FDIC v. Brown

• Decision Date: 10 December 1992
• Docket Number: Civ. A. No. H-91-2073.
• Citation: 812 F. Supp. 722
• Parties: FEDERAL DEPOSIT INSURANCE CORPORATION, in its separate corporate capacity, Plaintiff, v. Ronald BROWN, et al., Defendants.
• Court: U.S. District Court — Southern District of Texas

812 F. Supp. 722

FEDERAL DEPOSIT INSURANCE CORPORATION, in its separate corporate capacity, Plaintiff, v. Ronald BROWN, et al., Defendants.

Civ. A. No. H-91-2073.

United States District Court, S.D. Texas, Houston Division.

December 10, 1992.

James R. Buckner, Miller & Martin, Chattanooga, TN, Kevin B. Finkel, Meredith, Donnell & Abernethy, Houston, TX, for plaintiff.

Walter B. Stuart, IV, Vinson & Elkins, Houston, TX, for defendants.

MEMORANDUM AND ORDER

LAKE, District Judge.

Defendant Isabel Brown Wilson seeks partial summary judgment (Docket Entry No. 92), and the remaining defendants seek judgment on the pleadings (Docket Entry No. 91) because the Texas business judgment rule precludes FDIC from suing defendants for acts or omissions as directors of RepublicBank-Houston (RBH) unless FDIC alleges that defendants' conduct was fraudulent or ultra vires.

All parties express familiarity with the court's April 10, 1992, memorandum opinion in Resolution Trust Corporation v. Harry Holmes, Jr., et al., Civil Action No. H-92-0753. In Holmes the court held that the standard of care imposed by 12 U.S.C. § 1821(k) did not govern defendants' liability since all of the acts and omissions of defendants alleged by the RTC occurred before the enactment of § 1821(k). Because this statute creates a substantive liability, it would be manifestly unjust to apply it retroactively to defendants. The same holding applies in this case.

Section 1821(k) also states that: "nothing in this paragraph shall impair or affect any right of the Corporation under other applicable law." The question raised by defendants' motions is what causes of action FDIC has under other applicable law. FDIC argues that the reference to "other applicable law" includes federal common law. Defendants argue that the court should adhere to its statement in Holmes that the reference in 12 U.S.C. § 1821(k) to "other applicable law" is limited to applicable state law. Since FDIC also argues that the defendant directors would be equally liable under Texas law or federal common law (FDIC's Second Supplemental Brief at 2), the court will first address the standard of care under Texas law since, if FDIC is correct, the choice of law issue may be moot.

Defendants argue that the Texas business judgment rule limits FDIC to actions for fraud or ultra vires conduct by defendants. As the court has explained at hearings in this action and in Holmes, many of the discussions of the Texas business judgment rule in the Texas cases cited by FDIC and defendants are dicta. The court also acknowledges that the nineteenth century origin of the business judgment rule, which predated the maze of federal statutes and regulations applicable to all corporations, and in particular to banks, may at first blush make the rule appear anachronistic or at least counterintuitive to some notions of director liability, especially when applied in the context of a public banking corporation. Nevertheless, the rule remains a viable part of Texas jurisprudence and has been applied in the context of a modern publicly held corporation. E.g., Gearhart Industries, Inc. v. Smith International, Inc., 741 F.2d 707, 721 (5th Cir.1984). Also, notwithstanding its age, the business judgment rule still furthers the public policy of encouraging citizens to serve as corporate directors by immunizing them from acts and omissions that in hindsight proved to be wrong, as long as the directors were not personally interested in the transaction or did not act fraudulently or contrary to their lawful authority.

As defendants point out, with the benefit of hindsight, the FDIC or a disgruntled shareholder could almost always allege one or more acts of negligence by bank directors in approving a bad loan. Had the directors obtained better or more current appraisals, more or better security for the loan, and had the bank better monitored the payment history of the loan and subsequent changes in the credit-worthiness of the borrower, almost any loan could have been made more secure, or at least the bank could have suffered a smaller loss on it. The business judgment rule protects bank directors from being guarantors on loans made by banks. Absent such a rule defendants argue that people with business acumen and some record of business success, who would normally make good directors, would decline election as directors, and these positions might be filled instead by judgment-proof neophytes. The rule also encourages directors to exercise their judgment in making loans and not to foreclose credit markets to all but blue-chip borrowers. Defendants argue that abolition of the rule could discourage banks from making loans to first-time borrowers and fledgling enterprises.¹

After thoroughly analyzing the Texas business judgment rule, and requiring the parties to rebrief their arguments to eliminate citations to cases in which discussions of the rule were dicta, the court described the rule in RTC v. Holmes.

The genesis of the business judgment rule in Texas is the Supreme Court's decision in Cates v. Sparkman, 73 Tex. 619, 11 S.W. 846 (1889). There the district court sustained the defendants' general demurrer to plaintiff's petition, and the Supreme Court affirmed. Although the Court's opinion is not as precise as it could have been, it is clear that the Court, after deciding to treat the case as a shareholder's derivative action,² concluded that the negligence of a director, no matter how unwise or imprudent, does not constitute a breach of duty if the acts of the director were "within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved...." 11 S.W. at 849.

The breach of duty or conduct of officers and directors which would authorize, in a proper case, the court's interference in suits of this character is that which is characterized by ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless. Id.

Later Texas opinions have recognized and applied this rule. E.g., Langston v. Eagle Publishing Co., 719 S.W.2d 612, 616-617 (Tex.App. — Waco 1986, writ ref'd n.r.e.); Zauber v. Murray Savings Ass'n, 591 S.W.2d 932, 936 (Tex.Civ. App. — Dallas 1979), writ ref'd n.r.e., 601 S.W.2d 940 (Tex.1980). After discussing the origin and development of the rule, the Fifth Circuit, in Gearhart Industries Inc. v. Smith International, Inc., 741 F.2d 707, 721 (5th Cir.1984) concluded that "... Texas courts to this day will not impose liability upon a non-interested corporate director unless the challenged action is ultra vires or is tainted by fraud. (citations omitted) Such is the business judgment rule in Texas."

Although there is language from other Texas cases that discusses the duty of a corporate director in terms of ordinary care, the court has located only one case in which liability was imposed against a director for negligence. In Meyers v. Moody, 693 F.2d 1196, 1211 (5th Cir. 1982), cert. denied, 464 U.S. 920 104 S.Ct. 287, 78 L.Ed.2d 264 (1983), a judgment against Shearn Moody, Jr., the president, chairman of the board, and majority shareholder of Empire Life Insurance Company of America, was affirmed under a number of alternative theories, including negligence, gross negligence, intentional misconduct and breach of fiduciary duty of due care in the management of the corporation. The court does not find Meyers v. Moody to be persuasive authority for RTC's argument, however, for two reasons. First, Moody was not a disinterested director, he was the controlling director and chief executive officer of the corporation. Secondly, there is no indication in either the district court's memorandum opinion and order, 475 F.Supp. 232 (N.D.Tex. 1979), or the Fifth Circuit's opinion that Moody ever raised the business judgment rule before the jury was charged. Therefore, the Fifth Circuit had no occasion to address whether, upon a timely motion by Moody, the district court should have required the receiver of Empire to overcome the business judgment rule by amending its complaint.

The court finds that the business judgment rule as adopted and applied by Texas courts is not merely a defense to a claim of negligence or breach of fiduciary duty against a corporate director. It is a rule of substantive law that requires a plaintiff seeking damages on behalf of a corporation against its disinterested directors to plead and prove (1) that the conduct of the directors complained of was either ultra vires or fraudulent or (2) that the directors had a personal interest in the transactions complained of....

In its Second Supplemental Brief in Opposition to Defendants' Motions for Partial Summary Judgment and Judgment on the

Pleadings FDIC argues that the recent opinion in FDIC v. Wheat, 970 F.2d 124 (5th Cir.1992), shows that the court's analysis in Holmes was incorrect. In Wheat the Fifth Circuit affirmed a jury verdict in favor of FDIC against a director of a state chartered bank for breach of fiduciary duty in connection with his approval of an inadequately secured loan. The court approved a jury instruction that characterized the business judgment rule as a defense to negligence and breach of fiduciary duty claims. Among other things the instruction approved by the Fifth Circuit stated:

A director or officer of a bank shall not be held liable for an honest mistake of judgment if he acted with due care, in good faith, and in furtherance of a rational business purpose.

FDIC argues that Wheat establishes that the business judgment rule does not preclude an action for negligence against disinterested directors in the present case. Wheat is distinguishable from the instant case in several respects, however. First, Sudderth, the director found liable...