FDIC Professional Liability Lawsuits Deserve Close Scrutiny

Thursday, June 21, 2012 - 11:23

Recent Federal Deposit Insurance Corporation (“FDIC”) lawsuits filed against directors and officers of failed financial institutions may shape corporate law for years to come. Although many people assume that the allegations in such FDIC lawsuits are unique to banking, this is incorrect. The FDIC typically asserts claims for negligence and breach of fiduciary duty – the same causes of action that corporate officers and directors in any industry may face when lawsuits are brought by shareholders, customers or competitors. And even though the FDIC’s complaints are all filed in federal courts, the FDIC is required to bring its claims pursuant to the law of the state where the headquarters of the closed financial institution was located. Thus, the current round of FDIC litigation has the potential to create new state law precedent affecting all corporate officers and directors in a particular state.

Background

Between January 1, 2008 and June 15, 2012, the government closed 447 banks, compared to only ten closings during the entire five years before 2008.[1] There are currently about 30 FDIC lawsuits pending against bank directors and officers, with roughly the same number of additional FDIC lawsuits authorized to be filed. Such suits are typically filed two to three years after the government closes a bank. This is because the FDIC has three full years after a bank has been placed in receivership to file professional liability claims, assuming such claims had not already expired under the state’s applicable statutes of limitations (“SOL”) when the institution was closed. See 12 U.S.C. § 1821(d)(14). In addition, the FDIC is entitled to revive claims that have already expired under a state SOL if such a claim arises from “fraud, intentional misconduct resulting in unjust enrichment or intentional misconduct resulting in substantial loss to the institution.” Id. 

The same statute at section 1821(k) makes “gross negligence” the minimum standard of care to which bank directors and officers will be held liable, but the FDIC also may sue for simple negligence and/or breaches of fiduciary duty if state law permits.[2] Accordingly, FDIC complaints typically allege all three of these claims: gross negligence, simple negligence and breach of fiduciary duty, whether or not state law actually supports all of them. Typically, officer and director defendants then file motions to dismiss the claims they do not believe are supported by state law and/or by the allegations in the FDIC’s complaint. FDIC counsel appear to be content to let the defendants have the laboring oar in this early briefing, with FDIC then responding to arguments about specific state statutes or caselaw after being directed to them by the defendants.

The Current Wave Of FDIC Lawsuits

Statistics regarding FDIC’s pending professional liability lawsuits and the kinds of claims being made in the current round of complaints are set out in detail in recent articles prepared by Cornerstone Research.[3] The FDIC also prominently reports about its professional liability lawsuits at http://www.fdic.gov/bank/individual/failed/pls/. This FDIC website currently lists 30 pending suits by name and notes that additional suits have been authorized “in connection with 65 failed institutions against 562 individuals for D&O liability” as well as for 35 other lawsuits involving claims, such as attorney, accountant or appraiser malpractice; fidelity bond dishonesty; and other insurance matters. 

Litigation is only recently underway in most of these cases because motions to dismiss are typically filed early. After these motions are briefed, argued and resolved, the surviving claims move into discovery, which necessarily consumes a substantial amount of time because bank records about the questioned loans or investments are usually voluminous, and because many bank employees, officers and directors typically have been involved in the transactions or decision-making that the FDIC alleges to have been negligently conducted. Thus, both document discovery and depositions can consume a lengthy period of time.

A Matter Of State Law

For counsel defending former directors and officers against FDIC’s claims, a first step is to determine the standard of care expected for corporate officers and directors under applicable state law. Some states have statutes setting out, for example, an expectation of good faith and ordinary prudence by corporate officials in that state. Other states have addressed these questions only in caselaw. Defense counsel will need to become familiar with the state law definitions of negligence (some states refer to “simple negligence” and others to “ordinary negligence”), gross negligence and breach of fiduciary duty. Counsel will also need to determine whether the allegations are recognized causes of action in the particular state because state law sets the standard of care that bank directors and officers owe to their employer bank.[4] State law also determines procedural issues, such as whether the suit was timely filed under the state’s SOL.[5]

Counsel must also focus on how the “business judgment rule” is applied in the state. This too is sometimes governed by statute, while in other states it is addressed only in caselaw (or by a combination of the two). In a recent federal district court ruling in Georgia, for example, the court held that under Georgia’s business judgment rule, the FDIC’s allegations of mere negligence or carelessness by bank officials were insufficient as a matter of law.[6] However, the same ruling permitted FDIC to proceed to discovery on its claims of gross negligence and breach of fiduciary duty based on gross negligence. Although the ruling provides guidance to other corporate directors and officers in Georgia, it does not apply in other states, making clear that state-specific research is necessary to defend against FDIC professional liability claims wherever they are filed. 

A recent ruling in an FDIC lawsuit filed in California provides another example of the state-specific nature of these cases. The decision should also trouble corporate officers throughout California because the district court found that California’s business judgment rule protects only corporate directors – and not officers – from liability for negligence claims.[7] Although the trial court did certify the issue for an interlocutory appeal, the 9th Circuit recently denied the officer’s appeal petition, so the important question of whether California’s business judgment rule applies to officers remains unresolved.[8]

Stark Realities In FDIC Litigation

Even in a state where corporate officials are insulated from simple negligence and breach of fiduciary claims by the business judgment rule, the FDIC typically prevails against motions to dismiss its gross negligence claims.  This usually occurs because of the deference shown to the bank’s federal examiners whose pre-closing criticisms of bank management are quoted by the FDIC in support of its gross negligence claims. And of course, the FDIC and its counsel construe gross negligence very broadly and the business judgment rule very narrowly.  

Other stark realities when defending against FDIC lawsuits include the following:

  • Courts and jurors are inclined to assume that the FDIC must know why a particular bank failed and must know a good loan from a bad loan.
  • Most jurors dislike banks and bankers, particularly well-paid (or independently wealthy) directors and officers of a bank.
  • Most jurors have little sympathy for transactions that involve large dollar amounts, such as loans for the construction of million-dollar homes or multi-million-dollar development projects.

Adding to these realities is the fact that the FDIC never admits that economic factors – rather than alleged mismanagement – may have caused a loan to go bad or caused a bank to fail. Thus, defense counsel is left to persuade the court both that the FDIC is simply a civil litigant like any other that must show “causation” in order to prove its claims and that the bank defendants were just like most other people in the community, working hard to do their jobs in tough economic times.

If similar litigation brought by the government against former savings and loan officials in the 1990s is a guide, most of the FDIC’s current round of professional liability lawsuits will not go to trial. This is because the government is arguably more interested in the publicity generated when it files a new D&O action than it is in litigating the case to completion. Moreover, the FDIC often targets banks’ D&O insurance policies as its intended source of payment – rather than damages assessed against the individual bankers (who lost their jobs when the bank failed) – so a settlement with the D&O carrier will likely end the case. In addition, if discovery is going well for the bank defendants and the government’s claims are looking doubtful, the FDIC can easily settle the case for less than the anticipated cost of trial. But even if settlement occurs, a court’s rulings on motions to dismiss and motions for summary judgment in FDIC cases will live on in state common law. This is why each step of defending former bank officers and directors must be handled with care, and why counsel to any corporate entity should be aware of FDIC litigation as it proceeds.


[1] See http://www.fdic.gov/bank/individual/failed/banklist.html. “Banks” refers here to all FDIC-insured banks, savings banks and savings associations that have been closed by the government in the recent past.

[2] In O’Melveny & Meyers v. FDIC, 512 U.S. 79, 88 (1994), the Supreme Court held that unless an express federal statute provides otherwise, state law governs the FDIC’s rights and liabilities when it acts as the receiver for a failed financial institution. In all the director and officer (“D&O”) litigation brought by the FDIC, it sues as the receiver for a bank or savings association that previously was placed in receivership by the institution’s primary regulator.

[3] See e.g., Cornerstone Research, Trends in FDIC Lawsuits Against Directors and Officers, http://www.bankdirector.com/board-issues/liability/trends-in-fdic-lawsuits-against-directors-and-officers/.  

[4] In Atherton v. FDIC, 519 U.S. 213, 216 (1997), the Supreme Court held that state law sets the standards of care that bank directors and officers owe to their federally insured financial institution.

[5] See e.g., Resolution Trust Corp. v. Everhart, 37 F.3d 151, 154-55 (4th Cir. 1994) (relying on O’Melveny to determine if the failed bank’s receiver timely filed its claim against bank directors and officers under state law).

[6] FDIC as Receiver of Integrity Bank v. Skow, No. 11-cv-0111 (SCJ) (N.D. Ga. Feb. 27, 2012) (unpublished order).

[7] FDIC v. Perry, 2012 WL 589569 (C.D. Cal. Feb. 21, 2012). Some other states have expressly held that the common law business judgment rule applies to corporate officers as well as directors, but the same conclusion is merely implicit in a number of other states’ caselaw.

[8] FDIC v. Perry, No. 12-80033 (9th Cir. May 11, 2012) (order denying petition for permission to appeal pursuant to 28 U.S.C. § 1292(b) without further explanation).

 

Rosemary Stewart is a partner at Hollingsworth LLP, a litigation firm in Washington, DC. Following 16 years as a government financial institution regulator and enforcer, Ms. Stewart has represented bank directors and officers in investigations and lawsuits brought by the government for more than twenty years.

Please email the author at rstewart@hollingsworthllp.com with questions about this article.