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The Federal Deposit Insurance Corp. has filed a lawsuit against former officers and directors of Broadway Bank in connection with the bank's collapse two years ago.
March 8 -
A decision by a Georgia judge this week raised new obstacles in the Federal Deposit Insurance Corp.'s claims against former managers of the failed Integrity Bank.
March 1
WASHINGTON — A familiar question has emerged in courtrooms where the Federal Deposit Insurance Corp. is seeking billions from former executives: Does a bad business strategy justify legal blame for a bank's failure?
Federal law and a Supreme Court case from the nineties were supposed to provide an answer. Yet the states still wield clout to set the FDIC's bar for proving culpability, and a series of recent cases and rulings — including a much-watched decision in Georgia — show the issue remains a growing source of debate.
"What you see is courts going in different directions based on different analyses of the applicable state's … rule," said Kevin M. LaCroix, an attorney and executive vice president at OakBridge Insurance Services, who writes the
At issue are the two main types of accusations the FDIC makes against failed-bank officers and directors. One is "simple negligence," meaning someone meant to act in the bank's interest but made careless decisions that proved harmful. The other is "gross negligence" — where decisions were intentional and reckless — a more egregious violation which is also harder to prove.
Defendants have protested the FDIC's "simple" negligence standard, sometimes known as "ordinary" negligence. Their main tool are so-called "business judgment" rules, a principle in state law shielding managers whose crime was making bad business moves. In many states, if someone acted in good faith and met other criteria, the "simple" standard is barred.
A judge last week sided with former executives of Integrity Bank in Alpharetta, Ga., — seized in 2008 — saying the state's business-judgment rule prevented the FDIC's simple-negligence claim. (The FDIC is still pursuing a gross-negligence case.)
It was the first such ruling in this cycle of FDIC suits, but the issue has arisen in other cases, including against former IndyMac Bank chief executive Michael Perry and the now-settled action against Kerry Killinger and other former managers of Washington Mutual.
"The standard for 'business judgment' says that just simply making bad decisions doesn't get you where you need to be in terms of failed-bank litigation," said Henry Turner, the managing member of Turner Law Offices LLC in Decatur, Ga. "Every state that I know of has some version of the business judgment rule, and in most cases that was taken from Delaware law."
The outcome of the case — and others like it — could have an impact not only on the Deposit Insurance fund, but also on the amount of liability faced by those who ran institutions that collapsed. Roughly 25 suits so far have been filed. Yet more are expected, and none of the pending suits have yet gone to trial. (Some, including the Wamu case, have settled.)
The FDIC board of directors has authorized claims against more than 400 defendants, seeking about $7.8 billion. On Wednesday, the agency filed a
The Georgia decision by federal District Court Judge Steve Jones is seen by some as a potential precedent not only in Georgia but beyond, offering a strategy for challenging "simple" claims. Even if the case only affected the Peach State, however, the decision would still be significant, since Georgia has suffered more failures than any other state during the crisis. Indeed, the FDIC filed a suit last week in the same judicial district against former leaders of Freedom Bank, in Commerce, alleging claims of "simple" and "gross" negligence.
"It is not binding precedent, even in Georgia, because it's from a trial court. But it certainly is going to have influence in cases brought in Georgia courts," Turner said.
In other states, he added, "it will probably be 'persuasive' or 'influential' precedent, particularly since the Northern District of Georgia is a major federal court. … Even though it's not binding, the sides that can use that are going to argue it in their briefs."
Others were more explicit.
"It will be used by defendants in other jurisdictions in their respective cases, as this is the first case of an FDIC filed case in the current environment that has reached this" conclusion, said Mary Gill, a partner at Alston & Bird in Atlanta. "We can expect other courts to consider it and also rule favorably on motions to dismiss."
The FDIC and other observers counter that the success of a business-judgment defense is not so clear cut.
Richard Osterman, a deputy general counsel for the FDIC, said the agency still plans to bring cases in jurisdictions with business-judgment rules. Under those rules, he said, just showing good intentions is not enough for a director or officer to escape blame.
"They have to inform themselves of the material information that's available to them prior to making the decision," Osterman said. "They can't just rubber stamp things, and they can't violate their own policies and procedures. My sense is that the business judgment rule generally will not be available [to defendants] in our cases. In the cases that we bring, directors generally will not have informed themselves."
He downplayed the precedent-setting effect of recent rulings. "Pretty much all the decisions we're getting at this stage are going to be the first in this cycle. We're finally at the point where courts are starting to rule on some of these preliminary issues," Osterman said.
Many attorneys say the outcome of business-judgment defenses requires a state-by-state analysis of a specific state's rule barring "simple-negligence" cases.
"This is an open question in a lot of jurisdictions," said Larry Gangnes, an attorney at Lane Powell in Seattle. "It's an open question whether the business judgment rule can be used to preclude the FDIC from pursuing claims against bank executives under a negligence standard as opposed to gross negligence."
But prior legislation and court cases stemming from the previous savings-and-loan crisis had attempted to resolve the issue. In FDIC cases in the eighties, state laws sought to protect directors and officers from even "gross-negligence" claims.
But Congress ensured the FDIC could always at least bring the tougher — yet harder to prove — standard when lawmakers passed the Financial Institutions Reform, Recovery, and Enforcement Act in 1989. As for whether the FDIC is allowed to use the simpler standard, the 1997 Supreme Court case Atherton v. FDIC granted power to each state to decide which standard applies.
Even though those prior policies established standards, some attorneys argue they never really played out in court until now, with the pick-up in FDIC litigation following the mortgage meltdown.
"Shortly after FIRREA the industry improved tremendously. So we went for years without a significant number of bank failures," said Sanford "Sandy" Brown, a partner at Bracewell & Giuliani in Dallas. "This is the first opportunity that we've had post-FIRREA to have these concepts tested."
But David Baris, an attorney at BuckleySandler and executive director of the American Association of Bank Directors, said the FDIC is filing "simple-negligence" in states where failures were prevalent but the rules clearly bar the easier standard.
"Our reading of these cases is that Georgia, Illinois and California are all 'gross-negligence' states but the FDIC is still trying to sue under simple negligence," Baris said. "I can't read their minds on why. Maybe they think there is some kernel in the state law that would allow them to make the claim."
But Osterman indicated the FDIC will not bring the simpler claim if it does not believe there are grounds.
"Where state law permits suits against directors and officers for simple negligence, we will pursue claims under the standard," he said.
Indeed, in at least one example, the FDIC blocked a defense based on a state's business-judgment rule. In California, Perry, who ran IndyMac before its 2008 seizure made it the costliest failed bank of the crisis, asked a judge to dismiss a negligence claim based on the state's rule. But the judge balked, ruling California only protects directors — not corporate officers — from such claims. (Perry's attorneys are attempting to have the decision overturned in the Ninth Circuit Court of Appeals.)
"This is a very important issue not just for Mr. Perry but for all California corporations. … California would be a total outlier if it didn't apply the business judgment rule to officers," said D. Jean Veta, a partner at Covington & Burling who is representing the former CEO. "What corporation would want to incorporate in a state where its officers aren't protected by the business judgment rule?"
But other observers say the provisions of FIRREA and the Atherton decision have triggered a 50-state analysis.
The Georgia case "will be influential, but … there is an entirely different dynamic going on in California," said LaCroix. "The recent decision in the Integrity Bank case was a reflection of the court's analysis of the business judgment rule under Georgia law. … Different states may have a different case law history and a different interpretation of the business judgment rule."
