In 2009, there were 140 failed banks. So far this year, 16 more banks have been seized by the FDIC. There are 702 banks currently on the FDIC's troubled banks list, and regulators and analysts predict that several hundred of those likely will fail over the next two years.
Officers and directors of troubled financial institutions should pay serious and immediate attention to their risk of personal liability should their bank fail because the risk of litigation is becoming increasingly high. However, there are actions that can be taken to minimize as much as possible the risk of personal liability to bank agencies and shareholders when a bank fails.
The officers and directors of a failing or failed bank are subject to scrutiny by several federal and/or state regulators, but the most likely threat of litigation is from the FDIC. When a federally insured bank is closed, the FDIC is appointed as receiver. In that capacity, in order to recoup losses suffered by the bank, the FDIC has the authority, perhaps even a mandate, to pursue claims against the failed bank's officers and directors.
The liability of officers and directors is not based only on fraud or dishonesty. Officers and directors may be held liable for violations of bank policies and laws or regulations that resulted in safety and soundness violations; or failure to establish, monitor or follow proper underwriting procedures or heed warnings from regulators or advisors. Liability may also result from approving, overseeing or permitting a strategy of unsupportable growth with inadequate management supervision of liquidity or capital, measured in hindsight. That was the basis of claims recently brought against officers and directors of a failed Florida bank. In that case, the FDIC alleged, among other things, that the officers and directors allowed option ARM mortgages to represent 70% of the bank's residential loan portfolio, 60% of its total loan portfolio, and 575% of capital, all of which resulted from "reckless, high-risk and limited scrutiny lending to fuel the bank's aggressive and rapid growth." Given the rapid growth of so many community banks in the last ten years, it is likely the FDIC is considering making similar allegations against the officers and directors of many of the banks that have failed recently.
When Bank Failure Appears Imminent
The FDIC is much more likely to pursue claims against the officers and directors of a failed bank where it appears to the FDIC that the board was not actively engaged, that management or the board was in denial of the bank's troubles, or that the bank did not take appropriate action to respond to criticisms and concerns raised in regulatory exams. While in many cases the claims against the officers and directors of a failed bank will be based on events that occurred several years earlier, the FDIC will be less likely to pursue claims against officers and directors who remain actively engaged and who continue trying to the end to save the bank. In fact, even if failure appears inevitable, the board and management should continue taking all the steps they can to save the bank – responding to exam criticisms, complying with enforcement actions, seeking to raise capital, and managing the bank's nonperforming assets. These steps should be documented in board minutes and in correspondence with regulators.
If the bank is on notice from the FDIC that failure is scheduled, or if such notice is expected soon, there are things that officers and directors should do to prepare themselves in the event of post-failure litigation:
- Provide copies of relevant bank documents to special counsel to the board or another central source on behalf of all directors, such as the board chairman:
- Board minutes (documenting efforts to save the bank)
- Loan committee minutes
- Board Resolutions and Corrective Action Plans
- Documentation of compliance with regulatory criticisms
- Copies of D&O policies
- Correspondence with federal and state bank regulators
- Records of all internal meetings attended
- Letters and emails exchanged with management, regulators and bank counsel
- Document efforts, especially board and committee meeting minutes, to solve problems/save the bank.
- Resolve insider loans by payment or move to another bank.
- Comply with "golden parachute" rules which prohibit severance payments to insiders of troubled banks.
- Remove personal items from bank premises.
- Engage independent special counsel for the Board.
- Review D&O policies for coverage limits and exclusions.
If the Bank Fails
As of the date of seizure, all communication with the FDIC must be regarded as adversarial and made in anticipation of litigation. At that point, regular bank counsel cannot advise bank officers and directors on any matter which might be adverse to the FDIC. Therefore, it is important that the board retain independent special counsel prior to closure to, among other things, assist with FDIC interviews during the closing weekend. Selecting special counsel early in the process gives counsel time to review potential issues and be prepared for questions that may arise during the closing process. After closure, counsel will assist officers and directors to avoid/mitigate personal liability claims from regulators and shareholders. If the bank has a holding company, bankruptcy counsel also should be engaged.
Typically, the FDIC will file a claim for 100% of available coverage under the bank's D&O policy on the day the bank is seized. Bank officers and directors through counsel should immediately place D&O carriers on notice of claims and seek coverage determinations.