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Analysis of FDIC v. Loudermilk Decision

April 25, 2017

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The FDIC’s lawsuit against former directors and officers of the failed Buckhead Community Bank, one of the most closely watched Georgia corporate governance cases in years, went to trial in October, 2016.  The jury returned a verdict of nearly $5 million against the defendants for their role in the approval of four large commercial development loans that later defaulted.  FDIC v. Loudermilk, No. 1:12-cv-04156-TWT (N.D. Ga. Oct. 26, 2016).  It was less than a complete victory for the FDIC, which had sought over $21 million in damages based on ten bad loans, but the verdict nonetheless represents a significant recovery against directors and officers of a Georgia bank.  The case is all the more significant because it was the first known jury trial to evaluate a negligence claim under the business judgment rule as defined by the Georgia Supreme Court earlier on in the proceedings.

Editor’s Note:  This piece is an excerpt from the author’s 2016 Georgia Corporation and Business Organization Case Law Developments, which addresses decisions handed down in 2016 by Georgia state and federal courts addressing questions of Georgia corporate and business organization law.  The year saw a large number of decisions involving limited liability companies, continuing a trend from recent years.  The Georgia Supreme Court addressed some interesting and novel questions of corporate law, including whether an out-of-state LLC (or corporation) can avail itself of the removal right that permits Georgia-based companies to shift certain tort litigation from the county in which it is brought to the county where it maintains its principal office, and whether a nonprofit corporation has standing to pursue a write of quo warranto against public officials.

Buckhead Community Bank was closed by the Georgia Department of Banking and Finance in December, 2009, during the heart of the financial crisis.  The FDIC was named as receiver for the Bank.  In 2012, the FDIC filed suit against the Bank’s former directors and officers, alleging that they pursued an aggressive growth strategy aimed at building a “billion dollar bank,” causing the Bank’s loan portfolio to become heavily concentrated in commercial real estate acquisition and development loans.  The FDIC’s allegations were highly similar to allegations it made in dozens of other cases involving similarly situated banks that failed during the Great Recession.  In all, the FDIC filed over 100 civil actions between 2010 and 2015 in its capacity as its receiver for failed banks throughout the country, 25 of which were filed in Georgia against directors and officers of Georgia banks.  The vast majority of these cases have settled.  In fact, Loudermilk was only the second of these cases to proceed all the way to trial, and the first in Georgia.

As the case progressed to trial, it eventually focused on ten specific loans that were approved directly by the defendants acting as members of the Bank’s loan committee.  As to each of these loans, the FDIC alleged that approving the loans violated the Bank’s own loan policy, banking regulations, prudent underwriting standards and sound banking practices.  For instance, it was alleged that some loans exceeded the Bank’s loan-to-value guidelines but were approved anyway.  Other loans were approved without certain documentation that the FDIC alleged was necessary, such as current financial statements of borrowers and guarantors.  Other loans were allegedly approved before the loan application paperwork was final.  There was no claim that any of the loans were “insider” loans that provided a direct or indirect personal benefit to any of the defendants.

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Fourth Circuit Upholds FDIC’s Ordinary Negligence Claims

October 6, 2015

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The United States Court of Appeals for the Fourth Circuit, which governs North and South Carolina as well as Virginia, West Virginia and Maryland, has issued an important ruling in FDIC v. Rippy, a lawsuit  brought by the FDIC against former directors and officers of Cooperative Bank in Wilmington, North Carolina.  As it has done in dozens of cases throughout the country, the FDIC alleged that Cooperative’s former directors and officers were negligent, grossly negligent, and breached their fiduciary duties in approving various loans that caused the bank to suffer heavy losses.  The evidence showed the FDIC had consistently given favorable CAMELS ratings to the bank in the years before the loans at issue were made.  The trial court entered summary judgment in favor of all defendants, criticizing the FDIC’s prosecution of the suit as an exercise in hindsight.  The Fourth Circuit, however, vacated the ruling as it applied to the ordinary negligence claims against the officers.  In its opinion, the court held that the evidence submitted by the FDIC was sufficient to rebut North Carolina’s business judgment rule and thus allow the case to go to trial.  The Court found that the evidence indicated that the officers had not availed themselves of all material and reasonably available information in approving the loans.

The decision is specific to North Carolina-chartered banks and is based on the historical development of the business judgment rule in that state.  Nonetheless, there are certainly comparisons to be drawn to decisions from other states.  The emphasis on allegations of negligence in the decision-making process echoes last year’s decision in FDIC v. Loudermilk, in which the Georgia Supreme Court held that it was possible to bring an ordinary negligence claim against bank directors and officers who engage in a negligent process in making a decision.  While the Georgia Supreme Court in Loudermilk seemed to be of the view that it would permit claims to go forward against directors and officers who completely avoided their duties and acted as mere figureheads, the Rippy decision shows that in North Carolina, at least, the distinction between a viable case and one barred by the business judgment rule may be very fine indeed.  For instance, the FDIC’s evidence consisted largely of expert testimony that Cooperative’s officers failed to act in accordance with generally accepted banking practices by, among other things, approving loans over the telephone before they had examined all relevant documents, and by failing to address warnings and deficiencies in the bank’s (generally positive) examination reports.

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Maryland’s Business Judgment Rule Bars FDIC’s Ordinary Negligence Claims

March 31, 2015

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Another court has weighed in on the question of whether the FDIC can sue former directors and officers of failed banks for ordinary negligence.  The latest decision comes from a federal court in Maryland, which held that a gross negligence standard must be applied when evaluating the conduct of directors and officers under Maryland’s business judgment rule.  FDIC v. Arthur, Civil Action No. RDB-14-604 (D. Md. Mar. 2, 2015).

The facts of FDIC v. Arthur follow a now-familiar pattern.  Baltimore-based Bradford Bank failed on August 28, 2009 and the FDIC was appointed as its receiver.  The four defendants are the bank’s former president, a senior loan officer and two directors who served on the bank’s loan committee.  The FDIC alleged that the defendants were negligent, grossly negligent and breached their fiduciary duties to the bank in connection with seven commercial loan transactions, resulting in losses in excess of $7 million to the bank.  FIRREA holds bank directors and officers to a gross negligence standard of conduct; however, the FDIC has routinely asserted that applicable state law holds directors and officers to a stricter ordinary negligence standard, giving the FDIC the right to sue for ordinary negligence.  As a result, federal courts across the country have had to determine whether the business judgment rule, as interpreted by the appellate courts in which they sit, permits ordinary negligence claims.

In Maryland, the answer is that ordinary negligence claims are not permitted.  Like many states, Maryland has enacted a statutory standard of care.  Md. Code. Ann., Corps. & Ass’ns § 2-405.1(a)(3) provides that “[a] director shall perform his duties as a director, including his duties as a member of a committee of the board on which he serves…[w]ith the care that an ordinarily prudent person in a like position would use under similar circumstances.”  But as the court explained, decisions both before and after the enactment of § 2-405.1 make it clear that “the appropriate test to determine director liability is one of gross negligence.”  In the court’s view, the statute did not intend to supplant existing case law applying the business judgment rule and its gross negligence standard.  The court also noted that the gross negligence standard was consistent with both FIRREA and the standard of care employed by Delaware courts.  Maryland, like many states, frequently finds Delaware law to be influential in answering questions of corporate governance.

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Georgia Supreme Court Confirms Business Judgment Rule

July 12, 2014

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The Georgia Supreme Court issued its long-awaited decision in FDIC v. Loudermilk  on Friday, addressing whether the FDIC’s ordinary negligence claims against former directors and officers of failed banks are precluded by the business judgment rule.  There is a lot to digest in the Court’s 34-page opinion, but here are our initial thoughts.

The upshot for bank directors and officers in Georgia is that the business judgment rule is very much alive, and applies to banks to the same extent as other corporations.  That itself is big news—the Georgia Supreme Court had never addressed whether the business judgment rule exists in any context, and the FDIC had argued that if the rule existed at all, it did not apply to banks because the Banking Code imposes an ordinary negligence standard of care.  Much of the Court’s opinion is devoted to explaining how the business judgment rule developed as a common law principle and refuting the argument that the statute trumps the rule.

The Court explained, however, that the business judgment rule does not automatically rule out claims that sound in ordinary negligence.  It distinguished claims alleging negligence in the decision-making process from claims that do no more than question the wisdom of the decision itself.  A claim that a directors disregarded their duties by failing to attend meetings, for instance, could survive a motion to dismiss.  A claim that the decision itself was negligent, without any allegation relating to the process leading to the decision, will not survive.

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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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A Rundown on Georgia’s FDIC Failed Bank Litigation

June 11, 2013

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As we have reported before, Georgia has the unfortunate distinction of leading the nation in bank failures since the onset of the late-2000s financial crisis.  Georgia has also seen far more FDIC bank failure lawsuits than any other state:  15 of the 63 bank failure cases brought by the FDIC since 2010 involve Georgia banks and are currently pending in Georgia federal courts.  While some allegations vary from case to case, the general thrust of all of these lawsuits is that the former directors and/or officers of the banks were negligent or grossly negligent in pursuing aggressive growth strategies, with these strategies usually involving a high concentration of risky and speculative speculative real estate and acquisition, construction and development loans.  Here is a rundown of the most interesting and significant developments to date:

The most heavily litigated issue has been whether the business judgment rule insulates bank directors and officers from liability for ordinary negligence.  Beginning with Judge Steve C. Jones’ decision in FDIC v. Skow, concerning the failure of Integrity Bank, the district courts have consistently dismissed ordinary negligence claims, citing the business judgment rule.  As we previously reported in November, the Eleventh Circuit has agreed to hear an interlocutory appeal in the Skow case.  That appeal has now been fully briefed by the parties.  The FDIC’s briefs can be found here and here, while the Defendants/Appellees’ brief can be found here.  The parties’ briefs all focus on the interplay between the business judgment rule and Georgia’s statutory standard of care, with the FDIC arguing that the statute’s expression of an ordinary care standard precludes the application of any more lenient standard, and the Defendants/Appellees arguing that Judge Jones correctly followed the Georgia appellate courts’ interpretation of the business judgment rule.  Note:  This firm represents the Georgia Bankers Association and Community Bankers Association of Georgia, who have been granted leave to appear as amici curiae in support of the Defendants/Appellees.  The amicus brief can be found here.

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