On October 5, 2012, in the latest in a series of decisions addressing the question whether or not corporate officers (as differentiated from corporate directors) are entitled under California law to rely on the protections of the business judgment rule, Central District of California Judge Dale Fischer held that former officers of the failed IndyMac bank cannot assert an affirmative defense based on the business judgment rule in the FDIC’s failed bank lawsuit pending against them. Judge Fischer also addressed the question whether the individual officer could assert a number of other affirmative defenses against the FDIC. A copy of Judge Fischer’s memorandum opinion can be found here.

Background

IndyMac Bank failed on July 11, 2008. As discussed in detail here, On July 2, 2010, in the first lawsuit against former directors and officers of a failed bank it filed as part of the current wave of bank failures, the FDIC, as receiver of IndyMac, filed a lawsuit in the Central District of California against four former officers of IndyMac’s Homebuilder Division (HBD). 

The lawsuit is filed against Scott Van Dellen, HBD’s former President and CEO, who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved at least 40 of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved at least 57 of the loans at issue; ;and William Rothman, who served as HBD’s Chief Lending Officer from mid-2006 and who is alleged to have approved at least 34 of the loans at issue. The lawsuit seeks to recover damages from the four individual defendants for "negligence and breach of fiduciary duties." 

In their answers to the FDIC’s complaint, the officer defendants asserted a number of affirmative defenses, including a defense based on their assertion that their actions were protected by the business judgment rule. The parties filed cross-motions for partial summary judgment on a number of issues, including the question of whether or not the defendants were entitled to rely on the protections of the business judgment rule, as well as the defendants’ other affirmative defenses.  

The October 5 Ruling

Judge Fischer began her October 5 opinion with a detailed choice of law analysis. The defendants had argued, in reliance on the holding company’s Delaware incorporation, that Delaware law applied. The FDIC argued that because the bank was locating in and conducted its operations in California, California law governed. Judge Fischer found that regardless of which choice of law principles were used to determine the question, California law governed.

Having determined that California law applied, Judge Fischer then turned to the question of the applicability of California’s Business Judgment Rule (BJR). Judge Fischer noted that under California law, the BJR has two components, an “immunization from liability” codified in Corporations Code Section 309, and a “judicial policy of deference to the exercise of good faith business judgment in management decisions.”

The officer defendants conceded that the protections codified in Section 309 were not available (undoubtedly because Section 309 refers only to “directors”). So the question for Judge Fischer was whether the common law element of the BJR applies to officers.

After reviewing California case law and also the work of the California Law Revision Commission, Judge Fischer determined that “the Court is left with only one reasonable conclusion” – that is, that “the state’s business judgment rule does not protect officers” and therefore the individual officer defendants “may not use the business judgment rule as an affirmative defense.” Judge Fischer granted the FDIC’s motion for partial summary judgment in that respect.

Judge Fischer then went on and considered several of the individual defendants’ other affirmative defenses. Among other things, Judge Fischer concluded that California’s four-year statute of limitations applied to the FDIC’s claims against the four individuals for breach of fiduciary duty, rather than either FIRREA’s three-year statute of limitations or other shorter California statutes of limitation on which the individual defendants sought to rely.

Judge Fischer also concluded that the defendants are barred from asserting against the FDIC (as Indy Mac’s receiver) affirmative defenses for failure to mitigate, unclean hands and ratification, based on the FDIC’s pre- and post-receivership conduct, because, as Judge Fischer concluded, under California law, equitable defenses that would have been good against the Bank could not be raised against the FDIC as receiver.

Discussion

In several instances, individual defendants have successfully argued that their conduct is protected by the business judgment rule and accordingly, that they cannot be held liable for ordinary negligence. The most significant holding is the August 14, 2012 decision in the Northern District of Georgia in the Haven Trust case, in which Judge Steve C. Jones dismissed the claims against both the director and officer defendants, because of his determination that under Georgia law the directors’ and officers’ conduct is protected by the business judgment rule. The Haven Trust case is discussed here. Earlier in August, a judge in the Middle District of Florida, ruled in the FDIC’s failed bank lawsuit relating to the failed Florida Community Bank of Immokalee, Florida, that under Florida law directors cannot be held liable for ordinary negligence, as discussed here. The ruling in that case did not reach the question of whether or not officers can be held liable for ordinary negligence under Florida law.

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. Most recently, on June 7, 2012, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors. Judge O’Neill’s ruling is discussed here (second item).

The significance of Judge Fischer’s ruling in the Indy Mac case is that it was, by contrast to Judge O’Neill’s June 2012 decision, not solely with relationship to provisions of Section 309, which by its terms refers only to directors (a point conceded by the defendants in the Indy Mac case). Judge Fischer went on to hold that corporate officers may not rely on the protections of the common law business judgment rule, either.

Although Judge Fischer’s analysis in connection with her rulings regarding the defendants’ other affirmative defenses is not early as detailed as with respect to the business judgment rule, it is nevertheless significant that she determined as a matter of California law that the defendants cannot assert against the FDIC the affirmative defenses for failure to mitigate, unclean hands and ratification. As noted below, other courts, applying the laws of other jurisdictions, have reached contrary conclusions on the question of whether or not former Bank officers and directors can assert equitable defenses against the FDIC asserting claims as receiver as a failed bank.

Special thanks to a loyal reader for providing me with a copy of Judge Fischer’s October 5 opinion.

Under North Carolina Law, Failed Bank’s Former Directors and Officers Can Assert Equitable Defenses Against the FDIC: An October 2, 2012 ruling, applying North Carolina law, reached a different conclusion that Judge Fischer on the question of whether or not former directors and officers of a failed bank can assert equitable defenses against the FDIC. A copy of the October 2 opinion can be found here.

As discussed here, the FDIC had brought an action against nine former directors and officers of the failed Cooperative Bank of Wilmington, North Carolina. As detailed in the October 2 order, Eastern District of North Carolina Judge Terrence Boyle denied the defendants’ motion to dismiss.

The FDIC had also separately moved to strike the individual defendants’ affirmative defenses for avoidable consequence/failure to mitigate damages. The defendants contend that the terms of the loss-share agreement entered between the FDIC and Cooperative’s acquiring bank did not provide the acquiring bank with incentive to lessen the loan losses, which aggravated the losses or even cause the losses in connection with some loans. The FDIC moved to strike the defense, on the ground that it had “no duty” to the defendants.

The defendants argued in reliance on the U.S. Supreme Court’s 1994 ruling on O’Melveny & Myers v. FDIC that when the FDIC brings an action as receiver, it “steps into the shoes” of the failed bank and state common law governs questions of tort liability.

Judge Boyle noted that the courts are split on the question whether the “no duty” rule (on which the FDIC relied in its motion to strike) still applies after the O’Melveny decision. Citing an unpublished Fourth Circuit opinion, Judge Boyle concluded that state law governs what defenses are available against the FDIC. Judge Boyle found that under basic principles of North Carolina law, a plaintiff must take reasonable steps to mitigate damages. Accordingly Judge Boyle denied the FDIC’s motion to strike, allowing the defendants to assert the equitable defenses against the FDIC.

Although Judge Fischer reached a different conclusion in the Indy Mac case on the ability of individual defendants to assert equitable defenses against the FDIC as receiver of a failed bank, the difference in outcome in the two cases at least arguably can be explained by the difference in the two jurisdictions’ law that was applied. The two cases did at least conclude that the question of the availability of affirmative defenses is a question of state law.

Judge Boyle’s opinion not only ruled that the defendants can assert the equitable defenses but also implicitly rejected the FDIC’s “no duty” argument, one of several defendants to reach this conclusion.

For a detailed discussion of the issues surrounding the FDIC’s “no duty” argument, please refer to August 31, 2011 guest post, here.

Special thanks to a loyal reader for providing me with a copy of Judge Boyle’s opinion.