ncOn August 18, 2015, in an interesting opinion that takes a close look at exculpatory bylaw issues and the business judgment rule under North Carolina law, the Fourth Circuit affirmed in part and reversed in part the district court’s dismissal of the failed bank lawsuit the FDIC had filed against former directors and officers of Cooperative Bank of Wilmington, N.C. The appellate court affirmed the dismissal of all of the claims against the director defendants but reversed the lower court’s ruling as to the negligence and breach of fiduciary duty claims against the officer defendants.


This appeal had been very closely watched and had attracted a host of amicus briefs in support of the district court’s opinion. The appellate court’s mixed decision may have been less than the banking groups were hoping for, but overall the opinion has several features that should make them happy, as discussed below.  A copy of the Fourth Circuit’s opinion can be found here.



After the Cooperative Bank of Wilmington, N.C. failed in June 2009, the FDIC as the failed bank’s receiver initiated a lawsuit against certain former directors and offices of the bank, asserting claims for negligence, gross negligence, and breaches of fiduciary duty in connection with the defendants’ approval of 86 loans between January 2007 and April 2008. The FDIC alleged that in making the loans, the defendants had deviated from prudent lending practices established by the bank’s own loan policy, published regulatory guidelines, and generally accepted banking practices. In its lawsuit, the FDIC sought to recover approximately $40 million in losses the bank sustained in connection with the subject loans. The parties filed cross-motions for summary judgment.


As discussed here, on September 11, 2014, Judge Boyle granted the defendants’ motion for summary judgment, dismissing all of the FDIC’s claims against the former directors and officers. His sharply worded opinion was very critical of the FDIC’s positions.


With respect to the FDIC’s claims for ordinary negligence and for breach of fiduciary duty, Eastern District of North Carolina Judge Terrence Boyle ruled that “the business judgment rule applies and shields the defendants from liability.”


In making this ruling, Judge Boyle specifically found that the loans in question were made based on a rational business process, noting among other things that during the relevant time period, the FDIC as the bank’s regulator had itself rated the bank’s lending process as satisfactory and had given the bank an overall CAMELS ratings “2” for management, asset quality and sensitivity to market risks (CAMELS ratings are given on a scale of 1 to 5, with 1 being the highest. Banks scoring a 1 or a 2 “are considered well-managed and presenting no material supervisory concerns.”) Based on these examination ratings Judge Boyle found “as a matter of law, that defendants’ processes and practices for the challenged loans were rational.”


Judge Boyle also granted the defendants’ motion for summary judgment on the FDIC’s gross negligence claims, based on his finding that “the FDIC has presented no evidence that any of the defendants approved the challenged loans and made policy decisions knowing that these actions would harm Cooperative and breach their duties to the bank.” The FDIC appealed the district court’s rulings.


The August 18, 2015 Opinion

On August 18, 2015, in an opinion written by Judge Roger Gregory for a unanimous three-judge panel, the Fourth Circuit affirmed in part and reversed in part the district court’s summary judgment ruling and remanded the case to the district court for further proceedings. The Fourth Circuit affirmed the dismissal of all of the claims against the failed bank’s directors and affirmed the dismissal of the gross negligence claims against the directors and the officers, but reversed the dismissal of the negligence and breach of fiduciary duty claims against the officer defendants.


The appellate court first affirmed district’s grant of summary judgment to the director defendants as to the FDIC’s claims of ordinary negligence and breach of fiduciary duty. The appellate court noted that the bank, as permitted under North Carolina law, had a bylaw provision exculpating its directors from liability for negligence or for a breach of fiduciary duty in the absence of breaches of the duty of loyalty and the duty of good faith.


The FDIC did not allege that the directors had been disloyal, but rather that they were not entitled to the exculpatory provisions’ protection because they took actions that were harmful to the bank, “in part by making decisions without adequate information.” The appellate court called these allegations “insufficient,” because the alleged actions were not, as the North Carolina statutory provision requires, “clearly in conflict with the bank’s best interests.” The fact that decisions could have been made better does not meet these standards – especially, the appellate court added, in light of regulatory CAMELS scores.


However, the bank’s exculpatory provision does not apply to officers, so the appellate court turned to the question of whether the officers were, as the district court concluded, entitled to the protection of the business judgment rule. The appellate court found said, with respect to the district court rulings regarding business judgment rule that “while we agree with the district court’s interpretation, we find that the court improperly applied the rule.”


The appellate court found that the FDIC has presented adequate evidence to rebut the rule’s presumption that a corporation’s directors’ and officers’ decisions were made in good faith and in the corporation’s best interests. In reaching this conclusion, the court relied heavily on the affidavit of the FDIC’s banking expert witness. The appellate court noted that the witness had said in his affidavit that the officers had not acted in accordance with generally accepted banking practice and were inconsistent with practices at other institutions, and also noted that the expert witness’s report contained commentary about the bank’s CAMELS ratings, specifically that the notwithstanding the overall rating of 2 there were indications that the bank’s lending processes needed substantial improvement. This evidence, the court said, was sufficient to support a conclusion that the officers had not proceeded on an informed basis, which in turn was sufficient to rebut the business judgment rule’s presumption.


Finally, the appellate court affirmed the district court’s conclusion that the FDIC had failed to present evidence that the defendants were grossly negligent. The court noted that while the individuals may have failed to address deficiencies noted in the examination reports, those same reports repeatedly awarded Cooperative  ratings of “2” in the CAMELS ratings. The court said “in the face of this contradiction, we find that there is insufficient evidence that the Appellees acted wantonly or with reckless indifference.”



The district court’s opinion in this case had been cheered by banking groups because of its sharp criticism of the FDIC’s claims and its summary dismissal of the agency’s efforts to hold the individual directors and officers liable for the failed bank’s loan losses. Although the appellate court’s opinion is not as strong for the individuals as the district court’s had been, and although the appellate court reversed the lower court’s ruling in part as to the officer defendants, overall there is still much to hearten the banking groups who had urged the Fourth Circuit to affirm the district court.


First, the appellate court affirmed the dismissal of all of the claims against the failed bank’s former directors. The court’s conclusion that the bank’s exculpatory provisions were sufficient to protect the directors and to dismiss the negligence and breach  of fiduciary duty claims against them will gladden bank directors everywhere, particularly those  facing similar  FDIC failed bank claims.


The appellate court’s affirmance of the district court’s dismissal of the FDIC’s gross negligence claims – as to both the directors and the officers — will also please bank directors and officers everywhere, particularly given the court’s reference to the inconsistency between the FDIC’s allegations and the rating s the agency acting in its role as regulator had given the bank at the relevant time. Many banks similarly were highly rated before the financial crisis hit, and so many failed bank directors and officers similarly may be able to argue that the FDIC’s allegations against them are inconsistent with the agency’s own ratings at the time.


The appellate court did reverse the district court’s grant of summary judgment as the negligence and breach of fiduciary duty claims, but even here there is some good news (although it is small consolation to the specific individuals involved). The appellate court did at least agree that under North Carolina law officers as well as directors are entitled to the business judgment rule’s protection. Moreover, if the case were to go to trial, they would still have the opportunity to persuade the jury that there are entitled to the rule’s protection.


However, the appellate court did revive the negligence and breach of fiduciary duty claims against the officer defendants, which both the affected individuals and the banking groups that had rallied to this case will find disappointing. It is noteworthy that in reversing the district court, the appellate court relied so heavily on the affidavit of the FDIC’s expert witness. The particularly disheartening aspect of this part of the Fourth Circuit’s opinion for the various banking groups is that the FDIC will always be able to come up with an expert witness affidavit like the one the agency relied on here. These kinds of consultants are always available and the FDIC pretty much will always be able to find one to say the kinds of things the expert said here. If the expert affidavit is enough to rebut the business judgment rule and to preserve the FDIC’s  negligence claims against individual officers, it is going to be tough for individuals to use the rule to spring themselves from the cases against them, even if they are otherwise entitled to the protection of the business judgment rule.


The impact of the court’s rulings will be limited because they were made under North Carolina law. Relatively few banks in North Carolina failed during the current bank failure wave. However, the court’s rulings are likely to be persuasive throughout the Fourth Circuit, even in cases to which other states’ laws apply. As an appellate court ruling, it could be influential outside the Fourth Circuit as well, and to that extent former directors and offices facing FDIC lawsuits in other jurisdictions will seek to use the court’s rulings to their advantage – at least the rulings that they find helpful.


Avon Settles FCPA Investigation-Related Securities Lawsuit: As I have noted on this blog, though the FCPA itself does not provide a private right of action, in many instances companies involved in FCPA investigations are hit with follow on civil lawsuits, in the form of shareholder derivative actions or securities class action lawsuits. These follow on suits do not always fare well, as I have noted in the past on this site (refer, for example, here).


Among the follow-on suits that, at least initially, did not fare well was the FCPA investigation-related securities class action lawsuit filed against Avon and certain of its directors and officers. As discussed here, the court granted the defendants’ initial motion to dismiss – but did so with leave to amend. The plaintiffs amended their pleadings and the case went forward. In addition, late last year, Avon agreed to pay $135 million in criminal and civil penalties and accept a deferred prosecution agreement to end U.S. investigation into its China operations.


Now, the parties appear to have reached an agreement to settle the case, based on Avon’s agreement to pay $62 million. The parties’ agreement, which is subject to court approval, is described in the joint motion seeking approval (here)  According to an August 18, 2015 Reuters article describing the settlement  (here), all but $2 million of the settlement is to be funded by insurance.


All of which is a reminder that the bribery-related derivative and securities lawsuits are not only a significant frequency risk, but they can represent a severity risk as well, both for the companies involved, and, as this settlement demonstrates, for their insurers as well.