The decision of U.S. District Judge Royce Lamberth in the National Bank of Washington case was the most important legal decision on bank director and officer liability in years.
Bank officials should heave a sigh of relief.
Judge Lamberth ruled that a director who reviewed available facts and voted in a logically defensible manner cannot be held liable for losses that resulted from the transactions that were approved.
"Courts recognize that even disinterested, well-intentioned, informed directors can make decisions that, in hindsight, were improvident," the judge wrote.
"To impose liability on directors for these good-faith business decisions, however, would effectively destroy the corporate system in this country, for no individuals would serve as officers and directors."
An Important Precedent
If the NBW ruling is followed by other courts, claims by the Federal Deposit Insurance Corp., Office of Thrift Supervision, and Resolution Trust Corp. that bank directors and officers are held to a different, more stringent standard than other directors and officers will be repudiated, and the reign of boardroom terror will end.
Throughout the Feb. 17 decision there are signs and explicit statements that the FDIC over-stepped its bounds in the way it brought and prosecuted the case. "The careful reader will note," said the judge, "that many counts in FDIC's amended complaint could have been missed for at least two different reasons."
If followed, the judge's rulings will make it quite difficult for the FDIC, OTS and RTC to continue to claim that disinterested directors or officers are liable for good-faith decisions, such as lending decisions, that turned out to be wrong.
What Court Said
The key rulings can be summarized as follows:
* The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 does not establish a uniform "gross negligence" standard for bank officers and directors, and does not preclude suing if applicable state law allows claims for simple negligence.
* The standard of care required of directors under District of Columbia law "is singularly unclear," which causes the court to turn to "general principles of corporation law."
* General principles of corporation law are in agreement with the federal common law standard for bank directors as enunciated in an 1890 Supreme Court case, Briggs v. Spalding.
* Under general principles of corporation law and the Briggs case, the standard of care is gross negligence for transactions and actions that are "more routine" but is the less stringent 'simple negligence" for a vaguely defined category of cases where, because of the bank's unfamiliarity with the subject matter, "bank directors would be under an obligation to thoroughly investigate the prudence of making such a loan."
The court says the "directors of a bank must satisfy differently standards of care, depending on the circumstances under which they operated during any given act."
* Loan transactions involving insiders and disputed matters having to do with insiders' pay fall within the gross-negligence area, not the simple-negligence area.
* But "in truth there is no exact standard as to what conduct constitutes negligence or gross negligence in a given situation."
* The business judgment rule provides a complete defense to the actions of directors for gross negligence and "courts presume that directors acted in a good-faith, informed, and disinterested fashion unless and until the challenger of a particular decision adduces evidence that the presumption is invalid in a particular case."
* To overcome the presumption of disinterestedness, "the plaintiff must demonstrate some personal financial benefit devolving on the director."
* To overcome the presumption that a director acted in good faith the challenger must show that the director's decision "was primarily motivated by personal. interest, not by the best interests of the corporation."
* The standard of care applicable to officers is the same as the standard applicable to directors.
My general conclusion from studying this opinion is that we have allowed director and officer liability law to become much too complex.
As Judge Lamberth points out, "even though courts frequently speak as if simple and gross negligence were subject to simple and distinct classification and application, in truth there is no exact standard as to what conduct constitutes negligence or gross negligence."
As if to prove the point, he finds that the NBW directors violated neither the gross-negligence nor the simple-negligence standard.
And I believe that there is no case arising in a corporate law context in which specific, described conduct has been said to be negligent but not grossly negligent.
The legal ink spent on the distinction between negligence and gross negligence has been, it seems to me, just so much spilled ink.
Judge Lamberth has injected still another meaningless distinctions that serves the technical interests of lawyers who like to parse pleadings but has no reality in the boardroom or the courtroom.
Traditional corporate law has not been phrased in terms of negligence, but rather in terms of whether a prudent person would or could have done the same thing as the defendant when dealing with his or her own affairs.
This test has been supplemented by the business judgment rule, as courts have recognized that the prudent-person test is subjective and that corporate officers and directors should not be second-guessed if they were independent and acted in good faith.
The protections of the business judgment rule should be readily available, moreover, so that disinterested directors can focus on making capitalism work efficiently, not on their potential liabilities.
There needs to be a standard of care in informing oneself as a director, but there should be a strong presumption that this standard has been met.
Mr. Lowy, a partner in the law firm of Lowy & Tallackson, New York, is special counsel to the director-responsibility task force of the Conference of State Bank Supervisors. He wrote "High Rollers: Inside the Savings and Loan Debacle."