Under the 1989 thrift rescue law, the Federal Deposit Insurance Corp., as receiver or conservator of failed or faltering institutions, can inherit the powers of stockholders, officers, and directors.
Included is the power to sue those it deems responsible for a bank's or thrift's troubles.
This power is a topic of special concern for executives.
The critical section of the Financial Institutions Reform, Recovery, and Enforcement Act is section 1821(k). This establishes a standard by which officer and director conduct will be judged should an institution fail.
A Broad Interpretation
While there has been some dispute in the courts as to the kinds of conduct that will expose these executives to personal liability, recent court rulings have supported the FDIC argument that bankers should be held responsible for a broad range of actions and inactions.
These decisions have provided the increasingly litigious FDIC additional firepower to use against officers and directors of failed banks and thrifts.
Section 1821(k) says a "director or officer of an insured depository institution may be held personally liable for monetary damages in any civil action by, on behalf of, or at the request or direction of the [FDIC] . . . for gross negligence."
It also says: "Nothing in this paragraph shall impair or affect any right of the [FDIC] under other applicable law."
In interpreting section 1821(k), most courts have tended to broaden the potential liability of officers and directors of failed institutions.
Some fear that letting the FDIC sue only for gross negligence after a failure would create an incentive to let a bank fail in order to escape the more stringent negligence standard it might face under state law if it continued operating.
As a practical matter, whether that is true may be irrelevant. For the most part, occurs are permitting the government to bring suit against former officers and directors of failed institutions for conduct amounting to mere negligence.
All bank and thrift executives should be aware of this trend. Should their institutions fail, routine business decisions may be reexamined by an aggressive FDIC. This will place officers, directors, and their personal assets in substantial jeopardy.
When simple negligence becomes the standard, risks increase substantially.
The Law in Action
Last spring a federal district judge in Utah issued the first decision interpreting section 1821(k).
That case arose when, almost 18 months after the failure of the Utah-based Tracy Collins Bank and Trust Co., the FDIC filed a lawsuit against former officers and directors.
The government alleged they had been negligent, breached the fiduciary duty owed to the institution, engaged in unlawful insider transactions, and therefore were liable to the FDIC for more than $7 million in damages.
The defendants sought to have the complaint dismissed. They contended that under section 1821(k), the FDIC was not permitted to sue former officers or directors of a federally insured depository institution for monetary damages or conduct amounting to less than gross negligence.
The Basic Federal Standard
They argued that the section establishes gross negligence as the basic federal standard of liability.
The FDIC, they complained, was seeking recovery for "imprudent" loans they made or approved and for "waste of bank assets and mismanagement." But, they said, those claims amounted to mere negligence, or breach of their duty of care, not gross negligence or a higher degree of culpability.
Public policy was on their side, the defendants claimed. They insisted that the courts must balance the government's need to recover money damages for conduct amounting to aggravated fault on the part of directors and officers with the need to ensure that competent and qualified people serve on bank and thrift boards.
This balance could be struck, they argued, through adoption of a national standard of liability for gross negligence or a higher degree of fault.
Application of State Laws
The FDIC agreed that section 1821(k) establishes a national standard of liability. But the agency said the standard was a minimum one, which individual states could exceed by imposing liability for negligence.
It focused on the section's last sentence: "Nothing in this paragraph shall impair or affect any right of the [FDIC] under other applicable law."
The agency argued that the sentence preserves the ability of the government to bring suit, when authorized by state law, for monetary damages against directors and officers for ordinary negligence. Furthermore, the FDIC maintained, public policy favors holding officers and directors liable for their mismanagement and other wrongdoing.
Section 1821(k), the FDIC said, only limits the ability of states to insulate directors and officers by imposing a minimum liability standard of gross negligence or intentional tort.
Utah law, though, does not insulate directors and officers, but requires only a showing of negligence. As a result, the FDIC argued, Utah law was unaffected by section 1821(k) and the FDIC should be permitted to hold the defendants personally liable for ordinary negligence.
What Congress Intended
In its decision, the district court noted that there was no dispute about the provisions of the first part of section 1821(k). The court wrote:
"Congress clearly intended to preempt conflicting state and federal law on the issue of director and officer liability in this area and set a standard of gross negligence."
But when it turned to the last sentence of section 1821(k) ("Nothing in this paragraph shall impair or affect . . .), it ruled against the FDIC's interpretation.
The court did not hold that the sentence would leave intact the statutory and common law of states like Utah that allow suits based on ordinary negligence or breach of fiduciary duty.
The court ruled that the federal law establishes a "national, minimum standard of gross negligence" in suits against a depository institution's former officers and directors. This national standard "preempts state law allowing suits for conduct not rising to the level of gross negligence."
Rebuff to FDIC
Qualified and competent people, the court said, must direct the affairs of financial institutions. And as fiduciaries they should be held liable for intentional or grossly negligent conduct in the administration of an institution's affairs.
But the court found that section 1821(k) strikes a balance. On the one hand, it holds directors and officers accountable for aggravated fault or gross negligence. On the other, it shelters them from personal liability under lower standards of fault, including ordinary negligence.
"One motivation for sheltering officers and directors from claims of ordinary negligence is the important interest in encouraging aggressive and ambitious leaders to take the necessary steps to remedy the financial institution crisis this country faces," the court said.
To create "a situation where, even if an institution is fortunate enough to lure competent people to sit on its board, directors and officers are fearful of having every decision second-guessed" would not be productive, the court concluded in dismissing the complaint.
Victory for Regulator
At least one other court has interpreted section 1821(k) the same way as the district court did in the Tracy Collins case. But the district court's decision in Tracy Collins was overturned by the 10th Circuit Court of Appeals.
Also, lower courts in Oklahoma, California, Texas, Illinois, and Colorado have ruled in favor of the FDIC's interpretation.
For instance, a federal district court in Illinois recently issued a decision in a case brought by the FDIC against nine former directors and officers of Lyons Federal Trust and Savings Bank alleging breach of fiduciary duty, fraud, negligence, and breach of contract.
Lyons, obtained its charter as an Illinois savings and loan association in 1992. In August 1986 it converted to a federal charter and was renamed Lyons Federal Trust and Savings Bank. One year later, though, the Federal Home Loan Bank Board appointed the Federal Savings and Loan Insurance Corp., as receiver for Lyons, which by that time had become insolvent.
In the years before its insolvency, Lyons management had pursued a strategy of rapid growth. Departing from a traditional reliance on residential mortgage lending, Lyons invested heavily in real estate development and other higher risk ventures.
The Federal Home Loan Bank Board and the Illinois commissioner of savings and residential finance both considered Lyon's new lending and investment and became concerned about the situation at Lyons as early as 1983.
In fact, from 1984 until its insolvency in 1987, Lyons operated under a number of consent agreements and federal supervisory directives restricting its activities.
Allegation of Fraud
The FDIC, as manager of the FSLIC Resolution Fund, is entitled to bring suit on claims previously held by the insurance fund. The complaint filed by the FDIC in this case alleged that more than $20 million in losses at Lyons were caused by breaches of fiduciary duty, breaches of contract, negligence, and, in certain instances, fraud on the part of the bank's officers and directors.
The complaint detailed a number of allegedly unsound financial transactions in which the defendants caused Lyons to be engaged or to which they presented or failed to prevent.
One allegedly involved a sale of property by Lyons that resulted in what the FDIC referred to as a "false commission" being paid to a Lyons borrower.
The federal district court in Illinois that was handling the case noted that the laws of the state of incorporation generally govern the fiduciary duties of corporate directors. It then declined to follow the district court's decision in the Tracy Collins case and found that the last sentence of section 1821(k) "was intended to preserve state law rights."
The ruling comports with one of the stated purposes of the 1989 law, namely, to strengthen the enforcement powers of federal regulators of depository institutions.
As another court has states, in light of this purpose it would be "unreasonable to conclude that Congress intended to limit the FDIC's power to obtain damage awards by preempting state common law remedies that impose a higher standard of care on directors and officers.
Statute of Limitations
An interesting twist on the interpretation of section 1821(k) - and one that perhaps indicates the growing willingness of the courts to impose liability on former officers and directors of failed institutions - occurred in a recent decision by a federal district court in California.
In that case, the FDIC became the receiver, on April 10, 1987, for Central Savings and Loan Association. Claiming that former directors of Central had breached their fiduciary duty to the thrift, the FDIC filed suit on April 5, 1991 - almost four years later - seeking to recover a portion of the $80 million of losses incurred by Central.
The complaint alleged that the directors had engaged in various negligent acts through 1984 that constituted a breach of their fiduciary duty. The directors contended, though, that because the alleged breach of duty was predicated on negligent conduct, provisions of the California code that provide for a two-year statute of limitations should govern.
Because nothing in the FDIC's complaint indicated that the statute of limitations had expired, and because the suit referred to conduct that occurred only through 1984, the directors argued that the FDIC's cause of action was barred as of 1986 - a year before it became receiver. The FDIC may not revive a time-barred claim when it assumes control of an institution.
The FDIC argued, though that a four-year statute of limitations period applied.
Then, it noted that when filing a claim on a cause of action viable when it became receiver, the FDIC is entitled to file a complaint for an additional three years, or the applicable state statute of limitations, whichever is longer, from the date it became receiver.
It said that the action was viable on April 10, 1987, and, because of the four-year state statute of limitations, it properly filed suit on April 5, 1991.
Although the breach of fiduciary duty claim was based on allegedly negligent acts the court concluded that a claim of breach of fiduciary duty "is a cause of action in its own right and cannot be compartmentalized into another rubric for time-bar purposes." It ruled that a four-year period applied and, therefore, that the suit was timely filed.
The court then proceeded to interpret section 1821(k). It ruled that the second sentence of that section permitted suits by the FDIC for negligence and upheld the FDIC's complaint.
The court noted that "at first blush this opinion appears internally inconsistent" - because it found that the FDIC's complaint was not one for simple negligence, but that the 1989 law permits allegations of simple negligence.
But nonetheless, the court denied the defendants' motion to dismiss the suit.
Mr. De Feis, a former assistant United States attorney in the Eastern District of New York, is in the litigation department of the New York office of the law firm of Milbank, Tweed, Hadley & McCloy.