The FDIC sued the former directors and two former officers of Mutual Bank (Homewood, Illinois), along with Mutual Bank’s outside law firm, on October 25, 2011.  Mutual Bank was placed into FDIC receivership in July 2009, and its failure currently is estimated to cost the Deposit Insurance Fund $775 million.  A copy of the FDIC’s complaint is available here.

One of the unique aspects of this lawsuit is the FDIC’s allegations of corporate waste.  For example, the FDIC alleges that the directors approved a $250,000 payment for sponsorship of a “bank function.”  The bank function was actually the wedding of one of the directors, who was also the chairman’s and principal shareholder’s son.  In another example, the FDIC alleges that the directors allowed $495,000 of Bank funds to be used to make payments to another director for his wife’s defense of a Medicare fraud case.  In yet another example, the FDIC alleges that the directors permitted roughly $300,000 of Bank funds to be used to fund travel to an unnecessary directors’ meeting in Monte Carlo.  In total, the FDIC is seeking to recover at least $1.09 million from the directors who approved the wasteful transactions.

The FDIC is also suing the directors for their approval of $10.5 million of illegal dividend payments in 2007 and 2008, at a time when the Bank was hemorrhaging and under severe regulatory criticism.  The dividends were paid to the bank holding company, which in turn paid them to the shareholders, with 95% of the dividends being paid to the controlling family, which had four members on the Bank board.

The bulk of the FDIC’s complaint is devoted to its claims against the directors and senior officer defendants for approval of twelve loans that resulted in losses of over $115 million for the Bank.  As a backdrop for those claims, the FDIC describes a litany of the Bank’s operational deficiencies and failures, including: (i) a “dangerous” concentration in CRE and ADC loans; (ii) a failure to maintain a proper credit administration staff; (iii) an inappropriate reliance on outside mortgage brokers to structure and facilitate large loans; (iv) a failure to establish procedures to ensure compliance with the Bank’s loan policy and prudent lending practices; (v) an inability to generate timely and accurate financial reports; (vi) a routine disregard of the Bank’s loan policy; and (vii) an arrogant disregard of bank regulators and their criticisms.

Most of the bad loans were for purchase or refurbishing of existing hotel properties, and most of them were made after the commercial real estate market had started to decline and collateral values had plummeted.  In one example, in February 2008, the director and officers defendants approved a loan for nearly $29 million to a limited liability company to renovate a hotel in south Florida.  Approximately $20 million of the loan was used to refinance a prior loan that was already in default.  The Bank disbursed the funds without first obtaining formal approval by the loan committee.  Furthermore, at the time of the loan, the borrower had not received the required construction permits.  The Bank failed to monitor the project, and it disbursed construction draws on sham purchase orders.  In the end, the FDIC alleges, the estimated losses attributable to this loan are in excess of $16 million, plus interest.

Finally, the FDIC also asserts claims for legal malpractice, breach of fiduciary duty, and aiding and abetting against the Bank’s primary outside counsel (who was also a director) and his law firm.  In short, the FDIC alleges the Bank’s lawyer was aware of the regulators’ warnings about the Bank’s overconcentration in out-of-area projects; its poor underwriting practices; its inability or unwillingness to monitor and control large loans; and its overconcentration in the hotel industry.  Despite that knowledge, the FDIC alleges, the lawyer and his firm actively facilitated “massive” loans to developers that they knew or should have known would inflict huge losses on the Bank.  The FDIC also alleges that the lawyer and his firm failed to counsel the Bank on the illegality of the $10.5 million of dividend payments to the holding company.  In total, the FDIC is seeking $79 million in damages against the lawyer and his firm, plus a disgorgement of the more than $3 million of legal fees paid to the firm between January 2007 and April 2009.