Corporate Officers Held Not Entitled to Business Judgment Rule Protection Under California Law

Corporate Officers Held Not Entitled to Business Judgment Rule Protection Under California Law

A federal court has denied the motion of former IndyMac CEO Matthew Perry to dismiss the action that the FDIC, as the failed bank's receiver, had filed against him. In a December 13, 2011 order (here), Central District of California Judge Otis D. Wright II held that under California law the business judgment rule does not protect officers' corporate decisions and accordingly he rejected Perry's argument that the FDIC's complaint must be dismissed for failure to plead around the business judgment rule.

As discussed here, in July 2011, the FDIC as receiver for the failed IndyMac bank sued Perry alleging that as the bank's CEO he had breached his duties to IndyMac and acted negligently in allowing IndyMac to continue to generate and acquire more than $10 billion in risky residential loans for sale into the secondary market. As the secondary market became unstable, the bank was forced to take the loans into its own investment portfolio, where the generated substantial losses, allegedly in excess of $600 million. IndyMac failed on July 11, 2008 and the FDIC was appointed as the bank's receiver.

Perry moved to dismiss the FDIC's complaint, arguing that the FDIC failed to allege facts sufficient to overcome the business judgment rule. Perry argued that the business judgment rule applies and insulates him from personal liability for his actions prior to IndyMac's demise.

In opposing Perry's motion, the FDIC argued that under California law the business judgment rule does not apply to officers. Judge Wright agreed. He concluded that the relevant legal authority does not support a conclusion that common law business judgment rule encompassing the general judicial policy of deference to business decisions should apply to officers. He also found that California's statutory business judgment rule does not extend its protection to corporate officers. After reviewing the statute, applicable legislative history and relevant case law, he concluded that when the California legislature codified the business judgment rule, "it purposely excluded its application to corporate officers." Because the FDIC's allegations against Perry in his capacity as an office, Judge Wright denied his motion to dismiss.

Discussion

Historically, courts in applying the business judgment rule have not always carefully examined whether or not the rule's protection should apply to officers as well as to directors. Over time, some have argued rather vigorously that the rule should not apply to officers. Others have argued that officers should be entitled to rely on the business judgment rule. Certainly it would seem that in those jurisdictions where officers and directors are held to have the same duties then they should be entitled to the same protections.

In any event, the question of whether or not an officer is entitled to the same protection under the business judgment rule as a director is a question of state law on which state law will control. Judge Wright's decision is clearly reflection of his analysis under California state law. But though it is limited on that basis, his conclusion nevertheless highlights the interesting question whether as a matter of public policy the decisions and actions of corporate officers should enjoy the same protection under the business judgment rule as directors.

Setting aside the question of whether or not officers are entitled to the protection of the business judgment rule is the question of whether or not questions involving the applicability of the protections should be addressed at the motion to dismiss stage. There is the further procedural question of whether the plaintiffs must be expected to plead around the defense in order for their case to go forward, or whether the protections are in their nature more in the form of an affirmative defense to be invoked and substantiated by the defendant as the case goes forward. Judge Wright's analysis does not examine these issues in detail but they present and added level of inquiry beyond the issues Judge Wright does address.

In any event, special thanks to a loyal reader for providing me with a copy of Judge Wright's decision.

More About the FDIC's Settlement with WaMu Executives: As was widely reported yesterday, the FDIC has settled the action it brought as receiver for the failed Washington Mutual bank against three former WaMu executives and their wives.  The early reports did not specify the amount of the settlement, but a December 14, 2011 Wall Street Journal article (here) fills in some of the missing details.

The total amount of the settlement is $64 million, consisting of about $400,000 from the settling parties themselves, and the balance of the cash amount to be paid by insurance. The executives are also to forego a total of $24 million in retirement benefits and bonus claims.

The Journal article also makes a tantalizingly brief mention of a prior $125 million settlement that the FDIC previously reached "to release claims against other former outside directors and officers." As I noted here, there had been some suggestion in the press when the FDIC first filed its action against the three executives that the agency had separately settled or reached an agreement with the failed bank's outside directors, but the brief mention in the Journal article is the first affirmative substantiation I have seen since that time referencing this separate settlement. Any readers that can shed light on this separate settlement are encouraged to pass along whatever information they can.

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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