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FDIC v. Willetts Case Summary

On September 12, 2014, a federal district court in North Carolina ruled against the Federal Deposit Insurance Corporation (“FDIC”) and in favor of the former banking directors and officers of Cooperative Bank of Wilmington, North Carolina, finding that their behavior during the recent financial crisis did not constitute negligence, gross negligence, or a breach of fiduciary duty. 

Cooperative Bank was a commercial banking institution under North Carolina law with deposits insured by the FDIC. In June 2009, the North Carolina Commissioner of Banks declared Cooperative insolvent and named the FDIC as receiver of the Bank. In its official capacity, the FDIC filed this suit against former officers and directors for negligence, gross negligence, and breaches of fiduciary duty in connection with their approval of eighty-six loans made between January 5, 2007, and April 10, 2008, and sought $40 million in damages. 

The FDIC alleged that the approval of these loans was a deviation from prudent lending practices established by Cooperative’s loan policy, published regulatory guidelines, and generally established banking practices, such as obtaining and verifying current financial information, adhering to minimum loan-to-value ratios and adhering to maximum debt-to-income rations. 

The FDIC also alleged that the former officers and directors ignored prior regulatory criticisms and warnings pertaining to imprudent underwriting practices such as the failure to require hard borrower equity, failure to analyze and consider borrowers’ and guarantors’ contingent liabilities, failure to perform a global cash analyses of borrowers and guarantors with multiple entity relationships, and failure to perform proper debt service coverage analysis. 

The court ruled that the Business Judgment Rule defeated the FDIC’s negligence and breach of fiduciary duty claims. The Business Judgment Rule serves to prevent courts from unreasonably reviewing or interfering with decisions made by duly elected and authorized representatives of a corporation. The Business Judgment Rule is premised on two presumptions: first that in making a decision, the directors and officers acted with due care and in good faith in the honest belief that their actions were in the best interest of the corporation, and secondly that all decisions are attributed to rational business purposes. 

The court found that there was no evidence that any defendant engaged in self-dealing or fraud or any conduct constituting bad faith. The court considered the FDIC Reports of Examination that warned about underwriting and credit practices and found that these same reports also graded management, asset quality, and sensitivity to risks as being satisfactory with a CAMELS score of 2 and not requiring “material changes”. Using the FDIC’s own ratings and comments within the Report of Examination, the court rejected the FDIC’s argument. Therefore, the court found that the processes and practices for challenged loans were rational, based on the FDIC’s own assessments as well as other assessments performed by independent auditors that found that the Bank’s conduct was appropriate. 

The court emphasized that the former officers and directors were entitled to the Business Judgment Rule because Cooperative Bank’s pursuit of the challenged loans was in furtherance of its goal to grow to a $1 billion institution and stay competitive with other regional and national banks making substantial inroads into its territory. Thus, while there were clearly risks involved in Cooperative’s approach, the mere existence of risks cannot be said, in hindsight, to constitute irrationality. 

It would be wise for banks to take note that the judge, Terrence W. Boyle, referred to the FDIC’s own Reports of Examination, which were made prior to Cooperative’s failure, but used as evidence that Cooperative’s lending practices were rational. While the FDIC in this case tried to distinguish between its roles as a regulator and as a receiver, the Judge Boyle’s ruling establishes that the FDIC cannot contest whether the Bank’s lending practices were rational while at the same time placing no blame on its own risk assessments. 

Therefore, defendants in many other cases will be able to successfully demonstrate that their own Reports of Examination and CAMELS ratings were declared satisfactory by regulators prior to the financial crisis, and that the FDIC should not be able to characterize these same practices as being negligent.

Additional Resource
View Judge Terrence W. Boyle’s entire opinion here

Contact
For more information regarding this topic, please contact Stephen R. King, JD, AMLP, Member of the Firm and Director of the Regulatory Compliance Group, at 617-428-5448 or sking@wolfandco.com, or Jared N. Kinsler, Regulatory Compliance Consultant, at 617-261-8131 or jkinsler@wolfandco.com.