On October 25, 2011, the FDIC filed its latest failed
bank lawsuit, in connection with events surrounding the July 2009
failure of Mutual Bank of Harvey, IL. The FDIC's
complaint, which was filed in the Northern District of Illinois, names as
defendants eight former directors and two former officers of the bank. But in
addition, the complaint also names as defendants the bank's outside General
Counsel, who was also a director of the bank, and well as the General Counsel's law firm. There are a number of
other interesting things about this complaint as well.
The FDIC's complaint alleges that Mutual Bank's failure
has cost the FDIC's deposit insurance fund an estimated $775 million in losses.
In its lawsuit, the FDIC seeks to recover over $115 million in losses the bank
suffered on twelve commercial real estate loans, $10.5 million in unlawful
dividend payments and $1.09 million in wasted corporate assets.
The complaint asserts claims against the director defendants
and the officer defendants for gross negligence, negligence, and breach of
fiduciary duty. The complaint alleges that the directors and the officers
approved high-risk loans to uncreditworthy borrowers. The complaint also
asserts the directors failure to supervise the bank's lending
activities, approval of unlawful dividend payment and corporate waste.
The complaint also asserts claims against James Regas
and his law firm, Regas Frezadas & Dallas,
for legal malpractice, breach of fiduciary duty and aiding and abetting the
director and officer defendants' breaches of fiduciary duty. The lawyer and his
firm are allege to have facilitated the unlawful payment of dividends; failed
to counsel and prevent the bank's board from making grossly imprudent loans;
ignoring federal lending regulations; and facilitating bank transactions to
entities in which one of the attorney defendants held an interest, despite the
conflict of interest.
Interestingly, the roster of director defendants does not
include Pethinaidu Velchamy, the bank's former Chairman, or Parameswari
Velchamy, the former Chairman's wife, who was also a director of the bank. The
complaint alleges that the two have each filed a petition under Chapter 7 of
the bankruptcy code, and that "despite" their respective "culpability for the
events described," the stay in bankruptcy "precludes" naming them as a
defendant "unless the stay is modified or lifted."
Among other things, the Complaint alleges (in
paragraph 34) that the former Chairman has filed a lawsuit against the bank's
former auditors, in which the Chairman supposedly alleges that "the Bank's
balance sheet contained hundreds of millions of dollars in loans that had been
funded on the basis of substandard, if not reckless underwriting and ... were not
identified for corrective action because of critical failure in the Bank's
internal credit risk review function."
Though the former Chairman and his wife are not named as
defendants in the lawsuit, their son and daughter, both of whom served as
members of the board of directors, were named as defendants.
These family connections are particularly interesting in
relation to the FDIC's waste allegations. Among other things, the FDIC alleges
that board facilitated the payment of $250,000 in bank funds for the wedding of
the Chairman's daughter; authorized $495,000 in "bonuses" to pay the criminal
defense costs of the bank President's wife, who had been indicted for Medicaid
fraud; and approving the use of $300,000 in bank funds to hold a board meeting
in Monte Carlo.
Regas, the lawyer defendant, and his law firm, are
alleged to have been aware that loans referenced in the complaint were "grossly
deficient" but that despite the awareness of the "imprudence, and in some
cases, unlawful nature of these transactions," the lawyer and his firm failed
to protect the bank from foreseeable injury inherent in these transactions. The
law firm is alleged to have received over $3 million in fees between January
2007 and April 2009.
Regas is also alleged to have participated in a 2006 land
loan transaction involving undeveloped real estate. The $28.5 million loan was
originated by another bank for which Regas also served as director. The
individual that sold the land to the borrower is described in the complaint as
Regas's "close friend and business colleague." After the other bank made the
loan, Regas allegedly arranged for Mutual Bank to acquire a $24.5 million
participation in the loan. Regas allegedly steered the loan through the Mutual
Bank approval process and did not abstain from voting to approve the loan.
Regas is alleged to have abandoned his fiduciary duty to Mutual Bank in favor
of the other bank and his friend. The loss to the bank from the loan is alleged
to be approximately $24.5 million.
This latest complaint is the 16th lawsuit that
the FDIC has filed in connection with the current wave of bank failures, but so
far as I am aware, it is the first in which the FDIC has named a failed bank's
outside lawyer and law firm as defendants. During the last round of bank
failures in the S&L crisis, the FDIC pursued an aggressive litigation
approach and often included failed bank's lawyers or law firms as defendant. In
many of those cases, as here, the lawyer defendants had served on the failed
bank's board and were alleged to have engaged in conflicts of interest. That
prior history and the presence of those types of allegations here suggests that
we are not about to see a comprehensive campaign against the outside law firms
of failed banks. The firms or their lawyers are relatively unlikely to get
drawn into the type of failed bank litigation if the firm did not have an
attorney on the failed bank's board or did not otherwise allegedly engage in
conflicts of interest.
Out of the 16 failed bank lawsuits the FDIC has
filed so far, this is the fourth involving an Illinois Bank (there have also
been four lawsuits so far involving failed banks in California and Georgia,
respectively). Like many of the lawsuit filed so far, this one was not
filed until more than two years had elapsed since the bank's closure. Given the
fact that the bank closures did not really peak until late 2009 and early 2010,
and allowing for that two year plus lag time, we could start to see increasing
numbers of additional FDIC failed bank lawsuits in the months ahead.
Special thanks to a loyal reader for providing a copy of
the Mutual Bank complaint.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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