The FDIC filed a lawsuit against directors and officers of Heritage Community Bank (Glenwood, Ill.), which was taken into FDIC receivership in early February 2009.  The FDIC lawsuit was filed in federal court in Chicago on November 1, 2010, and it is the FDIC’s second suit against directors or officers of failed institutions since the advent of the current real estate recession. For a copy of the complaint, click here.

The FDIC’s case theory revolves around the bank’s commercial real estate (“CRE”) lending program.  The lawsuit alleges that the directors and officers failed to protect the bank from the “substantial inherent risks of large-scale CRE lending,” by:

  • routinely financing CRE projects without any meaningful analysis or adequate appraisals;
  • repeatedly making loans with excessive loan-to-value ratios; and
  • failing to properly evaluate the creditworthiness of CRE borrowers and guarantors.

One unique factual allegation in the lawsuit is that the bank routinely drew down interest reserves from specific loans and recorded it as income.  That practice, the FDIC alleged, generated phony profits, which the bank used to justify “substantial dividends” to the holding company and “generous incentive compensation” to its senior management.

The lawsuit asserts three distinct sets of claims – one set against the bank’s directors; a second set against the directors and officers on the bank’s loan committee; and a third set against the bank’s chief financial officer.

Claims Against Directors

The FDIC alleged that the directors had breached their duties under both federal law (FIRREA) and state law by:

  • failing to establish and enforce lending policies, including limits on CRE concentrations and limits on speculative or high-LTV projects;
  • failing to establish sufficient reserves for loan losses and maintaining adequate capital; and
  • failing to ensure that the bank had sufficient, capable personnel to undertake and administer the CRE lending program.

Claims Against Directors and Officers on Loan Committee

The FDIC similarly alleged that the members of the loan committee had violated FIRREA and state law duties by:

  • failing to enforce prudent lending policies;
  • failing to make informed decisions about loans they approved; and
  • failing to ensure that approved loans were properly monitored.

Claims Against Chief Financial Officer

The FDIC alleged that the bank’s CFO was grossly negligent (in violation of FIRREA), was negligent under state law, and breached his fiduciary duties to the bank under state law, by:

  • failing to ensure that the bank’s ALLL reserves were sufficient in the face of negative indicators, including an increasing number of distressed CRE credits;
  • failing to ensure that the bank maintained sufficient capital to cushion against high-risk CRE loan losses; and
  • improperly advising the board to approve dividends to the holding company and incentive compensation awards to senior management.

This lawsuit against the directors and officers of Heritage Community Bank is expected to start a small wave of D&O suits.  The FDIC recently announced that it expects to file actions against 70 directors and officers of failed institutions.  More suits are certainly on the way, and we will continue to update with additional D&O litigation information.