Can the former directors and officers of a failed bank assert affirmative defenses against the Federal Deposit Insurance Corporation as receiver of the bank based upon the agency’s conduct postclosure?

The Eleventh U.S. Circuit Court of Appeals recently answered that question in the affirmative.

Integrity Bank of Alpharetta, Georgia, closed in August 2008 and the FDIC took over as receiver. The agency filed suit against members of the bank’s Director Loan Committee, alleging that they negligently pursued an unsustainable growth strategy, engaged in high-risk lending practices, and approved loans that resulted in losses exceeding $70 million. The complaint also claimed that the defendants breached their fiduciary duty.

In defense, the directors and officers argued that Georgia’s business judgment rule protected them against claims of ordinary negligence and breach of fiduciary duty. The defendants also presented an affirmative defense based on the FDIC’s own actions – specifically, failure to mitigate damages, reliance, and estoppel.

The three-judge panel first tackled the application of the business judgment rule to bank directors and officers.

“Based on our reading of the pertinent statutory language, it appears to us that a bank director or officer who acts in good faith might still be subject to a claim for ordinary negligence if he failed to act with ordinary diligence,” the court wrote. Two state appellate courts, however, have held that the business judgment rule forecloses liability against officers and directors for ordinary negligence in discharging their duties. Federal courts in California have held that officers are not entitled to the benefits of California’s business judgment rule, even where the officers also were directors.

Given the conflict, the court punted and certified the following questions to the Georgia Supreme Court: “Does a bank director or officer violate the standard of care established by [Georgia statute] when he acts in good faith but fails to act with ‘ordinary diligence,’ as that term is defined [by state law]?” and “In a case like this one, applying Georgia’s business judgment rule, can the bank officer or director defendants be held individually liable if they, in fact as alleged, are shown to have been ordinarily negligent or to have breached a fiduciary duty, based on ordinary negligence in performing professional duties?”

The court then turned to the directors’ affirmative defenses. The FDIC asserted that it owed no duty to bank directors and officers, but the court disagreed. The Financial Institutions Reform, Recovery, and Enforcement Act is silent on the issue, and the court could not find a preexisting “no duty” rule under federal common law, distinguishing the case law cited by the FDIC.

“In asking this court to apply a ‘no duty’ rule – which bars tort actions brought by a bank’s directors and officers against the FDIC – to bar affirmative defenses asserted against the FDIC when it is the one advancing claims, the FDIC is asking us to extend a purported federal common law rule to a new and significantly different context,” the panel wrote.

Ruling that “[f]ederal common law is basically complete and closed,” the court refused to create it. “Because the FDIC has failed to demonstrate the existence of an established and long-standing common law rule barring defendants’ affirmative defenses, and because we must decline to create a barring rule, the FDIC is unentitled to partial summary judgment,” the court concluded.

To read the complaint in FDIC v. Skow, click here.

Why it matters: The Eleventh Circuit’s decision presents a mixed bag of results for bank directors and officers. On a positive note, the federal appellate panel ruled that such parties can assert affirmative defenses against the FDIC based on its postclosure conduct. On the other hand, the panel questioned whether the protections of the state’s business judgment rule could properly be applied to bank directors and officers. If the Georgia Supreme Court determines that the rule does not apply – as one federal district court judge in the state recently suggested (see our previous newsletter, here) – bank directors and officers will have a lot more to be concerned about.