In the context of Federal Deposit Insurance Corporation (FDIC) litigation against the former directors and officers of a failed bank, the Georgia Supreme Court has upheld the validity of the business judgment rule in the state – while leaving the door open for some negligence claims.

Answering a certified question from a federal district court, Georgia’s highest court determined that the business judgment rule is enshrined in state case law dating back to 1913 and has not been overruled by state statute. However, the court held that negligence claims alleging that decisions were made without deliberation or the requisite due diligence, or in bad faith, could be actionable.

The case involved nine former directors and officers of the failed Buckhead Community Bank. As receiver, the FDIC brought suit alleging the defendants were negligent with respect to the making of loans resulting in almost $22 million in losses.

Relying on the business judgment rule’s protection from liability for ordinary negligence, the officers moved to dismiss the suit. The FDIC countered that the rule was not a part of Georgia common law and even if it were, it would not apply to bank directors and officers who have a statutory duty in the state to exercise ordinary diligence and care.

Uncertain about the application of the rule in light of the statute, the federal court judge certified a question to the Georgia Supreme Court: “Does the business judgment rule in Georgia preclude as a matter of law a claim for ordinary negligence against the officers and directors of a bank in a lawsuit brought by the FDIC as receiver for the bank?”

With “an important qualification,” the court answered in the negative.

The unanimous court found “an implicit acknowledgement” of the business judgment rule in a number of prior decisions. But the court emphasized that case law “distinguished between claims of unreasoned and uninformed decisions and claims of unreasonable decisions. That is, we distinguished between cases in which a business decision was assailed for the way in which it was made – that the decision amounted to unthinking acquiescence, for instance, or was made without reasonable diligence to ascertain the relevant facts – and those in which the merit alone of the decision was disputed.” In other words, disputes about the wisdom of a business judgment “require something more than a mere want of ordinary care to establish liability,” but whether a business decision was in fact an exercise of judgment – “a product of deliberation, reasonably informed by due diligence, and made in good faith” – is open to judicial scrutiny.

A Georgia statute setting forth requirements for bank officers and directors did not supersede the common law business judgment rule, the court added.

The statute reads in part: “Directors and officers of a bank or trust company shall discharge the duties of their respective positions in good faith and with that diligence, care, and skill which ordinarily prudent men would exercise under similar circumstances in like positions. … A director or officer who so performs his duties shall have no liability by reason of being or having been a director or officer of the bank or trust company.”

Based on a review of statutory history and the underlying objective to allow financial institutions to exercise their business judgment, the statute should be understood as consistent with the common law, the court said.

“[T]hese provisions imply strongly that, if an officer or director fails to act in good faith or with such ordinary care, he is subject to liability,” the court wrote. “But taken in its legal context, the statutory reference to ordinary ‘diligence, care, and skill’ is most reasonably understood to refer to the care required with respect to the process by which a decision is made, most notably the diligence due to ascertain the relevant facts. So understood, the implication of liability means only that an officer or director who acts in bad faith or fails to exercise such ordinary care with respect to the process for making a decision is liable.”

The court rejected the defendants’ attempt to recognize a business judgment rule that would preclude all claims against officers and directors, settling on “a more modest business judgment rule.” Allowing some claims against bank officers and directors will not deter bank management from taking risks, the court said, underestimating the strength of the business judgment rule.

“[B]ank officers and directors are only expected to exercise the same diligence and care as would be exercised by ‘ordinarily prudent’ officers and directors of a similarly situated bank,” the court explained. Pursuant to the business judgment rule, a presumption exists that the officers and directors have acted in good faith and exercised ordinary care. “Although this presumption may be rebutted, the plaintiff bears the burden of putting forward proof sufficient to rebut it,” the court said. “All together, the limited standard of care, the conclusive presumptions as to reasonable reliance, and the rebuttable presumptions of good faith and ordinary care offer meaningful protection, we think, to officers and directors who serve in good faith and with due care.”

While the rule does not insulate “mere dummies or figureheads” from liability, it was never intended to, the court added. “[T]he business judgment rule precludes some, but not all claims, against bank officers and directors that sound in ordinary negligence,” the court concluded. “With that qualification, we answer the certified question in the negative.”

To read the court’s opinion in Federal Deposit Insurance Corporation v. Loudermilk, click here.

Why it matters: Courts have been faced with this issue in the wake of the financial crisis and FDIC suits against former directors and officers of failed banks. The Loudermilk decision presents a reasoned approach for Georgia, whose law, unlike California’s, specifically protects officers and directors. While the court declined to adopt the defendants’ more expansive interpretation of the law that would preclude all claims based on ordinary negligence, it did recognize that the protections of the business judgment rule generally apply to bank officers and directors who diligently inquire, engage and deliberate in a reasoned fashion. The wisdom of decisions taken with appropriate diligence and process will not be questioned by the courts.