Almost all cases brought by the FDIC in the last few years against former directors and officers of failed banks have been resolved by negotiated settlements. However, in a recent decision, a federal court judge in North Carolina granted summary judgment to the former directors and officers of a failed bank in an action brought by the FDIC.
The Cooperative Bank of Wilmington was declared insolvent in June 2009. The FDIC stepped in as receiver and initiated a lawsuit against former officers and directors of the bank alleging negligence, gross negligence, and breaches of fiduciary duty. The claims focused on the approval of 86 loans made over a 15-month period in 2007 and 2008, which the FDIC said deviated from prudent lending practices established by Cooperative’s loan policy, published regulatory guidelines, and generally established banking practices. The FDIC sought to recover approximately $40 million.
Relying on the North Carolina version of the business judgment rule, the directors and officers filed a motion for summary judgment, contending that they acted reasonably, in good faith and in the best interests of the bank. They also claimed that the losses allegedly incurred could not have been reasonably foreseen.
U.S. District Court Judge Terence W. Boyle – characterizing the FDIC’s position as “absurd” and “wholly implausible” – granted the motion.
“The substantial discovery produced in this case, which includes voluminous records, 15 depositions of party, third party, and expert witnesses including Cooperative’s regulators at the FDIC, fails to reveal any evidence that suggests any defendant engaged in self-dealing or fraud, or that any defendant was engaged in any other unconscionable conduct that might constitute bad faith,” the court said, refusing to engage in Monday morning quarterbacking.
“Although the decisions of defendants to engage in various forms of lending and to make the particular loans challenged in the complaint, and the wisdom of such decisions raise interesting discussion points in hindsight, the business judgment rule precludes this court from delving into whether or not the decisions were ‘good’ and limits the court’s involvement to a determination of whether the decisions were made in ‘good faith’ or were founded on a ‘rational business purpose,’ ” Judge Boyle wrote.
While the complaint alleged that the defendants ignored multiple Reports of Examination (ROE) issued by the FDIC warning Cooperative about underwriting and credit practices, the court said the very same ROEs also graded the defendants’ management, asset quality, and sensitivity to risks as “satisfactory” and not requiring “material changes,” with a CAMELS 2 rating.
“Therefore the facts show that the process that defendants used to make the challenged loans were expressly reviewed, addressed, and graded by FDIC regulators,” the court said, “and to now argue that the process behind the loans is irrational is absurd. Further, each of the loans at issue was subject to substantial due diligence and an approval process that defies a finding of irrationality.”
The defendants’ actions could also be attributed to a rational business purpose, the court found. “Cooperative’s pursuit of the challenged loans was in furtherance of Cooperative’s goal to grow to a $1 billion institution and stay competitive with other regional and national banks making substantial inroads into its territory,” Judge Boyle wrote.
“Although there were clearly risks involved in Cooperative’s approach, the mere existence of risks cannot be said, in hindsight, to constitute irrationality. Further, corporations are expected to take risks and their directors and officers are entitled to protection from the business judgment rule when those risks turn out poorly. Where, as here, defendants do not display a conscious indifference to risks and where there is no evidence to suggest that they did not have an honest belief that their decisions were made in the company’s best interests, then the business judgment rule applies even if those judgments ultimately turn out to be poor.”
Judge Boyle also took the opportunity to opine on the FDIC’s claim that the officers and directors should have foreseen the economic recession.
The FDIC’s “absurd” position “claims that defendants were not only more prescient than the nation’s most trusted bank regulators and economists, but that they disregarded their own foresight of the coming crisis in favor of making risky loans. Such an assertion is wholly implausible,” he wrote. “It appears the only factor between defendants being sued for millions of dollars and receiving millions of dollars in assistance from the government is that Cooperative was not considered to be ‘too big to fail.’ Taking the position that a big bank’s directors and officers should be forgiven for failure due to its size and an unpredictable catastrophe while aggressively pursuing monetary compensation from a small bank’s directors and officers is unfortunate if not outright unjust.”
To read the order in FDIC v. Willetts, click here.
Why it matters: This is the first time in the aftermath of the Great Recession that a court has soundly rejected FDIC’s claims that bank officers and directors could have foreseen the recession where federal regulators like Federal Reserve Chairmen Alan Greenspan and Ben Bernanke could not. It upheld the validity of the North Carolina business judgment rule, taking a hands-off approach to the analysis of the defendants’ actions once the court determined their actions were rational and employed in a good faith effort to advance the corporate interests. Significantly, Judge Boyle also used the FDIC’s own regulatory examinations of the bank and satisfactory ratings to rebut its contention that the defendants acted negligently. In view of the court’s complete dismissal of the claims, the FDIC is likely to appeal.