ATLANTA (CN) - The former directors of a failed Georgia bank cannot dismiss claims that they caused the bank's collapse by approving risky loans without adequate information or review, and despite regulators' warnings, a federal judge ruled.
The Atlanta-based Buckhead Community Bank failed in December 2009, after trying to implement an "aggressive growth strategy" that did not yield the expected results.
Beginning in 2005, the bank opened three new branches and expanded its loan portfolio, actively pursuing commercial real estate, development and construction loans.
The Federal Deposit Insurance Corporation, which took over the bank after Georgia regulators closed it, alleged that the bank's former directors and officers had contributed to its collapse by adopting reckless lending practices that had caused the bank to lose more than $21 million.
The FDIC sued nine former officers and directors who served on the bank's loan committee and oversaw the growth strategy, alleging negligence and gross negligence. It claimed the bank officials had taken unreasonable risks and violated bank policy by approving speculative loans without adequate information and review.
The bank's loan portfolio increased 240 percent from 2005 to 2007, mostly from gains in its high-risk real estate and construction loans, with risky and non-collectable loans making up a large part of the bank's core capital, according to the FDIC's complaint. The agency claimed that the bank's management had repeatedly ignored regulators' warnings about its excessive concentration in high-risk loans and about its poor underwriting and credit administration policies and had violated the bank's loan policy and banking regulations. The complaint details 12 loan transactions that the bank's loan committee allegedly approved or renewed without proper review, which, according to the FDIC, are representative of the disastrous policy that led to the bank's failure.
The defendant bank officials asked the federal court in Atlanta to dismiss the claims, countering that they were not negligent and that the FDIC's losses as receiver had been caused by the recent financial crisis. They also argued that Georgia's business judgment rule precludes ordinary negligence claims against bank officers and directors.
U.S. District Judge Thomas Thrash noted that, in general, federal courts in Georgia had concluded the state's business judgment rule shields bank directors and officers from ordinary negligence claims.
Georgia's business judgment rule protects corporate officers from liability when they make good faith business decisions in an informed manner, and only holds them liable when they engage in fraud or an abuse of discretion, according to the 19-page ruling.
But the judge said he was not convinced that the law should be applied to bank officers and directors in a lawsuit by the FDIC.
"I most respectfully disagree with my able and learned friends and colleagues," Thrash wrote. "There is every reason to treat bank officers and directors differently from general corporate officers and directors. In general, when a business corporation succeeds or fails, its stockholders bear the gains and losses. The business judgment rule is primarily applied in Georgia because 'the right to control the affairs of a corporation is vested by law in its stockholders - those whose pecuniary gain is dependent upon its successful management.' ... But when a bank, instead of a business corporation fails, the FDIC and ultimately the taxpayer bear the pecuniary loss. The lack of care of the officers and directors of banks can lead to bank closures which echo throughout the local and national economy. To some extent, the failure of bank officers and directors to exercise ordinary diligence led to the very financial crisis that continues to affect the national economy. By all accounts, the loose lending practices alleged by the FDIC in this case were rampant within Georgia's community banks."
Since there are no clear controlling precedents regarding the law's application to bank management, the Supreme Court of Georgia should decide the issue, the ruling states.
Thrash refused to dismiss the negligence and gross negligence claims, finding that the FDIC had sufficiently alleged that the defendants had failed to exercise even slight diligence in managing the bank.
The directors and officers had continued to approve risky loans despite the decline in housing sales and despite bank policies requiring increased diversification. They had also ignored regulators' warnings about the excessive concentration in real estate loans, risky loan-to-value ratios, lack of adequate monitoring and appraisals, and lax underwriting practices, according to the opinion.
A reasonable jury could find the directors and officers grossly negligent based on allegations that they had managed the bank's loan portfolio far more aggressively than peer banks, and had disregarded procedures that would have identified the deficiencies in the loans, Thrash concluded.
The FDIC has sufficiently detailed the involvement of each bank official in the 12 loss loans, according to the ruling.
Thrash also refused to consider reports of examination issued by the FDIC, which, according to the bank's directors, showed that the agency gave favorable reports to the bank until at least 2008. At this stage of the litigation, the court has no duty to weigh those reports against the allegations in the complaint to determine whether the directors had been negligent under Georgia law, the judge concluded.
Lead defendant Charles Loudermilk, the founder of lease-to-own retailer Aaron's, founded Buckhead Community Bank in 1998.
In addition to being the bank's chairman, Loudermilk was also the largest shareholder in the bank's holding company, according to the FDIC's lawsuit.
Robert Long, an attorney for the bank's board, said in a statement: "The complaint and the allegations are without merit and we will demonstrate that in court."