As the financial crisis unfolds, the impact on U.S. financial institutions of all sizes continues to grow. The Federal Deposit Insurance Corporation (FDIC) took over 140 failed banks in 2009 at a cost of $27.8 billion to the Deposit Insurance Fund, a new high since the end of the savings and loan crisis of the late 80s and early 90s. For 2010, the FDIC is preparing for even more bank failures, increasing its budget by 35 percent and adding more than 1,600 to its staff.
For the officers and directors of failed banks, the problems do not end when the FDIC is appointed receiver of their institution. The FDIC has the option of suing former board members and executives for engaging in allegedly unsafe and unsound banking practices, breaching fiduciary duties, committing gross negligence, and other potential claims. In some cases, it has already sent demand letters. We have seen several such demand letters and are already counseling many targeted directors and officers. The FDIC aggressively pursued similar lawsuits against former directors and officers of failed banks nearly two decades ago, seeking to satisfy the FDIC’s statutory mandate to recover assets by triggering coverage from D&O insurance or from the private holdings of high net-worth individuals.
In addition to FDIC litigation risk, the risk also exists that the federal banking agency with primary supervisory authority over the failed institution — which can be the FDIC (in the case of most failed state-chartered banks), the Federal Reserve (in the case of certain failed state-chartered banks), the Office of the Comptroller of the Currency (in the case of failed national banks), or the Office of Thrift Supervision (in the case of failed savings and loan associations) — can threaten or initiate an administrative enforcement proceeding against the failed institution’s directors and officers, in which the agency may seek a civil money penalty or even a permanent ban barring that individual from ever working in the U.S. banking industry. In many cases, D&O insurance policies do not cover the payment of civil money penalties, and the institution is generally statutorily prohibited from indemnifying a former director or officer for his or her civil money penalty.
To fully understand and guard against FDIC litigation risk and federal banking agency enforcement risk, all current and former executives of FDIC-insured depository institutions should consult with experienced counsel to determine the scope and coverage of their D&O insurance, to organize their business records in preparation for a defense against a potential suit, and to assess their personal legal risk and available defenses to any claim.
Tips for the Wary
While most bank executives assume that they are covered by D&O insurance against all claims asserting breach of fiduciary duties, this is not always the case. Mindful of the worsening economic situation and resulting increase in risk, many D&O insurers have created exclusions for claims brought against bank executives by regulatory agencies such as the FDIC. Even when the policy does not contain an explicit regulatory exclusion, D&O insurers often seek to deny coverage for claims brought by the FDIC as receiver for a failed bank under a socalled "insured-versus-insured" exclusion, which bars coverage for claims by one insured entity (e.g., the bank) against another (e.g., the officers and directors). In our experience, such efforts often have little basis in fact. Some courts, however, have held that coverage is precluded by the "insured-versus-insured" exclusion because the FDIC steps into the shoes of the bank when pursuing claims against the bank’s former directors and officers. The success of these coverage defenses will depend on the specific wording of the policy and the state in which the claim is brought.
Obviously, the best time to prepare for a lawsuit from the FDIC is before a bank fails. After the FDIC is appointed receiver, former bank executives may no longer have access to data and documents stored on bank computers, servers, or in office files. It is therefore important for bank executives to consult with experienced counsel, before (or as) significant concerns about the bank’s survival arise, in order to make a plan for preserving documents necessary to defend any possible FDIC claim, such as any relevant board minutes, loan committee minutes, and resolutions or corrective action plans that can be used as evidence to corroborate former directors’ or officers’ position that they were not responsible for the failure of the institution. This is a particularly sensitive area, however, and care should be exercised to avoid any future allegation that official institution records were removed from the premises.
With more than 100 additional bank failures forecast for 2010, it is important to prepare now for the worst. The statutes of limitations for the types of claims the FDIC may bring are determined by state law, and can vary significantly. Depending on the state, the FDIC may have years from the date of bank failure to assert claims against former executives. With the FDIC expecting increased funding, staffing and bank failures in 2010, officers and directors can anticipate that the agency will issue more demand letters and bring more lawsuits against them.
FDIC actions involve a number of specialized legal areas, including regulation of insured depository institutions, derivative claims and fiduciary obligations of directors under state law, and D&O insurance issues. It would be prudent for directors and officers of those institutions to consult with specialists in these areas, preferably before the need arises.