There Ought to be FDIC Lawsuits? Don't Bother, They're Here

Turns out that while some of us were wondering when the lawsuits arising out of the current bank wave would really start to accumulate, the FDIC itself was busy filing lawsuits -- they just didn't tell anybody about it, at least not until now. Specifically, the FDIC filed three more lawsuits in August than had previously come to light. At a minimum, these lawsuits suggest the FDIC has been more active in pursuing its litigation strategy than may have been perceived. The suits also suggest that the FDIC's declarations about its planned litigation strategy are very much in earnest.

The three newly publicized lawsuits, each of which were filed by the FDIC in its capacity as receiver of a failed bank, are as follows:

First, on August 8, 2011, the FDIC filed a lawsuit in the Eastern District of Michigan against a single former loan officer at Michigan Heritage Bank, of Farmington Hills, Michigan, which failed on April 24, 2009 (about which refer here). A copy of the complaint in this lawsuit can be found here. The complaint alleges that the individual, whom the complaint alleges had been CEO of a different Michigan bank that failed in 2002, caused the bank to incur losses in excess of $8.2 million. The complaint, which asserts claims of negligence, gross negligence and breach of fiduciary duty, alleges among other things that the lending officer "failed to conduct due diligence and analysis prior to originating and recommending approval of 11 commercial loans that resulted in losses" and "failed to adequately inform [the Bank's] board of directors and senior management of deficiencies with respect to those loans."

Second, on August 9, 2011, ,the FDIC filed a lawsuit in the District of Kansas against six former officers and directors of the Columbian Bank and Trust Company, of Topeka, Kansas, which failed on August 22, 2009 (about which refer here). The FDIC's complaint in this lawsuit can be found here. The FDIC seeks to recover losses of at least $52 million the bank allegedly suffered because the defendants allegedly "negligently, grossly negligently, and in breach of their fiduciary duties originated and/or approved poorly underwritten large commercial and commercial real estate loans ... and failed to properly supervise the Bank's lending function." The FDIC also alleges that the defendants (one of whom owned or controlled the bank's holding company) "failed to heed the warnings of bank supervisory authorities."

Third, on August 10, 2011, the FDIC filed a lawsuit in the Eastern District of North Carolina against nine former directors and officers of the Cooperative Bank, of Wilmington, North Carolina, which failed on June 19, 2009 (about which refer here). The FDIC's complaint in this action can be found here. The complaint alleges that defendants "failed to manage the inherent risks associated with their aggressive growth strategy" and "permitted a lax loan approval process." The complaint further alleges that through out the period 2005 through the bank's failure, state and federal regulators "repeatedly warned" the bank's management and board "about the risks associated with its high concentrations in speculative loans and weaknesses in lending functions," yet the bank's board "permitted and approved" the bank's continued lending practices. The FDIC alleges that the defendants' negligence, gross negligence and reckless conduct "ultimately led to the bank's failure."

There are a number of interesting things about these three new lawsuits, beyond the fact that they were filed on three successive days in August. For one thing, all three involved banks that failed more than two years before the complaints were filed. The timing of the filings relative to the earlier closures says something about the FDIC's internal timetable for working up potential lawsuits. Another thing about these lawsuits are that the involve banks in states that have not been particularly hard hit during the current bank failure. By and large the bank failures have involved banks in just a few states, particularly Georgia, Illinois, California and Florida. Hard to know for sure what it signifies, but it is interesting that none of these suits involve banks from those hard hit states.

Another interesting thing about these suits is that all three involve relatively small banks. The Michigan Heritage bank lawsuit  involves a single mid-level lending officer and relatively modest losses on a relatively small number of loans. The implication seems to be that the FDIC intends to be very thorough and that there are not going to be cases that are too small to bother with. This is a salvage operation, pure and simple, and the FDIC is going to recover everything it can, no matter how small.

In any event, when these three additional lawsuits are taken into account, the total number of lawsuits that the FDIC has filed against former directors and officers of failed banks as part of the current bank failure wave is now up to fourteen, five of which were filed in August, and half of which were filed since June 30, 2011. The fact that these suits were filed in August and are just coming to light now suggests the possibility that there could be other FDIC lawsuits that have been filed but that have not yet surfaced.

Whether or not there are other filed but not yet publicized suits out there, it is clear there are many more lawsuits to come. On its website, the FDIC has said that as of September 13, 2011, the agency has approved lawsuits involving suits in connection with 32 failed institutions against 294 individuals with damage claims of at least $7.2 billion. The FDIC's fourteen lawsuits to date involve only 103 directors and officers. The implication is that there are at least 18 more lawsuits yet to be filed - and that is only taking into account the lawsuits that have been approved as of September 13, 2011. There undoubtedly will be many lawsuits approved in the months ahead, with additional filings to follow after that.

Given the two year lag time between failure date and filing date that these three lawsuits described above demonstrate, and given the fact that the pace of bank failures only really accelerated during late 2009 and early 2010, it seems likely that the failed bank filings will not only continue well into at least 2012, but that over the next few months the pace of failed bank lawsuits could really take off. 

Indeed, one of the clear implications of the FDIC's lawsuit filings during August of this year is that the agency's declared litigation strategy is for real. The FDIC clearly does intend to pursue the active litigation strategy it has laid out on its website. And in light of these latest filings, the FDIC's litigation approach clearly will not be limited just to the largest banks, but could well involve many smaller failures as well.

To be sure, the FDIC's approach does not necessarily require an actual lawsuit in every case. Early on in connection with many of the bank failures, the FDIC has submitted notices of claim to the failed banks' former directors and officers and to the failed bank's D&O insurance carriers. In many cases, the FDIC may attempt to try to negotiate a settlement with the former directors and officers and the D&O carriers, without the actual filing of a civil action.

Reliable sources advise me that that is in fact exactly what happened in connection with one large failed bank in Florida. Apparently, the FDIC was able to negotiate a settlement in connection with the failed bank without actually filing a lawsuit against the failed bank's former directors and officers. To the extent the FDIC pursues this approach in other cases and succeeds in negotiating settlements, there could ultimately be fewer complaints. In view of the fact that this approach would avert the erosion of the D&O insurance limits of liability by the payment of defense expenses, this approach could actually result in improved recoveries.

But though there may be cases where actual lawsuit filings are averted, the likelier scenario in many cases is that there will be an FDIC lawsuit. With the revelation of the FDIC's August lawsuit filings, and the suggestion that the FDIC is now actively pursuing its litigation strategy, it is clear that the game is on. For months to come, one of the predominant stories on the directors and officers' liability scene will be the FDIC's pursuit of growing numbers of failed bank lawsuits against the former directors and offices of the failed institutions

One final note. The FDIC's website makes it clear that its litigation strategy is not limited just to suits against former directors and officers. The site says that the agency has "also has authorized 20 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 175 residential malpractice and mortgage fraud lawsuits are pending, consisting of lawsuits filed and inherited."

Active Self-Defense: As discussed in prior posts (refer for example here), the individuals dragged into the failed bank lawsuits will rely on a number of theories in order to try to defend themselves. Former Indy Mac Chairman and CEO Michael Perry is taking a different approach. He has launched a website called "Not Too Big to Fail" (here) on which he is attempting to defend himself against charges the FDIC has asserted against him and other former IndyMac executives.

As discussed here, in July 2011, the FDIC filed a lawsuit in the Central District of California against Perry. The FDIC alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses. Perry has also been named as a defendant in other lawsuits arising out of IndyMac's July 2008 failure.

On his website, Perry asserts that "not one of the lawsuits against me has merit." He says that "I and the management team and directors of IndyMac Bank made prudent and appropriate business decisions based on the facts available to us at the time and always with the primary goal being to keep IndyMac bank safe and sound."

The name of the site is taken from Perry's complaint that IndyMac did not receive government bailout funds that were made available to other banks. He asserts that this occurred because IndyMac was "not too big to fail."

Though Perry's website represents a rather impressive display of self-justification, it seems unlikely that his Internet-based public relations campaign will accomplish much. I suppose though for someone in Perry's position there is some satisfaction involved with telling off the regulators, even if it is unlikely to change the outcome of any of the claims against him. The one thing that is clear is that Perry is both unrepentant and defiant.

Well, Maybe Next Year: For those who missed the allusion in the title of this blog post, the reference was to the lyrics of the song “Send in the Clowns,” from Stephen Sondheim’s Broadway musical A Little Night Music. The lyrics include these lines: “Sorry my dear/ But where are the clowns?/Quick, send in the clowns/Don’t Bother, they’re here.” 

Although many have sung this tune, it is has perhaps become most closely associated with Judy Collins. There are actually a surprising number of versions on You Tube of Judy Collings singing this song. Here's an audio only version.

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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