Does the Business Judgment Rule Protect Bank Officers and Directors?

When a corporation suffers significant losses, or ultimately fails, frustrated shareholders, creditors, or others often try to sue the corporation and/or its officers and directors for losses caused by mismanagement of the officers and directors. Typically, officers and directors of corporations are protected from mismanagement claims under the legal theory known as the “Business Judgment Rule.” The Business Judgment Rule basically provides that decisions of officers or directors acting in good faith and with an honest belief that the actions taken are in the best interest of the company, are not subject to challenge or liability. Generally, a plaintiff must show that an officer or director violated a fiduciary duty to the company, or the duties of care, good faith, or loyalty to defeat application of the Business Judgment Rule. Normally, it is a major hurdle for a plaintiff to defeat the defense of the Business Judgment Rule.

There are some recent cases, however, that put into question whether the Business Judgment Rule applies to bank officers and directors. When an FDIC insured bank closes, the FDIC may pursue claims against directors or officers to recoup the losses. Under the federal statute known as FIRREA [1], the FDIC would need to prove gross negligence in order to hold a director or office liable for bad business judgments. Because the standard under FIRREA is difficult for it to achieve, the FDIC often brings claims under state law, seeking to apply a lower, simple negligence standard. Moreover, in a number of recent cases, the FDIC has argued the Business Judgment Rule should not apply to bank directors and officers. In the Loudermilk [2] case in Georgia, following the failure of Buckhead Community Bank in 2009, the FDIC filed suit against the directors and officers of the bank for alleged negligence in managing the bank’s loan portfolio. The directors and officers moved to dismiss the claim under Georgia’s Business Judgment Rule. The Federal District Court Judge in that case refused to apply the Business Judgment Rule, however, opining that the banks are different than normal corporations because of the broad implications of a bank failure. The Court reasoned that when a standard business corporation fails the stockholders bear the losses, but when a bank fails “the FDIC and ultimately the taxpayer bear the pecuniary loss [3].” Noting that Georgia law on the issue was unsettled, the Judge certified the question to the Georgia Supreme Court. Recently, on April 21, the Georgia Supreme Court heard arguments on the application of the Business Judgment Rule to bank officers and directors.

If the FDIC’s position is upheld, and then spreads to other states, community banks may face hard times in finding good qualified individuals to serve as officers and directors. In the Loudermilk case, Georgia’s Attorney General made this precise point, arguing that if bank officers and directors were not protected by the Business Judgment Rule “the result would be the resignation of many skilled directors and officers and the inability to attract skilled directors and officers.” The decision by the Georgia Supreme Court is expected later this year.

To protect themselves, banks and their officers and directors should stay apprised of this situation, and carefully review their D&O policies and limits to ensure they have adequate insurance in the event of a claim. Many banks under-insure their directors and officers, relying on the Business Judgment Rule, a policy that banks should reconsider in the face of decisions like Loudermilk. There are many nuances to the application of the Business Judgment Rule. Officers and directors should consider the pitfalls before the issues arise, by working closely with their attorneys and insurance specialists to minimize their exposure.

[1] The Financial Institutions Reform, Recovery, and Enforcement Act of 1989, 12 U.S.C. § 1821(k).
[2] FDIC v. Loudermilk, No. 1:12-cv-4156-TWT, 2013 WL 6178463 (N.D. Ga. Nov. 25, 2013). Although the case was brought in federal court, the FDIC made state law claims, and argued successfully that the Business Judgment Law should not apply to bankers.
[3] See FDIC v. Loudermilk, WL 6178463, (N.D. Ga. Nov. 25, 2013).

If you have any questions regarding this article or its   possible impact on  your activities and operations, please contact your Sherman & Howard attorney or any member of the Banking  & Finance Practice Group.

Sherman Howard has prepared this advisory to provide general information on recent legal developments that may be of interest. This advisory does not provide legal advice for any specific situation and  does not  create an  attorney-client relationship between any reader and  the Firm.

©2014  Sherman & Howard L.L.C.                                                                                        May 23, 2014