A Failed Bank, A Lawsuit, and Some Interesting Questions

Though 268 banks have failed since January 1, 2008, there has been relatively little litigation related to the failed banks, as least so far. For example, the FDIC only recently filed its first action against former directors and officers of a failed bank (as discussed here). There have also been relatively few suits brought by private investors as well, though that could change. The failed bank lawsuits do continue accumulate, however, including an investor lawsuit recently filed in state court in Georgia that both has some interesting features and that may present some interesting potential D&O insurance coverage issues.

The case in question was initiated on July 22, 2010 in Fulton County (Georgia) State Court by three investors in Georgian Bankcorporation. The company operated Georgian Bank in Atlanta, which was taken over by regulators on September 25, 2009. The defendants are two of the company's former directors and officers, one of whom was the company's Chairman and CEO for several years, and the other of whom was the successor Chairman and CEO.

All three of the plaintiffs were investors in the bank holding company. Two of the three plaintiffs served as company directors until 2003. All of the parties are residents of Georgia.

The complaint seeks damages for negligent misrepresentation. The plaintiffs allege that the defendants negligently misrepresented the negative effects of the economic slowdown was having on the bank; negligently failed to timely and fully report to plaintiffs various adverse regulatory actions taken against the bank and related regulatory findings; and negligently failed to inform plaintiffs that a key depositor was withdrawing its more than $200 million in deposits.

The complaint is emphatic that it is asserting claims only for negligent misrepresentation. Paragraph 11 of the complaint states that the plaintiffs "exclude and disclaim" any allegations under the federal and state securities laws; common law fraud; intentional, reckless or knowing misconduct; breach of fiduciary duty or mismanagement. In addition, in paragraph 12 the complaint emphasizes that the claims of it asserts are direct, on behalf of plaintiffs, and not derivative, on behalf of the company.

There are a number of interesting things about this complaint, beyond just the fact that it represents an example of a recent bank failure that resulted in a D&O lawsuit.

First, the complaint's insistence that the plaintiffs are "disclaiming" a number of kinds of allegations suggests the narrow line the plaintiffs are trying to walk. Their disavowal of all securities law claims seemingly is calculated to try to avoid the initial pleading hurdles and defenses to which securities claims are vulnerable, as well as to avoid any possible federal question jurisdiction that might facilitate the case's removal to federal court.

The other claims plaintiffs disavow, particularly the fraud and intentional misconduct allegations, may reflect a desire to avoid the conduct exclusions typically found in D&O insurance policies.

The plaintiffs' insistence that they are asserting only direct not derivative claims is clearly an effort to fend off the FDIC, which might otherwise (and who knows, may yet) intervene to assert its rights as receiver under FIRREA to control litigation asserted in the right of the failed bank itself. (For more about the FDIC's rights under FIRREA, refer here). The plaintiffs' wariness about the FDIC's interest in the lawsuit is apparently well founded, because, as I discussed in a prior post, the FDIC has sent letters to former officials at the failed bank detailed potential claims the FDIC may assert against them.

The complaint also raises a number of potential D&O insurance coverage issues.

The first has to do with the fact that two of the plaintiffs are former directors of the company. The typical D&O insurance policy has an "insured vs. insured" exclusion precluding coverage for claims brought by one insured against another insured. The two former directors would be insureds under most D&O policies, and so all else equal, their claim would involve an insured vs. insured claim. The exclusion potentially might preclude coverage for this claim.

However, the typical insured vs. insured exclusion also usually has multiple exceptions that carve back coverage for certain kinds of claims (derivative action, for example). In recent years, among the coverage carve backs found in many D&O policies is a carve back for claims brought by former directors and officers more than four year (sometimes three years) after they left their position. This new lawsuit presents an interesting example of a case where the inclusion of this coverage carve back could be crucial to preserving coverage.

A second interesting thing about this case from an insurance standpoint relates to the plaintiffs' insistence that they are asserting only claims for negligent misrepresentation. The reason this is interesting is though the plaintiffs are asserting harm to their investment interests, they are not asserting claims base on the securities laws. Rather they are quite deliberately asserting claims solely under the common law.

The reason this is interesting is in connection with the definition of the term "securities claim" found in the typical public company D&O insurance policy. Many policy forms do not include within the definition claims asserted under common law, and so carriers are often requested to amend the definition of the term to include common law claims. Some carriers resist this change, arguing either that the change is unnecessary or that claimants will not assert claims on that basis.

The deliberately narrowed way the plaintiffs have framed their claims in this case both illustrates why the inclusion of common law claims in the definition of "securities claims" is appropriate and provides and example of a case in which the change could be critical.

The deliberately narrow way the plaintiffs framed their complaint also underscores the challenges claimants may face in trying to assert claims against former directors and officers of failed banks. Between worries that the FDIC will sweep in and try to take over the claim and concerns that D&O insurance coverage issues could eliminate possible insurance recoveries, prospective claimants face some formidable obstacles. Indeed these considerations may be among the reasons why there has been relatively little D&O litigation (so far) as a result of the current round of bank failures.

A July 27, 2010 Atlanta Journal Constitution article about the lawsuit can be found here.

Special thanks to Henry Turner, counsel for plaintiffs in the case, for providing a copy of the 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.