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Sept

19

2011

Claims Against Failed Bank D&O’s Will Spike in 2012

By Jonathan Joseph*

The total number of bank failures since the banking crisis began in 2008 is now dangerously close to 400. To date, the FDIC has only filed 14 lawsuits against failed bank directors and officers from thirteen different failed banks.  A total of 103 former bank directors and officers have been named in these suits.

Based on published statistics and our own analysis of U.S. bank failures from 2008 to September 16, 2011, we believe that approximately 80 additional suits will be brought by the FDIC, as receiver, in the next two years. While the FDIC’s investigation and claim process has moved slowly, the number of damage suits authorized and filed is quickening and, we expect, will spike in 2012.

In August 2011, 5 new suits were filed, more than double any previous month. Currently, the FDIC’s website states it has authorized suits in connection with 32 failed institutions against 294 individuals for D&O liability with damage claims of at least $7.2 billion.  All but one of these suits involved banks that failed prior to July 2009. Consequently, while 14 lawsuits have been filed and the FDIC has approved claims against an additional 191 directors and officers who served 18 different failed banks, this significantly understates the number of new suits to be filed and D&O’s to be named.

The current round of bank failures began somewhat slowly in 2008. The closing of IndyMac Bank in July 2008 marked the beginning of a huge acceleration of failures with 140 failures in 2009 and 157 in 2010.  The pace has slowed in 2011 with 71 failures year to date.  Some of the 18 authorized FDIC lawsuits not yet filed may settle; however, the FDIC will approve additional lawsuits against bank directors and officers at an increased pace in the ensuing months because 252 or 64 percent of the current round of bank failures occurred between July 9, 2009 and December 31, 2010.  The FDIC is now approaching the decision point in many of these pre-2011 failures including the retention of outside law firms to prosecute damage claims on its behalf, as receiver.

D&O liability suits are generally only pursued if the FDIC concludes they are both meritorious and cost-effective.  Before seeking recoveries from individual directors and officers, the FDIC conducts an investigation into the causes of the failure. The FDIC states on its website that investigations are usually completed within 18 months from the time the institution is closed, but lawsuits typically aren’t filed for another few months to a year.  Investigations can extend longer and lawsuits are sometimes filed just before the third anniversary of a bank’s failure.

Here are some illustrations: Georgia’s Silverton Bank failed on May 1, 2009 and suit was filed on August 22, 2011 (27 months).  Haven Trust Bank in Georgia failed on December 12, 2008 and suit wasn’t filed until July 14, 2011 (32 months).  Cooperative Bank in North Carolina was closed in June 2009 and suit was filed August 10, 2011 (26 months). On the other hand, Wheatland Bank in Illinois failed on April 23, 2010 and suit was filed on May 5, 2011 (13 months).  With $11.2 billion in assets, San Francisco based United Commercial Bank was closed and most of its assets were assumed by East West Bank on November 6, 2009.  Yet after almost two years, no public announcement of FDIC damage claims against any of UCB’s executive officers and directors have surfaced.  United Commercial Bank was California’s largest ever commercial bank failure.

Not all bank failures result in Director and Officer (D&O) lawsuits. The FDIC brought claims against directors and officers in 24 percent of the bank failures between 1985 and 1992. Since July 2009, the FDIC was named receiver at 323 failed banks.  Bank failures have been most heavily focused in Georgia (70), Florida (56), Illinois (45), California (37), Washington (17) and Minnesota (16). If one assumes the same 24 percent ratio of suits from the 1985 – 1992 era will be repeated in connection with failures since June 2009, former directors and officers of about 80 additional banks could be targets of FDIC damage suits in the next two years in addition to the 14 suits already underway.  The actual number could be somewhat higher but we doubt it will be much lower.

Prior to filing a lawsuit against a director or officer of a failed bank, staff for the FDIC, in its capacity as the receiver (or outside counsel representing the FDIC as receiver), will mail a demand letter to the bank’s officers and directors asserting the FDIC’s claims for monetary damages arising out of the bank’s failure.  These demand letters typically do not distinguish between the different roles that officers and directors may have played under the circumstances nor is much effort made (at this point in the process) to determine which officers and directors in a particular organization may have been negligent, grossly negligent, breached fiduciary duties or wasted assets.

In a number of recent suits, the FDIC has focused on outside directors that had more banking industry expertise than other directors (i.e., directors of Silverton Bank) who were not themselves professional bankers.  Directors with lending, accounting and CPA expertise may potentially be held by FDIC to higher standards, which could make them more visible targets.  Often the FDIC’s demand letter is sent to trigger a claim under the bank’s director and officer liability policy and as part of an attempt to settle with the responsible parties.  If a settlement cannot be reached, however, a complaint will be filed, typically in federal court. Thus, in many of the upcoming lawsuits, the FDIC may pursue claims against individuals but will also focus on the insurance proceeds that could be available in connection with many failures especially those that occurred prior to 2011 (when regulatory exclusions were not as widespread).

It is crucial that officers and directors of a troubled or failed bank retain knowledgeable insurance coverage and bank regulatory counsel to assert rights to coverage under the bank’s liability policies and to determine whether the facts and circumstances raise unique or special legal defenses.   Officers and directors of all distressed banks should attempt to retain experienced outside counsel prior to a bank’s failure as the bank’s existing counsel will usually be conflicted out upon failure.  Notice of circumstances that could give rise to coverage under a policy should be filed with insurers on a timely basis (usually pre-failure) and written follow-up by coverage counsel with insurers post-failure  is often be necessary. If a director or bank officer hasn’t done so prior to failure, they should always retain experienced counsel at the first hint of an investigation or demand arising out of the bank failure.

In many of cases, the FDIC’s ultimate objective will be the recovery of D&O insurance proceeds.  For this reason, it is often advisable to retain a combined legal team that has the capability to address insurance issues, liability and damage claims, regulatory enforcement actions (such as banking industry bans and civil money penalties) and, in rarer cases, criminal probes and indictments.

*About the Author: For over thirty-two years, Jonathan Joseph has focused on the representation of community and regional banks and officers and directors of distressed and failed banking organizations in connection with regulatory, transactional and corporate matters.  He is a member of the Financial Institutions Committee of the California State Bar and a leading banking industry lawyer in California.  Mr. Joseph founded the firm of Joseph & Cohen, Professional Corporation, in 2006 and is its Chief Executive Officer.  Joseph & Cohen currently represents financial institutions and officers and directors of troubled and failed banks from its office in San Francisco, CA.

For additional information, please email the author: Jon@JosephandCohen.com.

© Joseph & Cohen, Professional Corporation. 2011. All Rights Reserved.

JOSEPH LAW NEWSBRIEF: FDIC Paves the Way for Private Investors to Recapitalize Troubled Banks and Bid for Failed Banks

The recently announced high profile recapitalization of Pacific Capital Bancorp by investor Gerald Ford and affiliates, coupled with the newest FAQ issued by the FDIC on April 23, 2010, indicates that private equity now has several paths to successfully enter the queue for failed bank acquisitions and troubled bank recapitalizations.  However, it is also clear that the FDIC, as gatekeeper, is primarily opening the door to “patient” money invested by “anchor groups” who are willing to subject themselves to federal bank agency scrutiny.  It remains extremely important for such potential investors to engage qualified bank regulatory attorneys and consult closely and early with the FDIC staff as every prospective transaction will inevitably involve a variety of significant bank regulatory and policy judgments.

At the end of August 2009, the FDIC promulgated its Policy Statement for Failed Bank Acquisitions (“Policy Statement”).  It provided that covered private equity investors will be required to hold their investments in subject institutions for a three year period and agree to other restrictions not applicable to non-covered organizations that acquire failed banks.  On January 6, 2010, the FDIC issued Questions and Answers (“Initial FAQ”) to interpret portions of the Policy Statement. Both the Policy Statement and the Initial FAQ appeared to signal the FDIC’s discomfort with the supervisory risks associated with private investors participating in failed bank acquisitions.  As a result, the ability and willingness of private equity investors to participate in the huge recapitalization needs of the banking industry were stymied.  By default, existing banks and thrifts and their holding companies were favored in connection with failed bank acquisitions.

On April 23, 2010, the FDIC issued new Questions and Answers (“April FAQ”) to clarify elements of the Policy Statement and the Initial FAQ.  The April FAQ helped to clarify, among other things,  the “one-third test” first discussed in the Policy Statement, the applicability of the Policy Statement to “less than 5% investors” and requirements for offshore investors. Additionally, and perhaps most significantly for existing “troubled banks,” the FDIC provided a reasonably clear test of when recapitalizations of existing banking organizations will be exempt from the Policy Statement. As a result, a road map now exists for private investors to participate in failed bank acquisitions and recapitalizations of existing banks.

Private equity investors that are seeking to participate in so called “inflatable” banks or “platform” banks (i.e., smaller healthy banks that are super capitalized with the intention to acquire assets of failed or troubled banks) may find one element of good news in the April FAQ.  The recapitalization standard mentioned above provides that the Policy Statement will not apply to investors if a recapitalized institution acquires one or more failed bank in an eighteen month period following recapitalization if the acquired assets in the aggregate are less than 100% of the recapitalized organization’s total assets.   In the final analysis, the Initial FAQ and the April FAQ make clear that private investors wishing to flip their investments or make quick profits will face overwhelming obstacles.  On the other hand, private investors with a long term investment horizon may now potentially enter the banking arena.

Private equity contemplating investments in existing banking organizations will need to clearly understand the restrictions and limitations in the Policy Statement if the institution they invest in anticipates exceeding the “100% of total assets” threshold.   While the FDIC has offered more clarity about the one-third test and recapitalizations, ambiguity regarding the rules in this area is  still plentiful.  Our sense is that bank holding companies and banks seeking to rely on the recapitalization exemption, should probably commit to private investors in recapitalizations that future bank acquisitions will be structured so that the Policy Statement will not apply.  At this point in the economic cycle, banking organizations and private equity investors must work closely together in consultation with the banking agencies, qualified bank regulatory and transactional lawyers and investment bankers in order to wisely and pragmatically manage the complex legal, regulatory and business risks that exist in the current banking environment.

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References:

  • FDIC, Final Statement of Policy on Qualifications for Failed Bank Acquisitions, August 26, 2009 (http://edocket.access.gpo.gov/2009/pdf/E9-21146.pdf).
  • FDIC, Questions and Answers Posted January 6, 2010 (http://www.fdic.gov/regulations/laws/faqfbqual.html).
  • FDIC, Additional Questions & Answers Proposed to Address Recent Questions – April 23, 2010 (added to the January 6, 2010 Q&As).

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