On October 25, 2011, the FDIC filed its latest failed bank lawsuit, in connection with events surrounding the July 2009 failure of Mutual Bank of Harvey, IL. The FDIC’s complaint, which was filed in the Northern District of Illinois, names as defendants eight former directors and two former officers of the bank. But in addition, the complaint also names as defendants the bank’s outside General Counsel, who was also a director of the bank, and well as the General Counsel’s law firm. There are a number of other interesting things about this complaint as well.
The FDIC’s complaint alleges that Mutual Bank’s failure has cost the FDIC’s deposit insurance fund an estimated $775 million in losses. In its lawsuit, the FDIC seeks to recover over $115 million in losses the bank suffered on twelve commercial real estate loans, $10.5 million in unlawful dividend payments and $1.09 million in wasted corporate assets.
The complaint asserts claims against the director defendants and the officer defendants for gross negligence, negligence, and breach of fiduciary duty. The complaint alleges that the directors and the officers approved high-risk loans to uncreditworthy borrowers. The complaint also asserts the directors failure to supervise the bank’s lending activities, approval of unlawful dividend payment and corporate waste.
The complaint also asserts claims against James Regas and his law firm, Regas Frezadas & Dallas, for legal malpractice, breach of fiduciary duty and aiding and abetting the director and officer defendants’ breaches of fiduciary duty. The lawyer and his firm are allege to have facilitated the unlawful payment of dividends; failed to counsel and prevent the bank’s board from making grossly imprudent loans; ignoring federal lending regulations; and facilitating bank transactions to entities in which one of the attorney defendants held an interest, despite the conflict of interest.
Interestingly, the roster of director defendants does not include Pethinaidu Velchamy, the bank’s former Chairman, or Parameswari Velchamy, the former Chairman’s wife, who was also a director of the bank. The complaint alleges that the two have each filed a petition under Chapter 7 of the bankruptcy code, and that “despite” their respective “culpability for the events described,” the stay in bankruptcy “precludes” naming them as a defendant “unless the stay is modified or lifted.”
Among other things, the Complaint alleges (in paragraph 34) that the former Chairman has filed a lawsuit against the bank’s former auditors, in which the Chairman supposedly alleges that “the Bank’s balance sheet contained hundreds of millions of dollars in loans that had been funded on the basis of substandard, if not reckless underwriting and … were not identified for corrective action because of critical failure in the Bank’s internal credit risk review function.”
Though the former Chairman and his wife are not named as defendants in the lawsuit, their son and daughter, both of whom served as members of the board of directors, were named as defendants.
These family connections are particularly interesting in relation to the FDIC’s waste allegations. Among other things, the FDIC alleges that board facilitated the payment of $250,000 in bank funds for the wedding of the Chairman’s daughter; authorized $495,000 in “bonuses” to pay the criminal defense costs of the bank President’s wife, who had been indicted for Medicaid fraud; and approving the use of $300,000 in bank funds to hold a board meeting in Monte Carlo.
Regas, the lawyer defendant, and his law firm, are alleged to have been aware that loans referenced in the complaint were “grossly deficient” but that despite the awareness of the “imprudence, and in some cases, unlawful nature of these transactions,” the lawyer and his firm failed to protect the bank from foreseeable injury inherent in these transactions. The law firm is alleged to have received over $3 million in fees between January 2007 and April 2009.
Regas is also alleged to have participated in a 2006 land loan transaction involving undeveloped real estate. The $28.5 million loan was originated by another bank for which Regas also served as director. The individual that sold the land to the borrower is described in the complaint as Regas’s “close friend and business colleague.” After the other bank made the loan, Regas allegedly arranged for Mutual Bank to acquire a $24.5 million participation in the loan. Regas allegedly steered the loan through the Mutual Bank approval process and did not abstain from voting to approve the loan. Regas is alleged to have abandoned his fiduciary duty to Mutual Bank in favor of the other bank and his friend. The loss to the bank from the loan is alleged to be approximately $24.5 million.
This latest complaint is the 16th lawsuit that the FDIC has filed in connection with the current wave of bank failures, but so far as I am aware, it is the first in which the FDIC has named a failed bank’s outside lawyer and law firm as defendants. During the last round of bank failures in the S&L crisis, the FDIC pursued an aggressive litigation approach and often included failed bank’s lawyers or law firms as defendant. In many of those cases, as here, the lawyer defendants had served on the failed bank’s board and were alleged to have engaged in conflicts of interest. That prior history and the presence of those types of allegations here suggests that we are not about to see a comprehensive campaign against the outside law firms of failed banks. The firms or their lawyers are relatively unlikely to get drawn into the type of failed bank litigation if the firm did not have an attorney on the failed bank’s board or did not otherwise allegedly engage in conflicts of interest.
Out of the 16 failed bank lawsuits the FDIC has filed so far, this is the fourth involving an Illinois Bank (there have also been four lawsuits so far involving failed banks in California and Georgia, respectively). Like many of the lawsuit filed so far, this one was not filed until more than two years had elapsed since the bank’s closure. Given the fact that the bank closures did not really peak until late 2009 and early 2010, and allowing for that two year plus lag time, we could start to see increasing numbers of additional FDIC failed bank lawsuits in the months ahead.
Special thanks to a loyal reader for providing a copy of the Mutual Bank complaint.