Many financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution. In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter. In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats. The individuals selected by private equity firms as board representatives often serve on a number of different bank boards. As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: cross-guarantee liability to the FDIC.
The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:
- the default (failure) of a “commonly controlled” insured depository institution; or
- open bank assistance provided to a “commonly controlled” institution that is in danger of failure.
This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure. As many of us see each Friday, the amounts of these estimated losses are often quite high. In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year. Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving 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.
On April 4, 2012, the FDIC filed an action against the former directors and officers of Cape Fear Bank, Wilmington, NC (“Cape Fear” or the “Bank”). The lawsuit was filed shortly before the expiration of the 3-year statute of limitations which commenced when the Bank was closed and placed into FDIC receivership on April 10, 2009. For a copy of the FDIC’s complaint, click here.
The FDIC’s complaint identifies two central causes of Cape Fear’s failure. First, the FDIC alleges that the D&O defendants pursued a flawed strategy of opening branch operations without consideration for the cost of new branch operations and without any plan to monitor those operations. Second, the FDIC alleges that the defendants were enticed by the real estate “bubble,” and that they aggressively pursued rapid growth through high-risk and speculative real estate lending. The defendants approved loans even where the Bank lacked sufficient capital, causing the Bank to become overly dependent on brokered deposits, which in turn severely impaired earnings. Worse yet, the defendants failed to employ basic prudent lending practices and controls. Specifically, the FDIC alleged that the defendants routinely approved loans that: (i) violated the Bank’s own loan policy and applicable lending regulations; (ii) lacked proper financial analysis or verification of the borrower’s creditworthiness; (iii) lacked a proper appraisal of the collateral; and (iv) increased CRE and ADC concentrations that had previously been criticized by regulators. To make matters even worse, the FDIC alleges, the defendants attempted to mask the Bank’s mounting capital problems by approving additional bad credits and making new advances on non-performing loans, often replenishing interest reserves that allowed borrowers to pay interest with borrowed funds. The complaint identifies 23 specific failed CRE and ADC loans that resulted in approximately $11.2 million of losses, which is the amount the FDIC seeks in damages.
One of the unique aspects to this case is the allegation that Cape Fear’s president and CEO “dominated” the board of directors and the Bank’s lending function. This unique case theory does not offer any insulation to the other directors and officers, however, as the FDIC contends that they failed to exercise their independent judgment and duties.
Bryan Cave attorney Jerry Blanchard will be among the panelists examining enterprise risk management at the 2012 SNL Community Bankers Conference. Other participants in the panel include Thomas Dujenski, the FDIC Atlanta Regional Director, David Ruffin of Credit Risk Management, LLC, and Bob Doby, Jr. of Yadkin Valley Bank. The panel will be moderated by SNL’s Shawn Ryan.
The SNL Community Bankers Conference focuses on how banks can adjust to the changing environment, mitigate risks, take advantage of genuine opportunities, and ultimately prosper. It will be held May 3-4 at the Saddlebrook Resort in Tampa, Florida. For more information, go to http://www.snlcenter.com/cbc/2012/default.asp.
Sixty-three banks have failed in Florida from April 2008 through March 2012. But until recently, the FDIC had not filed any lawsuits against former D&Os of those failed Florida banks. That all changed on March 13, 2012, when the FDIC filed a complaint against the former directors of Florida Community Bank (“FCB”) of Immokalee, Florida. For a copy of the FDIC’s complaint, click here.
FCB was placed into FDIC receivership on January 29, 2010. The losses to the Federal Deposit Insurance Fund arising from FCB’s failure are estimated to be $349.1 million.
According to the FDIC’s complaint, FCB strayed from its long-time agriculture-based strategy, and it embarked on a risky growth strategy by focusing on CRE and ADC loans outside of its local market. FCB took on “extreme” concentrations in CRE and ADC loans that were several times the concentrations of the average bank in its peer group. The FDIC contends that FCB’s board approved high-risk loans that were in violation of the bank’s own loan policy and that were based on grossly deficient underwriting and questionable appraisals. The board continued to approve high-risk loans, the FDIC alleges, even after it had actual knowledge that the real estate market was failing. The FDIC is seeking damages in excess of $62 million arising from eight bad credits — seven ADC and CRE loans and one personal loan (for nearly $6 million) that the FDIC contends was approved by the bank’s president in violation of his lending authority.
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.
On March 7, 2012, the FDIC filed an action against the former directors and two former officers of Broadway Bank (“Broadway”) of Chicago, Illinois. For a copy of the FDIC’s complaint, click here. Broadway was placed into receivership on April 23, 2010. The FDIC estimates that the losses to the Federal Deposit Insurance Fund due to Broadway’s failure will approach $400 million.
The lawsuit alleges that the D&O defendants embarked on “reckless” strategy of rapidly growing the bank’s assets by approving high-risk ADC and CRE loans without regard for appropriate underwriting and credit administration practices, the bank’s own loan policies, and federal lending regulations. The risks to the bank was exacerbated, the FDIC alleges, because many of the loans were for projects located outside of Illinois, and Broadway did not have sufficient staff to monitor those projects.
The FDIC is particularly galled by the D&O defendants’ approval of two “grossly imprudent” loans immediately following a meeting at which federal and state regulators warned the board about the risks of CRE lending. Those loans resulted in losses to the bank of approximately $12 million.
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.
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.
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.