Does the Business Judgment Rule Apply to Bank Directors?

By Dawn Causey

Not according to the FDIC. The FDIC continues to sue directors to recover for business judgments gone wrong. These actions ignore the long history of courts respecting boards of directors exercising their judgments in what they thought were the best interests of the bank.

The business judgment rule is a basic pillar of U.S. corporate law that prevents courts from second-guessing the decisions of directors who have acted in good faith with due care and within the directors’ authority. Challengers to judgments made in accordance with the rule must demonstrate bad faith or gross negligence. It is intentionally a high burden of proof and one that the FDIC has repeatedly tried to lower.

In 1997, the FDIC tried to convince the U.S. Supreme Court that directors were subject to a federal common law negligence standard of liability that was a much lower burden for the agency. However, in Atherton v. FDIC, the Court rejected the FDIC’s argument unanimously and directed the agency to apply the state business judgment rule standards.

Now the FDIC has made a run at those state standards. ABA questioned the FDIC’s tactics in its brief filed on behalf of the industry and all of the state bankers associations in a case involving a failed North Carolina bank where the FDIC attempted to hold directors personally liable for ordinary negligence in their business judgments. ABA argued such an approach would negate decades of established case law, undermine the sound policy rational supporting the rule, and diminish the rule’s economic and social benefits.

The case, FDIC v. Willetts (renamed FDIC v. Rippy on appeal), involved a series of loans that went sour. The district court chastised the FDIC for requiring directors to have more effective crystal balls than the regulators themselves. Citing public statements by high-ranking administrative officials about the foreseeability of the economic downturn, the district court rejected the FDIC’s attempts to use 20/20 hindsight and make the directors guarantors of their lending decisions.

Fear of liability for regulatory hindsight is a real issue for bank boards. As noted in ABA’s survey attached to the brief, 20 percent of the banks responding lost a director or officer due to concerns about personal liability and 40 percent reported that positions had been rejected over that concern. Among individual survey respondents, 97 percent reported that they were somewhat or very concerned about their potential personal liability for their business decisions and 87 percent reported that a reduction in the legal protection against personal liability would affect their willingness to serve on boards or in the bank.

ABA and the state bankers associations were not alone in their opposition to the FDIC action. The U.S. Chamber of Commerce filed a brief that urged the Appellate Court to not only apply the higher standard, but also to make it easier for directors and officers to win cases against the FDIC. As stated in their brief, “directors and officers in failed bank litigation have only one real chance to dispose of a case before trial: summary judgment. If Defendants do not prevail on summary judgment, they face a Hobson’s choice of settling (often at significant personal expense) or litigating (with ruinous amounts of potential liability in the balance). Not surprisingly, the great majority of cases, even cases with marginal or wholly insubstantial claims, settle.”

For all these reasons, ABA urged the Court to reject the FDIC’s efforts to tailor the business judgment rule to the FDIC’s interest. “The FDIC’s position has no support in controlling case law or sound public policy.” Bank directors deserve the benefit of the business judgment rule. Let’s hope the Fourth Circuit Court of Appeals follows that sound policy.