Directors of U.S. Financial Institutions Experience Another Chilly Blast

Georgia banking

Many parts of the United States have experienced a cold and bleak winter from which they are only now emerging.  Banks (both in the U.S. and beyond) have also been experiencing heavy weather, albeit over a much longer period. Nor have the directors and senior managers within these institutions been immune from criticism, investigation, proceedings and even prosecution. A recent chilly blast from the State of Georgia serves as a reminder that for directors of banks the forecast remains uncertain.

The case in question involves a company called Buckhead Community Bank (BCB) and is one of many cases brought against directors and officers of banks by the Federal Deposit Insurance Corporation (FDIC), the regulator that takes an unusually strong interest in D&O insurance (as a I recently blogged).

BCB is alleged to have implemented an “aggressive growth strategy” resulting in a 240% increase in the bank’s loan portfolio in 2007.  In 2009 BCB entered into receivership, and sometime after that the FDIC sued the directors saying they had failed to abide by “prudent and sound banking practices”.

Does the Business Judgement Rule Apply?

Predictably, the directors’ defence was that the financial crisis was unforeseeable and that they should in any event enjoy the protection of the Business Judgment Rule.  This is the principle (tacitly acknowledged by the UK courts as well) that a court will not lightly interfere with a board’s decision-making process nor will it substitute their judgment for that of the board.

Unfortunately for the directors concerned, the court in the northern district of Georgia, whilst acknowledging the existence of the Business Judgement Rule, questioned whether it should apply to banks in the same way as it  routinely applies to other types of public company.  As the Court put it:

[to some extent]… the failure of bank officers and directors to exercise ordinary diligence led to the very financial crisis that continues to affect the national economy…

The Court seemed to be saying: “You put us in this mess.  Don’t expect us to get you out!”

In any event, the Court certified to Georgia’s Supreme Court the question as to whether bank directors and officers should enjoy the protection of the Business Judgement Rule in light of public policy.  That decision is awaited.  As the authors of the Mondac Briefing Note conclude:

“… narrowing the scope of the business judgement rule could certainly have a chilling effect on the decisions of bank directors and officers beyond courts merely venting at financial sector defendants…”

Beyond the States

Nor should it be assumed that this is just a U.S. issue.  In October 2013, the UK government published its Financial Services (Banking Reform) Bill proposing a maximum custodial sentence of 7 years and/or an unlimited fine on senior persons within a bank whose conduct is judged to have fallen far below what could reasonably be expected of a person in their position.

The conduct in question might include taking a decision on behalf of a bank or the failure to prevent a decision being taken in circumstances where the individual is aware that the decision may cause the bank to fail. That seems an invitation to the courts to apply hindsight and to circumvent the Business Judgment Rule.

To borrow a phrase from history: “When the U.S. litigation environment for bank directors sneezes, their foreign counterparts should watch out in case they catch  cold too!”

 


I am indebted to David Keenan and William Alderman in the Mondac Business Briefing (publication date 12/19/2013) for drawing my attention to this case.

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Directors & Officers, Financial Services

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