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Shelter From the Gathering Storm

By: Michael Hartley

The current financial crisis is unparalleled since the savings and loan crisis, when 1,813 financial institutions were closed. There were 140 bank closures in 2009, with the FDIC projecting that an even higher number of banks will close in 2010. Approximately 80 percent of the closures in 2009 were banks with assets under $1 billion, and more than 65 percent had assets of $500 million or less, based on FDIC data. Recent figures suggest that the current financial crisis may ultimately overshadow the experience 20 years ago, according to an article in the Atlanta Journal-Constitution last year.

In most instances, the closure of a bank is preceded by a variety of regulatory mandates. These include heightened supervisory initiatives, such as a board resolution or a memorandum of understanding, as well as more substantive formal enforcement initiatives, such as a cease and desist order that mandates steps the bank must take to attain financial soundness and prompt corrective actions if the bank continues to fail to comply. In general, these directives impose additional requirements on the banks to raise capital and place restrictions on lending activity. As a director of a distressed bank, navigating through these troubled waters can be treacherous and, unfortunately, the risk of litigation is high.

The officers and directors of a distressed or closed bank face scrutiny by one or more regulators, but the most likely threat of litigation is from the FDIC. When a federally insured bank is closed, the FDIC is appointed as conservator or receiver. The FDIC may then pursue a claim against directors or officers of the closed financial institutions in an effort to recoup losses to the bank. Of the financial institutions that closed in the period between 1985 and 1992, the FDIC initiated claims against the former officers and directors of 24 percent of those institutions.

According to an FDIC policy statement, claims will not be brought against officers and directors “who fulfill their responsibilities, including the duties of loyalty and care, and who make reasonable business judgments on a fully informed basis and after proper deliberation.” In general, actions were brought against officers and directors during the savings and loan crisis where the FDIC believed that there was evidence of (i) dishonest conduct or abusive insider transactions; (ii) violations of internal policies, law or regulations that resulted in a safety or soundness violation; or (iii) failure to establish, monitor or follow proper underwriting procedures, or heed warnings from regulators or advisors.

In a replay of the earlier crisis, the FDIC has begun to investigate many of the closed banks and to make pre-litigation demands for payment of civil damages against officers and directors of some closed banks for losses incurred by the bank. There is no public source of information regarding the number of investigations or subpoenas that have been issued by the FDIC. It is also too early to determine how aggressive the FDIC will be in filing civil actions against officers and directors of closed banks. As noted in the FDIC policy statement, however, “the FDIC brings suits only where they are believed to be sound on the merits and likely to be cost effective.”

Accordingly, to determine the ability of an individual to respond to a claim, if successful, it is routine for the FDIC to seek personal financial information from the officers and directors as part of the investigation. In addition, the FDIC typically sends its demand for payment of civil damages directly to the D&O insurance carrier to provide the requisite notice under the policy to trigger insurance coverage as a potential source of recovery if liability is established.

With the heightened risk of litigation in the financial sector, there are certain steps that counsel for bank officers and directors may take to prepare for claims or litigation that may follow. Meeting with the board members and reviewing the examination reports and other documents available while the bank remains open will provide insight into the specific issues that confront the board and management.

It is important that documents pertaining to the bank are preserved and counsel may give guidance on specific document preservation procedures.

In this environment, it is especially important for bank officers and directors to have a clear understanding of the scope and potential limitations of their D&O insurance policies. There are a variety of clauses that may impact the availability of insurance coverage in these cases. In the wake of the savings and loan crisis, insurance carriers began to include regulatory exclusions in D&O policies, in an effort to reduce exposure to claims for civil damages and penalties sought by the regulators. Bank directors and officers will want to know whether their policies contain such limitations and have sought legal counsel regarding the practical impact of the limitations. Other provisions of the insurance policy may require that certain action be taken to afford coverage.

For example, to provide maximum coverage, many policies require that the insureds furnish a “notice of circumstances” under the policy, which is typically prepared by counsel familiar with the specific claims made by the regulators and other claimants and provides a description of potential claims that may be brought against the insureds. Such notices may provide coverage under the policy that the directors and officers otherwise would not have. Accordingly, directors and officers should seek counsel to consider whether a notice of circumstances is warranted.

The waves of litigation from the financial crisis will undoubtedly continue. Take steps now to prepare for claims or litigation that may follow, including (i) gaining an understanding of the particular issues confronting the bank, through a review of the examination reports and other documents available while the bank remains open; (ii) a review of the D&O policies; and (iii) the preparation of a notice of circumstances. There may be other steps that are also appropriate at this juncture, depending on the particular facts and circumstances of the bank.
Michael Hartley is a partner in the Los Angeles office of national law firm Alston & Bird. Contact him at 213-576-1004 or michael.hartley(at)

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