Banking Law Roundup


No. 73  Perspectives on Developments in the Law from The Sharp Law Firm, P.C. October  2012

Decision Shows FDIC Power to Ban Officials from Banking 

            The Federal Deposit Insurance Corp. (FDIC) has broad powers to banish bank officials from the industry, a recent decision by the United States Court of Appeals in Chicago demonstrates. 

            The FDIC also has the authority to impose significant civil monetary penalties in cases of insider wrongdoing, the decision indicates.

            At issue in Michael v. FDIC, 687 F.3d 337 (7th Cir. 2012), were conduct and omissions of two brothers who formerly owed Citizens Bank & Trust Co., a state bank insured by FDIC.  The brothers were found to have violated Regulation O (12 C.F.R. Part 215), which regulates banks’ loans to insiders; to have double-pledged stock in support of their business transactions; to have violated their fiduciary duties; and to have engaged in unsafe or unsound banking practices.  They were banned from banking and assessed $175,000 in civil penalties, which the court called “modest.”

            The FDIC and the court imposed those sanctions because of the brothers’ involvement in three separate transactions, but both bodies said banishment from banking would have been supported by their role in any one of the three situations.

            In one transaction, the brothers failed to disclose their personal roles in a transaction in which a hotel originally had been purchased for $2.58 million and put through a series of trans-actions which supposedly justified a $3.95 million price, of which their bank agreed to lend $2.9 million in an approval in which both brothers participated.  In another transaction, the brothers pledged the same shares of their bank’s stock to two separate banks in support of the brothers’ transactions with those banks.  In the third transaction, the brothers failed to advise Citizens of their interest in a real estate deal that the bank financed and in which a co-investor was allegedly duped into signing numerous papers. 

            The FDIC Board found that a common theme emerged when examining the transactions:  “Respondents exploited their positions as Bank directors, deliberately overstated the value of assets, and concealed their true financial interest to entice lenders and investors to fund their business ventures.”

            Affirming, the 7th Circuit said 12 U.S.C. § 1818(e)(1) authorized the Board to permanently remove from banking a bank officer, director, employee or controlling shareholder if (1) the person directly or indirectly violated a law, rule, or regulation, participated in an unsafe or unsound banking practice, or breached his fiduciary duty; (2) as a result of this conduct, the bank suffered or will probably suffer a financial loss or the person received a financial benefit; and (3) the conduct involved personal dishonesty or demonstrated a willful or continuing disregard for the safety or soundness of the bank. 

            The court’s examination of the alleged violation of a law, rule or regulation focused on Regulation O.  Under Regulation O, “[a]n extension of credit is considered made to an insider to the extent that the proceeds are transferred to the insider or are used for the tangible economic benefit of the insider.”  12 C.F.R. § 215.3(f).  However, an exception applies if the loan is made on substantially the same terms as loans to non-insiders, the loan does not involve more than the normal risk of repayment or present other unfavorable terms, and the borrower uses the proceeds in a bona fide transaction to acquire property, goods or services from the insider.  In addition, Regulation O requires that the insiders’ interest be disclosed and that they abstain from voting on the loan.  See 12 C.F.R. § 215.4. 

            Because the loan in the first transaction involved unusual risk, because the brothers’ roles were not fully disclosed, and because they participated in the approval, they could not find solace in Regulation O, the court said.  The failure to properly disclose their roles, a lending limit violation, and their failure to abstain from voting also caused the court to find Reg O violations in the third transaction.

            But the FDIC and the court also found breaches of fiduciary duty in these transactions.  “Self-dealing, conflicts of interest, or even divided loyalties are inconsistent with fiduciary responsibilities,” the court said.  “A person can breach a fiduciary duty by failing to disclose material information, even if not asked.”                                              

            The agency and the court also found the brothers to have engaged in unsafe or unsound practices.  They found that the first and third transactions exposed the bank to abnormal risk of loss or harm contrary to prudent banking practice, and constituted willful disregard under § 1818(e)(1).  They also found that the double-pledging of stock was an unsafe and unsound practice which exposed a bank to loss or harm.

            Persons interested in bank insider liability issues should also review FDIC v. Spangler, 836 F.Supp.2d 778 (2011), in which the court sustained the FDIC’s complaint against a bank’s officers, directors and loan committee members on state-law grounds.

New Law Prohibits False U.C.C. Filings

            Illinois’ enactment of Article 9 of the Uniform Commercial Code (810 ILCS 5/9-101 et seq.) has been amended to prohibit and punish filing of false financing statements.

            Not only does P.A. 97-0836 make such false filings a crime, it creates a powerful civil remedy for injured persons.   Under new § 9-501.1, injured persons may sue and recover the greater of $10,000 or actual damages; attorney’s fees; expenses of bringing the action; and, in the discretion of the court, exemplary damages.  It also creates an administrative procedure for termination of the false filing.

Reformation Request Not Barred By Credit Agreements Act 

            The Illinois Credit Agreements Act (815 ILCS 160) does not prohibit a debtor from seeking reformation of a written agreement on grounds of mutual mistake of fact, a majority of a panel in the Appellate Court’s Third District has ruled.

            At issue in Schafer v. UnionBank/Central, 2012 IL App (3d) 110008, was a security agreement which had been checked to cover “All Debts” instead of “Specific Debts.”  When the bank used the security agreement to seize and sell debtors’ property upon default on transactions other than the one in which it was given, the debtors sued for conversion.  The bank raised the security agreement as a defense, and the debtors asked that it be reformed.  Over an objection by the third judge, the majority said the Credit Agreements Act does not prevent such reformation.

                                                                        John T. Hundley,, 618-242-0246

1115 Harrison, P.O. Box 906, Mt. Vernon, IL 62864 • Telephone 618-242-0246 • Facsimile 618-242-1170 •
Business Transactions • Litigation • Financial Law • Problem Finances • Real Estate • Corporate • Commercial Disputes • Creditors’ Rights •
Arbitration • Administrative Law • Employment Matters • Estate Planning • Probate • Family Matters