In addition to the podcast and the blog post, we also have a white paper titled Why Your Board Should Stop Approving Individual Loans. That white paper analyzes what the board’s role should be in overseeing the bank, and why approving individual loans threatens this oversight. If boards keep approving loans, we’re next going to have to look into how to address our concerns via Instagram, courrier pigeon, or smoke signals.
In case you didn’t get it from the title of this blog post, I think the answer is absolutely, 100 percent, yes! Bank Directors should not be approving individual loans, and Banks should not be asking their Directors to approve individual loans.
77 percent of executives and directors say their board or a board-level loan committee plays a role in approving credits, according to Bank Director’s 2019 Risk Survey. And Boards of smaller banks are even more likely to be involved in the loan approval process. According to the survey, almost three quarters of banks over $10 billion in assets do not have their directors approve loans, but over 80% of banks under $10 billion in assets continue to have board-approval of certain loans.
These survey results generally conform to our experience. Two weeks ago, Jim McAlpin and I had the pleasure of leading five peer group exchanges on corporate governance at the 2019 Bank Director Bank Board Training Forum. The issue of board approval of loans came up in multiple peer groups, but the reaction and dialogue were radically different based on the size of the institutions involved. In our peer group exchange involving the chairmen and lead directors of larger public institutions, one of the chairman phrased the topic along the lines of “is anyone still having their directors approve individual loans?” Not one director indicated that they continued to do so, and several agreed that having directors vote on loans was a bad practice.
A few hours later, we were leading a peer group exchange of the chairman and lead directors of smaller private institutions. Again, one participant raised the issue. This time the issue was raised in an open manner, with a chairman indicating that they’d heard from various professionals that they should reconsider the practice but so far their board was still asking for approval of individual loans. A majority of the directors in attendance indicated concurrence.
It can be a challenge, when economic times are relatively good, to take time away from thinking about new opportunities to discuss topics like D&O insurance. Even though I am biased, I’ll admit that, in those times, discussing the risks of potential liability and how to insure those risks can feel both a pretty unpleasant and a pretty remote thing to be discussing. However, like all risk-related issues, it is precisely in those times when business is going well that a little bit of counter-cyclical thinking and attention can do the most good over the long haul.
As you approach your next D&O policy renewal – and particularly in the 30-60 days prior to the expiration of your current policy, there are a few things that you may want to consider.
Multi-year endorsements – what’s the catch?
In good times, many insurers will offer packages styled as multi-year policies, usually touted as an option that allows for some premium savings and perhaps a reduced administrative burden. However, as with all things, these advantages may come with a catch.
Many multi-year endorsements will reserve to the insurer the discretion to assess additional premium on an annual basis within the multi-year period if the risk profile of the bank changes in a material way. So premium savings may not ultimately be realized, depending on the facts.
Beyond this, some multi-year endorsements will actually impose additional requirements on the insured to provide notice of events that could trigger the carrier’s repricing rights or other conditions. Those obligations may be triggered when those events occur on an intra-period basis, which can set up a potential foot-fault for an organization that does not keep those requirements front of mind (which can be a practical challenge, as if those events are happening, it is likely that there are a number of issues competing for management and the board’s attention).
Companies looking at multi-year endorsements should make sure they understand fully the terms on which the multi-year option is being provided and should have counsel or an independent broker review the specific language of the proposed multi-year endorsement itself on their behalf. In addition, while it may be tempting to use a multi-year endorsement to try to extend the renewal horizon and to try to reduce the administrative burden that comes with the renewal process, doing so may also reduce your ability to negotiate appropriate enhancements to your policy terms over the multi-year period.
Multi-year policies may be the right fit for your institution, but they should not be viewed as a one size fits all solution. Before heading down that road, ask yourself how much is being saved and how real those savings actually are and, perhaps just as importantly, whether avoiding a broader discussion of your coverage strategy on at least an annual basis is a good thing or not.
What about the bank has changed?
Times of economic expansion often bring with them opportunities to explore new lines of business. In addition, substantial recent technological innovations in the financial services industries and increasing consumer demands for technological solutions have meant that not only are new market opportunities being explored but that they are being explored in new ways. And if that isn’t enough, there is always the ever-changing regulatory and compliance landscape to contend with.
All of these trends – as well as your decisions of where and how your institution will choose to participate (or not to participate) in them – bring with them new and different risks. To the extent that your bank has expanded its offerings, changed its footprint or portfolio mix, or otherwise changed its policies or ways of doing business, you should think about how those changes may impact your insurance needs. It can be easy, particularly when you have a long relationship with an incumbent carrier, for the renewal process to become somewhat rote.
The United States Court of Appeals for the Fourth Circuit, which governs North and South Carolina as well as Virginia, West Virginia and Maryland, has issued an important ruling in FDIC v. Rippy, a lawsuit brought by the FDIC against former directors and officers of Cooperative Bank in Wilmington, North Carolina. As it has done in dozens of cases throughout the country, the FDIC alleged that Cooperative’s former directors and officers were negligent, grossly negligent, and breached their fiduciary duties in approving various loans that caused the bank to suffer heavy losses. The evidence showed the FDIC had consistently given favorable CAMELS ratings to the bank in the years before the loans at issue were made. The trial court entered summary judgment in favor of all defendants, criticizing the FDIC’s prosecution of the suit as an exercise in hindsight. The Fourth Circuit, however, vacated the ruling as it applied to the ordinary negligence claims against the officers. In its opinion, the court held that the evidence submitted by the FDIC was sufficient to rebut North Carolina’s business judgment rule and thus allow the case to go to trial. The Court found that the evidence indicated that the officers had not availed themselves of all material and reasonably available information in approving the loans.
The decision is specific to North Carolina-chartered banks and is based on the historical development of the business judgment rule in that state. Nonetheless, there are certainly comparisons to be drawn to decisions from other states. The emphasis on allegations of negligence in the decision-making process echoes last year’s decision in FDIC v. Loudermilk, in which the Georgia Supreme Court held that it was possible to bring an ordinary negligence claim against bank directors and officers who engage in a negligent process in making a decision. While the Georgia Supreme Court in Loudermilk seemed to be of the view that it would permit claims to go forward against directors and officers who completely avoided their duties and acted as mere figureheads, the Rippy decision shows that in North Carolina, at least, the distinction between a viable case and one barred by the business judgment rule may be very fine indeed. For instance, the FDIC’s evidence consisted largely of expert testimony that Cooperative’s officers failed to act in accordance with generally accepted banking practices by, among other things, approving loans over the telephone before they had examined all relevant documents, and by failing to address warnings and deficiencies in the bank’s (generally positive) examination reports.
Another court has weighed in on the question of whether the FDIC can sue former directors and officers of failed banks for ordinary negligence. The latest decision comes from a federal court in Maryland, which held that a gross negligence standard must be applied when evaluating the conduct of directors and officers under Maryland’s business judgment rule. FDIC v. Arthur, Civil Action No. RDB-14-604 (D. Md. Mar. 2, 2015).
The facts of FDIC v. Arthur follow a now-familiar pattern. Baltimore-based Bradford Bank failed on August 28, 2009 and the FDIC was appointed as its receiver. The four defendants are the bank’s former president, a senior loan officer and two directors who served on the bank’s loan committee. The FDIC alleged that the defendants were negligent, grossly negligent and breached their fiduciary duties to the bank in connection with seven commercial loan transactions, resulting in losses in excess of $7 million to the bank. FIRREA holds bank directors and officers to a gross negligence standard of conduct; however, the FDIC has routinely asserted that applicable state law holds directors and officers to a stricter ordinary negligence standard, giving the FDIC the right to sue for ordinary negligence. As a result, federal courts across the country have had to determine whether the business judgment rule, as interpreted by the appellate courts in which they sit, permits ordinary negligence claims.
In Maryland, the answer is that ordinary negligence claims are not permitted. Like many states, Maryland has enacted a statutory standard of care. Md. Code. Ann., Corps. & Ass’ns § 2-405.1(a)(3) provides that “[a] director shall perform his duties as a director, including his duties as a member of a committee of the board on which he serves…[w]ith the care that an ordinarily prudent person in a like position would use under similar circumstances.” But as the court explained, decisions both before and after the enactment of § 2-405.1 make it clear that “the appropriate test to determine director liability is one of gross negligence.” In the court’s view, the statute did not intend to supplant existing case law applying the business judgment rule and its gross negligence standard. The court also noted that the gross negligence standard was consistent with both FIRREA and the standard of care employed by Delaware courts. Maryland, like many states, frequently finds Delaware law to be influential in answering questions of corporate governance.
The Georgia Supreme Court issued its long-awaited decision in FDIC v. Loudermilk on Friday, addressing whether the FDIC’s ordinary negligence claims against former directors and officers of failed banks are precluded by the business judgment rule. There is a lot to digest in the Court’s 34-page opinion, but here are our initial thoughts.
The upshot for bank directors and officers in Georgia is that the business judgment rule is very much alive, and applies to banks to the same extent as other corporations. That itself is big news—the Georgia Supreme Court had never addressed whether the business judgment rule exists in any context, and the FDIC had argued that if the rule existed at all, it did not apply to banks because the Banking Code imposes an ordinary negligence standard of care. Much of the Court’s opinion is devoted to explaining how the business judgment rule developed as a common law principle and refuting the argument that the statute trumps the rule.
The Court explained, however, that the business judgment rule does not automatically rule out claims that sound in ordinary negligence. It distinguished claims alleging negligence in the decision-making process from claims that do no more than question the wisdom of the decision itself. A claim that a directors disregarded their duties by failing to attend meetings, for instance, could survive a motion to dismiss. A claim that the decision itself was negligent, without any allegation relating to the process leading to the decision, will not survive.
As we have reported before, Georgia has the unfortunate distinction of leading the nation in bank failures since the onset of the late-2000s financial crisis. Georgia has also seen far more FDIC bank failure lawsuits than any other state: 15 of the 63 bank failure cases brought by the FDIC since 2010 involve Georgia banks and are currently pending in Georgia federal courts. While some allegations vary from case to case, the general thrust of all of these lawsuits is that the former directors and/or officers of the banks were negligent or grossly negligent in pursuing aggressive growth strategies, with these strategies usually involving a high concentration of risky and speculative speculative real estate and acquisition, construction and development loans. Here is a rundown of the most interesting and significant developments to date:
The most heavily litigated issue has been whether the business judgment rule insulates bank directors and officers from liability for ordinary negligence. Beginning with Judge Steve C. Jones’ decision in FDIC v. Skow, concerning the failure of Integrity Bank, the district courts have consistently dismissed ordinary negligence claims, citing the business judgment rule. As we previously reported in November, the Eleventh Circuit has agreed to hear an interlocutory appeal in the Skow case. That appeal has now been fully briefed by the parties. The FDIC’s briefs can be found here and here, while the Defendants/Appellees’ brief can be found here. The parties’ briefs all focus on the interplay between the business judgment rule and Georgia’s statutory standard of care, with the FDIC arguing that the statute’s expression of an ordinary care standard precludes the application of any more lenient standard, and the Defendants/Appellees arguing that Judge Jones correctly followed the Georgia appellate courts’ interpretation of the business judgment rule. Note: This firm represents the Georgia Bankers Association and Community Bankers Association of Georgia, who have been granted leave to appear as amici curiae in support of the Defendants/Appellees. The amicus brief can be found here.
The pace of FDIC lawsuits against former bank directors and officers picked up considerably in the second half of April. Between April 15th and the end of the month, the FDIC filed eight D&O lawsuits. Each of the lawsuits relate to bank failures allegedly arising from an overconcentration in CRE and ADC loans. In six of the eight cases, the FDIC’s complaint was filed only days before the expiration of the 3-year limitations period. Here is a short synopsis of each new case:
The first lawsuit was filed against the former senior officers of Riverside National Bank of Florida (Ft. Pierce, FL). The bulk of the FDIC’s complaint in that case focused on failed loans that had been secured by stock of Riverside’s affiliated holding company. We previously summarized the lawsuit in our April 24, 2013 blog post.
Later on April 15th, the FDIC sued two former senior officers of City Bank (Lynwood, WA). According to the FDIC’s complaint, City Bank’s president and CEO alone had loan approval authority of up to $42 million, which was equal to the legal lending of the Bank. The complaint seeks the recovery of $41 million arising from the failure of 26 separate loans.
The FDIC’s lawsuit against the former directors and officers of Bank of Wyoming is an interesting one. Here, the D&O carrier, BancInsure, apparently denied coverage for the FDIC’s pre-suit claim. Prior to the filing of the FDIC’s complaint, the former D&Os negotiated a settlement with the FDIC that provided for: (i) a “confession of judgment” in the amount of $2.5 million; and (ii) an assignment of the D&Os’ coverage claims against BancInsure in favor of the FDIC. The filing of the lawsuit on April 23rd was a mere formality to allow the court to enter the judgment.
On April 25th, the FDIC sued the former D&Os of Peninsula Bank of Florida. The lawsuit was filed in the Middle District of Florida, which as we reported in our September 13, 2012 blog post, has held that Florida’s statutory version of the Business Judgment Rule insulates corporate directors from claims for ordinary negligence. Consistent with that ruling, the FDIC sued the former directors of Peninsula Bank for gross negligence, but sued the former officers for ordinary negligence. The complaint seeks the recovery of $48 million.
The FDIC took a similar approach in its lawsuit against the former directors and officers of Frontier Bank (Everett, WA). It sued the former officers for ordinary negligence and the former directors for gross negligence, presumably because of the protections afforded by Washington State’s Business Judgment Rule. The complaint seeks the recovery of $46 million in connection with 11 loans.
The FDIC’s complaint against the former directors of Eurobank is the third such suit filed in connection with the failure of a bank in Puerto Rico. As it did in the previous two suits, the FDIC took advantage of a Puerto Rican statute which permits it to also assert a direct action against the directors’ D&O carrier. The complaint seeks the recovery of more than $55 million in connection with 12 failed credits.
The FDIC sued the former D&Os of Champion Bank (Creve Coeur, MO) on April 29th. The bulk of the FDIC’s complaint centers on seven out-of-state loan participations that Champion Bank had purchased from a lead bank for real estate projects in Nevada, Arizona and Idaho. According to the FDIC’s complaint, one of the former officers negligently represented that the lead bank would repurchase the participations upon Champion Bank’s request. The other D&O defendants negligently relied on that representation, as there was no such agreement with the lead bank. The lawsuit seeks the recovery of $15.56 million in damages.
Finally, on April 30th, the FDIC filed a complaint against the former D&Os of Midwest Bank and Trust Company (Elmwood Park, IL). This lawsuit has two very distinct sets of legal theories. The first set of claims is asserted against the former D&Os in connection with their approval of six failed loans that resulted in damages of at least $62 million. The second set of claims is asserted against the former directors in connection with their alleged violation of the Bank’s investment policy. Specifically, the FDIC alleges that the former directors failed to sell preferred stock of Fannie Mae and Freddie Mac that it held for investment purposes, despite its auditor’s adverse classification of the stock. The FDIC seeks a separate award of damages in the amount of $66 million in connection with this set of claims.
The FDIC has begun posting copies of its settlement agreements on its website. It recently came under fire after the L.A. Times printed an article criticizing the FDIC for not being more transparent on the issue of whether its litigation efforts are bearing fruit. The FDIC responded to that criticism by posting the settlement agreements on its website. This website will likely be updated from time to time with new settlement agreements.
Not all of the settlement agreements posted on the FDIC’s site are from D&O cases. At least a few of them are from claims against brokers, lawyers or accountants for the failed banks. At this time, we don’t see any particular trends or patterns based on the settlement agreements on claims against former D&Os.
Last week the FDIC filed its 51st lawsuit against former directors and officers of failed banking institutions since July 2010. This most recent suit is against the former chairman, former CEO and former Chief Credit Officer of La Jolla Bank, which failed and went into FDIC receivership on February 19, 2010. A copy of the lawsuit is available here.
Many of the central themes in the FDIC’s complaint are consistent with its other recent D&O lawsuits – the Bank pursued an aggressive growth strategy fueled by heavy concentrations in commercial real estate lending, with insufficient underwriting and loan policy compliance, and without regard to deteriorating market conditions. What makes this case different is the FDIC’s theory that the Bank’s CEO and COO gave preferential loan treatment to certain Friends of the Bank (“FOB”). The senior officers, both of whom were compensated in large part based on loan production, allegedly granted oral approval of FOB loans, pressured lower-level bank personnel to recommend FOB loans with little or no underwriting, and concealed FOB loans that had gone into troubled status. Seven such FOB loans went into default, and the FDIC is seeking damages in excess of $57 million in connection with those loans.
Perhaps the most significant aspect of this case is that the FDIC is not seeking to hold most of the directors liable for the Bank’s losses. That decision is likely rooted in both the facts of the case and California’s version of the Business Judgment Rule. The factual allegations in the complaint suggest that the Chairman had actual knowledge of the Bank’s lax underwriting and loan policy compliance, and that the other directors may not have known about those deficiencies until much later. Ordinarily, the FDIC might still seek to hold the other directors liable for ordinary negligence. However, as several district courts have already ruled, California’s version of the Business Judgment Rule shields directors from claims for ordinary negligence. The FDIC therefore was limited to claims for gross negligence under FIRREA. It has asserted a gross negligence claim against the Chairman, but it apparently determined that the facts of the case do not support such a claim against the other directors.
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