FDIC Expected to Rev Up Failed-Bank Litigation in 2013

The Federal Deposit Insurance Corp. is poised to fatten its docket of lawsuits against directors and officers of failed community banks next year.

Lawsuits against individuals have picked up in recent months. The FDIC had filed 23 lawsuits through early December, according to Cornerstone Research, a Boston consulting firm that advises lawyers who represent bank officers. The agency filed 16 lawsuits in 2011.

The FDIC is also pursuing more cases against smaller institutions. The average size of failed banks at the heart of its lawsuits in the first quarter was $1.2 billion. The average size fell to just $154 million in the fourth quarter.

The FDIC is expected to keep filing more lawsuits. "Using the S&L crisis as a historical benchmark, the possibility of more lawsuits has historical credibility," says Kevin LaCroix, a lawyer who writes the "D&O Diary" blog.

Following the savings and loan crisis of the 1980s, federal agencies filed lawsuits in connection with nearly a quarter of the institutions that failed, LaCroix says. So far, agencies have only pursued litigation against directors and officers of 9% of the institutions that failed during the recent crisis.

The FDIC investigates why each bank failed, agency spokesman Greg Hernandez says in response to the speculation. "If it's found that a bank's former directors and officers played a role in the institution's failure, the FDIC will file professional liability lawsuits."

Various factors drove the recent upswing. Several failures are bumping up against a statute of limitations deadline. Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, that period is typically three years, says Henry Turner, a Decatur, Ga., lawyer who represents bank officers and directors. The latest crisis began in late 2008.

"The high-water mark of bank closures was the latter part of 2009 and early 2010," LaCroix says. "So you will be running up against the statute in a lot more bank failures. All else being equal, it leads you to think there will be more lawsuits."

Some courts have approved tolling agreements, where both sides agree to extend the deadline for filing of lawsuits. That can add one to two years to a statute of limitations, Cornerstone Research has said.

The average-institution size has decreased because of many of the largest banks that failed have already been the subject of suits. "It's just a question of how the crisis unfolded," LaCroix says.

The FDIC filed lawsuits against the leaders of the largest institutions first because they had the largest pool of assets that could be seized, says Catherine Galley, a senior vice president at Cornerstone. "Part of [the FDIC's] mandate was to recover as much as possible for the deposit insurance fund," she says.

A federal jury agreed this month with the FDIC that the residential construction division of IndyMac acted recklessly, declaring that three former executives were culpable for more than $168 million in loan losses.

A week later a $12 million settlement between former IndyMac Bank Chief Executive Michael Perry and the FDIC was announced. It included $1 million paid directly by Perry, and as much as $11 million coming from insurers that back professional liability claims.

The FDIC lost an estimated $12 billion from IndyMac's failure.

Another factor expected to drive litigation is the dwindling of the dollars to be had from executives' insurance policies. "The amount of available insurance is being eroded by the defense costs for directors and officers," LaCroix says.

Also, other interested parties, including jilted shareholders, may have filed lawsuits against failed-bank officers and directors. That further reduces the pile of insurance money available, LaCroix says.

Perry opted for a settlement because the insurance funds available for his defense had been exhausted by the multiple claims brought against former IndyMac officers and directors, his lawyer has said.

Since there is a lag between the authorization and the filing of a lawsuit, and because the FDIC has announced that it has increased the number of authorizations, "the FDIC is trying to communicate that there will be more" litigation, LaCroix says.

The FDIC's own internal projections also provide clues, though they are not clear-cut, LaCroix says. As of Dec. 11, the FDIC had authorized the filing of lawsuits against 742 individuals from 89 failed banks. The FDIC has so far filed lawsuits in association with 40 of those banks.

A case pending at the U.S. Court of Appeals for the 11th Circuit on the question of simple negligence could also influence the pace of FDIC lawsuits next year, Galley says. This year a judge sided with former executives of the failed Integrity Bank in Alpharetta, Ga., saying that the FDIC was barred from bringing a simple-negligence claim under the state of Georgia's business-judgment rule. If the appellate court upholds that ruling on simple-negligence claims, it could make things more difficult for the FDIC.

"It's obviously a very important issue," Galley says. "It's a much bigger hurdle [to prove] gross negligence. I don't know that a [ruling adverse to the FDIC] would slow down the pace of lawsuits, but it would definitely make the FDIC more inclined to settle some cases."

Though the issue deals with Georgia state law, the court's ruling will likely affect cases in other parts of the country, LaCroix says. If the court rules against the FDIC, "it may encourage more directors and officers to try to defend themselves," he says.

The 11th Circuit's ruling on the case, currently pending as an interlocutory appeal, is likely to come in the first quarter, Turner says.