Bank Officers May Be Liable for Poor Loan Decisions Under a Theory of Negligence

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Bank Officers May Be Liable for Poor Loan Decisions Under a Theory of Negligence
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Riker Danzig Banking Alert: September 8, 2015
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The United States Court of Appeals for the Fourth Circuit recently vacated a lower court’s grant of summary judgment on negligence and breach of fiduciary duty allegations against the officers of a failed bank.  See F.D.I.C. ex rel. Co-op. Bank v. Rippy, 2015 WL 4910473 (4th Cir. Aug. 18, 2015).  Beginning in 2006, the FDIC began warning a North Carolina bank about its underwriting and credit administration standards.  The warnings continued until 2009, when the FDIC issued a Cease and Desist Order requiring the bank to take certain actions to restore capital.  The bank failed to do so, and the bank closed three months later, with the FDIC named as receiver.  The FDIC claimed to have suffered $216.1 million in losses and filed a lawsuit in 2011 against the bank’s officers and directors personally, alleging negligence, gross negligence and a breach of fiduciary duty.  The District Court granted the defendants summary judgment, holding that North Carolina’s business judgment rule protected the officers and directors against negligence and fiduciary duty claims in the absence of any evidence of self-dealing, fraud or bad faith, and that there was insufficient evidence of gross negligence.

On appeal, the Fourth Circuit found that the District Court had misapplied the business judgment rule with regard to the officers.  12 USC 1821(k) provides that a director or officer of an insured depository institution may be liable to the FDIC for monetary damages 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.”  The United State Supreme Court has interpreted this provision to mean that the gross negligence standard applies to all bank officers and directors, unless a state has a stricter standard.  See Atherton v. F.D.I.C., 519 U.S. 213 (1997).  In North Carolina, a bank officer or director may be liable for ordinary negligence, so officer and directors there are held to this stricter standard.  See N.C.G.S. § 55–8–30(a) (for directors) and N.C.G.S. § 55–8–42(a) (for officers).

Despite this stricter standard, North Carolina has other statutes to give additional protections to officers and directors.  First, it allows a corporation to include exculpatory clauses in their articles of incorporation which protect directors from ordinary negligence, as long as the director did not know that his or her actions were clearly contrary to the corporation’s best interests.  See N.C.G.S. § 55–2–02(b)(3).  Second, North Carolina’s business judgment rule protects officers and directors of corporations by creating a rebuttable presumption that officers and directors “acted with due care (i.e., on an informed basis) and in good faith in the honest belief that their action was in the best interest of the corporation,” meaning that “a director may be protected by the business judgment rule even if he fails to meet the prescribed standards of conduct set forth in North Carolina’s [banking] statute.”

In interpreting North Carolina law, the Fourth Circuit first found that the bank’s directors were protected by the exculpatory clause in the bank’s articles of incorporation, holding that it protected the directors unless they knew or believed that their acts or omissions were clearly in conflict with the bank’s best interests.  Because the directors had only made decisions without adequate information and did not “clearly” know such decisions were not in the bank’s best interest, the Fourth Circuit affirmed the grant of summary judgment to the directors.

The bank’s officers, however, were not protected by the exculpatory provision and were protected only by North Carolina’s business judgment rule.  Though the business judgment rule created a presumption that the officers acted in good faith and on an informed basis, the FDIC could rebut this by, among other things, presenting evidence that the officers failed to act on an informed basis.  Notably, the FDIC submitted an expert report as its evidence that the officers failed to act on an informed basis, specifically alleging that the officers approved loans over the telephone without reviewing documents and often did not review documents until after loans were funded.  Thus, the Fourth Circuit vacated the District Court’s grant of summary judgment to the officers on the claims of negligence and the breach of a fiduciary duty.  Finally, the Fourth Circuit also found there was no evidence of any intentional wrongdoing by the officers and directors, and the gross negligence claim therefore was properly dismissed.

It should be noted that, as in North Carolina, a bank’s director or officer may be liable under New Jersey law for negligence or the breach of a fiduciary duty.  See Resolution Trust Corp. v. DiDomenico, 837 F. Supp. 623 (D.N.J. 1993).  That said, unlike in North Carolina, New Jersey banks may include exculpatory clauses in their articles of incorporation which protect both directors and officers from personal liability claims, as long as the director or officer may not be relieved of liability for acts or omissions “(i) in breach of that person’s duty of loyalty to the association or its members [defined as an act or omission which that person knows or believes to be contrary to the best interests of the association or its members in connection with a matter in which he has a material conflict of interest]; (ii) not in good faith or involving a knowing violation of law; or (iii) resulting in receipt by that person of an improper personal benefit.”  See N.J.S.A. § 14A:2-7;  N.J.S.A. § 17:12B-38.1; see also Resolution Trust Corp. v. Hovnanian, 1994 U.S. Dist. LEXIS 19359 (D.N.J. Oct. 11, 1994) (holding that the business judgment rule protected claims against a bank’s directors).  In New York, on the other hand, a bank’s directors or officers also may be liable for simple negligence, and are not protected by the business judgment rule.  See Fed. Deposit Ins. Corp. v. Ornstein, 73 F. Supp. 2d 277 (E.D.N.Y. 1999); Resolution Trust Corp. v. Gregor, 872 F. Supp. 1140 (E.D.N.Y. 1994); F.D.I.C. v. Bober, 2002 WL 1929486, at *2 (S.D.N.Y. Aug. 22, 2002).  This decision provides a good lesson on the value of well-drafted exculpatory clauses in a bank’s articles of incorporation.

For a copy of the decision, please contact Michael O’Donnell at modonnell@riker.com.