By Leonard J. Rubin

On July 2, 2010, the FDIC filed the first lawsuit in the current financial crisis against former officers of a closed financial institution arising from alleged loan losses to the bank. The FDIC filed a complaint in federal court in California against former officers of the homebuilding division of IndyMac Bank for civil money damages. The action was filed almost two years after the bank was closed by the regulators and the FDIC was appointed as Receiver. The FDIC made claims against several former officers for negligence and breach of fiduciary duty which allegedly caused the losses in Acquisition, Development and Construction loans during 2002-2007.  In the wake of the savings and loan failures between 1985 and 1992, bank regulators filed claims against former directors and officers in connection with approximately 24 percent of bank closures .

Officers and directors of troubled financial institutions should pay serious and immediate attention to their risk of personal liability should their bank fail because the risk of litigation is becoming increasingly high. However, there are actions that can be taken to minimize as much as possible the risk of personal liability to bank agencies and shareholders when a bank fails.

The Claims

The officers and directors of a failing or failed bank are subject to scrutiny by several federal and/or state regulators, but the most likely threat of litigation is from the FDIC. When a federally insured bank is closed, the FDIC is appointed as receiver. In that capacity, in order to recoup losses suffered by the bank, the FDIC has the authority, perhaps even a mandate, to pursue claims against the failed bank's officers and directors.

The liability of officers and directors is not based only on fraud or dishonesty. Officers and directors may be held liable for violations of bank policies and laws or regulations that resulted in safety and soundness violations; or failure to establish, monitor or follow proper underwriting procedures or heed warnings from regulators or advisors. Liability may also result from approving, overseeing or permitting a strategy of unsupportable growth with inadequate management supervision of liquidity or capital, measured in hindsight.

When Bank Failure Appears Imminent

The FDIC is much more likely to pursue claims against the officers and directors of a failed bank where it appears to the FDIC that the board was not actively engaged, that management or the board was in denial of the bank's troubles, or that the bank did not take appropriate action to respond to criticisms and concerns raised in regulatory exams.  While in many cases the claims against the officers and directors of a failed bank will be based on events that occurred several years earlier, the FDIC will be less likely to pursue claims against officers and directors who remain actively engaged and who continue trying to the end to save the bank.  In fact, even if failure appears inevitable, the board and management should continue taking all the steps they can to save the bank – responding to exam criticisms, complying with enforcement actions, seeking to raise capital, and managing the bank's nonperforming assets.  These steps should be documented in board minutes and in correspondence with regulators.

If the bank is on notice from the FDIC that failure is scheduled, or if such notice is expected soon, there are things that officers and directors should do to prepare themselves in the event of post-failure litigation:

1)    Provide copies of relevant bank documents  to special counsel to the board or another central source on behalf of all directors, such as the board chairman:

• Board minutes (documenting efforts to save the bank)
• Loan committee minutes
• Board Resolutions and Corrective Action Plans
• Documentation of compliance with regulatory criticisms
• Copies of D&O policies
• Correspondence with federal and state bank regulators
• Records of all internal meetings attended
• Letters and emails exchanged with management, regulators and bank counsel

2) Document efforts, especially board and committee meeting minutes, to solve problems/save the bank.

3) Resolve insider loans by payment or move to another bank.

4) Comply with "golden parachute" rules which prohibit severance payments to insiders of troubled banks.

5) Remove personal items from bank premises.

6) Engage independent special counsel for the Board.

7) Review D&O policies for coverage limits and exclusions.

If the Bank Fails

As of the date of seizure, all communication with the FDIC must be regarded as adversarial and made in anticipation of litigation. At that point, regular bank counsel cannot advise bank officers and directors on any matter which might be adverse to the FDIC. Therefore, it is important that the board retain independent special counsel prior to closure to, among other things, assist with FDIC interviews during the closing weekend. Selecting special counsel early in the process gives counsel time to review potential issues and be prepared for questions that may arise during the closing process. After closure, counsel will assist officers and directors to avoid/mitigate personal liability claims from regulators and shareholders. If the bank has a holding company, bankruptcy counsel also should be engaged. 

D&O Coverage

Typically, the FDIC will file a claim for 100% of available coverage under the bank's D&O policy on the day the bank is seized. Bank officers and directors through counsel should immediately place D&O carriers on notice of claims and seek coverage determinations.

For additional information on this subject, contact Len Rubin, len.rubin@nelsonmullins.com.  

The articles published in this newsletter are intended only to provide general information on the subjects covered. The contents should not be construed as legal advice or a legal opinion. Readers should consult with legal counsel to obtain specific legal advice based on particular situations.