One of the critical issues in building a D&O insurance program is the question of how to structure the insurance. Among the more complex issues is how to divide the program between “traditional” D&O insurance coverage and Excess Side A DIC insurance (which in effect provides catastrophic protection for individual directors and officers in certain defined circumstances). A more basic issue is how to “layer” the program between primary and excess insurers, and how much capacity each of these layers should have in the overall program.

 

The question of how to layer a D&O insurance program is certainly not new, but it remains a vital question and a source of continuing scrutiny and debate, because the way that an insurance program is structured can potentially have a significant impact in the event of a claim.

 

In the latest issue of InSights, I take a detailed look at the problems and challenges associated with D&O insurance layering and also suggest a few ways these problems and challenges can be reduced, or at least managed. The InSights article can be found here.

 

Worth Noting: Readers interested in developments regarding the duties of directors outside of the United States will want to take a look at the October 16, 2012 article from Mark Bestwetherick of the Clyde & Co. law firm entitled “Directors’ Duties and the Increasing Requirement for D&O Insurance in the UAE” (here). The article takes a look at pending changes to the UAE company law and the potential impact on the changes to director indemnification and insurance.

 

The World’s Worst Typos (In Pictures): Read ‘em and weep. Find them here.

 

A significant side-effect from the current bank failure wave has been the FDIC’s assertion of claims against the former directors and officers of many of the failed banks. The FDIC’s claims have in turn raised significant questions of insurance coverage under many of the failed banks’ D&O insurance policies. As discussed in a prior post (here), one of the significant coverage issues that has come up is whether or not the claims of the FDIC, which it is asserting in its capacity as receiver for the failed banks, are precluded under the Insured vs. Insured exclusion found in most D&O insurance policies. (The Insured vs. Insured Exclusion is sometimes referred to as the I v I exclusion.)

 

In what is as far as I know the first decision on this issue as part of the coverage litigation arising out the current bank failure wave, the federal court in Puerto Rico has ruled that the I v I exclusion in the D&O insurance program of the failed Westernbank of Mayaguez, Puerto Rico does not preclude coverage for the FDIC’s claims against the failed bank’s former directors and officers. A copy of the court’s October 23, 2012 decision can be found here.

 

Regulators closed Westernbank on April 30, 2010, which according to the FDIC cost the insurance fund $4.25 billion. In October 2011, certain of the former Westernbank directors and officers had sued the bank’s primary D&O insurer in state court in Puerto Rico (about which refer here). The FDIC as receiver for Westernbank moved to intervene in the state court action, and on December 30, 2011, removed the state court action to the District of Puerto Rico. On January 20, 2012, the FDIC filed its amended complaint in intervention, in which it named as defendants certain additional directors and officers,  and, in reliance on Puerto Rico’s direct action statute, the D&O insurers in the bank’s D&O insurance program. A copy of the FDIC’s amended complaint can be found here.

 

In its complaint, the FDIC, as Westernbank’s receiver, seeks recovery of over $176 million in damages from the former bank’s directors and officers as well as their conjugal partners, based on twenty-one alleged grossly negligent commercial real estate, construction and asset-based loans approved and administered from January 28, 2004 through November 19, 2009. In its complaint in intervention in the directors and officers coverage action against the bank’s D&O insurers, the FDIC seeks a judicial declaration that its claims against the directors and officers are covered under the policies. All of the defendants moved to dismiss the respective claims against them.

 

In his October 23 opinion and order, Judge Gustavo Gelpi denied all of the motions to dismiss. His rulings with respect to the D&O insurers’ motions to dismiss the coverage actions against them appear on pages 16 and following in the October 23 opinion.

 

The D&O insurers had moved to dismiss the coverage actions that had been filed against them in reliance on the I v I exclusion in the primary insurance policy. The exclusion provides that “The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against an Insured …which is brought by, or on behalf of, an Organization or any Insured Person other than an Employee of an Organization, in any respect and whether or not collusive.” The insurers argued that as receiver for the failed Westernbank, the FDIC stood in the shoes of Westernbank, which is an insured under the policy, and therefore the FDIC’s claims against the failed bank’s directors and officers were precluded from coverage under the D&O insurance policies by operation of the I v I exclusion.

 

As Judge Gelpi noted in his opinion these same issues were raised and litigated in a number of cases during the S&L crisis two decades ago. And as Judge Gelpi also notes in his opinion, these prior courts had split on the question of whether or not a D&O insurance policy’s Insured vs. Insured Exclusion precludes coverage for claims brought by the FDIC in its capacity as receiver against a failed bank’s former directors and officers. In summarizing these cases, Judge Gelpi noted that the question of the applicability of the exclusion in this context “is ambiguous.”

 

Judge Gelpi then, “with these differences in mind,” turned to the “purposes of the exclusion, the complaint and the specific terms of the policy for guidance.” He noted that the “obvious purpose” of the exclusion is to protect against collusive law suits; however, he also noted that the exclusion itself on which the insurers sought to rely made the exclusion applicable to Insured vs. Insured claims “whether or not collusive.”

 

The question to which Judge Gelpi then turned is whether or not the FDIC’s claims against the former directors and officers of Westernbank were “brought by, on behalf of or in the right of, and Organization or any Insured Person.” Judge Gelpi noted that the policy defines the term “Organization” as the named entity, each subsidiary and debtors in bankruptcy proceedings. After citing these provisions, Judge Gelpi summarily concluded that “Accordingly, the court finds that the FDIC’s course of conduct does not run afoul of this provision.” In reliance on prior cases that had concluded that the I v I Exclusion “does not prelude the FDIC from seeking redress from the Insurers.” 

 

By way of further elaboration, Judge Gelpi noted that the FDIC is suing “on behalf of depositors, account holders, and a depleted insurance fund,” and therefore that “the FDIC’s role as a regulator sufficiently distinguishes it from those whom the parties intended to prevent from bringing claims under the Exclusion.”

 

Discussion

Judge Gelpi’s ruling in this case is a significant victory for the individual directors and officers who hoped to be able to rely on the D&O insurance policies in order to be able to defend themselves against the FDIC’s claims against them, as well as for the FDIC, which hopes to be able to recover the losses it claims from the D&O insurance policies.

 

As the first decision on this insurance coverage issue in connection with the current bank failure wave, Judge Gelpi’s ruling will also obviously be of great interest to other failed bank directors and officers who face FDIC claims and whose D&O insurance carriers have tried to deny coverage in reliance on their respective policies’ Insured vs. Insured Exclusions. But while Judge Gelpi’s decision unquestionably will be helpful to the directors and officers in the other cases, it is far from the final word on the subject.

 

For starters, the split of authority in the cases from S&L crisis era remains. As Judge Gelpi noted, the courts have gone both ways on these issues and the carriers undoubtedly will continue to attempt to rely on the cases holding that the Insured vs. Insured exclusion does preclude coverage for claims brought by the FDIC.

 

A further reason that Judge Gelpi’s decision is unlikely to provide the final word on the subject is that other courts may not find the logic on which Judge Gelpi relied as compelling as he did. Judge Gelpi does not, for example, appear to have even considered the question of whether or not an action by the FDIC in its capacity as receiver of a failed bank (and therefore in effect, “standing in the shoes of the failed bank”) is an action “in the right of” the Organization, within the language and meaning of the exclusion. Other courts may consider it important in considering the exclusion’s potential applicability to address this issue expressly, as Judge Gelpi’s opinion does not. These other courts, in more careful consideration of this issue, might also conclude that the FDIC asserting claims as a failed bank’s receiver is asserting claims “in the right of” the failed bank and therefore that the exclusion applies.

 

In support of his conclusion, Judge Gelpi also considered it important that the FDIC was not only suing in its capacity as receiver, but was also suing on behalf of “depositors, account holders, and a depleted insurance fund.” Indeed, many of the courts that had ruled during the S&L crisis era that the Insured vs. Insured exclusion did not preclude coverage for claims by the FDIC had made their decisions in reliance on the same or similar observations about the FDIC’s claims.

 

The insurers, however, will likely contend that even if the FDIC is acting on behalf of these other constituencies in bringing the suit, it is first and foremost bringing the suit in its capacity as receiver for the failed bank, as that is the basis upon which it has any right to bring the claims in the first place. The insurers will further argue that the sole basis on which the FDIC has any right to assert the claims is because, by operation of the receivership, it is acting “in the right of” the failed bank, and therefore the preclusive language of the exclusion applies, notwithstanding the fact that the FDIC may have other purposes and motivations in bringing the action. The policy’s exclusion does not require, in order for the exclusion to apply, that the action be brought “solely” or “only” “in the right of” the Organization. The insurers will argue that because the action was brought “in the right of” the Organization, the exclusion applies notwithstanding the fact that in bringing the claim the FDIC was also action on behalf of other constituencies.

 

All of which is a long way of saying that though the policyholders and the FDIC prevailed in this case, these issues are likely to continue to be litigated, and the split of cases we saw during the S&L crisis is likely to continue.

 

Very special thanks to the several readers who supplied me with copies of Judge Gulpi’s opinion.

 

Another Georgia Failed Bank Lawsuit: On October 23, 2012, the FDIC, as receiver for the failed United Security Bank of Sparta, Georgia filed its latest failed bank lawsuit. The complaint, which the FDIC filed in the Northern District of Georgia, can be found here.

 

United Security bank failed on November 6, 2009. The FDIC’s lawsuit as the bank’s receiver is filed against a single defendant, Pierce Neese, the bank’s former CEO and also a bank director. The FDIC’s complaint asserts claims of Negligence and Gross Negligence against Neese in connection with 16 loans made between November 10, 2005 and March 27, 2008, which the agency alleges caused damages to the bank of over $6.373 million.

 

An unusual feature of the FDIC’s complaint, and perhaps the explanation why there is only a singe defendant is the case, is the agency’s allegation that from 2002 until March 2006, Neese “was effectively the Bank’s senior credit officer and functioned as a ‘One-Man Bank.’” Even after the bank established itself as a three-person LLC at the direction of regulators, Neese “continued to function as the Bank’s ‘one-man’ LLC until the Bank failed. According to the complaint, the bank even had print advertisements stating, “Meet Our Loan Committee, Pierce Neese.” The FDIC alleges that by dominating and usurping the loan approval process, Neese rendered the usual lending controls ineffective.

 

The FDIC’s complaint against Neese is the latest that the FDIC has recently filed as banks that failed in 2009 approach the third year anniversary of their closure (about which refer here). The complaint is also is the 35th lawsuit that the FDIC has filed as part of the current failed bank wave and the 17th that the agency has filed so far in 2012. The FDIC’s lawsuit against Neese is also the tenth lawsuit the FDIC has filed in connection with a failed Georgia bank. Although Georgia has had more failed banks than any other state, the percentage of all failed bank lawsuit involving failed Georgia banks is even greater than the percentage of all bank failures involving Georgia banks. For now at least, it seems as if the regulators are focusing on Georgia more than other states.

 

The growing problem of M&A-related litigation has been well-documented on this site (refer for example here). The prevalence of M&A litigation has grown to the point that virtually every M&A transaction involves litigation, and often involving multiple lawsuits in multiple jurisdictions. These growing problems have been well-documented (refer for example here and here), but coming up with solutions has proven challenging.

 

An October 2012 paper by the U.S. Chamber Institute for Legal Reform entitled “The Trial Lawyers’ New Merger Tax” (here) takes a comprehensive look at M&A litigation and proposes a number of possible legislative solutions to the problems associated with multi-jurisdiction litigation. The paper is being released in conjunction with the U.S. Chamber Institute for Legal Reform’s annual Legal Reform Summit, being held on October 24, 2012 at the U.S. Chamber of Commerce in Washington. D.C.

 

The paper opens with a description of the current state of M&A-related litigation. The paper certainly does not hold back in characterizing the state of M&A litigation. Among other things, the paper describes M&A litigation as “extortion through litigation” that permits trial lawyers to “hold transactions hostage until they collect a ‘litigation tax’ draining a share of the merger’s economic benefit away from shareholders and into the lawyers’ own pockets.”

 

The paper includes a detailed review of recent statistical studies documenting the M&A related litigation trends, noting in particular (and citing the Cornerstone Research’s analysis of M&A litigation, about which refer here) that on average each transaction is subject to five lawsuits, and that many deals attract more than 15 suits. In some cases, merger deals have attracted as many as 25 lawsuits.

 

The paper also notes that increasingly these multiple lawsuits are filed in multiple jurisdictions, which forces defendants “to litigate in numerous jurisdictions that are incapable of coordinating with each other, particularly state courts in different states,” which “dramatically increases the cost of defense and increases the settlement pressure regardless of the merits of the underlying claims.” Because “no   procedure exists to consolidate identical cases filed in the courts of different states and in federal court,” judges today “cannot stop the abuse.”

 

Although there are many aspects of the M&A litigation problem, the paper focuses its proposed solutions on the multiple jurisdiction litigation issue, in part because it is “a principal source of the trial lawyers’ settlement leverage.” The paper suggests several possible legislative reforms to “prevent plaintiffs’ lawyers from exploiting” the burdens imposed by multiple jurisdiction litigation by “eliminating forum shopping and forum multiplication.”

 

In order to address these issues, the paper suggests three possible legislative reforms (not necessarily mutually exclusive) at the federal level. First, the paper suggests that Congress could “enact a statute requiring all merger-related litigation to be brought in the state of incorporation of the defendant company.” (The paper notes that this proposal has also been advanced by committee of the Association of the Bar of the City of New York.) Second, the paper suggests that Congress could amend the “carve outs” in SLUSA and CAPA to required that class actions brought under the carve-outs “may be filed only in the courts of the defendant company’s state of incorporation.”

 

Third, to address the fact that many of these merger related lawsuits are brought in federal court, the paper suggests that Congress could enact legislation providing that any lawsuits relating to mergers or acquisitions that are brought in federal court should be transferred immediately to a federal court for the district containing the state capital.

 

The paper also notes that there is also possibility for legislative reform at the state level, but state legislative reform could be cumbersome and could take time because to be effective it would require enactment by a significant number of states. The paper does note that the M&A litigation problem could be addressed if states enacted legislation specifying the merger objection litigation must be brought in the state of incorporation.

 

The paper contains a number of possible solutions to the multiple jurisdiction litigation problem which are worthy of further discussion and consideration. There is no doubt that the multiple jurisdiction litigation does nothing to benefit shareholders and in fact accomplishes only the multiplication of legal costs and burdens, and therefore there is no doubt that active steps should be taken in order to try to eliminate this problem.

 

As important as it is to address the multiple jurisdiction litigation problem, however, it is worth noting that even if the multiple jurisdiction litigation problem is addressed that will not address all of the concerns with M&A litigation. As the paper itself notes about the legislative reforms proposed, “although these reforms will not entirely eliminate the problem of abuse, they will stop the multiplication of litigation and forum shopping and … and enable companies to fight back against unjustified claims” which, the paper concludes, would make it “more difficult for trial lawyers to collect the litigation tax.”

 

It is probably also worth noting that though the paper’s proposal regarding M&A litigation filed in federal court could reduce the problems when separate M&A-related suits are filed not just in state court but also in federal court, the proposal would not eliminate the problem. Even the transfer scheme that the paper contemplates for the suits filed in federal court would still allow for the possibility of parallel suits proceeding simultaneously in state and federal court. While it would be hoped that the courts would coordinate their actions in order to try to eliminate duplicative litigation burdens and expense, there is nothing about the federal court transfer proposal that would assure that the duplicative litigation would not go forward. 

 

I do think it is interesting that all of the proposals suggested are focused on reforming litigation procedures. The paper does not mention another reform M&A litigation reform proposal that at least for a time had a certain amount of cachet – that was the notion of incorporating a forum selection clause in the company’s charter documents in order to require certain types of shareholder suits to be brought in the courts of the company’s state of incorporation. This idea certainly has its advocates; however, as discussed here, companies that adopted these forum selection by laws found themselves targeted in a wave of shareholder suits challenging the by-laws. It appears that with the litigation and controversy, the forum selection by-law idea may not enjoy the same currency that perhaps it once did.

 

I will say that by addressing the multiple jurisdiction problem rather than trying to come up with a broader proposal attempting to eliminate abusive M&A-related litigation altogether, the paper has chosen a target about which it will easier to reach a consensus on the need for reform and that can be addressed at least in part with some identifiable legislative actions. The reform proposed in the paper is achievable and could help to reduce a serious problem facing corporate America. It is not necessary to agree with all of the paper’s rhetoric in order to agree with the proposed legislative reforms. The proposals suggested in the paper are serious and merit further discussion and consideration and I hope that Congress will take up these issues – at least once they have addressed the looming “fiscal cliff.”

 

Towers Watson Launches 2012 D&O Liability Insurance Survey: Towers Watson is once again taking up its annual D&O Liability Insurance Survey. This survey has a long and venerable tradition in the D&O insurance industry. The Survey went off-line briefly for a few years, but now it is back. The annual survey report, which Towers Watson makes freely available, is a valuable resource for everyone in the D&O insurance industry.

 

Because the survey results are so valuable for everyone in the industry, everyone participant has a stake in seeing that the survey is as representative as possible of the overall D&O industry. The survey is only as good as the data that results from the survey participants, and the more participants there are the better will be the survey results. So everyone has a stake in seeing that as many D&O insurance buyers as possible complete the survey.

 

The 2012 Towers Watson D&O Liability Insurance Survey can be found here. I hope that every D&O Diary reader will forward the survey link to their clients and encourage them to complete the survey. Again, the more companies the complete the survey the better the form will be. So please take the time to forward the survey to your client companies and encourage them to complete the survey form. Please note that the survey must be completed by November 30, 2012.

 

A summary regarding the 2011 Towers Watson D&O Liability Survey can be found here.

 

In its June 2010 decision in the Morrison v. National Australia Bank, the U.S. Supreme Court enunciated a "transactions" test to determine the applicability of the U.S. securities laws. The Court said that the U.S. securities laws apply only to "transactions in securities listed on domestic exchanges and domestic transactions in other securities." Lower courts have wrestled with Morrison’s “second prong” as they struggled to determine what constitutes a "domestic transaction in other securities." As the Second Circuit has commented, Morrison itself “provides little guidance as to what constitutes a domestic purchase or sale.”

 

Recent developments in the SEC’s pending case against mid-level Goldman Sachs executive Fabrice Tourre and involving the infamous “built to fail” Abacus CDO transaction underscore the difficulties courts face in wrestling with Morrison’s second prong.

 

As discussed here, in April 2010, the SEC filed an enforcement action against Goldman and Tourre. Goldman settled the SEC’s claims against the company for a total of $550 million in penalties and disgorgement (as discussed here). Tourre was not a part of the settlement and the SEC’s action against him has remained pending and is moving toward a July 2013 trial date. Tourre, who allegedly was involved in structuring and marketing the securities at issue in the case, is perhaps best known for his reference to himself in an email as “fabulous Fab.” (An April 2010 New York Magazine article entitled “The Fabulous Life of Fabrice Tourre” can be found here.)

 

As the case against Tourre went forward, one important development was Southern District of New York Judge Barbara Jones’s June 2011 ruling (here) dismissing a part of the SEC’s case based on Morrison.  Tourre moved to dismiss a portion of the complaint relating to the sale of Abacus notes to IKB, a German bank. Tourre argued that because the actual seller in the transaction was a Cayman Islands based issuer, there was an insufficient connection to this country to allow the SEC to pursue claims pertaining to IKB’s purchase of the notes.

 

As discussed in a guest post on this blog (here) by Angelo Savino of the Cozen O’Conner law firm, Judge Jones found that Morrison’s second prong requires a showing that “irrevocable liability” has been incurred in the U.S. She specifically rejected that argument that it was sufficient to satisfy Morrison’s second prong that the transaction closing took place in the United States; she said that

 

In view of the fact that none of the conduct or activities alleged by the SEC, including the closing, constitute facts that demonstrate where any party to the IKB note purchases incurred “‘irrevocable liability [,]’” . . . the SEC fails to provide sufficient facts that allow the court to draw the reasonable inference that the IKB note “purchase[s] or sale[s were] made in the United States.” 

 

Judge Jones dismissed the portion of the complaint relating to the IKB transaction, but other portions of the complaint involving domestic securities purchasers remained pending.

 

The SEC’s enforcement action has now been reassigned from Judge Jones to Southern District of New York Judge Katherine Forrest, a relatively new judge who has been on the bench for just one year. The SEC, perhaps trying to take advantage of this change, has now moved to reconsider Judge Jones’s ruling pertaining to the IKB notes transaction, as discussed in detail in interesting October 19, 2012 article on the New York Times Dealbook blog (here) by Wayne State University law professor Peter J. Henning.

 

The SEC’s motion for reconsideration is based on the Second Circuit’s March 2012 decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, in an opinion that came down about nine months after Judge Jones’s ruling in the Goldman Sachs case. The Second Circuit quoted with approval the “irremovable liability” standard Judge Jones had articulated in the Goldman case. But the appellate court added that “a sale of securities can be understood to take place at the location at which title is transferred” and held that “to sufficiently allege a domestic transaction in securities not listed on a domestic exchange, we hold that a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.” (The Second Circuit’s decision in the Absolute Activist Value Master Fund case is discussed in detail here).

 

In moving for reconsideration of Judge Jones’s ruling, the SEC, in reliance on the fact that the closing of the IKB transaction took place in the United States, argued that the U.S. securities laws do apply to the IKB transaction and therefore that  its claims pertaining to the IKB transaction should not have been dismissed. Toure disputes whether these charges can be reinstated at the point in the case, arguing in particular that the parties have already conducted extensive discovery and if the dismissed claims were reinstated, discovery would have to be reopened and the trial date would have to be further postponed.

 

Judge Forrest has yet to rule on the SEC’s motion, which, according to Professor Henning’s article, was argued last week. While the motion has not yet been resolved, the issues that it presents highlight the struggle the lower courts have had to deal with in trying to apply Morrison’s second prong. Judge Jones did the best she could with what was essentially a blank slate at the time, and it is noteworthy that the Second Circuit itself not only did not reject her “irrevocable liability” test but expressly incorporated it into the standard the appellate court applied. But the Second Circuit further held that the place where title transferred can also be sufficient to establish that a deal is a “domestic transaction in other securities.” That is, the appellate court affirmed a basis for the securities laws to apply on a ground Judge Jones expressly rejected.

 

As Judge Forrest takes up the SEC’s motion for reconsideration, it is not going to be enough for her simply to consider the Second Circuit’s decision in Absolute Activist Value Master Fund case. She is also going to have to take into account the fact there are at least two other cases pending before the Second Circuit that could even further impact evolving standards under Morrison’s second prong. As discussed here, appeals before the Second Circuit remain pending both in the Porsche case and in the Société Générale case. Both are high-profile cases and both raise potentially significant issues under Morrison’s second prong. (Background on the Société Générale case can be found here and background on the Porsche case can be found here.)

 

Although the standard the Second Circuit articulated in the Absolute Activist Value Master Fund case seemingly provides a sufficient basis to address both of these two remaining appeals, there is always the possibility that the appellate court’s rulings in the two pending cases might provide further gloss on the standard the court previously articulated. In other words, there is a danger that even if Judge Forrest were now to reconsider Judge Jones’s earlier ruling in the Goldman case, it is possible that when the Second Circuit’s rulings later come down in the two pending cases that there might be yet other considerations presented that might affect the question whether or not the SEC’s allegations concerning the IKB transaction should be reinstated.

 

It is entirely possible that when the Second Circuit finally releases its long awaited rulings in the Porsche and Société Générale cases that these issues will substantially cleared up. That isn’t much help now for Judge Forrest, the SEC or Tourre. As Professor Henning points out in his article linked above, the stakes for Goldman and for the SEC are high in this pending case, which is one of the highest profile cases to come out of the financial crisis. And it seems possible that Judge Forrest’s ruling on the SEC’s motion for reconsideration will provide judicial interpretation of Morrison’s vexing second prong.

 

Silver Anniversary: Long-time readers of this blog will know that The D&O Diary is an attentive follower of American Lawyer writer Susan Beck, whom I interviewed for this site in January 2012 (refer here). In recognition of her 25th anniversary with The American Lawyer, Beck wrote a retrospective article entitled “The Paper Chase” (here) reflecting on her two and a half decades with the publication. Beck’s article not only provides an interesting overview of her career in legal journalism, it also provides an interesting perspective on the changes in the legal industry and in her profession during her time with the magazine. It was interesting to recall the events on which she has reported and even to see many familiar names, like that of our old friend Tower Snow, whom Beck has interviewed.

 

I had to laugh at her reminiscences about the magazine’s coverage of the collapse of the Shea and Gould law firm, whose 80-year old principals continued to come to work every day. Beck recalled one of the principals, Milton Gould, as saying: “We’re kind of like an octogenarian’s gonads, still there but not of much use."

 

During her time with the American Lawyer, Beck has been posted to New York and San Francisco, but she is now a neighbor of mine here in Northeast Ohio. As she notes in her American Lawyer article, “In 2007 I moved back to my hometown of Cleveland, which I love. With a phone and an Internet connection, I can work almost anywhere. The one thing that hasn’t changed is that every day I’m still searching for a great story.” When I interviewed her for this site, Beck had this to say about living in Cleveland:

 

I love it. There are a lot of great things about New York and San Francisco, but I feel a level of comfort in Cleveland that I missed in those other cities. It’s a lovely place to live. The cost of living is so much better, the people are so nice and friendly, and I even prefer the weather. Those SF summers were way too cold and foggy, and I like snowy winters. On the down side, all our pro sports teams really suck right now. 

 

As befits her journalistic skills, Beck’s assessment of living in Cleveland is succinct and accurate. Everyone here at The D&O Diary congratulates Beck on her 25 years at the American Lawyer. We all also look forward to reading her terrific articles for years to come.

 

After a nearly three-month period in which the FDIC filed no new lawsuits against the former directors and officers of a failed bank, the agency has in recent days filed two new suits, both involving banks that were approaching the third anniversary of their closure. The FDIC’s latest lawsuit, filed in the Northern District of Georgia on October 17, 2012, against certain former directors and officers of the failed American United Bank of Lawrenceville, Georgia, which was closed by regulators on October 23, 2009. A copy of the FDIC’s complaint can be found here.

 

The FDIC’s complain, which it filed in its capacity as American United’s receiver, names as defendants two former officers of American United – T. Glenn Thompson, the bank’s former CEO, and Joel C. Taylor, the bank’s former Chief Lending Officer – as well as six individual members of the bank’s board of directors. The complaint asserts claims against the individuals for negligence and for gross negligence.

 

The complaint alleges that “rather than manage the Bank’s lending function in a sound and responsible manner, the Defendants took unreasonable risks with the Bank’s loan portfolio, allowed irresponsible and unsustainable rapid asset growth concentrated in high-risk and speculative acquisition development and construction and commercial real estate loans and loan participations, disregarded regulator warnings about lending activities, violated the Bank’s loan policies and procedures, and knowingly permitted poor underwriting in contravention of the Bank’s policies and reasonable industry standards.” The FDIC alleges that these actions caused damages to the bank “in excess of $7.3 million.”

 

The FDIC’s complaint against the former American United officials is the 34th lawsuit that the FDIC has filed as part of the current failed bank wave and the 16th that the agency has filed so far in 2012. The FDIC filed a considerable number of complaints in the first few months of this year, filing 12 new lawsuits in the first five months of the year. But then for two months, until mid –July, the agency filed no new lawsuits, and then after filing two on July 13, filed no further lawsuits until November.

 

The apparent slowdown in the FDIC’s new lawsuit filings during the period between May and October 2012 was surprising not only because of the more rapid pace of filings in the first five months of the year, but also as 2012 progressed, the third anniversaries of the closures of an increasing number of banks has been approaching. Given that the number of bank failures ramped up as 2009 progressed, it seemed likely that the number of new lawsuits would have increased during the year, as the three-year statute of limitations for increasing numbers of failed banks approached.

 

The slowdown is surprising for another reason as well, which is that while there have been a couple of very large gaps this year (together stretching over nearly a five month period) during which only a small number of lawsuits were filed, the agency has continued each month to update its website to show that an increasingly larger number of lawsuits have been filed. As the latest update on October 9, 2012, the agency has authorized suits in connection with 80 failed institutions against 665 individuals for D&O liability. These figures are inclusive of the now 34 lawsuits involving 33 institutions and  naming 280 former directors and officers that have been filed so far – suggesting an increasingly large backlog of as yet unfiled complaints.

 

As I have previously noted on this blog, knowledgeable persons have advised me that at least part of the explanation for the apparent filing slowdown is that the FDIC and the prospective defendants (and their insurers) have in some instances been involved in negotiations. In some instances, the FDIC has requested that the indivudals agree to a tolling agreement which stays the running of the statute of limitations while the negotiations continue. These negotiations have in at least some cases permitted matters that might otherwise have resulted in litigation to be resolved without a complaint being filed. While that might well account for some of the slowdown, the increase in the numbers of authorized lawsuits does suggest that there is still a backlog of cases to be filed. It still seems likely that as the third anniversary of bank failures from late 2009 and early 2010 approaches (which period was the high water mark of the current bank failure wave) we should be seeing an upsurge in new FDIC lawsuits, especially given the extent to which the number of authorized lawsuits exceeds the number of lawsuits filed

 

The FDIC’s suit against the former American United officers is the ninth lawsuit so far involving a failed Georgia bank, meaning that lawsuits involving banks from Georgia account for more that a quarter of failed bank lawsuits so far. At one level, this is not a surprise, since there have been many more bank failures in Georgia as part of the current bank failure wave than any other state. But the over 80 Georgia banks that have failed since August 2008 represent only about 18 percent of the over 440 banks that have failed during that period, meaning that the failed Georgia banks have been targeted at a disproportionately higher rate. By way of contrast, Florida, which also has experienced a very high bank failure rate so far, has only had one failed bank lawsuit. Georgia banks were very heavily represented in the earliest part of the current bank failure wave, so it  may be that these apparent mismatches will even out over time as more suits are filed.

 

There is one other interesting feature of the new American United case, which is that the FDIC has included allegations of ordinary negligence. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. More recently (as discussed here), in the FDIC’s lawsuit against former directors and officers of the failed Haven Trust bank, Northern District of Georgia Judge Steve C. Jones affirmed that Georgia’s business judgment rule is applicable to the actions of bank directors and officers. Based on that determination, Judge Jones dismissed the FDIC’s claims against the directors and officers for ordinary negligence and breach of fiduciary duty. In light of that earlier decision, it would seem that the defendants in the new American United case have a basis on which to seek to have the negligence claims against them dismissed. (The FDIC, undoubtedly anticipating this argument, included in its complaint specific allegations asserting that the defendants are not entitled to rely on the business judgment rule, at paragraph 55 and following.) 

 

Very special thanks to a loyal reader for providing me with a copy of the FDIC’s American United complaint.

 

Welcome to the Blogosphere: The D&O Diary is very happy to welcome D&O Discourse, a new blog from the securities litigation group of the Lane Powell law firm. The new blog, which can be found here, will, according to the firm, “discuss select securities and corporate governance litigation developments of interest to public companies and their directors and officers, D&O liability insurance carriers and brokers, plaintiffs’ and defense lawyers, and economists, forensic accountants and other professionals whose practices involve securities and corporate governance litigation.” The new site looks good, and based on its early entries it will represent a welcome addition to the blogosphere. Everyone here at The D&O Diary looks forward to following the site in the future.

 

Regulatory ADD? : Francine McKenna, the author of the re: The Auditors blog, has an interesting October 18, 2012 article in Forbes Magazine entitled “Is the SEC’s Ponzi Crusade Enabling Companies to Cook the Books, Enron-Style?” (here). In the article, McKenna suggests that the SEC, eager to make up for its failure to catch Madoff, is disproportionately devoting resources to Ponzi-scheme prosecution and also to FCPA enforcement activities, to the detriment of its efforts to root out “fraudulent or misleading accounting and disclosures by public companies.” McKenna questions whether “a stretched SEC” might be “neglecting accounting fraud.” McKenna’s article looks at whether the reduced accounting fraud enforcement activity in recent years is the result of decreased fraud or a reduced emphasis on the issue from the regulatory agency.

 

In a concluding section that will be of interest to readers of this blog, McKenna’s article closes with a seven-point checklist to use to test for accounting risk at any particular company.  

 

More About Opt-Outs: I have written frequently about class-action opt-outs on this site (most recently here) In an October 18, 2012 Metropolitan Corporate Counsel article entitled “The Securities Class Action Opt-Out Plaintiffs: By the Numbers” (here), Neal Troum of the Stradley Ronon Stevens & Young law firm takes a closer look at class action opt-outs recoveries. Troum concludes that “institutional investors with significant losses on account of securities fraud may recover more as opt-out plaintiffs than class members in securities fraud actions.” He suggests that “institutional investors have their options and, with increasing frequency, they are choosing a different path.”

 

In addition to indemnification, corporate directors and officers also may have the right under applicable law and corporate by-laws to have their costs of defense advanced before the ultimate right to indemnification has been determined. A question that often arises is whether a corporation may withhold advancement. A recent decision from the Ontario Superior Court of Justice determined that a corporation did not have to advance the costs certain former directors and officers had incurred in defending claims the corporation had filed against them. The decision is clearly significant for directors and officers of companies in Canada, but it also provides an interesting context within which to consider the limits of advancement rights here in the U.S. as well. A copy of the September 28, 2012 decision can be found here.

 

Background

Look Communications is a technology company organized under the Canadian Business Corporations Act (CBCA). Its business fortunes faltered and its board ultimately approved a sale of its assets through a court-supervised process. Following the sale, the board authorized the payment of bonuses to certain officers and directors and also allowed corporate officials to receive compensation for the cancellation of certain stock option and other equity rights. Altogether the company paid over $20 million in bonus compensation and in compensation for the options and equity rights, representing about 32% of the asset sale proceeds.

 

After the award of the bonuses and other compensation was disclosed, shareholders filed significant objections. The board authorized the payment of $1.5 million in retainers to law firms acting on behalf of the directors and officers, who then resigned once the retainers had been paid.

 

In July 2011, after an investigation by Look’s new management, Look commenced an action against the former directors and officers alleging that the individuals had breached their fiduciary duties and seeking repayment of the bonuses and equity cancellation payments. The individual defendants, in reliance on the company’s by-laws as well as a written indemnification agreement, demanded that the company advance their expenses incurred in defending against the company’s lawsuit. The company refused and the individuals filed separate actions seeking judicial declarations of their advancement and indemnification rights.

 

Under Section 124 of the CBCA, a company may indemnify its directors and officers for legal proceedings in which the individuals become involved as a result of their association with the company, as long as the individual seeking indemnification “acted in good faith and with a view of the best interests of the corporation.” Look’s by-laws made these permissive indemnification rights mandatory. A separate indemnification agreement required Look to advance legal costs in any proceeding, including one brought by Luck itself, subject only to an obligation to repay if a court determined that the individual was not entitled to indemnification.

 

The former directors and officers argued in reliance on the by-laws and indemnification agreement that they were entitled to automatic advancement of their defense fees; that they were also entitled to a presumption that they had acted in good faith; and that their ultimate entitlement to indemnification could only be determined after a full evidentiary trial.

 

Look argued in reliance on Section 124(4) that a corporation is permitted to advance defense fees only “with the approval of the court,” which, Look argued, required the court to assess the parties’ conduct to determine whether the persons seeking advancement had acted in good faith. Look further argued that the individuals had not acted in good faith and were not entitled to advancement and submitted affidavits and other materials in support of this position.

 

The Court’s Ruling

In his September 28, 2012 opinion, Justice Laurence A. Pattillo noted the court’s critical supervisory role in the statutory indemnification scheme, observing that “in my view, requiring the court to scrutinize indemnification and advances in circumstances where a corporation has sued its former directors and officers ensures corporations cannot arbitrarily avoid indemnity and advancement obligations to former directors and officers who have acted in good faith and in the best interests of the corporation, while at the same time ensuring that directors and officers who have not so acted cannot further harm the corporation.”

 

Justice Pattillo further observed that the court’s supervisory role still obtained notwithstanding the fact that the parties had a written indemnification agreement that made the rights to advancement automatic. He said that just as a corporation cannot indemnify a director or officer if the statutory requirement of good faith conduct has not been met, “neither … can they contract to exclude the court’s discretion to approve advancement.”

 

Justice Pattillo further concluded that the court approval specified under Section 124(4) requires the consideration of evidence. Because the directors and officers are entitled to a presumption that they acted in good faith, the burden is on the corporation seeking to avoid advancement to establish a “strong prima facie case” that the statutory standard has been met.

 

Based on the affidavits and other material Look submitted, Judge Pattillo concluded that Look had presented sufficient evidence that all but one of the individuals seeking advancement had acted in bad faith, in their own self interest and not in the best interest of the company, and therefore were not entitled to advancement.

 

Discussion

This case represents an unusual circumstance where a corporation was able to avoid its obligation to advance defense expenses of its directors and officers. It is, however, a reflection of both the unusual factual circumstances and the particular features of the applicable Canadian statutory provisions. The indemnification provisions in the Delaware Corporations Code (which governs the many U.S. corporations incorporated in Delaware) do not contemplate the same level of judicial supervision that the court exercised here. Indeed, Justice Pattillo specifically declined to consider Delaware case law, notwithstanding the fact that Delaware courts are “well regarded in this area of the law,” noting that the Delaware statutory provisions “contain no statutorily imposed conduct requirement.”

 

The outcome is also a reflection of the unusual facts involved. As the Osler law firm noted in its October 11, 2012 memorandum about the decision (here), the facts in this case (at least as found on an interim basis) “appear to have been exceptional” and that in many other cases, courts would be unable to make the kind of determination made here solely on the basis of a “paper record,” without live witnesses and credibility determinations.

 

While the outcome here may be the result of the uncommon factors, what is not uncommon is for these types of advancement disputes to arise, particularly where, as here, the claims have been brought against former management by their successors and the claims is asserted on behalf of the corporation. The successor management often contends that the corporation should not have to fund the defenses of the persons whose conduct they are claiming to have harmed the corporation.

 

As I noted in a recent post discussing an advancement decision under Ohio law (here), the general pattern and practice is that corporate directors and officers are entitled to have their defense fees advanced, subject only to an undertaking to repay in the event of an ultimate determination that the individual is not entitled to indemnification.

 

The Ontario court’s decision is noteworthy not only because of the critical supervisory role the court played in the determination of the individual’s advancement rights, but also because of the court’s determination that it was obligated under the statute to play the supervisory role notwithstanding the parties’ agreement to make the right of advancement automatic.

 

For corporations frustrated by their advancement obligations, the level of court supervision exercised here may represent an attractive model. I will say though that there is also something to be said for the rights of corporations and their directors and officers to arrange their indemnification and advancement obligations contractually, at a time when there are no claims pending, and for those arrangements to be respected when the claims do arise. I also note a concern about substantive legal rights being decided on less than a full evidentiary record. Here, because these individual defendants will now not have their defense fees advanced, they may be forced to settle simply to avoid financial ruin, whether or not that outcome is actually warranted by the merits of the dispute.

 

The Story of the Year?: Two recent guest posts on this site have discussed the question of fiduciary liability insurance coverage for settler liability claims. First, on September 19, 2012, Kim Melvin and John Howell of the Wiley Rein law firm posted a guest post (here) commenting on the New York Court of Appeals decision in Federal Ins. Co. v. IBM (2012), which was followed by an October 11, 2012 commentary by Rhonda Prussack and Larry Fine of AIG (here).

 

Now in a October 15, 2012 post on his blog, The D&O E&O Monitor (here) , Joe Monteleone has added his observations about the exchange of views in the two guest posts on this site. Among other things, Joe refers to the questions that the New York case has raised as “the story of the year.” Joe provides some interesting additional insight on the issues as well.

 

Homeowners File Latest Libor-Related Antitrust Case: On October 4, 2012, a group of homeowners filed the latest class action lawsuit against the banks that participated in setting the Libor rates. In their complaint, which can be found here, the homeowners, who had adjustable rate mortgages tied to the Libor benchmark, allege that they were harmed by the rate-setting banks’ alleged manipulation of the rates. The homeowners assert claims based on the Sherman Act, the New York antitrust laws and RICO. Although there have been numerous antitrust actions previously filed against the Libor rate setting banks, this lawsuit, according to press reports, is the first to be filed on behalf of homeowners.

 

An overabundance of airplane time and a shortage of Internet access (not the mention my day job’s unrelenting requirements) have kept The D&O Diary on the blogging sidelines despite a host of noteworthy events in recent days. The march of events moves ever onward, but before the sands of time envelop recent notable events altogether, we note them briefly here.

 

Alcoa Settles Bribery Suit With Alba: On October 9, 2012, Alcoa announced (here) that it had agreed to pay Aluminum Bahrain B.S.C. (better known as “Alba”) $85 million to settle the long-running RICO action that the state-owned Bahraini aluminum smelter had filed against the company in the Western District of Pennsylvania. The settlement is noteworthy in a number of respects, not the least of which the settlement’s size. The settlement is also noteworthy given the identity of the claimant, as discussed below.

 

As discussed here, in February 2008, Alba had sued Alcoa, one of its affiliates, and two individuals (one of whom was an officer of an Alcoa affiliate), alleging that the defendants had engaged in a 15-year conspiracy involving overcharging, fraud and bribery of Bahraini officials. The complaint alleges that one of the individual defendants, Victor Daladeh, funneled payments to one or more (unnamed) Bahraini officials as part of an alleged conspiracy to cause Alba to cede a portion of its equity to Alcoa, to pay Alcoa inflated prices for alumina, and to corrupt the integrity of senior Bahraini officials. Alba’s complaint sought to recover damages from the defendants based on the alleged violations of the Racketeer Influenced and Corrupt Organizations Act (RICO), conspiracy to violate RICO, and for fraud.

 

The case was stayed for several years while related U.S. government investigations continued. (The government investigations are continuing.) However, in November last year, Alcoa’s lawyers persuaded the Western District of Pennsylvania Judge Donetta Ambrose to lift the stay so that the defendants could file a motion to dismiss. Among other things, the defendants argued, in reliance on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, that the court should dismiss the case because the alleged wronging on which Alba relied in support of its claim took place entirely outside the U.S. and therefore not appropriately the subject of a lawsuit in the U.S. under U.S. laws. As discussed in Victor Li’s August 1, 2012 Corporate Counsel article (here), Judge Ambrose rejected defendants’ motion, finding that Alcoa’s Pittsburgh headquarters was the “nerve center” of the alleged scheme, because the control and decision-making of the alleged conspiratorial enterprise came from Pittsburgh.  

 

According to its October 9 press release, Alcoa will pay the $85 million settlement amount in two installments, with half to be made at the time of the settlement and the other half to be paid one year later. The press release also states that Alcoa and Alba have “resumed a commercial relationship” and entered into a long-term supply agreement, “demonstrating a mutual desire to work together going forward.” The settlement does not resolve Alba’s claims against Daladeh, who according to news reports, has been arrested in October 2011 by British officials and charged with bribing officials at Alba.

 

As I have previously noted on this blog, one of phenomena associated with the recent upsurge in FCPA enforcement activity has been related growth in follow-on shareholder litigation. However, by contrast to these more common types of follow-on civil suits, this action was not brought by Alcoa’s shareholders; rather, this lawsuit was brought by the alleged victims of the corrupt activity (and indeed, the suit was initiated before there had been any separate governmental enforcement action; the government action followed after the civil suit).

 

As anti-bribery enforcement activity has increased, the prospect for follow-on civil litigation has also grown. In that regard, the size of the settlement in this case and the claimant’s relative success in bringing its claim will not go unnoticed. The likelihood is that companies that become enmeshed in bribery allegations could also face related civil litigation, and in light of this sizeable settlement, the threat of civil litigation will include not only the possibility of claims from shareholders, but also possible claims from the purported victims of the alleged corrupt activity.

 

Pfizer Settles Celebrex-Related Securities Suit for $164 Million: According to papers filed with the Court, Pfizer has settled the long-running securities suit alleging that Pharmacia (which Pfizer acquired in 2003) had misrepresented the safety of its anti-inflammatory drug, Celebrex, for $164 million. A copy of the parties’ October 5, 2012 stipulation of settlement can be found here. 

 

As discussed here, shareholders first sued Pharmacia and certain of its directors and officers in 2003, alleging that the company had released only part of a long-term clinical study the company had commissioned on the side effects of the drug. The complaint also alleged that scientists affiliated with the company had used the partial data to write an article in the Journal of t he American Medical Association, while failing to reveal that only part of the data was used. When Pharmacia later sought to the FDA’s approval to market the drug without certain warning labels, the agency declined based on questions concerning the completeness of the study results, following which the company’s share price declined.

 

This case had a long and complex procedural history. District of New Jersey Anne Thompson had initially dismissed the case on statute of limitations ground. But as discussed here, in 2009, the Third Circuit reversed the district court, and the case returned to the District Court. The settlement comes as an October 22, 2012 trial date loomed. 

 

Nate Raymond and Ransdell Pierson’s October 9, 2012 Reuters article about the settlement can be found here.

 

This settlement is noteworthy in many respects, not least of which because of its size. However, in a world of class action securities lawsuit settlements measured in the billions, even a settlement of this size does not attract as much attention as it might have at one time. Indeed, according to my research, this $164 million settlement does not even break the top 50 of all time securities lawsuit settlements. It is not even the largest securities suit settlement, having been exceeded, among others, by Bristol Myers Squibb’s $300 million securities lawsuit settlement (about which refer here).  The settlement amount alone does not take into account the defense fees incurred, which, given the case’s long and complicated procedural history, also likely were substantial (particularly given the approaching trial date). 

 

It is not an original observation, but the total economic cost of this kind of litigation is truly astonishing. 

 

Breaking Lull, FDIC Files Latest Failed Bank Lawsuit: On October 2, 2012, in the first lawsuit the FDIC has filed since July in its capacity as receiver of a failed bank against the bank’s former directors and officers, the FDIC filed a lawsuit in the Northern District of Illinois against six former directors and officers of the failed Benchmark Bank of Aurora, Illinois. The FDIC’s complaint can be found here.

 

Benchmark Bank failed on December 4, 2009 (about which refer here). In its complaint, the FDIC alleges that the defendants breached their duties of care by approving certain high-risk acquisition, development and construction loans. The FDIC seeks to recover losses “of at least $13.3 million” allegedly caused by the defendants gross negligence, negligence and breaches of fiduciary duties.

 

The Benchmark Bank lawsuit is the fifteenth failed bank lawsuit the FDIC has filed during 2012 and the 33rd overall that the FDIC has filed as part of the current bank failure wave. However, it is the first the FDIC has filed since mid-July and only the third the FDIC has filed since late May. The slow filing pace is all the more surprising as comes three years after what had been the period when bank closures were ramping up in earnest. All is equal, it seems as if there would have been more lawsuits filed like this one as the three year closure anniversary approached.

 

The slowdown is all the more surprising because the lull has come even though the FDIC has continued to indicate on its website (here) on a monthly basis that the number of lawsuits the agency has authorized has increased. Indeed, in its latest update (dated October 9. 2012), the FDIC indicated that it has authorized suits in connection with 80 failed institutions against 665 individuals for D&O liability. These figures are inclusive of the 33 filed D&O lawsuits involving 32 institutions, naming 272 former directors and officers. filed so far. 

 

As the number of authorized lawsuits has continued to accumulate and as the three year closure anniversary of an increasingly large number of banks has approached, it has seemed as if we would be seeing increasing numbers of lawsuits filed. Yet in the last five months there have only been three new suits filed, and this latest complaint is the first in three months. Knowledgeable participants in this process have advised me that part of the reason for the slowdown is that in a number of instances the FDIC is engaged in negotiations to see if the matters can be resolved without litigation. But as the number of lawsuits authorized continues to increase it does seem likely that sooner or later we will be seeing an upsurge in new complaints. It just hasn’t happened yet.

 

In the meantime, it is reassuring to note that the number of new bank closures has dwindled. There have been no new bank closures so far during October 2012, after only three in September 2012 and only one in August 2012. It certainly can be hoped that now, more than four years after the depths of the financial crisis, perhaps the wave of bank closures is finally about to come to an end.

 

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.

 

I am pleased to publish below a guest post from Rhonda Prussack, Executive Vice President and Product Manager, Fiduciary Liability, for Chartis, and her colleague at Chartis, Larry Fine, Global Head Professional Liability Claims, Financial Lines Claims. Rhonda’s and Larry’s guest post is written in response to a recent guest post on this blog about the scope of fiduciary liability insurance, written by Kim Melvin and John Howell of the Wiley Rein law firm. Kim and John’s prior guest post can be found here.

 

 

I would like to thank Rhonda and Larry for their willingness to publish their article on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Any readers who are interested in publishing a guest post on this site are encourage to contact me directly. Here is Rhonda’s and Larry’s guest post:

 

In Ms. Melvin’s and Mr. Howell’s article on the IBM coverage denial decision posted here on September 19th, several good points were made, notably that plan fiduciaries typically wear “two hats” – one as settlor (i.e. the party making a business decision about a plan – for instance to terminate benefits or amend the terms of a plan) and the other as plan fiduciary (i.e. the party implementing the plan changes). However, Ms. Melvin and Mr. Howell then concluded that policyholders should not expect or necessarily want their policies to cover settlor capacity matters, even for an insured that wears two hats.

 

 

The IBM Case

In the plan participant class action against IBM, the plaintiffs alleged that IBM’s conversion of a traditional pension plan to a cash balance pension plan violated ERISA.  An excess fiduciary liability carrier denied having any coverage obligations on the grounds that the underlying suit related to “settlor capacity” acts as opposed to “fiduciary” acts.    A federal district court (and more recently a circuit court of appeals) upheld the carrier’s denial. As the authors correctly asserted, these decisions did not create a gap in coverage.  Nevertheless, they exposed an existing gap which carriers have been handling differently.

 

Is the Defendant a Fiduciary?

The question of whether a defendant is a fiduciary at all, or whether they were acting as a fiduciary when performing the acts in question, is often the main disputed question in an ERISA suit. For many years, certain carriers were narrowly interpreting their policies for clients that wore two hats and taking coverage positions based on opinions on the underlying merits of cases and defenses raised therein.  These carriers have presented a Hobson’s choice in which successful defenses based on lack of fiduciary status have led to the threat of lost coverage.  More customer-focused carriers, concerned that insureds get the benefit of their bargain, have been interpreting their policies more broadly, and some are now clarifying by means of endorsements.

 

Coverage Denials Based on Settlor Capacity

Ms. Melvin and Mr. Howell also pointed out that lawsuits “involving purely settlor issues are rare,” although in our experience, many carriers commonly reserve the right to deny coverage on that basis.  Often the result of these two facts is that insureds have to either fight with their carrier concerning allocation, or live in fear of future efforts by the carrier to recoup what it has paid, especially if the insureds are successful in a “settlor act” defense.

 

Coverage Not Traditionally Limited to Individuals   

The authors also made the point that fiduciary liability insurance arose at least in part from the desire to protect individuals against the personal liability imposed under ERISA for breaches of fiduciary duty. However, despite the individual fiduciary coverage at its core, fiduciary liability insurance for commercial insureds has traditionally included coverage for the organization sponsoring the plans, as well as for the plans themselves – even when individual fiduciaries are not named in a suit.  Yes, individual plan fiduciaries should definitely be concerned about their exposures (and the fact that they are expressly excluded from D&O policies). To address that concern, the most cutting-edge policies provide ample protections for individuals, including advancement of defense costs when the corporate sponsor fails to do so. However, the reality is that fiduciary liability policies cannot compete in today’s market if they limit their protections solely or even primarily to individual fiduciaries.

 

Costs in Settlor Matters Can Be Significant

It is true, as the authors maintained, that fiduciary policies do not step in to pay “benefits” owed pursuant to a plan, so that the coverage for “settlor act” claims, which some carriers provide, will generally be limited to defense costs.  It should be noted, however, that defense costs alone in purported “settlor act” cases can be in the substantial 8-figure range.   It is clear that carrying sufficient fiduciary liability insurance is eminently prudent and turning down broad coverage is ill-advised, since the product is still relatively inexpensive and offers substantial protection to corporate bottom lines.

 

Insureds have a right to expect that their fiduciary liability policies will protect all Insureds (including the plan itself and the corporate sponsor) from the various types of suits alleging breaches of ERISA and similar laws. 

 

The D&O Diary’s European itinerary continued this past weekend with a brief visit to Berlin, Germany’s capital and largest city. With a population of about 3.4 million within its city limits, Berlin is nearly as large as Los Angeles. It is, these days, a lively and dynamic city. It is also in many ways a surprisingly beautiful city, with a beautiful river — the River Spree follows a more or less east-west course across the city — and a beautiful big green heart — the Tiergarten, a 500-acre park built by the Hohenzollerns as a hunting preserve, is at the center of the city.

 

For all of its urban beauty and present dynamism, it is impossible to visit Berlin without encountering the city’s complex past. It was particularly well-timed to have visited Berlin during Germany’s annual reunification celebration, as there is no better place to contemplate reunification than standing on Pariser Platz facing the Brandenburg Gate. Following the Second World War, the Gate was located in the Soviet occupation zone, so when the Berlin Wall was built, the Gate stood just within East Berlin – a fact that underscores how the Wall cut through the city like a knife. At the same time, the celebrations at the Gate when the Wall came down may be among the most vivid and inspiring events of the last century. The Gate and The Wall — one way another, one of these, the Gate or the Wall, or sometimes the Gate and the Wall, played a part in many of the most important events in the 20th Century.

 

The Wall is almost completely gone now. Near my hotel in Potsdamer Platz a very short stretch of the Wall is preserved, together with a photographic display showing how the Platz had been laid to waste during the Second World War and left desolate during the Cold War because the Wall bisected its former location. Other than the special display, all traces of the Wall in the immediate area and of the Platz’s former desolation have been erased. After reunification, the Platz became “Europe’s largest construction site” and ranks of tall office towers and other commercial buildings now surround it. Directly across from my hotel is the Sony Center (pictured), a huge multi-structure facility with an enormous covered central courtyard and a mix of restaurants, theaters and shops. Standing in the Platz today, it is almost impossible to imagine that The Wall was ever there and even harder to believe that it was removed such a short time ago.

 

Following reunification, the forces of progress and change have moved quickly in Berlin and you can certainly understand how Berliners might have wanted to leave the past behind. However, Berliners have taken deliberate steps to preserve the memory of The Wall. The accompanying picture shows one of the sections of  Die Mauer (The Wall) that have been preserved. The area around Checkpoint Charlie  (the crossing point for entry into the American sector of occupied Berlin) includes a number of different memorials about The Wall. The Checkpoint Charlie museum affords an interesting overview of The Wall’s history – how events at the end of the war (including the Berlin airlift), and post-war events like the nuclear arms race, the Hungarian uprising and the Cuban Missile crisis, among many other things, led to the building of The Wall.

 

There are of course many other complications in Berlin’s recent history. Indeed, at times, the history can be almost overwhelming. I arrived in Berlin during a tremendous rain storm, which ordinarily would have meant lousy conditions for touristing. But the downpour proved entirely appropriate for a visit to the Holocaust Memorial, located a couple of blocks south of the Gate. The dark clouds and rain provided an appropriately somber atmosphere for the hundreds of stark black stele in the memorial.

 

As the Holocaust memorial shows, Berliners have not shrunk from confronting the city’s complex history. Just the same, there are some memories that are still too complicated even for Berlin. It took a fair amount of detective work for me to find the former location of Hitler’s Chancellery, on Wilhelmstrasse in what was East Berlin. The location is now an enormous construction site. I did my best to figure out the location of Hitler’s bunker. A small and obscure information sign acknowledges (at the very bottom, in the last sentence on the sign) that the bunker had been located nearby, without specifying the exact spot.

 

I guess I can understand why there hasn’t been any effort to highlight the site’s historical importance. The danger is that the spot could become a memorial for Hitler or even a pilgrimage site for a certain type of misguided soul (not meaning to suggest anything about myself with that latter comment). It could also attract completely inappropriate tourist operations. By way of illustration, the area around Checkpoint Charlie is full of tourist-oriented shops like “Checkpoint Currywurst” and “Die Mauer Souvenirs,” and display stands where you can have your picture taken with men wearing Soviet and American Army uniforms. If the location of Hitler’s Bunker were to be more openly recognized and the site started attracting tourists, there undoubtedly would soon be stores selling Third Reich tchotchkes and stage shows offering to let you relive the Nazi experience. It could also become a focal point for a very dangerous kinds of political action. For Berliners, history includes ghosts and demons for now too dangerous to admit even into a reunified city.

 

After a day spent confronting Berlin’s complicated 20th century history, it was a relief on Sunday morning to take the U-Bahn (subway) to the city’s West Side to visit Schloss Charlottenburg (Charlotte’s Palace). Sophie Charlotte, the wife of Friedrich III, the Elector of Brandenburg, built the palace in the late 17th and early 18th centuries as a summer retreat, but it became the preferred residence of subsequent Hohenzollern rulers, including Charlotte’s famous grandson, Frederick the Great. The structure itself was heavily damaged during the Second World War, but it has now been beautifully restored, and its gardens, which are open to the public as a park, provide a tranquil urban oasis.

 

After touring the Schloss and the gardens, I then went to get a better sense of the city itself, particularly two of its justly famous avenues. Kurfürstendamm, a broad avenue lined with plane trees, runs from just to the southwest of the Tiergarten to the western end of the city. The street is lined with stores and shops. It is often compared to the Champs-Élysées, because of the trees and street’s width, but the Berlin street lacks the Parisian boulevard’s drama (there is, for example, no Arc de Triomphe or Tuilleries at the ends of the street). I think the more apt comparison is the Magnificent Mile on Chicago’s Michigan Avenue. Both are commercial streets and stores lining both are almost identical – there is even a Nike Town on Kurfürstendamm. The Berlin street is visually interesting — but I am not much of a shopper, so I found it a little dull.

 

A more interesting place to visit is Unter den Linden, perhaps Berlin’s most famous street. The broad tree-lined boulevard runs east from the Brandenburg Gate across the River Spree. The middle stretch of the street is completely torn up for subway construction right now, but despite the construction the street was still a pleasant place to stroll on a sunny Sunday afternoon. Before reunification, Unter den Linden was entirely in East Berlin. The number of institutions and other important buildings along the avenue – including, for example, Humboldt University, the Berlin State Library, the Berlin State Opera, and the Berlin Cathedral – provides another reminder of what a devastating thing The Wall was for the city. It cut off access to the city’s historic heart.

 

On the day I visited, there was an art festival taking place on one of the walkways along the River Spree, at the point where the river intersects with Unter ten Linden. I sat at a sidewalk café along the walkway and watched the crowd and the river flow by while I enjoyed a plate of bratwurst, sauerkraut and mashed potatoes. I found myself thinking about how just a short time ago, many of the Sunday afternoon strollers would have been unable to see the art festival or walk along the river there. They are all just Berliners now, but as I studied the faces of the passersby who were old enough, I wondered – East Berliner or West Berliner? Was this one separated from a loved one by The Wall, was that one maybe a border guard who manned a watchtower? Maybe these questions don’t matter now, or at least shouldn’t matter now. But the thought did bring home to me what a great and challenging thing reunification has been.

 

These observations about Berlin left me with much to ponder. About the only thing I know for sure is that two days are not nearly enough to take in fully a city as big and complex and fascinating as Berlin. I feel that in some ways, I was very unfair to the city. I deliberately focused on the city’s past, and so came away with only just enough sense of the city’s present to know that there is so much more to see and do there. Berlin has been and is again one of the world’s great cities and deserves a longer visit.

 

For those of you who may not have seen it because I posted it on Columbus Day, my post about my recent visit to Munich can be found here.

 

Schloss Charlottenburg

 

 

 

 

 

 

 

 

 

 

 

 

River Spree

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bratwurst und Sauerkraut mit Kartoffeln