Doctors, lawyers and accountants can be sued for malpractice if their negligence harms their clients. But suits against corporate officers and directors are treated differently. If corporate leaders make bad decisions, the "business judgment rule" can shield them from liability to shareholders who claim the mistakes cost them money. That rule says that, even if an officer or director blunders, he or she will not be liable unless the challenged decision involved fraud, illegality or self-dealing. The business judgment rule has worked for a long time to prevent suits against officers and directors for routine business misjudgments.
In many states, the same rule applies to bank officers and directors. Where it applies, the good-faith lending decisions made by bank officers and directors are protected from liability, even if the loans turn bad and cause the bank losses.
The rules are anything but clear-cut, however. The business judgment question is unsettled in New York, and a Georgia judge recently suggested that bank directors should be held to stricter liability standards than ordinary directors, despite other Georgia court decisions to the contrary.
Meanwhile, the Federal Deposit Insurance Corp. is pressing simple negligence claims against bank directors in some states, including Georgia, Illinois and North Carolina, in the face of business judgment rule defenses. It has also taken the position that it can sue bank officers and directors of a failed New York bank for simple malpractice, or negligence, without concern for whether that conduct would be protected by the business judgment rule. That is, if a bank makes mistakes in extending loans that go bad, and the bank subsequently fails, the FDIC's position is that it can sue its officers and directors for its losses, even if their underwriting decisions were made in good faith and did not involve fraud, illegal conduct or insider lending.
During the thrift crisis of the 1990s, the FDIC obtained a pair of federal trial court rulings that New York bank directors do not enjoy the business judgment rule protection available to corporate directors. However, this question has never been addressed by any appellate court in New York, and so we do not know whether such courts would agree with a heightened liability standard for bank directors. They may well decide that it makes no sense to hold the directors of New York's 260 remaining banks to a stricter liability standard than applies to the directors of its 475,000 other corporations.
The uncertainty surrounding the interpretation of the business judgment rule has real ramifications for community banks that are competing tooth and nail against larger banks, and each other, for quality loans. Community bank directors want the freedom to exercise their honest business judgment when it comes to lending, but unlike other corporate directors, they run the real risk of being sued if the loans default and the bank fails.
The FDIC's "Professional Liability Lawsuits" web page says that bank directors "are allowed to exercise business judgment without incurring legal liability," but it also notes that bank directors can be sued for "simple negligence."
A 1992 policy statement acknowledges that banks need to be able to "attract and to retain experienced and conscientious directors and officers." To that end, the FDIC assures officers and directors that "most suits" it files are limited to misconduct involving dishonesty, abusive transactions with insiders, violations of applicable laws, regulations, or bank underwriting policies, or disregard of regulatory warnings.
However, the FDIC has pursued some malpractice claims against community bank directors and officers premised on the absence of business judgment rule protection. In such cases, it seeks to hold directors and officers liable for simple negligence, without any showing that the challenged conduct involved fraud, illegality or self-dealing.
Where simple negligence is the standard, it becomes easy to second-guess underwriting decisions after a loan goes bad. This approach may be a good way to maximize recoveries to the insurance fund, but can create headwinds for community banks trying to attract quality officers and directors in already difficult business environment.
Mitchell Berns is a financial services litigator at Fox Rothschild LLP in New York. He served as a regulator of the Federal Home Loan Banks, and has defended community bank directors and officers against breach of fiduciary duty claims asserted by the FDIC.