In a victory for directors and officers, the U.S. Supreme Court on Tuesday made it tougher for regulators to hold top officials responsible for bank and thrift failures.
Justice Stephen G. Breyer, writing for the court, said the federal government must follow state law when prosecuting directors and officers of failed institutions.
Justice Breyer added a major exception: The government may ignore state laws that indemnify directors and officers of failed institutions if it can prove gross negligence.
The decision puts an end to hundreds of lawsuits brought by the Federal Deposit Insurance Corp. The FDIC has been arguing that it only has to prove simple negligence, or that officials made a bad decision that led to an institution's failure.
But the high court said the agency must use the negligence standard adopted by the state where the bank is located. Most states require the government to prove gross negligence, which requires executives to know that they are making decisions that will result in losses to their institutions. It is much harder to prove than simple negligence.
"State law sets the standard of conduct as long as the state standard is stricter than the federal statute," Justice Breyer wrote. "The federal statute, nonetheless, sets a gross negligence floor, which applies as a substitute for state standards that are more relaxed."
Industry officials praised the ruling, which resolves the last legal dispute stemming from the thrift crisis of the 1980s.
"This is very obviously a win for our side," said Michael F. Crotty, deputy general counsel for litigation at the American Bankers Association. "There will not be federal common-law simple negligence suits against officers and directors any longer."
"This is a great victory for directors," said Ronald R. Glancz, a partner at Venable law firm in Washington. "The great majority of state laws are favorable to directors and officers. We are very comfortable relying on them."
A 1994 study by the Washington law firm of Kirkpatrick & Lockhart found that 31 states had gross negligence standards. Only four used simple negligence. The law was unclear in the remaining states.
"This is the most sensible and logical standard," said Douglas M. Kraus, a partner at the New York law firm of Skadden, Arps, Slate, Meagher & Flom. "It avoids judicial second-guessing of actions of corporate directors taken in good faith and on a reasonable basis."
But Mr. Kraus said this case won't resolve the issue for good. The justices did not say which state's law applies to federally chartered institutions with multistate operations. Congress or the courts must resolve this issue, he said.
FDIC General Counsel William F. Kroener said the agency will continue to bring negligence suits. "It provides us with a clear standard and as a result will reduce our litigation costs," Mr. Kroener said.
The FDIC had 236 director and officer liability cases pending as of November 1996.
The Supreme Court's decision in Atherton v. FDIC stems from the December 1989 failure of City Federal Savings Bank, Bedminster, N.J. The Resolution Trust Corp., the FDIC's predecessor in the case, charged the directors approved three loans for $100 million to borrowers who eventually defaulted. All the directors except for John W. Atherton Jr. settled.