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Eleventh Circuit Will Hear Appeal on Scope of Georgia’s Business Judgment Rule

In August, the Northern District of Georgia reaffirmed its prior ruling in the Integrity Bank case that Georgia’s version of the Business Judgment Rule shields former directors and officers from FDIC claims for ordinary negligence. Our discussion of that ruling can be found here. In doing so, the district court acknowledged that there was “substantial ground for difference of opinion,” on the issue, and it granted the FDIC’s request to petition the Eleventh Circuit Court of Appeals for an interlocutory appeal.

On November 16th, the Eleventh Circuit granted the FDIC’s petition, paving the way for an interlocutory appeal on the district court’s ruling. The parties will brief their respective arguments in the coming weeks, and it is likely that several interested non-parties will also seek to file amicus (“friend of the court”) briefs. The Eleventh Circuit may elect to hear oral argument on the issue, but it is not required to do so. A decision will likely come down within the next year.

The Eleventh Circuit’s ruling is expected to have a significant impact on the scope of claims that the FDIC may assert against former directors and officers of failed banks in Georgia. If the Court affirms the district court below, then the FDIC will be limited to prosecuting claims for gross negligence, which involves a much higher standard of care. If the Eleventh Circuit reverses, then the FDIC will continue to pursue D&O claims for ordinary negligence based on a lower threshold of negligent conduct. Either way, the Eleventh Circuit’s decision should be a significant turning point for FDIC claims in Georgia.

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FDIC Sues Former D&Os of Community Bank of West Georgia

The FDIC has filed its fifth professional liability lawsuit since early October. Its most recent lawsuit is against the former directors and officers of Community Bank of West Georgia (Villa Rica, Georgia), which went into receivership in June 2009. A copy of the FDIC’s complaint is attached here.

Community Bank of West Georgia (the “Bank” or “Community Bank”) opened in March 2003. The FDIC alleges that the Bank’s original business plan was to grow its assets for a planned sale within five years. Towards this end, the FDIC contends, the Bank focused on increasing its real estate lending, primarily in ADC and CRE loans and purchase of loan participations.

The FDIC’s claims for negligence and gross negligence are rooted in many of the same types of general allegations that have become part of the FDIC’s standard pleading mantra: (i) failure to comply with the Bank’s own policies and procedures, banking regulations, and prudent lending practices; (ii) failure to adequately monitor and supervise the Bank’s lending function; (iii) disregard of regulators’ warnings and failing to address obvious problems; (iv) deficient underwriting, risk management, and credit administration practices that left the Bank “fatally exposed to the inevitable cyclical decrease in real estate values.” In total, the FDIC seeks to recover losses in excess of $16.8 million from 20 specific loans and loan participations.

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FDIC Sues Former Directors of Benchmark Bank (Aurora, Illinois)

On October 2nd, the FDIC filed its 33rd lawsuit against former directors or officers of failed banking institutions since the beginning of the current economic recession.  This suit is against the former directors of Benchmark Bank (“Benchmark” or the “Bank”) of Aurora, Illinois, which was placed into FDIC receivership on December 4, 2009.  For a copy of the FDIC’s complaint, click here.

A central theme of the FDIC’s complaint is that the director defendants, all of whom served on the Director’s Loan Committee, embarked on a strategy of aggressive growth through the approval of high-risk acquisition, development and construction (“ADC”) and commercial real estate (“CRE”) loans.  The director defendants approved the high-risk loans, the FDIC alleges, “without analysis of their economic viability or a complete evaluation of the creditworthiness of borrowers and guarantors”.   Even after the real estate market declined, the FDIC contends, the director defendants exacerbated the Bank’s problems by making new loans and renewing existing troubled loans, rather than curtailing ADC/CRE lending and preserving capital to absorb losses from existing loans went bad.

The most unique of the FDIC’s case theory centers on the role of Benchmark’s former chairman, Richard Samuelson, who was not only a director, CEO, and long-time acting president of the Bank, but also the principal originator of the Bank’s ADC and CRE loans.  As CEO and acting president of the Bank, Mr. Samuelson was ultimately responsible for the underwriting and credit administration of loans.  Yet those functions were never segregated from the loan origination function, leaving the Bank with a significant internal control deficiency.  Moreover, since Mr. Samuelson originated most of the ADC and CRE loans, it created a dynamic in which credit analysts were very reluctant to report underwriting deficiencies on his loans.  To make matters worse, the FDIC contends, Mr. Samuelson earned generous incentive awards from his loan originations, providing him with additional motivation to ensure that loans were approved.  In view of these facts, the FDIC alleges, the director defendants knew or should have known that the ADC and CRE loans required a higher degree of scrutiny and monitoring.  The FDIC contends that the director defendants breached their duties with respect to 11 specific ADC and CRE loans, resulting in losses of over $13.3 million.

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Fall 2012 Update on Regulatory and Legal Changes Affecting Community Banks

Bank regulators have been as busy as usual in 2012, but some of the more interesting regulatory and legal changes have come from non-bank regulators and the courts. And, the JOBS Act changes described below actually lifts the regulatory burden on banks a bit, a rare respite in an otherwise challenging regulatory environment.

The JOBS Act eases bank capital activities and M&A.  The Jumpstart Our Business Startups Act affects community banks in 4 key ways:

  • “Going public” is easier. Banks that have less than $1 billion in gross revenue can qualify as an “emerging growth” company and take advantage of relaxed rules that allow them to “test the waters” and obtain a confidential prior review of an IPO filing by the SEC, provide reduced executive compensation disclosures and file without a SOX 404 attestation by the bank’s auditors.
  • The “crowdfunding” rule (expected in early 2013) will provide banks significant flexibility in raising $1 million per year from their community without IPO-type expenses and without adding new investors to their shareholder count.
  • Private offerings are easier. Rules affecting private offerings are being relaxed so that a bank will be able to use public solicitation and advertising to attract investors as long as the bank takes reasonable steps to ensure that those investors are accredited.
  • Going or staying private is easier because the shareholder count triggering “going public” was raised from 500 to 2,000. And, shareholders from a bank’s “crowdfunding” offerings and from employee compensation plans are now excluded from the shareholder count. These helpful changes to shareholder count rules mean that some banks can bring in new investors or even acquire another bank without triggering the obligation to “go public,” a significant cost and compliance barrier. Also, banks with a shareholder count under 1,200 can “go private” following a 90-day waiting period.
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Federal Courts in Georgia and Florida Dismiss Ordinary Negligence Claims

We have previously summarized an important district court ruling dismissing the FDIC’s ordinary negligence claims against former directors and officers of Integrity Bank of Alpharetta, Georgia.  The FDIC asked the U.S. District Court for the Northern District of Georgia to reconsider its decision in that case, but the court recently denied that request and reaffirmed its rationale that Georgia’s version of the Business Judgment Rule bars claims for ordinary negligence against corporate directors and officers.  A copy of the court’s recent order in the Integrity Bank case is available here.  Although the district court declined to reconsider its prior dismissal of the ordinary negligence claims, it acknowledged that there was “substantial ground for difference of opinion” on that issue, and it granted the FDIC’s request to certify an order of interlocutory appeal to the Eleventh Circuit Court of Appeals.  Everyone in the D&O defense community, and especially those here in Georgia, is anxiously awaiting to learn if the Eleventh Circuit will accept interlocutory appeal of the case.

In the meanwhile, district courts in two other cases have weighed in on whether the Business Judgment Rule bars claims for ordinary negligence.  The first of these also comes from the Northern District of Georgia, and specifically from the FDIC’s lawsuit against certain former directors and officers of Haven Trust Bank.  (We have previously summarized the Haven Trust complaint.)  Utilizing the same rationale set forth in the Integrity Bank rulings, the court here ruled that the FDIC’s claims for ordinary negligence are not viable by virtue of the Business Judgment Rule.  Furthermore, the court ruled, to the extent that the FDIC’s claims for breach of fiduciary duty are based on the same alleged acts of ordinary negligence, those claims are foreclosed by the Business Judgment Rule as well.  The ruling was not a complete victory for the D&O defendants, however, as the court declined to dismiss the FDIC’s claims for gross negligence under FIRREA.  Specifically, the court held that the FDIC had alleged, in a collective fashion, sufficient facts on which a jury might reasonably conclude that the defendants had been grossly negligent.  Despite that holding, the court took the unusual step, “in the interest of caution,” of ordering the FDIC to replead the gross negligence claim with specific allegations as to each defendant’s involvement or responsibility for the alleged wrongful acts.  A copy of the court’s ruling can be viewed here.

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FDIC Sues Former Directors and Officers of Community Bank of Arizona

On July 13, 2012, the FDIC filed its 31st professional liability lawsuit since the advent of the current economic downturn.  This suit was filed against seven former directors and officers of Community Bank of Arizona (“CBOA” or the “Bank”), all of whom served on the Bank’s Board Loan Committee.  CBOA had four branches in metropolitan Phoenix before it was closed and placed into receivership on August 14, 2009.  For a copy of the FDIC’s complaint, click here.

As it has in prior D&O lawsuits, the FDIC generally alleges here that the defendants: (i) took unreasonable risks with the Bank’s asset portfolio; (ii) violated the Bank’s own loan policies and procedures when approving the acquisition of loans; (iii) ignored warnings regarding risky real-estate and constructions loans, and (iv) knowingly permitted poor underwriting in contravention of the Bank’s policies and reasonable industry standards.

The FDIC’s sharpest criticisms of the defendants relate to CBOA’s acquisition of loan participations without conducting any of its own underwriting.  Most of these loans were acquired from CBOA’s larger “sister bank,” Community Bank of Nevada (“CBON”).  The CBON loans were principally made to real estate developers in Nevada, and seventy-five percent (75%) of the participations that CBOA purchased from CBON ultimately became problem loans.  According to the FDIC’s complaint, the defendants “rubber stamped” the purchase of the loan participations, all without having CBOA: (i) conduct independent financial analysis of the loans; (ii) obtain updated appraisals of the collateral; (iii) obtaining or analyzing financial statements of the guarantors; or (iv) conducting independent site inspections as required by the CBOA loan policy.

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FDIC Sues Former Bank Officer for Fraud

On May 23, 2012, the FDIC filed an action against the former directors and select former officers of Innovative Bank (“Innovative” or the “Bank”).  Innovative was based in Oakland, California, and it had four other branches in the state when it was closed by the FDIC in April 2010.  For a copy of the FDIC’s lawsuit, click here.

The FDIC’s complaint in this case contains the same hallmark claims for negligence, gross negligence and fiduciary breach that we have come to expect from its D&O suits.  But this case is unique in that the FDIC also asserts a direct claim for fraud.

The alleged fraud was rooted in the Bank’s high-volume SBA lending program.  According to the complaint, the senior vice president in charge of SBA lending, Jimmy Kim, had free rein to originate, recommend and approve SBA loans, all with virtually no supervision by senior management or the board of directors.  The SBA loans generated huge commissions for Mr. Kim, and he reportedly received monthly commissions in excess of $100,000.  In order to continue the flow of high commissions, the FDIC alleges, Mr. Kim colluded with borrowers and loan brokers to cause the Bank to extend millions of dollars of loans that absent fraud would not have qualified for the SBA lending program.

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FDIC Lawsuits: Avoiding the Worst Outcome

While the FDIC lawsuits paint a picture of inattentive, runaway directors and officers, a number of the practices that the FDIC found objectionable could be found at many healthy institutions. 

In the wake of over 400 bank failures since the beginning of 2008, the FDIC is well underway with its process of seeking recoveries from directors and officers of failed banks who the FDIC believes breached their duties in the course of managing those institutions. As of mid-May 2012, the FDIC had filed lawsuits against almost 30 groups of directors and officers alleging negligence, gross negligence and/or breaches of fiduciary duties. While the litigation filed by the FDIC tends to sensationalize certain actions of the directors and officers in order to better the FDIC’s case, there are lessons to be learned.

Some of the take-aways from the FDIC lawsuits are fairly mechanical: carefully underwrite loans, avoid excessive concentrations, and manage your bank’s transactions with insiders. However, there are two major themes that are more nuanced and which are present in almost all of the lawsuits. Those themes relate to the loan approval process and director education.

Develop a thoughtful loan approval process. As evidenced by the recent piece published on bankdirector.com, a spirited debate among industry advisors is currently taking place with respect to whether directors should approve loans or not. On the one hand, many attorneys believe directors have a duty to consider and approve (or decline to approve) certain credits that are or would be material to their banks. Regulation O requires approval of certain credits, the laws of some states require approval of some loans, and there is a general feeling among many bank directors that they should be directly involved in the credit approval process. In addition, many bank management teams believe that directors should “buy in” with them to material credit transactions.

On the other hand, the FDIC litigation clearly focuses on loan committee members who approved individual loans that did not perform. This should give pause to directors in general and loan committee members in particular. It is now the belief of many legal practitioners that the practice of approving individual loans when the loans are not otherwise required to be approved by the directors paints a target on the backs of the loan committee members. The FDIC may be able to target directors who participated in the underwriting of a credit (or were deemed to have done so given their involvement in the approval process) when they did not have the expertise necessary to do so. Some practitioners argue that the directors should instead focus on the development and approval of loan policies that place appropriate limits on the types of loans and the amounts that the bank is willing to make. This policy would be consistent not only with safe and sound banking principles but also with the board’s risk tolerance, and it would be appropriate to seek guidance from management and outside advisors on the development of the policy. The idea is that it is much more difficult to criticize a policy than an individual credit decision with the benefit of hindsight.

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​FDIC Sues Former D&Os of First Bank of Beverly Hills

The latest drama from Beverly Hills is not a revival of Beverly Hills 90210 or a sequel to Beverly Hills Cop, but rather a 42-page complaint filed against the former directors and officers of First Bank of Beverly Hills (“FBBH” or the “Bank”).  FBBH was closed and put into receivership on April 24, 2009.  The FDIC’s lawsuit was filed on April 20, 2012, just days before the expiration of the three-year limitations period.  For a copy of the FDIC’s complaint, click here.

According to the complaint, the director and officer defendants pursued an “unsustainable business model” focused on rapid asset growth through the extension of high-risk CRE and ADC loans.  At the same time, the FDIC alleges, the defendants were weakening the Bank’s capital position by approving large quarterly dividend payments (based on “false profits” from problematic loans) to the Bank’s parent corporation, in which many of the defendants were shareholders.

A common refrain throughout the FDIC’s suit is the defendants’ alleged “willful disregard” of the Bank’s own Loan Policy.  For example, the defendants approved two loans that were in violation of the Loan Policy’s prohibition against loans for construction projects with “difficult topography.”  One loan was for a project that ultimately failed because it sat directly atop the San Andreas Fault.  And the second loan was for a project that failed because the vast majority of the land was ultimately deemed undevelopable due to the Endangered Species Act.

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

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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