Banks have been one of the hardest hit and most scrutinized businesses in the financial crisis we all now refer to as the Great Recession. After two consecutive years in which there were no regulatory bank failures in this country, 2007 gave us the briefest glimpse of what was to come, with three (3) banks being seized by regulators and the Federal Deposit Insurance Corporation (FDIC) installed as conservator or receiver. The pace picked up in 2008 with 25 bank failures, followed by an avalanche of failures in 2009 (140), 2010 (157), 2011 (92) and 2012 (51). Since 2012, the trend has shown a steep decline in bank failures, with only six (6) this year through July 2015. While there were some mammoth bank failures – IndyMac and WAMU come to mind – the majority of the banks that were seized by regulators from 2008 through 2012 were smaller, community banks. Some bank executives and bank customers were prosecuted criminally for a variety of fraudulent activities, including making false entries in the records of a financial institution and forging documents. Perhaps the most aggressive of litigants in the financial crisis, the FDIC in its capacity as receiver, filed scores of lawsuits against directors and officers (D&Os) of failed banks, which for the most part claimed that these D&Os approved loans without adhering to the appropriate standard of care. This standard of care under federal law is at least gross negligence, but may be more stringent depending on state law. 12 U.S.C. § 1821(k).
The vast majority of these director and officer cases settled before trial. The settlement agreements are available on the FDIC’s website, www.fdic.gov. Bookending these settlements are two cases that were resolved with final judgments: the IndyMac case, which resulted in a $169,000,000.00 verdict by a California jury in December 2012, and the Cooperative Bank case (“Rippy”), in which a North Carolina district court judge entered summary judgment in favor of the defendant directors and officers in September 2014. Recently, the Fourth Circuit Court of Appeals in the Rippy case affirmed the summary judgment in favor of the directors, but reversed that in favor of the officers based upon the different standards of care imposed upon directors and officers under North Carolina corporate law. Thus, in the evaluation of the same loans and same banking practices, the directors were exonerated and the officers are forced to defend the claims in court, possibly in a trial if the parties are unable to reach a settlement.
With the substantial decline in regulatory bank failures, it is likely that there will be far fewer director and officer cases filed by the FDIC. While these cases have involved a morass of banking regulations and terms (CAMELS is a bank rating standard, not an ill-tempered mode of desert transportation), they have primarily turned on corporate practices and standards generally applicable to businesses and business litigation. This series of articles will explore the concepts from these FDIC cases, as they may be applicable to other commercial matters.
RISK EVALUATION: IT’S BETTER TO BE A DIRECTOR THAN AN OFFICER
Based in part upon cases arising out of the Savings & Loan crisis of the late 1980s and early 1990s in Florida, it appeared that both directors and officers of Florida corporations had the same statutory protections from liability when performing their duties on behalf of Florida corporations. Following the adoption of Section 607.0831, Florida Statutes, for years Florida state and federal decisions held that both directors and officers of Florida corporations were protected by this statutory version of the business judgment rule, meaning that no matter how poor their business judgment was, directors and officers would only be held personally responsible to a corporation or its shareholders upon a showing that they engaged in conduct that was either fraudulent, illegal or in bad faith. See Sheridan Healthcorp, Inc. v. O’Rourke, No. 00-020282, 2007 WL 7035809 (Fla. Cir. Ct. Broward Cnty., July 12, 2007) (citing In re Bal Harbour Club, Inc. v. AVA Development, Inc., 316 F.3d 1192 (11th Cir. 2003)). This analysis seemingly dates back to 1993 when the court in Fed. Deposit Ins. Corp. v. Gonzalez, 833 F. Supp. 1545, 1556 (S.D. Fla. 1993) analyzed Section 607.0831 and concluded that “prior to July 1, 1987 (the date on which the statute became effective), the law of Florida imposed liability on corporate directors and officers for simple negligence, and after that date, Florida imposed liability only for acts constituting more than gross negligence.” The Eleventh Circuit reached the same conclusion in FDIC v. Stahl, 89 F.3d 1510 (11th Cir. 1996). Then, in one of the earlier Great Recession FDIC cases, the court in Fed. Deposit Ins. Corp. v. Price, No. 2:12-cv-00148-UA-DNF, 2012 WL 3242316, at **2-3 (M.D. Fla. Aug. 8, 2012) reiterated this same approach.
Unfortunately for corporate officers, after some earlier adverse rulings, the FDIC was able to overcome prior precedent by focusing on the actual language of Section 607.0831. See, e.g. Fed. Deposit Ins. Corp. v. Brudnicki, No. 5:12–cv–398–RS–GRJ, 2013 WL 2145720, *2 (N.D. Fla. May 15, 2013) (dismissing ordinary negligence claim against director defendants, but allowing the same claim against those defendants who were both officers and directors to stand, finding that Section 607.0831 does not provide a heightened level of protection for directors acting in their capacity as officers). In fact, Section 607.0831 begins by stating, “[a] director is not personally liable…” The statutory provision does not contain any reference to officers of a corporation. Thus, courts like Brudnicki reasoned that the Florida legislature did not intend to provide the same level of protection to corporate officers when making business decisions as afforded to corporate directors.
The Rippy case, based upon North Carolina law, shows that this disparity of exposure between directors and officers is not unique to Florida. In Rippy, the Fourth Circuit Court of Appeals ruled that the protections provided to directors under North Carolina’s business judgment rule insulated them from negligence liability. The directors were exonerated because they could only be held liable if they were grossly negligent, which requires a showing that they did not show even slight care in their business decisions. The bank officers in Rippy, who did not have the benefit of this rule for engaging in and making the very same business judgments as the directors, are now faced with a trial and the potential for adverse personal judgments totaling millions of dollars each.
So what is the practical impact of decisions like the ones in the Brudnicki and Rippy cases? Well, for example, if a corporate officer’s business judgments are subject to a negligence standard, six (6) strangers to the business of the corporation and the loan transactions at issue (we call them jurors) will decide if the officer should have approved the loans. While these six strangers may well be equipped to ferret out lies, self-dealing and fraud – the kinds of things for which directors would be liable – asking them to look to the past and decide whether loan underwriting, appraisals, engineering and environmental reports provided a sufficient basis to make a loan seems too high of an expectation. Frankly, having a court or a jury second guess business judgments which are unaccompanied by objective wrongdoing like self-dealing or a complete lack of care (i.e., gross negligence) translates into the kind of second-guessing that inhibits business judgments. It is important to remember that the rulings in these bank director and officer cases are not limited to claims brought by the FDIC or to banking. Because FIRREA applies state law when the standard of proof for liability is less than gross negligence, these cases may well apply to the conduct of directors or officers of any corporation. The cases will provide the measure for the conduct of Florida corporate officers until a state appellate court rules to the contrary.
WHAT IS AN OFFICER/DIRECTOR TO DO?
What can be done to limit the exposure of officers who are also directors when they participate in decisions of the board of directors? Clear by-laws and corporate policies can help, critically serving to specify the kinds of transactions that can only be approved by directors. As is often the case, corporate officers routinely serve on the board of directors. Maintaining a clear record of the kinds of transactions that require board approval, and including a statement that those officers who serve on the board and who vote for such transactions do so solely in their capacity as directors, should protect the officer/directors from being judged by a negligence standard when acting in their capacity as directors. Corporate by-laws should also make clear that officers who are also directors are to be held only to the standard of care applicable to directors when participating in board discussions and votes.
This promises to be an evolving area of corporate litigation – not just limited to banking and receivership litigation – so having carefully crafted by-laws can provide protection to corporations that recognize the benefit of involving high ranking corporate officers in board of director’s deliberations. In banking, the by-laws can help protect officer/directors from unfair treatment by regulators such as the FDIC. In other corporations, clearly worded by-laws can help protect officers, when acting in their dual capacity as directors, from broad exposure to shareholder claims and potential creditor claims. While the officers will still have increased exposure for actions taken in their capacity as officers, such as approving loans that do not require board approval, there is no good reason to allow their liability for decisions made as directors to be broader than other directors.
By-laws are contracts between the corporation and its shareholders. With the risk of shareholder litigation against officers being judged on a negligence standard, businesses that use the corporate form can use by-laws, insurance and carefully drafted documentation to provide a fair legal environment necessary to attract and retain savvy, talented officers.
“JUST GET CANNED BYLAWS OFF THE INTERNET!” TEXTED THE SOON-TO-BE PRESIDENT AND CHAIRMAN OF THE BOARD AS HE DROVE DOWN THE HIGHWAY WITH NO SEAT BELT AND HIS BRAKE FAILURE WARNING LIGHT FLASHING.
John E. “Sean” Johnson is a partner with Johnson & Cassidy, P.A. in Tampa, Florida. A substantial part of his business and commercial litigation practice involves defending bank directors and officers in suits brought by the FDIC in its receivership capacity. Recently, Sean was named the Best Lawyers 2016© Tampa Litigation – Banking and Finance “Lawyer of the Year” for Tampa, an annual recognition given to only one lawyer in each community for a given practice area. Sean can be reached at (813) 699-4859, or by visiting www.jclaw.com.