BLOGS: All Risks Covered

1.28.2016, 10:40:00 AM

North Carolina nears 100 captive benchmark

We are pleased to congratulate the North Carolina Department of Insurance, which recently announced that North Carolina’s captive insurance program now oversees nearly 100 captive insurance companies.

For 2015, North Carolina Department of Insurance approved 44 new captive insurance companies, bringing the total number of captives domiciled in North Carolina to 96. Additionally, certain of those captive are licensed protected cell companies housing 240 cells or series. In the prior year, 2014, North Carolina grew by 49 captives.

Insurance Commissioner Wayne Goodwin reported that "From the start, we have been committed to growing and continually improving the captive insurance program in North Carolina.” He continued by saying “I am proud that, in such a short time, we have become one of the fastest growing states for captive insurance in the country.”

With two great successive years of 44 and 49 formations, North Carolina is rapidly becoming a presence in the captive insurance industry. For comparison, South Carolina gained 20 captives in 2014 and 30 in 2015.


1.21.2016, 8:16:00 AM

Corporate duties of bank directors in North Carolina (part 2)

In Part 1, we introduced you to the history of Cooperative Bank and the background of Federal Deposit Insurance Corporation v. Rippy, 799 F.3d 301 (4th Cir. 2015), also known as FDIC v. Willetts.

The bank officers and managers prevailed at the trial court level on all claims
Rippy was clearly not a case where the bank managers were accused of giving themselves loans on sweetheart terms; the FDIC produced no evidence of fraud or old-fashioned self-dealing.  In light of no evidence of bad faith conduct, Judge Boyle determined that on the record before him, the managers had employed a rational – if wrong – process in approving these 86 lot loans and 9 commercial loans which varied from the normal underwriting guidelines and had acted with a rational business purpose (even if, in retrospect, that business purpose was imprudent and flawed). 

In a prior examination of the bank, the FDIC had reviewed the policies and procedures in place and gave the bank a satisfactory CAMELs score of “2” in 2006 (1 is the highest CAMEL score, and 5 is the lowest CAMEL score).  Judge Boyle construed this prior stamp of regulatory approval as demonstrating, as a matter of law, that the procedures were clearly not “irrational” and could serve a valid business purpose.[1] 
Judge Boyle was also critical of the FDIC’s view of history and imposition of clairvoyance on the bank’s managers. 

Although there were clearly risks involved in Cooperative's approach, the mere existence of risks cannot be said, in hindsight, to constitute irrationality. Further, corporations are expected to take risks and their directors and officers are entitled to protection from the business judgment rule when those risks turn out poorly. Where, as here, defendants do not display a conscious indifference to risks and where there is no evidence to suggest that they did not have an honest belief that their decisions were made in the company's best interests, then the business judgment rule applies even if those judgments ultimately turned out to be poor.[2]

Similarly, the FDIC’s claim for gross negligence failed as a matter of law because there was no evidence that the managers had ignored the well-being of the bank or engaged in any willful or wanton conduct.[3] 
Judge Boyle closed his opinion in a sharp passage which did not mince words and clearly establishes his view:

It appears that the only factor between defendants being sued for millions of dollars [compared to] receiving millions of dollars in assistance from the government is that Cooperative was not considered to be "too big to fail." Taking the position that a big bank's directors and officers should be forgiven for failure due to its size and an unpredictable economic catastrophe while aggressively pursuing monetary compensation from a small bank's directors and officers is unfortunate if not outright unjust.

The FDIC appealed. 

 Judgment in favor of the directors is affirmed.

 On appeal to the Fourth Circuit, a panel of judges agreed that all directors and officers were entitled to summary judgment in their favor on the claims for gross negligence and bad faith.  The panel also agreed that all the bank’s directors were entitled to summary judgment on all  claims against them.  However, the panel reversed Judge Boyle and remanded the case for trial as to whether the bank’s officers exercised bad faith in approving the 86 lot loans and certain commercial loans which ultimately failed. 

 Beginning with director liability, the Court noted that Cooperative’s articles of incorporation include the statutorily-permitted exculpatory clause.  N.C.G.S. 55-2-02(b)(3) (corporate articles may include a  “provision limiting or eliminating the personal liability of any director arising out of an action whether by or in the right of the corporation or otherwise for monetary damages for breach of any duty as a director.[4]  No such provision shall be effective with respect to (i) acts or omissions that the director at the time of such breach knew or believed were clearly in conflict with the best interests of the corporation. . .”).  Note, however, that the statute does not permit limitations on the duty of loyalty and the duty of good faith.  Thus, the directors were in the clear unless the FDIC could show a breach of the duty of loyalty or the duty of good faith.

 In the absence of any allegations that the directors breached their duty of loyalty, the FDIC argued that there was a breach of the duty of good faith.  There was also no evidence of self-dealing, fraud, or bad faith conduct on the part of the directors.  The FDIC argued that making decisions without adequate information rose to the level of bad faith, however these arguments were rejected.  As the Court stated, “[t]he exculpatory clause protects directors from monetary liability unless the directors “knew or believed [that their acts or omissions] were clearly in conflict” with the Bank's best interests.”[5]  Merely because the result was harmful or “decisions could have been better made do[es] not rise to the level of bad faith. . .”  Accordingly, summary judgment in favor of the directors on the claims of ordinary negligence and breach of fiduciary duty was affirmed.

 Judgment in favor of the officers is reversed.

Turning to officer liability, the officers were not covered by the same exculpatory provisions in Cooperative’s articles of incorporation which shielded the directors (indeed, N.C.G.S. 55-2-02(b)(3) does not extend to officers).[6]  Thus, the officer’s liability was analyzed strictly through the business judgment rule.  To overcome the presumptions of the business judgment rule, the FDIC had to show that the officers “(1) did not avail themselves of all material and reasonably available information (i.e., they did not act on an informed basis); (2) acted in bad faith, with a conflict of interest, or disloyalty; or (3) did not honestly believe that they were acting in the best interest of Cooperative.”
The FDIC mainly attacked whether the officers were acting on an informed basis.  The FDIC’s expert witness in banking practices noted that the officers did not act in accordance with generally acceptably and prudent banking practices.[7]  They approved loans over the telephone, sometimes without first reviewing documentation.  Sometimes they approved loans without reviewing any documentation, and sometimes did not receive the documentation until after loans were funded.  Cooperative had also failed to address some warnings and deficiencies which regulators had noted in a 2006 bank examination (related to credit administration and audit processes).

This article originally appeared in the Professional Liability Underwriting Society's Journal. In Part 3, we will explain why the result is in harmony with existing North Carolina and Delaware corporate law.

[1] Willetts, 48 F.Supp.3d at 850-51.
[2] Id. at 851
[3] Id. at 851-52.
[4] Rippy, 799 F.3d at 311.
[5] Id. at 312.
[6] Note that defendant Fredrick Willetts, III was both CEO and Chairman of the Board of Directors.  He was both an officer and a director.  The exculpation statute provides no protection to Mr. Willetts for violations of the duty of care committed as an officer. 
[7] Rippy, 799 F.3d at 313.


1.12.2016, 8:36:00 AM

Corporate duties of bank directors in North Carolina (part 1)

Federal Deposit Insurance Corporation v. Rippy, 799 F.3d 301 (4th Cir. 2015), also known as FDIC v. Willetts, is a closely-watched case arising from the failure of a community bank in eastern North Carolina. The case included heavy amicus involvement from the U.S. Chamber of Commerce, the North Carolina Commissioner of Banks, and over 55 other banking associations. The Fourth Circuit’s ruling, even if inarticulate, does not deviate from widely-accepted views of the business judgment rule, as adopted in North Carolina or Delaware. Corporate leaders must continue to adhere to a deliberative and informed process in corporate decision-making.

The rise and fall of Cooperative Bank

Cooperative Bank’s history is not an uncommon one. Founded in Wilmington, North Carolina in 1898, it operated as a thrift until 1992, focusing its business on providing loans for single-family housing. Likely as a result of the savings and loan crisis, in 1992 the Bank converted into a state-chartered savings bank, regulated by the FDIC. Ten years later (2002), the bank’s leadership decided to increase its assets from $443 million to $1 billion by 2005. An ambitious goal. This growth strategy focused on commercial real estate lending.

As part of this goal, the bank’s senior leadership approved 86 loans made between January 2007 and April of 2008. As the New York Times reported, “[t]he bank’s most innovative loan program allowed customers of certain real estate developers to buy overpriced building lots with no money down and no payments – of principal, interest, or even closing costs – for two years.” It comes as no surprise that some of those loans were, in retrospect, of questionable quality. Eventually, Cooperative entered receivership. The FDIC claims it lost a total of $216.1 million due to Cooperative’s failure.

The bank concentrated its lending in the acquisition, development, and construction loan segment of the market. Among the questionable loans were “lot loans” for vacation properties. A bank customer would attend an investment seminar and become convinced that they could buy a coastal North Carolina building lot, with views of the water, without spending any money out of pocket for two years (i.e., no closing costs, no down payment, and no payments towards principal or interest). From the customer’s view, within two years, the value of the lot will have appreciated and they would be able to flip the building lot to another buyer as property values continued to appreciate. This was presented to customers as being a risk free investment with no money out of pocket. The average price of these lots was approximately $280,000 (ranging from $101,900 to $999,000, with most in the 200-350,000 range). The FDIC claims that Cooperative lost 66 percent of the money lent through this program.

Additionally, the officers and certain directors approved nine commercial real estate loans (mostly for real estate development and construction in the greater Wilmington area) for between for between $1.5 and $10.5 million each. Each lending transaction was allegedly woefully deficient; either because of stale financial documents, insufficient cash flow to service the debt load, inadequate or wrongly valued security, etc. The FDIC estimates its loss on these nine loans was over $20 million.

After the bank’s failure in 2009, the FDIC, as receiver, sued the bank’s directors and officers alleging simple negligence, gross negligence, and breach of fiduciary duty. The FDIC alleged that the approval of these loans by the bank’s leadership varied from the underwriting standards adopted by the bank, published guidelines on loan underwriting, and industry practices. Further, the FDIC alleged that in approving these 86 loans, the managers of the bank specifically ignored or acted counter to prior warnings from regulators regarding improper loan underwriting. The FDIC sought between $4.4 million and $33 million from each named defendant officer or director.

The FDIC, in an examination, questioned the above loan practices. The bank’s (third-generation) CEO stated that all of these loans would have at least 10% equity (90% LTV) and would not be no-interest. The trick, from a banking point of view, is that Cooperative typically lent 80% of the purchase price and received a 20% down payment. The real estate developer had lent the down payment money to the buyer and promised to make the interest payments to Cooperative for the first two years. The developer profited because it would purchase the lot only after it had found a buyer who was willing to pay twice what the developer had paid. The developer was not selling property out of his ‘inventory,’ so much as he was acting as a broker or intermediary. By selling the lots at a substantial premium (after obtaining an appraisal based on other inflated lots), the developer could make the down payment, make two years of interest payments, and still profit on the transaction. Certain directors and officers of Cooperative also believed that by participating in these transactions, the bank would be able to gain lucrative construction lending business once these lots were developed.

The FDIC’s claims and the business judgment rule

Rippy is significant because, among other things, it was the first case in this wave of recent FDIC litigation where the bank’s directors and officers obtained summary judgment at the trial level on all claims of negligence and breach of fiduciary duty against them.

Judge Boyle entered summary judgment in favor of the directors and officers on the basis of the business judgment rule. Judge Boyle flatly rejected the FDIC’s notion that the officers and directors of this community bank could have foreseen the real estate bubble when other economic leaders in the nation did not.

The business judgment rule has historically provided a robust protection for claims against officers and directors who act in the best interests of the company, in good faith and with due care. Analogizing to the law of trusts, courts have long reasoned that corporate directors owe fiduciary duties to the corporation and its shareholders which they serve. The rule’s adoption by courts ensures that officers and directors will be protected from liability for good faith decisions, even if those decisions were glaringly wrong in hindsight. The rule thus limits a court (or a plaintiff’s) ability to Monday-morning quarterback business decisions which meet the hallmarks of good faith decision making. Without the broad deference to director and officer decision making afforded by the business judgment rule, corporations would take far less risks and innovation would be stifled. Decisions which are made by a loyal and informed board, for a rational business purpose, will not create liability for the directors. In other words, decisions made in the board room will typically not be second-guessed in the courtroom.

Under North Carolina statutory corporate law:

(a) A director shall discharge his duties as a director, including his duties as a member of a committee:
(1) In good faith;
(2) With the care an ordinarily prudent person in a like position would exercise under similar circumstances; and
(3) In a manner he reasonably believes to be in the best interests of the corporation.

N.C.G.S. § 55–8–30(a); see also id. § 55–8–42(a) (providing identical standard for corporate officers). North Carolina corporate law also permits the corporation to limit the personal liability of a director for any breaches of the duty of care, as long as the director did not know (or believe) that his actions were “clearly in conflict with the best interests of the corporation.” N.C.G.S. § 55–2–02(b)(3). Corporations are not allowed to provide their officers with this same protection.

Last year, at the trial court level, Judge Boyle reiterated the well-known business judgment rule in entering summary judgment in favor of the managers.
The business judgment rule involves two presumptions. First, it establishes "an initial evidentiary presumption that in making a decision the directors [and officers] acted with due care (i.e., on an informed basis) and in good faith in the honest belief that their action was in the best interest of the corporation." Second, the business judgment rule establishes, absent rebuttal of the first presumption, a "powerful substantive presumption that a decision by a loyal and informed board will not be overturned by a court unless it cannot be attributed to any rational business purpose."

FDIC v. Willetts, 48 F.Supp.3d 844, 850-51 (E.D.N.C. 2014).

In other words, under the business judgment rule, there is a presumption that corporate directors and officers are acting in good faith and with due care. This presumption puts the burden on the plaintiff (here, the FDIC) to come forward with evidence that the officers
“(1) did not avail themselves of all material and reasonable available information (i.e., they did not act on an informed basis);
(2) acted in bad faith, with a conflict of interest, or disloyalty; or
(3) did not honestly believe that they were acting in the best interest of [the bank].”

Rippy, 799 F.3d at 313.

This article originally appeared in the Professional Liability Underwriting Society's Journal. In Part 2, we will finish the story of FDIC v. Rippy, as well as explain why the result is in harmony with existing North Carolina and Delaware corporate law.


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