As the subprime meltdown has become a more generalized economic crisis, the adverse consequences have moved far beyond the residential real estate sector where the trouble first began. Until recently, however, the worst effects were concentrated in the financial sector. But as Chrysler’s recent bankruptcy filing shows, the turmoil is no longer limited to the finance sector alone. The infiltration of the credit crisis into the larger economy not only threatens a rise in bankruptcies, but could also include increased bankruptcy-related securities litigation, much of which may be outside the financial sector.


An indication of how these developments might arise can be seen in the securities class action lawsuit filed in the Northern District of Texas on April 30, 2009, against certain former officers of Idearc, Inc. A copy of the complaint can be found here. Idearc "manages and delivers print, online and wireless publishing and advertising services on multiple platforms," including yellow and white pages, online directories and search services. Idearc itself filed for protection under the U.S. bankruptcy laws on March 3, 2009, and so is not named as a defendant in the securities lawsuit.


The complaint alleges that in 2006 and 2007, the company had "touted" its credit and collection policies and procedures, which it claimed had resulted in a steady decline in its bad debts. However, the complaint alleges, during 2007, the company "relaxed" its credit policies "in order to increase the dollar amount" of reported revenue.


The complaint further alleges that the company, "by selling to non-creditworthy customers, effectively reported tens of millions of dollars of sales that it otherwise would not have reported while accumulated tens of million of dollars of uncollectible receivables." However, the complaint alleges, in mid-2008, the company admitted that it had relaxed its credit policies in 2007, and "began to write off these uncollectible receivables in a piecemeal fashion over several quarters."


The complaint alleges that by year end 2008, the company had written off $47 million of receivables, which among other things "materially contributed to the company’s need to file for bankruptcy protection." The complaint alleges that investors were misled by the company’s disclosures regarding its credit and collection policies and procedures as well as by the piecemeal revelation of its company’s growing problems with receivables collections and reserve for bad debts.


As the economy sours, many companies – including companies outside the financial sector, like Idearc – are likely to experience increasing difficulties realizing the anticipated benefits from customer, vendor or counterparty obligations. By the same token, reduced economic activity may render many companies unable to meet their own obligations to their creditors, suppliers and others.


As these problems accumulate, other companies will find it necessary to seek protection under the bankruptcy laws. The officers and directors of many of these bankrupt companies, like those at Idearc, may find themselves the target of a post-filing securities class action lawsuit. Another recent example of a post-filing bankruptcy lawsuit involves former directors and officers of MRU Holdings, about which I previously wrote here.


The increase of these kinds of bankruptcy related lawsuits may be the means by which the current wave of subprime and credit crisis-related litigation spreads outside the financial sector. In its recent quarterly report on securities litigation (here), Advisen suggested that "it is likely that the wave of subprime-related suits, and in particular suits filed against financial services companies, will crest in 2009." The report goes on to suggest that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed …broadly affecting all sectors."


More Failed Banks: In what is now a standard weekend ritual, this past Friday evening the FDIC closed three more banks, bringing the year to date total number of failed banks to 32. The three banks closed this Friday night were: Silverton Bank of Atlanta, Georgia, which prior to its closure had assets of $4.1 billion, making it the fifth largest bank to fail since the beginning of 2008 (further details about the bank can be found here); Citizens Community Bank of Ridgewood, N.J. , which had assets of $45.1 million (refer here); and America West Bank of Layton, Utah, which had assets of $299.4 million (refer here).


Silverton is the sixth Georgia bank to be closed this year and the eleventh since January 1, 2008, the highest total for any state during either of those two periods.


In light of their relatively small size, both Citizens Community Bank and America West Bank qualify as community banks. As I recently noted (here), the 2009 bank failures have largely involved these kinds of smaller community banks. Indeed, 27 of the 32 banks that have failed so far this year have involved financial institutions below $1 billion in assets, which is one standard measure of community banks.


Silverton was quite a bit larger than these community banks, and it is also somewhat unusual in that Silverton did not take deposits from the general public or make loans to consumers. Silverton was a wholesale bank, providing services, according to the Wall Street Journal (here), to one in every five banks in the country. Silverton was known as the Bankers Bank until last year. Its customers, depositors and investors are all banks. Banks that had invested in Silverton will incur losses as a result of its failure, which could pose problems other banks.


The FDIC’s complete list of failed banks since October 2008 can be found here. The Wall Street Journal has a nifty interactive table of all the failed banks here, which can be sorted by name, closure date, asset and deposit size, and other factors. (The Journal’s list does not yet include Citizens Community Bank and America West Bank.)


Speakers’ Corner: On Monday, May 4, 2009, I will be in New Orleans at the spring meeting of the Casualty Actuarial Society, participating on a panel entitled "An Update on the Credit Crisis and Related Issues for D&O Insurers." The panel will be chaired by Joe Lebens of the Towers Perrin firm, and will include Stephanie Plancich from NERA Economic Consulting and David Bradford from Advisen. More information about the session and the conference can be found here.