Corporate

Failed NC Bank Execs Granted Summary Judgment on All FDIC Claims

 On September 11, 2014, in a sharply worded order that will give heart to the FDIC’s many other failed bank litigation targets, Eastern District of North Carolina Judge Terrence Boyle, applying North Carolina law, granted the summary judgment motion of the former directors and officers of the failed Cooperative Bank of Wilmington, N.C., in the lawsuit the FDIC had filed against them in its capacity as the failed bank’s receiver. Judge Boyle rejected all of the FDIC’s claims against the former bank officials. The defendants in other failed bank lawsuits undoubtedly will seek to rely on Judge Boyle’s ruling that the loan underwriting actions on which the FDIC sought to base its liability claims are protected by the business judgment rule. A copy of Judge Boyle’s order can be found here.

A September 15, 2014 memo about Judge Boyle’s opinion from Mary Gill and Laura Tapson of the Alston & Bird law firm entitled “Bank Directors and Offices Win Summary Judgment on All FDIC Claims” can be found here.

Background

After the Cooperative Bank of Wilmington, N.C. failed in June 2009, the FDIC as the failed bank’s receiver initiated a lawsuit against certain former directors and offices of the bank, asserting claims for negligence, gross negligence, and breaches of fiduciary duty in connection with the defendants’ approval of 86 loans between January 2007 and April 2008. The FDIC alleged that in making the loans, the defendants had deviated from prudent lending practices established by the bank’s own loan policy, published regulatory guidelines and generally accepted banking practices. In its lawsuit, the FDIC sought to recover approximately $40 million in losses the bank sustained in connection with the subject loans.

Earlier on in the case, Judge Boyle had denied the defendants’ motion to dismiss the FDIC’s lawsuit. Following discovery, the defendants filed a motion for summary judgment on all claims against them. .

The September 11 Order 

In his September 11 Order, Judge Boyle granted the defendants’ motion for summary judgment, dismissing all of the FDIC’s claims against the former directors and officers.

With respect to the FDIC’s claims for ordinary negligence and for breach of fiduciary duty, Judge Boyle ruled that “the business judgment rule applies and shields the defendants from liability.”

Judge Boyle said that under North Carolina law the business judgment rule “serves to prevent courts from unreasonably reviewing or interfering with decisions made by duly elected and authorized representatives of a corporation, “ adding that “absent proof of bad faith, conflict of interest, or disloyalty, business decisions of officers and directors will not be second-guessed if they are the product of a rational process and the officers and directors have availed themselves of all material and reasonably available information.” (Citations omitted) There can be no liability even if a subsequent finder of fact considers a decision “stupid, egregious, or irrational” so long as the court determines that “the process employed was either rational or employed in a good faith effort to advance the corporate interest.”

Judge Boyle first concluded that “the FDIC failed to reveal any evidence that suggests that defendants engaged in self-dealing or fraud or that any defendant was engaged in any unconscionable conduct that might constitute bad faith.” While the wisdom of the lending decisions may “raise interesting questions in hindsight,” the business judgment rule precludes the court from “delving into the whether or not the decisions were ‘good’.”

Given that Judge Boyle found no indication that the decisions were the result of bad faith, conflict of interest or disloyalty, the only question left was whether the decisions were the result of a rational process and in furtherance of a rational business purpose.

In concluding that the loan decisions that are at the heart of the FDIC’s case were the result of a rational process, Judge Boyle relied in particular on the FDIC’s own Reports of Examination during the period when the loans were made,  in which the bank’s management had been graded as “satisfactory” and not requiring “material changes.” The CAMELS ratings in the ROE of “2” for management, asset quality and sensitivity to market risks “show that the process the defendants used to make the challenged items were expressly reviewed, addressed and graded by the FDIC regulators in the 2006 ROE, adding that for the FDIC “to now argue that the process behind the loans is irrational is absurd.” (Judge Boyle noted in a footnote that CAMELS ratings are given on a scale of 1 to 5, with 1 being the highest. Banks scoring a 1 or a 2 “are considered well-managed and presenting no material supervisory concerns.”)

Based on these examination ratings and the comments of the bank’s independent auditors in 2006, 2007 and 2008, Judge Boyle found “as a matter of law, that defendants’ processes and practices for the challenged loans were rational.”

Judge Boyle also concluded that the challenged loans could be attributed to a rational business purpose, noting that while there were “clearly risks” associated with the bank’s goal of growing to be a $1 billion institution and to stay competitive with other banks that were making inroads into its territory, “the mere existence of risks cannot be said in hindsight to constitute irrationality.” He added that “where as here, defendants do not display a conscious indifference to risks and where there is no evidence to suggest that they did not have an honest belief their decisions were made in the company’s best interests, then the business judgment rule applies even if those judgments ultimately turned out to be poor.”

Judge Boyle also granted the defendants’ motion for summary judgment on the FDIC’s gross negligence claims, based on his finding that “the FDIC has presented no evidence that any of the defendants approved the challenged loans and made policy decisions knowing that these actions would harm Cooperative and breach their duties to the bank.” He added that “the FDIC cannot show that any of the defendants engaged in wanton conduct or consciously disregarded Cooperative’s well- being.”

In closing, Judge Boyle went out of his way to express his disdain for the FDIC’s contention that not only was the global financial crisis foreseeable, but it was actually foreseen by the individual defendants, a contention on which he felt compelled to comment because of the “absurdity of the FDIC’s position.” Judge Boyle reviewed numerous public comments made by various government officials before and after the financial crisis, including then-U.S. Secretary of the Treasury Hank Paulson and Federal Reserve Chairman Ben Bernanke, to the effect that regulators could not have seen the financial crisis approaching, and then commented that

The FDIC claims that the defendants were not only more prescient than the nation’s most trusted bank regulators and economists, but that they disregarded their own foresight of the coming crisis in favor of making the risky loans. Such an assertion is wholly implausible. The surrounding facts … belie the FDIC’s position here. It appears that the only factor between defendants being sued for millions of dollars and receiving millions of dollars in assistance from the government is that Cooperative was not considered “too big to fail.”

Judge Boyle concluded saying that for big banks to be forgiven for their role in the financial crisis because of their size while the directors and officers of small banks are pursued for monetary compensation “is unfortunate if not outright unjust.”

Discussion

In assessing Judge Boyle’s ruling here, it needs to be kept in mind that the kinds of claims the FDIC asserted against the former directors and officers of Cooperative Bank are pretty typical of the kinds of claims the agency has asserted against the former directors and officers of many other failed banks in the FDIC’s various failed bank’s lawsuits. For Judge Boyle to characterize the FDIC’s various positions as “absurd” and “implausible” is extraordinary. Judge Boyle not only dismissed the FDIC’s claims but seemed to reject the very premises on which the claims were based. It is fair to say – and I suspect that individual defendants in other failed bank cases will try to say – that if the FDIC’s position in this case is “absurd,” then its position in many other cases where it has asserted the same basic claims is also absurd.

There is another feature of Judge Boyle’s decision that is noteworthy, and that is his willingness to refer to the FDIC’s own Reports of Examination, made prior to the bank’s failure, as evidence that the bank’s lending practices involved rational processes. In its many failed bank lawsuits, the FDIC takes great pains to try to distinguish between its role and activities as a regulator and its role and activity as receiver. The debate on this distinction often takes place in the context of a debate over whether defendants can assert affirmative defenses against the FDIC. Judge Boyle determinations in the course of reviewing the defendants’ summary judgment motion simply disregards the distinction on which the FDIC so frequently seeks to rely; if the question is whether or not the bank’s lending practices were rational, then the FDIC’s pre-failure assessment of the bank’s lending practices are relevant.

The Alston & Bird memo to which I linked above states that Judge Boyle’s decision is “the first summary judgment ruling to address the business judgment rule in the wave of FDIC litigation following the financial crisis.” Other defendants will undoubtedly seek to rely on Judge Boyle’s rulings in the Cooperative Bank case as they seek to obtain summary judgment in their own cases. The ruling will obviously be of greatest use in other cases to which North Carolina law apply. As it turns out, that is a relatively small number of the pending cases. My information review of the FDIC’s online listing of its failed bank lawsuits suggests that there may be as few as only two other failed bank lawsuits pending in North Carolina federal courts.

Whether Judge Boyle’s ruling will prove to be useful or influential in cases to which the law of jurisdictions other than North Carolina law apply remains to be seen. The Alston & Bird memo suggests that even outside North Carolina, Judge Boyle’s application of the business judgment rule to grant summary judgment here “should provide strong support for granting summary judgment in favor of the D&Os in other cases as well.” While it can be argued that North Carolina’s version of the business judgment rule is not dissimilar to that applicable in other jurisdictions, the difference in applicable law might be enough for other courts to use as a basis to distinguish Judge Boyle’s analysis.

Where Judge Boyle’s decision might be most useful in other cases is the use he made of the FDIC’s Reports of Examination and CAMELS ratings. Many of the banks that failed collapsed quickly. Many of the institutions that failed appeared to be healthy only a short time before the closed, particularly at the outset of the financial crisis. The defendants in many of the other failed bank cases will be able to show that their management and lending practices were regarded as satisfactory by regulators just prior to the onset of the crisis. At least in the many pending cases where there are no allegations of self-dealing or conflict of interest, the defendants in other cases like the defendants here may be able to rely on the regulators’ own pre-failure positive assessment of their banks’ lending practices to refute the FDIC’s hindsight attempt to characterize those same practices as negligent.

Special thanks to Mary Gill of Alston & Bird for sending me a copy of Judge Boyle’s decision as well as providing me with a copy of her law firm’s memo.

A Note about Banks and Cyber Disclosure: According to its review of 10-Ks and 10-Qs of 575 publicly traded banks, LogixData concluded that 303 of the banks’ (52%) SEC reports had “absolutely no mention of anything related to cyber security.” (Hat Tip: The CorporateCounsel.net blog, here).

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 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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