WASHINGTON - The federal appeals court in Philadelphia has made it easier for the government to successfully sue directors and officers of failed thrifts, reigniting a legal debate the industry thought it had already had won.
The U.S. Court of Appeals for the Third Circuit, ruling June 26 in Resolution Trust Corp. v. Cityfed Financial Corp., said the government has to prove only that directors erred.
The 2-to-1 decision directly contradicts rulings by four other federal appeals courts, all of which said the government must show that directors made business decisions they should have known were wrong. That standard, known as gross negligence, is harder to prove.
Cityfed's directors plan to ask the court to reconsider, said Douglas Kraus, a partner at Skadden, Arps, Slate, Meagher & Flom, who represented four outside directors. If that fails, the directors will appeal to the Supreme Court, he said.
The high court would likely accept the case because it often hears appeals when the circuits split on a case, said Michael Crotty, deputy general counsel for litigation at the American Bankers Association.
The Cityfed decision allows the RTC to use the easier standard in negligence suits brought in Pennsylvania, New Jersey, Delaware, and the Virgin Islands.
"I am very disappointed," said Philip Gasteyer, general counsel at America's Community Bankers. "To my mind, there is a direct conflict with the clear language of" the 1989 thrift bailout law.
In the decision, the court made two key interpretations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, the law at issue.
First, the court said a portion of the law known as the savings clause specifically states that the act does not infringe upon other RTC powers, including the right to bring simple negligence cases.
Second, the court said eliminating simple negligence claims would contradict the legislative history of the act, which shows Congress wanted to make it easier to sue directors and officers.
Directors and officers at all financial institutions should take note, Mr. Gasteyer said.
"The significance isn't just for the thrift industry," he said. "It is for directors and officers in general. It continues the uncertainty of what the standard of care is if their institution should fail."
Making it easier to sue directors will make it harder to keep people on bank and thrift boards, Mr. Kraus said.
"Business people dislike uncertainty, so it is going to make it much more difficult to find capable people to serve as officers and directors," he said.
The $10 billion-asset Cityfed of Bedminster, N.J., failed in December 1989. In its complaint, the RTC charges that the directors and officers failed to oversee 10 large construction loans made between 1984 and 1989. The loans resulted in a $12.7 million loss.
In particular, the RTC said directors had failed to hire competent underwriters, never produced a written loan policy, and approved loans after they already had closed.