As the UK Government shapes, and reshapes, provisions in the Financial Services (Banking Reform) Bill to make individual accountability a reality for senior individuals within banks (and now also more widely within PRA-regulated investment firms with permissions to deal as principal), it is interesting to glimpse how such issues are being considered elsewhere. In the US, Judge Thomas W Thrash Jr., of the District Court for the Northern District of Georgia (Atlanta Division), proposes to ask the Supreme Court of Georgia to consider whether the business judgment rule should supplant the standard of care required of bank officers and directors in a suit brought by the Federal Deposit Insurance Corporation (FDIC) as the bank’s receiver.
There is a common law presumption in the US, referred to as “the business judgment rule” that directors act in the best interests of the corporation they serve and that a court will therefore not review the substantive wisdom of directors’ business decisions. The presumption may be rebutted by pleading facts which, if taken as true, would show that the directors violated their duty of care or duty of loyalty.
The rule derives from the public policy consideration that directors need to be able to take informed and prudent risks. Directors would be frozen in inaction if they were to be subject to legal action for decisions which in hindsight were monetarily or otherwise unsuccessful for the corporation, and ultimately investors would suffer the consequences. The business judgment rule is notoriously difficult to overcome and generally requires a clear indication of fraud, gross negligence or self-interest.
In this case, the FDIC, as receiver for the bank, claimed that the bank’s former directors and officers had been negligent, and grossly negligent, in their management of the bank’s loan portfolio, and that this negligence led to the bank’s failure. The directors and officers argue that in Georgia, the business judgment rule applies to them, and would preclude the bringing of an ordinary negligence claim against them as a matter of law.
Under the Financial Institutions Reform, Recovery, and Enforcement Act,
“[a] director or officer of an insured depository institution may be held personally liable for monetary damages in any civil action by, on behalf of, or at the request or direction of [the FDIC as receiver] for gross negligence, including any similar conduct or conduct that demonstrates a greater disregard of a duty of care (than gross negligence) including intentional tortious conduct, as such terms are defined and determined under applicable State law.” 12 U.S.C. § 1821(k).
There is Supreme Court authority that the “gross negligence” standard is a floor, and does not prevent state law applying a stricter standard. In Georgia,
“[d]irectors 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.” O.C.G.A. § 7-1-490(a).
This provision has been interpreted in Georgia as allowing claims against bank directors and officers. Although the Court of Appeals has held that in general the business judgment rule precludes claims for ordinary negligence against the officers and directors of a corporation, no State Court in Georgia has explicitly extended the business judgment rule to protect the officers and directors of a bank being sued by the FDIC as receiver. It seems that Federal courts have uniformly applied the business judgment rule to protect bank officers and directors.
The Judge disagrees with that approach, for which he says there is no controlling precedent, noting that:
“there is every reason to treat bank officers and directors differently from general corporate officers and directors. In general, when a business corporation succeeds or fails, its stockholders bear the gains and losses. The business judgment rule is primarily applied in Georgia because the right to control the affairs of a corporation is vested by law in its stockholders – those whose pecuniary gain is dependent upon its successful management. But when a bank, instead of a business corporation fails, the FDIC and ultimately the taxpayer bear the pecuniary loss”.
The Judge also suggests that where the FDIC brings a case as receiver, this “is not simply a private case between individuals [but rather a case that] involves a federal agency appointed as a receiver of a failed bank in the midst of a national banking crisis”. It is not wholly clear why the fact that the claim is made by a receiver, who stands in the shoes of the bank, should deprive directors and officers of defences that would have been available in a claim brought by the bank itself.
In any event, the Judge declined to apply the business judgment rule to the ordinary negligence claim, and considered that the facts alleged were capable of supporting a finding of gross negligence, given that regulatory concerns had been ignored, the bank had invested far more aggressively that its peers, and had failed to adhere to procedures that would have identified the deficiencies. The Defendants’ motions to dismiss were denied, and the issue of unsettled law will be certified to the Supreme Court of Georgia by separate order. It will be interesting to see what the State Supreme Court makes of it.