Wednesday, January 2, 2013

FYI: 4th Cir Holds BK Trustee Could Not Pursue Claims Against Parent Bank's Directors and Officers

The U.S. Court of Appeals for the Fourth Circuit recently held that a bankruptcy trustee could not assert claims against a parent bank's directors and officers allegedly responsible for the mismanagement and failure of a subsidiary bank. 
More specifically, the Court ruled that, as derivative claims related to the mismanagement of the wholly-owned subsidiary, the claims could be brought only by the Federal Deposit Insurance Corporation as the receiver of the failed subsidiary bank, because the trustee had failed to show that the bank holding company had suffered damages separate and distinct from those at the subsidiary level.
The Court also ruled, however, that a separate trustee claim against the officers and directors for improperly subordinating the bank holding company's majority interest in a real estate investment entity could proceed.
A copy of the opinion is available at:  
When a wholly-owned subsidiary bank ("Subsidiary Bank") failed due to insolvency, the Federal Deposit Insurance Corporation was appointed receiver ("FDIC-R") and liquidated all of Subsidiary Bank's assets.  As a result of Subsidiary Bank's failure and liquidation, its parent company ("Debtor Parent Bank") filed for Chapter 7 bankruptcy.  The directors and officers (collectively, "Directors") of Debtor Parent Bank also served as the officers and directors of Subsidiary Bank.
The bankruptcy trustee ("Trustee") later filed an adversary proceeding, asserting breach of fiduciary duty and negligence against Directors in their capacity as officers and directors of Debtor Parent Bank resulting in the failure of Subsidiary Bank, and the improper subordination of Debtor Parent Bank's interest in a real estate holding entity in which Debtor Parent Bank held a majority interest.
In response, Directors moved the bankruptcy court to, among other things, transfer the action to federal district court or to dismiss the case for failure to state a claim under the Federal Rules of Civil Procedure.  The bankruptcy court transferred the case to district court.
The lower court granted the Directors' motion to dismiss, concluding that Trustee lacked standing to bring the action as Trustee had pled only claims derivative of Director's operation of Subsidiary Bank and the right to bring such claims belonged exclusively to FDIC-R.    Trustee appealed, arguing, first, that the claims were direct claims against Directors and, alternatively, that, because FDIC-R declined to pursue its claims against Directors, Trustee was free to bring those claims even if they were derivative in nature. 
The Fourth Circuit affirmed as to the claims related to management and failure of Subsidiary Bank, but reversed as to the claim for improper subordination of Debtor Parent Bank's interest in the real estate holding company. 
As you may recall, FDIC-R succeeds "to all rights, titles, powers, and privileges of the insured depository institution, and of any shareholder . . . of such institution with respect to the institution and the assets of the institution."  12 U.S.C. § 1821(d)(2)(A)(i) ("Section 1821(d)(2)(A)(i)"). 
Noting that, although under bankruptcy law Trustee had the authority to assert any cause of action that Debtor Parent Bank could have brought in its own right, including derivative claims as the sole shareholder of Subsidiary Bank, the Fourth Circuit pointed out that Section 1821(d)(2)(A)(i) exclusively vests FDIC-R with causes of action for losses sustained by Subsidiary Bank.  The court thus focused on whether Trustee pled a basis of liability that stemmed only from Directors' duties in their operation and management of Subsidiary Bank or whether Trustee also pled additional causes of action related to Directors' duties toward Debtor Parent Bank. 
Concluding that Trustee pled primarily causes of action for liability derivative of the alleged mismanagement of Subsidiary Bank, the court ultimately ruled that, with the exception of the claim that  Debtor Parent Bank improperly subordinated its majority interest in the real estate entity, Trustee lacked standing to assert claims belonging exclusively to FDIC-R. 
In so ruling, the Court of Appeals noted that Trustee largely failed to plead distinct and separate harm specific to Debtor Parent Bank at the holding company level and that, being Debtor Parent Bank's only asset, the Subsidiary Bank incurred damages no different from any damages incurred at the parent level.  Cf. Lubin v. Skow (In re Integrity Bancshares, Inc.), 382 Fed. App'x 866 (11th Cir. 2010)(ruling that FDIC-R succeeded to all derivative claims against officers and directors of a failed subsidiary bank and that bankruptcy trustee could have asserted claims for direct harm to debtor holding company had trustee raised direct claims in his pleadings).   
In reaching this conclusion, the court also rejected Trustee's argument that she had standing as a result of a letter from FDIC-R declining for reasons of cost to pursue a civil claim against Directors.   As the court explained, not only was there no statutory authority by which the FDIC-R could transfer to another party its exclusive statutory rights, but the letter from FDIC-R contained nothing prohibiting it from proceeding at a later date against Directors if it so chose.
With respect to Trustee's allegation that Directors allowed Debtor Parent Bank to improperly subordinate its interest in a real estate holding company, the court ruled that this particular allegation supported a direct claim against Directors, because the Trustee adequately pled direct harm to Debtor Parent Bank unrelated to mismanagement of the Subsidiary Bank.  In ruling that this claim was not a derivative claim belonging to FDIC-R, the court concluded that the lower court erred in dismissing this particular claim and that Trustee could accordingly proceed with this claim.
The Court of Appeals thus affirmed the district court's dismissal of the derivative claims, but reversed as to the direct claim related to Debtor Parent Bank's interest in the real estate investment entity.

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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