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Bank Officers Must Face Negligence Claims

RICHMOND, Va. (CN) - The Fourth Circuit revived claims that Cooperative Bank of North Carolina failed because of risky housing loans that officers issued negligently.

Founded 117 years ago in Wilmington as a community bank, Cooperative spent the start of this century focusing on commercial real estate lending, eventually growing its assets to $1 billion as a state commercial banking institution.

It collapsed in 2009 amid the housing crisis, however, causing the Federal Deposit Insurance Corp. more than $216.1 million in losses as receiver.

The FDIC sued the bank and its officers and directors in 2011, but a federal judge in Wilmington shielded those individuals from liability at summary judgment.

That decision had rested on the court's finding that the negligence and breach-of-fiduciary claims could not overcome North Carolina's business-judgment rule, and that there was insufficient evidence to support claims of gross negligence.

Though the Fourth Circuit agreed as to the gross-negligence claims last week, it found that the ordinary-negligence and fiduciary-breach claims may stick against the officers.

"Certainly, it is convenient to blame the Great Recession for the failure of Cooperative, and in turn for the losses sustained by the FDIC-R when it took over the bank," Judge Roger Gregory wrote for a three-person panel.

"However, there is evidence in the record, as outlined above, that suggests that 'in the exercise of reasonable care,' the bank officers could have 'foreseen that some injury would result from [their] act[s] or omission[s], or that consequences of a generally injurious nature might have been expected,'" the 30-page ruling continues.

Exam reports from both of Cooperative's regulators that predate the recession "indicated that the bank was utilizing unsafe practices," Gregory added.

"And while the Recession undoubtedly contributed to the failure of the bank, it may have been only one of many contributing factors," the ruling states. "This is a genuine issue of material fact, and thus this is a question for a jury."

North Carolina's business-judgment rule protects bank executives if there is no proof that their actions knowingly conflicted with the bank's best interest, but the appellate panel found "that the [trial] court improperly applied the rule."

Although the recession's role in the bank's failure cannot be discounted, bank regulators and an independent auditor previously found that the bank used "unsafe practices," the decision states.

Indeed the independent consultant, Brian Kelley, slammed the bank for failing to operate "in accordance with generally accepted banking practices," and that the officers "failed to address warnings and deficiencies in the bank's examination reports," Gregeory wrote.

The consultant noted that bank officers often "approved loans over the telephone, without first examining relevant documents," according to the ruling.

"Moreover, they often did not receive the loan documents until after the phone calls, and sometimes not until after the loans had already been funded," Judge Gregory added.

Gregory said "Kelley's affidavit and reports thus provide a sufficient basis for rebutting the presumption that the bank's officers acted on an informed basis," meaning that they availed "themselves of all material and reasonably available information."

The FDIC must abandon its bad-faith claims against the bank's nine officers and directors, led by former CEO Frederick Willetts III, the court ruled.

"Actions that might have been harmful or decisions that could have been better made do not rise to the level of bad faith in this context," the ruling states.

Thomas Gilbertsen with the D.C. firm Venable represents the bank officers.

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