The Federal Deposit Insurance Corp. has a lot of tools to recoup money lost on bank failures, but one of its easiest options is at risk of being taken away.
An appeals court will review a ruling by the U.S. District Court for the Northern District of Georgia that barred the FDIC from pursuing claims against the officers and directors of Integrity Bank for simple negligence. The bank failed in 2008.
The ruling determined that the failed bank's officers and directors were protected against simple negligence by business judgment rules that prevent proverbial Monday morning quarterbacking on loans that go bad.
The FDIC appealed. Earlier this month, the U.S. Court of Appeals for the Eleventh Circuit agreed to hear the case.
The stakes were already high given the lofty number of failures in Georgia, but elevation to the appellate level raises them even more, lawyers say. If the appellate court upholds the ruling, the FDIC will have to present a more robust case as it looks to replenish the Deposit Insurance Fund through such claims.
If the appellate court sides with the FDIC, then its ruling could have consequences for all banks, observers say.
"It becomes a much more important decision now that the Eleventh Circuit has agreed to hear it," says Chip MacDonald, a partner at Jones Day. If the FDIC prevails, "it would make it much harder for all banks to find capable people to be directors. The first thing that anybody asks is, 'What is my liability as a director?'"
The lower court's initial ruling did not void the FDIC's claim in its entirety; the FDIC was still able to pursue claims by alleging gross negligence. The FDIC does not comment about ongoing litigation.
The definition of negligence and gross negligence varies from state to state, but a case built around simple negligence is easier to win because it covers a broader spectrum and has a lower burden of proof. Gross negligence is based on more egregious behavior, but is harder to prove.
Simple negligence could hinge on how thoroughly a director read loan proposals. But the business judgment rules protect bank leaders from such claims, as long as they act in a way that a reasonable person would have acted under similar circumstance. Essentially, it is a gray area, and that is what worries bankers and their lawyers.
"If you act in good faith and you were well informed, the court should presume that you acted in a reasonable manner and fulfilled your duties," says Daniel C. McKay 2nd, a partner at Vedder Price who represents several former directors and officers of failed Chicago-area banks. "You shouldn't be subjected to attack down the road for a decision that turned out to be incorrect."
Banks usually take out insurance to cover officers and directors from litigation tied to their decisions. But there is no policy that can cover the reputational harm to a bank or its leaders when they are hit with litigation.
Georgia's definition of gross negligence is liberal enough to cover some instances of simple negligence, but the FDIC is still fighting to keep both options open. Most of the agency's cases have claims of both simple and gross negligence, along with breach of fiduciary duty. The FDIC's board has authorized the agency to pursue lawsuits against 617 individuals tied to 73 institutions that have failed since 2009. The FDIC has filed 32 lawsuits against 266 directors and officers, settling two cases. Georgia is home to eight of the cases.
Several lawyers say they are following the case because the appellate court's ruling would reach far beyond its own jurisdiction.
"Other courts take notice of what is going on elsewhere," McKay says. "Our hope is that the appellate court sends the same kind of message: We should respect the business judgment rule."
While the FDIC is merely trying to recover some of the money Deposit Insurance Fund lost from bank failures, allowing litigation against bank officers and directors for simple negligence could lead to lawsuits by other parties, such as shareholders, making it harder for banks to find good talent.
"The FDIC has a duty to maximize the return to the Fund," says Lawrence Kaplan, a partner at Paul Hastings. "But if it becomes really easy to be sued as a director and you have your personal assets in jeopardy, why would you want to do that?"