Why it matters
A shareholder suit against a bank holding company and its directors and officers was precluded by the Federal Deposit Insurance Corporation’s (FDIC) receivership of the underlying failed bank, the Tenth Circuit Court of Appeals has ruled. A class of bank holding company shareholders sued after the Utah-based Barnes Banking Company collapsed in 2010, allegedly due to risky lending practices. Although the federal appellate panel was not immune to the position of the plaintiffs—noting that the allegations provided evidence of a pattern of financial recklessness—the court affirmed dismissal of the suit based on the principal that claims against the holding company represent derivative injuries to the Bank, and claims of a shareholder against a bank and assets of the bank belong to the FDIC as receiving under Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). Accordingly, shareholders seeking to look through the corporate veil of a failed bank to get to the holding company will face a formidable task in any effort to obtain recovery apart from the efforts of the FDIC.
In January 2010, the Barnes Banking Company closed and the Federal Deposit Insurance Corporation (FDIC) was appointed as receiver. Two years later, three different shareholders filed derivative suits against the bank’s holding company, Barnes Bancorporation and its officers and directors.
Each of the complaints alleged the bank ran aground due to risky lending practices and that the officers and directors breached their fiduciary duty. As required by Utah law, a demand letter accompanying the complaints described the holding company as having a single asset: the bank.
The FDIC filed a motion to intervene in the state court suit, arguing that it possessed the exclusive statutory authority under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) to assert the derivative claims at issue. When the state court granted the FDIC’s motion, the agency removed the case to federal court.
Fighting the FDIC’s involvement in the case, the plaintiffs tried to move the case back to state court and moved to dismiss the FDIC from the litigation for failure to state a claim. Both motions were denied and a federal district court judge granted the FDIC’s motion to dismiss, albeit with room to amend.
The shareholders responded with a second amended complaint trying to refocus their allegations from harm at the bank level to mismanagement at the holding company, claiming that the bank’s management should have been removed and replaced, for example, and that the holding company improperly issued dividends. An additional claim that the holding company misused $265,000 to pay for an insurance policy for the directors and officers was also added.
On the FDIC’s second motion to dismiss, the district court not only granted the motion but also did so without leave to amend. The plaintiffs appealed.
Agreeing with the district court, the Tenth Circuit Court of Appeals affirmed dismissal. “Because almost all of the plaintiffs’ claims assert injury to the Holding Company that is derivative of harm to the Bank, those claims belong to the FDIC,” the panel wrote. The one claim advanced by the plaintiffs not owned by the FDIC—that the bank directors and officers misappropriated $265,000—lacked sufficient details to survive the motion, the court added.
First, the panel reviewed whether the federal courts had proper jurisdiction over the dispute. The crisis to the United States banking system in the 1980s and subsequent passage of FIRREA, which provides that all suits to which the FDIC is a party shall be deemed to arise under federal law, pointed the way.
The shareholders’ argument that the FDIC never filed a pleading—just a motion to intervene—and was therefore never a party to the case failed to sway the panel. A majority of courts to consider the issue have excused the failure to file a pleading in some circumstances, the court said, and the FDIC successfully intervened before it removed the case.
Treating an intervening entity as a party even without requiring them to file a pleading “is consonant with the Federal Rules,” the court said, as defendants who have not filed pleadings in response to a complaint are still referred to by the Rules as “parties.” Further, “allowing the FDIC to intervene and remove the case is consistent with Congress’ purpose in enacting FIREEA: providing the FDIC a federal forum.”
That settled, the court turned to the merits of the dispute.
FIRREA grants the FDIC “all rights, titles, powers, and privileges of the [bank], and of any stockholder . . . of such [bank] with respect to the [bank] and the assets of the [bank],” so that when the FDIC became Barnes’ receiver, FIRREA gave the FDIC all rights that the holding company, a stockholder of the bank, possessed with respect to the bank and its assets.
Lacking guidance in the Tenth Circuit on whether FIRREA applied to a situation where a suit for breach of fiduciary duty was brought against a bank holding company’s officers after a subsidiary bank has gone into FDIC receivership, the panel turned to decisions from the Fourth and Seventh Circuits, as well as an unpublished opinion from the Eleventh Circuit.
In each of those cases, the courts found the FDIC’s receivership trumped the plaintiffs’ claims. “If the Holding Company’s claims are based on harm derivative of injuries to the Bank, then they qualify as claims of a shareholder ‘with respect to the [bank] and the assets of the [bank]’ and belong to the FDIC,” the panel wrote.
Under Utah law, derivative suits are defined as “those which seek to enforce any right which belongs to the corporation,” the court explained. Other than the claim regarding the $265,000 allegedly misused by the defendants, the shareholders “do not allege any harm to the Holding Company that is distinct and separate from the harm to the Bank.”
For example, the claim that the defendants made improper dividend payments to the Holding Company’s shareholders could not be distinguished, the court said, because “even if the plaintiffs could show that dividend payments weakened the Holding Company’s finances, this weakening would not have injured plaintiffs absent the Bank’s failure,” and the payments “thus did not cause any independent harm, but rather resulted in injury because of the Bank’s failure.”
“Plaintiffs allege that mismanagement by the defendants harmed the Bank and in turn the Holding Company,” the panel said. “They have attempted to carefully plead their claims, alleging that the defendants breached their duties to the Holding Company by failing to protect the Holding Company from mismanagement—by these same defendants—at the Bank level. But plaintiffs nonetheless seek redress for injuries that first befell the Bank, and reached the Holding Company only derivatively as a result of its ownership interest in the Bank. Under Utah law, such claims are decidedly derivative in nature.”
The result was also consistent with the requirement that shareholders not circumvent the interests of creditors and the FDIC, the court added.
“Ultimately, even though plaintiffs in this case may not have been to blame for the losses incurred, they did fail to prevent the officers and directors from incurring the losses at issue,” the panel wrote. “After the Bank had run aground, these plaintiffs then brought suit to recover their losses. However, the Bank’s failure imposed losses not only on sophisticated parties like plaintiffs, who had the ability to inspect the Bank’s records, but also on ordinary depositors, whom the FDIC is obliged to make whole.”
The fact that the FDIC may ultimately elect not to pursue litigation against the defendants does not entitle the plaintiffs to pursue it, the court noted.
A final claim that the defendants wasted $265,000 in company funds on insurance premiums for the directors and officers and “potential business opportunities” could not save the suit. Although the FDIC asserted no claim to the funds, the plaintiffs failed to plead sufficient facts to explain how these “common expenditures would constitute an actionable wrong.”
“We are not unmoved by the frustration that plaintiffs express as they describe the collapse of the Barnes Banking Company,” the panel concluded, refusing to permit the plaintiffs to file a third amended complaint. “And our decision should not be read as evincing approbation of the conduct allegedly engaged in by its officers and directors, much less the larger pattern of misconduct exemplified by those alleged actions. The allegations demonstrate a pattern which, when repeated in many instances, inflicted severe injury on our financial system and on the many families whose livelihoods were dependent on that system.
“But, we uphold the district court’s order because we recognize the broad scope of authority afforded the FDIC in dealing with the aftermath of just such a bank failure. Bank holding company shareholders, concerned about the potential collapse of a bank, must employ their powers as shareholders to stave off a bank collapse. When they fail to do so, they cannot then get underfoot and attempt to advance claims which are inconsistent and interfere with the cleanup efforts properly delegated by Congress to the FDIC.”
To read the opinion in Barnes v. Harris, click here.