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Article: Will the FDIC’s Claims Against Directors and Officers of Failed Banks for Simple Negligence Yield to the Protections of the Business-Judgment Rule?

November 01, 2012
Business Litigation Reports

Federal legislation has yet to specify the extent to which state law may protect directors and officers of failed banks against claims of simple negligence by FDIC, and Congress may soon be urged to step in. For now, directors of banks can breathe a modest sigh of relief. Earlier this year, the Federal District Court for the Northern District of Georgia ruled that directors of banks that failed during the 2008 economic collapse cannot be liable to the FDIC for simple negligence in a case when the directors qualify for protection under a state’s business-judgment rule.

Whenever a bank insured by the FDIC fails, the FDIC will cover the bank’s depository losses while retaining authority to sue those it deems responsible for causing the bank to fail. Integrity Bank of Alpharetta, Georgia had losses of over $70 million and failed. The FDIC, in its capacity as receiver of the failed Integrity Bank, brought a professional-liability lawsuit against a number of the bank’s former officers and inside and outside directors.

Such actions by the FDIC are nothing new. Since 2009, the FDIC has authorized over 460 lawsuits and formally filed 27 complaints in federal district courts. Some of the larger bank failures, including those of IndyMac and Washington Mutual, have been followed by professional liability lawsuits, yet many of the largest bank failures have not been. If history is any guide, bank directors and officers may face professional liability complaints or settlement agreements in the coming years.

The district court’s recent order in the case against Integrity Bank and its directors and officers should offer some comfort. Almost all of the 27 complaints the FDIC has filed since 2009 accuse the directors and officers of simple negligence, gross negligence, and breach of fiduciary duties. In many states, including Georgia, however, the business-judgment rule protects against claims for simple negligence. To qualify for protection under the business-judgment rule, as recited by the Georgia court (quoting the Georgia statute), a director or officer must have “discharge[d] 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.” Given the contours of that protection, the district court determined that the FDIC’s “claims for ordinary negligence and breach of fiduciary duty based upon ordinary negligence fail to state a claim upon which relief can be granted.”

It follows from the ruling that, to hold Integrity Bank’s former directors liable, the FDIC would have to prove they were grossly negligent. For instance, the Georgia court referred to instances where a defendant has “engage[d] in fraud, bad faith, or an abuse of discretion” as instances that would extend beyond simple negligence and outside “the ambit of the protections of the business judgment rule.” Gross negligence is more difficult to prove than simple negligence.

Notwithstanding the court’s decision with respect to Integrity Bank and its former directors, the FDIC is persisting in its efforts to hold directors liable for simple negligence. The FDIC is seeking reconsideration of the court’s ruling and indicated that it may appeal to the U.S. Court of Appeals for the Eleventh Circuit. Following the Integrity Bank order, the agency also filed two more complaints in Georgia against directors and offices of failed Georgia banks. Both allege claims for simple negligence.

The business-judgment rule has yet to be tested outside of Georgia as a defense against a claim of simple negligence by FDIC. Thus, there is cause for doubt and room for argument. Officers and directors of failed banks should monitor how courts handle the FDIC’s simple-negligence claims against former directors and officers who invoke the business-judgment rule in their defense. Beyond that, officers and directors may ask Congress to pass legislation that federalizes the business-judgement defense for bank officers and directors.   On the flip side, if the Georgia district court’s ruling starts a trend, then the FDIC may seek expanded authority from Congress to hold officers and directors liable for simple negligence.