A recurring issue in the litigation the FDIC has filed against the directors and officers of failed banks is the question of whether or not officers – as opposed to directors – can rely on the business judgment rule as a defense under applicable state law. A July 8, 2013 decision by Judge Dean Pregerson applying California law concluded (as have other courts in failed bank cases) that the California’s statutorily codified Business Judgment Rule protects only directors, not offices. But, as Judge Pregerson found, there are also ircumstances when directors cannot rely on the Business Judgment rule as the basis for a motion to dismiss, either. A copy of Judge Pregerson’s July 8, 2013 opinion can be found here.
The First Bank of Beverly Hills failed on April 24, 2009. On April 20, 2012, the FDIC in its capacity as receiver for the failed bank filed a lawsuit against ten former directors and officers of bank. In its complaint (here), the FDIC seeks to recover losses of at least $100.6 million the bank allegedly suffered on nine poorly underwritten acquisition, development and construction loans and commercial real estate loans from March 2006 through July 2007.
The FDIC asserts claims against the ten defendants for negligence, gross negligence and breach of fiduciary duties. The complaint alleges that the defendants approved or allowed the loans in question in willful disregard of the bank’s own loan policies and with “willful blindness” to the risks and imprudence of the loan decisions. The complaint alleges that at the same time the defendants were approving these risky strategies, they were “weakening the Bank’s capital position by approving large quarterly dividend payments to the Bank’s parent company,” of which several defendants were shareholders. The complaint alleges that the individual defendants “lined their own pockets” with these dividends.
The defendants moved to dismiss arguing, among other things that they are protected by California’s business judgment rule from the claims of breach of fiduciary duty.
The July 8 Order
In his July 8 order, Judge Pregerson denied the defendants’ motions to dismiss. He considered the motions of the director defendants and of the officer defendants separately.
First, with respect to the director defendants, Judge Pregerson concluded that “the FDIC had pleaded facts sufficient to overcome the business judgment rule.” He concluded that the FDIC “has stated a claim for the directors receiving improper personal benefits, which, if true may deprive them of the protection of the business judgment rule.” He also noted that the FDIC “has stated a claim for the directors’ abdication of corporate responsibility,” adding that “the FDIC alleges that the directors approved loans so facially deficient that the made reliance [on information provided by others] unwarranted.”
Judge Pregerson also concluded that the director defendants were not entitled to dismissal of the breach of fiduciary duty claims based m the exculpatory clause in the bank’s articles of incorporation. The inclusion of an exculpatory clause in corporate charters is permitted under California law, but the exculpation available under these provisions is limited by exceptions. Judge Pregerson found that the FDIC’s allegations here come within the exceptions. Among other things, Judge Pregerson found, quoting the language of the statutory limitations on exculpatory clauses, that the complaint alleges that the director defendants “received an improper personal benefit” and also that the FDIC had “pleaded facts amount to ‘reckless disregard’” and that “state a claim for an ‘unexcused pattern of inattention that amounts to an abdication of duty.
With respect to the officer defendants, Judge Pregerson, following several other courts applying California law, concluded that corporate officers, as opposed to directors, are not entitled to rely on the business judgment rule.
It is worth noting that Judge Pregerson did not definitively rule that the director defendants cannot rely on the protection of the business judgment rule, only that – based on the FDIC’s allegations, which must be take as true for purposes of the dismissal motion – the business judgment rule cannot serve as a basis for dismissing the FDIC’s claims in against the director defendants at the dismissal motion stage.
Many of the directors and officers named as defendants in the FDIC’s failed bank lawsuits have raised the business judgment rule as a defense and sought to rely on the rule as the basis of a motion to dismiss. Judge Pregerson’s rulings here, based on the FDIC”s allegations, that the director defendants cannot rely on the rule as the basis for dismissal of the agency’s claims, is a reminder that the business judgment rule is not a defense to certain kinds of allegations. Specifically Judge Pregerson’s ruling show that director defendants may not be able to rely on the rule as a defense against allegations of self-interested conduct or of abdication of duties.
Judge Pregerson’s decision that the California Business Judgment Rule does not protect officers is consistent with prior federal court rulings applying California law in FDIC failed bank cases where officers of the failed banks have sought to invoke the rule. Refer, for example, here.
In several jurisdictions, individual defendants have successfully argued that their conduct is protected by the business judgment rule and accordingly, that they cannot be held liable for ordinary negligence. The most significant holding is the August 14, 2012 decision in the Northern District of Georgia in the Haven Trust case, in which Judge Steve C. Jones dismissed the claims against both the director and officer defendants, because of his determination that under Georgia law the directors’ and officers’ conduct is protected by the business judgment rule. The Haven Trust case is discussed here. Earlier in August, a judge in the Middle District of Florida, ruled in the FDIC’s failed bank lawsuit relating to the failed Florida Community Bank of Immokalee, Florida, that under Florida law directors cannot be held liable for ordinary negligence, as discussed here. The ruling in that case did not reach the question of whether or not officers can be held liable for ordinary negligence under Florida law.
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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