Pub. 12 2015 Issue 3

O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G N E W M E X I C O R E A L I Z E D R E A M S Fall • 2015 15 The Claims. The Federal Deposit Insurance Corporation, as receiver for Cooperative Bank, a state-chartered savings bank in North Carolina, brought a civil action against several directors and officers of that bank, alleging that the directors and officers were negligent, grossly negligent, and breached their fiduciary duties, resulting in the failure of the bank. The District Court applied the business judgment rule to shield the directors and officers from liability. The FDIC then appealed that decision to the Court of Appeals. FDIC v. Rippy, et al., No. 14-2078 (4th Cir., Aug. 18, 2015). The Facts. The decision of the Court of Appeals described various types of information that had been made available to the bank’s management over the years. In the course of its an- nual reviews of the bank, the FDIC identified deficiencies in credit administration and underwriting and attributed those deficiencies to weaknesses in management oversight. The FDIC also discovered problems with audit practices, risk manage- ment and liquidity. The North Carolina Commission of Banks, in its annual reviews of the bank, observed that management had been slow to correct deficiencies and weaknesses identified in previous examinations, including weak credit administration practices, use of stale financial information in the loan approv- al process and problematic audit practices. An audit by an in- dependent third party revealed similar deficiencies. The FDIC ultimately issued a cease and desist order setting forth certain actions that the bank was to take; however, the bank failed to comply with the order, resulting the appointment of the FDIC as receiver. The Damages Claimed. In 2011, the FDIC filed its com- plaint against certain directors and officers of the bank, alleging that the directors and officers were negligent, grossly negligent, and breached their fiduciary duties. The FDIC sought damages from each director and officer in amounts ranging from $4.4 million to $33 million. The District Court granted summary judgment in favor of the directors and officers, finding that the FDIC failed to reveal any evidence that any defendant engaged in self-dealing or fraud or that any defendant was engaged in conduct that constituted bad faith, and, thus, the directors’ and officers’ actions were protected by the business judgment rule. Improper Reliance on Internal Reports. On appeal by the FDIC, the Court of Appeals affirmed the District Court’s decision granting summary judgment in favor of the bank’s directors on all claims and in favor of the bank’s officers on the claims of gross negligence. However, the Court remanded the FDIC’s claims of negligence and breach of fiduciary duty against the bank’s officers. The Court of Appeals determined that a question of material fact existed as to whether the officers properly relied on reports and other information developed and provided by the bank’s experienced loan officers and credit ad- ministrators. The business judgment rule provides an evidentiary pre- sumption that, in making a decision, the officers 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 corpora- tion. The presumption may be rebutted with evidence showing that the officers (a) did not avail themselves of all material and reasonably available information (i.e., they did not act on an informed basis); (b) acted in bad faith, with a conflict of inter- est, or disloyalty; or (c) did not honestly believe that they were acting in the best interest of the bank. The Court of Appeals found there was evidence in the record that the bank’s regulators and its independent auditor found its commercial loan administration and underwriting process lacking. Furthermore, an expert presented by the FDIC criti- cized the bank’s loan and credit administration process as con- trary to standard banking practices. Accordingly, there was a genuine issue of material fact, to be considered by a jury on remand, as to whether the officers’ reliance on reports of their credit administrators and loan officers (rather than reports of the regulators and independent auditor) was reasonable. Lessons Learned. In carrying out their oversight duties, bank directors and officers should consider engaging inde- pendent banking industry professionals to advise them on the implementation of policies and procedures that comply with standard banking practices and regulations or should other- wise ensure that policies and procedures developed internally comply with standard banking practices and regulations. While the business judgment rule may provide a presumption that di- rectors and officers acted in good faith and with due care, that presumption may be rebutted by evidence showing that the di- rectors and officers improperly relied only upon internally pre- pared information.  Debbie Ramirez is a Shareholder in the Modrall Sperling Law Firm in Albuquerque and Santa Fe. She represents New Mexico and national lenders throughout the state and may be reached at (505) 983-2020 or debbie.ramirez@modrall.com .