financial institutions who remove originals or copies of financial institution records under such circumstances breach their fiduciary duty to the institution.” Presumably the FDIC would also object to a director or officer of a healthy bank copying and removing bank documents if the FDIC concludes that it is being done for improper purposes, although the FIL does not specifically address that issue.

Even though the guidance comes late in the game, we believe it is helpful for the FDIC to articulate its position on this matter to provide clarity to industry participants. We are disappointed, however, that the FDIC chose to issue this broad guidance through a financial institution letter (which cites no statutory authority or judicial decisions in support of its position) rather than through a formal rulemaking process whereby affected parties could offer comments.

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FDIC Brings Suit Against Former Officers of Community Bank & Trust of Cornelia

March 12, 2012

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On February 24, 2012 the FDIC, in its capacity as receiver, filed suit against the former President & CEO as well as the former Sr. Vice President of the Retail Banking Group for Community Bank & Trust of Cornelia, Georgia.  In the complaint, the FDIC seeks to recover losses in excess of $11 million that the FDIC alleges the bank suffered as a result of the defendants’ breaches of fiduciary duties, negligence, and gross negligence.  For a copy of the FDIC’s complaint, click here.

Community Bank & Trust of Cornelia, Georgia failed on January 29, 2010.  The Bank had been in existence since 1900, and had 36 branches across northeast Georgia at the time of its closing.  Defendant Charles Miller became the CEO of the Bank in 2006, and during the time that he served as CEO, co-defendant Trent Fricks served as Sr. Vice President of a retail banking group of the Bank.

All of the claims in the FDIC suit relate to the Bank’s Home Funding Loan Program, and to losses allegedly caused by that program between January 6, 2006 and December 2, 2009.  The complaint alleges that the Home Funding Loan Program developed through a relationship between defendant Fricks and Robert Warren, who owned several mortgage brokerage entities, collectively referred to as Home Funding Corporation.  The complaint alleges that the Bank provided bridge loans to the customers of the Home Funding Corporation entities, who were ostensibly real estate investors, in return for a commitment letter from Home Funding Corporation to the Bank in which it agreed to purchase the loan back from the Bank at maturity.  The loans related to purchases of investment single family residences in the Atlanta low end housing market, and were alleged to have been high risk, short term loans.  The complaint alleges that defendant Fricks was directly responsible for the program, and personally approved the loans despite material underwriting deficiencies, and numerous violations of the bank’s loan policy, such as failing to obtain complete financial statements, failing to obtain appraisals, and exceeding the bank’s LTV ratio limit.  Further, the complaint alleges that the numerous deficiencies and problems with the Home Funding Loan Program and with Fricks’ conduct were brought to the attention of CEO Miller, and he failed to act on any of the problems that were identified, allowing losses to continue to mount.

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Court Confirms “Gross Negligence” Standard for Bank Director Liabilty in Georgia

February 29, 2012

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As many readers are aware, Georgia has led the nation in the number of failed financial institutions in the recent financial crisis.   Integrity Bank, of Alpharetta, was one of the first of those banks to fail in Georgia, on August 28, 2008, and drew the first lawsuit filed by the FDIC as receiver against former directors and officers in Georgia.  The lawsuit was filed against former members of the Director Loan Committee of the Bank, and asserted claims against the Defendants based on their alleged pursuit  of an unsustainable rapid growth strategy, involving high risk lending concentrated in speculative real estate and acquisition, construction and development loans.   The suit alleged over $70 million in losses from 21 such loans, between February 4, 2005 and May 2, 2007.

On February 27, 2012, in response to motions to dismiss filed by the defendants, and motions to strike certain affirmative defenses filed by the FDIC as Receiver, Judge Steven C. Jones of the United States District Court for the Northern District of Georgia issued an Order which made some critical rulings regarding the standard of care and the availability of certain defenses in actions brought by the FDIC as receiver in Georgia.  A copy of the Order is available here.  Given that this is the first such substantive ruling in this context by a court in Georgia, the decision is notable and will likely have a significant impact on future FDIC litigation in Georgia going forward.

Of potentially greatest significance, the Court granted the Defendants motion to dismiss all of the FDIC’s claims based on ordinary, as opposed to gross, negligence.    The Court was persuaded that in Georgia, the deviation from the standard of care necessary to state a claim against former bank officers and directors must rise at least to the level of the “gross negligence” floor set by the Financial Institutions Reform, Recovery and Enforcement Act of 1989  (FIRREA) .   The Court reached this conclusion after determining that Georgia ‘ s Business Judgment Rule protects directors and officers from claims based on simple, or ordinary, negligence.   This sets the bar fairly high for the FDIC to prevail on claims against former directors and officers of failed banks,and should provide some comfort in that regard.

Detracting somewhat from the defendants victory on that aspect of the motion to dismiss, however, Judge Jones also ruled that the relatively unexceptional allegations by the FDIC of uncontrolled rapid growth and over concentration in speculative and risky acquisition, development and construction loans were sufficient to withstand a motion to dismiss, even at the heightened “gross negligence” standard.   Thus, while the decision sets the bar high for the FDIC to ultimately prevail on these sorts of claims, it does not necessarily provide much ammunition to argue for dismissal at the motion to dismiss stage.

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FDIC Sues Former Officers of Silver State Bank

February 17, 2012

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On February 9, 2012, the FDIC sued four former officers of Silver State Bank (Henderson, NV). Silver State operated 12 branch offices in and around Las Vegas and 4 branch offices in metro Phoenix. In addition, it had 12 loan production offices in several western states and in Florida. Silver State was closed and placed into FDIC receivership in September 2008. For a copy of the FDIC’s complaint, click here.

The defendants in this action are Silver State’s former CEO, the former EVP of Real Estate Lending and two former loan officers. According to the FDIC’s complaint, in early 2006, the CEO steered the bank on an aggressive growth strategy focused on high risk Acquisition, Development and Construction (”ADC”) loans. The CEO and the EVP of Real Estate Lending aggressively pursued lending opportunities in the Bank’s two principal markets – Las Vegas and Phoenix – despite numerous indications that those markets were in steep decline. The FDIC liberally cited several articles published by the EVP that predicted that the real estate market would suffer a painful crash. Despite his own predictions, and his own acknowledgements once the market started to seriously decline, the EVP allegedly sugar-coated his reports on market conditions to the Bank’s board, and he continued to recommend speculative ADC loans to the Senior Loan Committee. The FDIC in part attributed the defendants’ “reckless” behavior to the Bank’s compensation structure, which richly incentivized loan officers to make loans without regard to quality or risk.

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FDIC Brings Suit Against Former Officers of Failed California Bank

February 6, 2012

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In its most recent lawsuit relating to a bank failure, the FDIC, in its capacity as receiver of the failed County Bank of Merced, California has filed a complaint against former officers of the bank.  The complaint was filed on January 27, 2012, in the Eastern District of California.  Interestingly, County Bank had failed on February 6, 2009, so the FDIC ultimately filed its complaint just short of the expiration of the three (3) year period from the date of receivership within which it can file claims. A copy of the FDIC’s complaint is available here.

The complaint names five (5) former officers of the bank all of whom served on the bank’s Executive Loan Committee.  It essentially alleges that the defendants allowed the bank to make what it characterizes as “imprudent” real estate loans, especially loans for the construction and development of residences.  The complaint alleges that the bank’s real estate lending policies were not safe and sound banking practices, that the bank disregarded its own credit policies and approved loans to non-credit worthy borrowers.  It also alleges that the bank’s management continued to invest in risky commercial real estate lending even after the marker had begun to decline.

The complaint focuses on twelve (12) specific loans, and alleges claims against each of the defendants for negligence and breach of fiduciary duty.  The loans were made between December 2005 and June 2008, and FDIC contends they caused the bank losses in excess of $42 million.

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