The FDIC has sued the former officers and directors of Central Bank and Trust Company ("Central"), alleging that their gross negligence caused the bank to lose $62 million in unpaid loans and $66 million in preferred stock that the bank held in mortgage lenders Fannie Mae and Freddie Mac. The defendants have moved to dismiss the complaint, arguing that their decisions to approve the loans and retain the stock are shielded by the business judgment rule.

Background

Central was a Minnesota-chartered bank based in St. Paul, Minnesota. It was a member of the Federal Reserve System, and its deposits were insured by the FDIC. In 2003, state regulators investigated the bank and found that its risk management practices were inadequate given the size and risk profile of the bank. The regulators warned that the bank was vulnerable to a slowdown of the economy and ordered the bank to adopt new lending policies. The FDIC alleges that officers and directors adopted such policies but failed to adhere to them when they approved certain risky loans.

Specifically, the FDIC challenges loans that the bank made to six borrowers from 2005 to 2008. The FDIC alleges that Defendants disregarded the bank's own policies in approving these loans by failing to ensure the borrowers' ability to repay, disregarding evidence of the borrowers' financial weakness, and structuring loans with terms that were unreasonably generous to the borrowers. The FDIC alleges that the bank’s approval of loans to these borrowers constituted gross negligence.

In addition to the loan challenges, the FDIC also challenges officers’ and directors’ decision to retain certain preferred stock in mortgage lenders Fannie Mae and Freddie Mac. Though many banks held securities in these companies, the FDIC alleges that Central held them in an unusually high concentration. The FDIC alleges that, under the bank's own policies, Central was required to sell these securities because they could not justifiably have been expected to return to their "basis value"—the price at which the bank purchased them. Central nevertheless decided to retain the securities, and the bank lost over $66 million when they became practically worthless. Again, the FDIC alleges that Central’s decision to retain these securities constituted gross negligence.

On May 14, 2010, the Minnesota Department of Financial and Professional Regulation ("MDFPR") closed Central, and the FDIC was appointed receiver. As receiver, the FDIC succeeded to any rights of the bank's stockholders, depositors, accountholders, and other creditors. The FDIC filed this suit on April 30, 2013.

Business Judgment Rule

The officers and directors of Central argue that the FDIC's claims are barred by the business judgment rule. Under Minnesota law, the business judgment rule "'is a presumption that directors of a corporation make business decisions on an informed basis, in good faith, and with the honest belief that the course taken was in the best interest of the corporation." The purpose of the rule is to protect directors who have been diligent and careful in performing their duties from being subjected to liability from honest mistakes of judgment. Under Minnesota law, however, "it is a prerequisite to the application of the business judgment rule that the directors exercise due care in carrying out their corporate duties." If directors fail to exercise due care, then they may not use the business judgment rule to shield their conduct.

1. Based on the above fact you must do a complete analysis of whether or not the officers and directors will be liable for the losses of the bank to the FDIC. Your analysis may include facts that you are assuming, but you must state what you are assuming in that discussion.
2. Do you think that the result for the officers and the directors might be different? Why or why not? Explain. Again tell me what facts you assumed in making this decision. You may decide different or the same, but you must be able to defend the position you take.

Answer rating: 100% (QA)

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