Federal Deposit Insurance Corporation as Receiver for Midwest Bank and Trust Company v. Giancola et al

Filing 84

MEMORANDUM Opinion and Order Signed by the Honorable Joan B. Gottschall on 3/19/2014. Mailed notice(ef, )

UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF ILLINOIS
EASTERN DIVISION
FEDERAL DEPOSIT INSURANCE
CORPORATION AS RECEIVER FOR
MIDWEST BANK AND TRUST
COMPANY,
Plaintiff,
v.
JAMES J. GIANCOLA; JEROME JAY
FRITZ a/k/a J.J. FRITZ; ANGELO A.
DIPAOLO; BARRY I. FORRESTER;
ROBERT J. GENETSKI; GERALD F.
HARTLEY; HOMER J. LIVINGSTON,
JR.; JOSEPH R. RIZZA; EGIDIO V.
SILVERI a/k/a E.V. SILVERI; LEON
WOLIN; THOMAS A. CARAVELLO;
SHELDON BERNSTEIN; THOMAS H.
HACKETT; MARY M. HENTHORN;
KELLY J. O’KEEFFE; BROGAN M.
PTACIN; JOHN S. SPEAR; and
WILLIAM H. STOLL,
Defendants.

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Case No. 13 C 3230
Judge Joan B. Gottschall

MEMORANDUM OPINION & ORDER
The FDIC has sued the former officers and directors of Midwest Bank and Trust
Company (“Midwest”), alleging that their gross negligence caused the bank to lose $62 million
in unpaid loans and $66 million in preferred stock that the bank held in mortgage lenders Fannie
Mae and Freddie Mac. The defendants have moved to dismiss the complaint, arguing that their
decisions to approve the loans and retain the stock are shielded by the business judgment rule.
Five other judges in this district have rejected this argument in cases involving substantially
similar allegations. Those judges have held that where the FDIC alleges that the defendants
failed to obtain necessary information to make rational business decisions, the business judgment

rule does not warrant dismissal. Because the FDIC has alleged that was the case here, the
motion to dismiss is denied.
I. BACKGROUND
Midwest was an Illinois-chartered bank based in Elmwood Park, Illinois. It was a
member of the Federal Reserve System, and its deposits were insured by the FDIC. In 2003,
state regulators investigated the bank and found that its risk management practices were
inadequate given the size and risk profile of the bank. The regulators warned that the bank was
vulnerable to a slowdown of the economy and ordered the bank to adopt new lending policies.
The FDIC alleges that Defendants adopted such policies but failed to adhere to them when they
approved certain risky loans.
Specifically, the FDIC challenges loans that the bank made to six borrowers from 2005 to
2008. The FDIC alleges that Defendants disregarded the bank’s own policies in approving these
loans by failing to ensure the borrowers’ ability to repay, disregarding evidence of the
borrowers’ financial weakness, and structuring loans with terms that were unreasonably generous
to the borrowers. The FDIC alleges that Defendants’ approval of loans to these borrowers
constituted gross negligence.
In addition to the loan challenges, the FDIC also challenges Defendants’ decision to
retain certain preferred stock in mortgage lenders Fannie Mae and Freddie Mac. Though many
banks held securities in these companies, the FDIC alleges that Midwest held them in an
unusually high concentration. The FDIC alleges that, under the bank’s own policies, Defendants
were required to sell these securities because they could not justifiably have been expected to
return to their “basis value”—the price at which the bank purchased them.

Defendants

nevertheless decided to retain the securities, and the bank lost over $66 million when they

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became practically worthless. Again, the FDIC alleges that Defendants’ decision to retain these
securities constituted gross negligence.
On May 14, 2010, the Illinois Department of Financial and Professional Regulation
(“IDFPR”) closed Midwest, and the FDIC was appointed receiver. As receiver, the FDIC
succeeded to any rights of the bank’s stockholders, depositors, accountholders, and other
creditors. The FDIC filed this suit on April 30, 2013.
II. LEGAL STANDARD
To survive a motion to dismiss pursuant to Rule 12(b)(6), a complaint must “state a claim
to relief that is plausible on its face.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (citing Bell Atl.
Corp. v. Twombly, 550 U.S. 544, 570 (2007)). A claim satisfies this pleading standard when its
factual allegations “raise a right to relief above the speculative level.” Twombly, 550 U.S. at
555-56; see also Swanson v. Citibank, N.A., 614 F.3d 400, 404 (7th Cir. 2010) (“[P]laintiff must
give enough details about the subject-matter of the case to present a story that holds together.”).
For purposes of the motion to dismiss, the court takes all facts alleged by the claimant as true and
draws all reasonable inferences from those facts in the claimant’s favor, although conclusory
allegations are not entitled to this presumption of truth. Virnich v. Vorwald, 664 F.3d 206, 212
(7th Cir. 2011).
III. ANALYSIS
Five other judges in this district have considered motions to dismiss in cases brought by
the FDIC involving substantially similar allegations. See FDIC v. Elmore, No. 13 C 1767, 2013
WL 6185236 (N.D. Ill. Nov. 22, 2013) (St. Eve, J.); FDIC v. Pantazelos, No. 13 C 2246, 2013
WL 4734010 (N.D. Ill. Sept. 3, 2013) (St. Eve, J.); FDIC v. Giannoulias, 918 F. Supp. 2d 768
(N.D. Ill. 2013) (Grady, J.); FDIC v. Mahajan, No. 11 C 7590, 2012 WL 3061852 (N.D. Ill. July

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26, 2012) (Kendall, J.); FDIC v. Spangler, 836 F. Supp. 2d 778 (N.D. Ill. 2011) (Dow, J.); FDIC
v. Saphir, No. 10 C 7009, 2011 WL 3876918 (N.D. Ill. Sept. 1, 2011) (Pallmeyer, J.). The
court’s analysis in this case is guided by these recent decisions.
A. Consideration of Documents Attached to the Motions to Dismiss
As an initial matter, the court must determine which materials it should consider in
deciding the motion to dismiss. Defendants have attached numerous exhibits to their motion,
including minutes of meetings of the Board of Directors, internal memoranda, and reports of
regulators regarding the bank’s exposure to risk.

Defendants argue that these documents

demonstrate that the FDIC’s allegations are false. For example, they point to a 2010 report in
which the Federal Reserve Bank of Chicago found that the bank’s procedures for assessing risk
were fundamentally sound. The FDIC argues that the court may not consider these exhibits
because they are outside the scope of the complaint.
Generally, matters outside the complaint may not be considered on a motion to dismiss.
Venture Assocs. Corp. v. Zenith Data Sys. Corp., 987 F.2d 429, 431 (7th Cir. 1993). An
exception to this rule is that the court may consider “documents that are critical to the complaint
and referred to in it.” Geinosky v. City of Chi., 675 F.3d 743, 745 n.1 (7th Cir. 2012). The
Seventh Circuit has stated that this “is a narrow exception aimed at cases interpreting, for
example, a contract.” Levenstein v. Salafsky, 164 F.3d 345, 347 (7th Cir. 1998). The documents
that Defendants have asked the court to consider, however, are more akin to exhibits typically
submitted in connection with a motion for summary judgment. They are lengthy, complex
materials that contain a great deal of information, some of which is helpful to the FDIC, and
some of which is helpful to Defendants. It is not appropriate for the court at this stage of the
case to interpret these documents or to weigh the evidence contained in them. Pantazelos, 2013

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WL 4734010, at *4 (finding that it was premature to consider documents offered to refute FDIC
allegations). The court, therefore, will not consider these documents at this time.
B. The Illinois Banking Act and Midwest’s Charter
Defendants argue that the FDIC’s fiduciary duty and negligence claims are barred by the
Illinois Banking Act and Midwest’s charter. The Illinois Banking Act provides that a bank in
Illinois may “establish that a director is not personally liable to the bank and its shareholders for
monetary damages for a breach of the director’s fiduciary duty,” so long as the bank does not
insulate the director for liability for gross negligence, a breach of the duty of loyalty, bad faith, or
a transaction from which the director derived an improper personal benefit. 205 Ill. Comp. Stat.
5/39(b). Midwest’s charter provides as follows:
To the fullest extent permitted by the Illinois Banking Act as the same exists or
may be hereafter amended, a director of this Bank shall not be liable to the Bank
or its stockholders for monetary damages for breach of fiduciary duty as a
director.
(Mot. to Dismiss Ex. J, ECF No. 48-10.) Defendants argue that the charter exculpates them from
liability insofar as the FDIC alleges claims based solely on Defendants’ negligence.
In Saphir, the court considered the same argument, but held that by invoking the bank’s
charter, the defendants were asserting an affirmative defense. 2011 WL 3876918, at *5. The
court held that it was inappropriate to decide the merits of this affirmative defense on a motion to
dismiss. Id. The five courts that have considered this argument post-Saphir have also agreed
that reliance on the bank’s charter is an affirmative defense that cannot be decided on a motion to
dismiss.

Elmore, 2013 WL 6185236, at *6 n.6; Pantazelos, 2013 WL 4734010, at *4;

Giannoulias, 918 F. Supp. 2d at 774; Mahajan, 2012 WL 3061852, at *7; Spangler, 836 F. Supp.
2d at 792. This court agrees, and so the motion to dismiss on this ground is denied.

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C. Business Judgment Rule
Defendants next argue that the FDIC’s claims are barred by the business judgment rule.
Under Illinois law, the business judgment rule “‘is a presumption that directors of a corporation
make business decisions on an informed basis, in good faith, and with the honest belief that the
course taken was in the best interest of the corporation.” Mahajan, 2012 WL 3061852, at *7
(citing Ferris Elevator Co., Inc., 674 N.E.2d 449, 452 (Ill. App. Ct. 1996)). The purpose of the
rule is to protect directors who have been diligent and careful in performing their duties from
being subjected to liability from honest mistakes of judgment. Stamp v. Touche Ross & Co., 636
N.E.2d 616, 621 (Ill. App. Ct. 1993). Under Illinois law, however, “it is a prerequisite to the
application of the business judgment rule that the directors exercise due care in carrying out their
corporate duties.” Davis v. Dyson, 900 N.E.2d 698, 714 (Ill. App. Ct. 2008). If directors fail to
exercise due care, then they may not use the business judgment rule to shield their conduct. Id.
There is disagreement within this district as to whether a defendant may assert the
business judgment rule as a defense at the motion to dismiss stage. Compare Saphir, 2011 WL
3876918, *5-9 (finding that the business judgment rule was an affirmative defense) with
Spangler, 836 F. Supp. 2d at 792 (finding that the business judgment rule is not an affirmative
defense). Courts in similar cases have recognized, however, that they need not resolve this
disagreement, because even if the business judgment is not an affirmative defense, the FDIC’s
claims would survive its invocation at this stage. Elmore, 2013 WL 6185236, at *5.
For example, in Spangler, the FDIC alleged that defendants “disregarded regulatory
warnings of unsafe lending practices and monthly reports reflecting dangerous loan
concentration and excessive growth, failed to follow the bank’s business plans and loan policies,
and took no action to reform underwriting practices in response to criticism.” 836 F. Supp. 2d at

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792. The court held that these allegations were sufficient to defeat the business judgment rule at
the motion to dismiss stage, as they supported a finding that the defendants not only “misjudged
the proper safeguards to be taken,” but also “failed to obtain the necessary information to make
rational business decisions regarding those safeguards.” Id.
Similarly, in Mahajan, the FDIC alleged that the defendants “received repeated warnings
from both the FDIC and the IDFPR that the Defendants’ management of the Bank had serious
failings, including undersecured loans, unsafe levels of reserves, and insufficient staff to
adequately monitor loans and associated collateral.” 2012 WL 3061852, at *8. It alleged that
the defendants “were aware of these warnings but took no action to rectify the concerns” and
that, by 2008, regulators warned that the bank’s failings “presented an imminent threat to the
institution’s viability.” Id. Again, the court found that assuming these allegations were true, the
defendants’ actions could not be excused by the business judgment rule.
In Giannoulias, the “[t]he defendants’ alleged negligence generally [fell] into the
following categories: (1) approving high-risk loans and loan-renewals without proper
underwriting, e.g., failing to verify the finances of borrowers and guarantors, (2) ignoring the
bank’s loan policy, e.g., approving loans based upon an ‘as completed’ (not ‘as is’) appraisal,
and (3) ignoring market risks and regulatory warnings about over-concentration in [commercial
real estate]/[acquisition, development, and construction] loans.”

918 F. Supp. 2d at 770

(citations omitted). The court noted that the FDIC’s allegations were similar to the allegations in
Spangler and held that they overcame the presumption created by the business judgment rule.
Id. at 774. The court held that it did “not consider it a close question” that the FDIC adequately
pled claims for gross negligence, negligence, and breach of fiduciary duty. Id. at 772.

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And in Elmore and Pantazelos, the court concluded that allegations that the defendants
failed to heed regulator warnings, adhere to bank policies, and obtain adequate information from
borrowers were “similar to those in Spangler and Giannoulias, where the courts refused to apply
the business judgment rule at the motion to dismiss stage.” Elmore, 2013 WL 6185236, at *6;
Pantazelos, 2013 WL 4734010, at *6.
The same allegations are present here. With respect to the challenged loans, the FDIC
alleges that the Federal Reserve Bank of Chicago and the IDFPR warned Defendants that their
risk-management practices were unsound and that the bank was vulnerable to a slowdown in the
economy. These regulators made specific recommendations to Defendants, which the FDIC
alleges Defendants did not follow. Instead, Defendants allegedly loaned millions of dollars to
borrowers without obtaining even basic information that would enable them to make a rational
business decision to approve the loan. The FDIC alleges that Defendants’ conduct violated the
bank’s own policies requiring, among other things, that the borrower’s ability to repay be
demonstrated by an objective analysis of financial information, that loans to borrowers be limited
to a certain amount, and that appraisals be obtained before approving loans that were secured by
real estate. This court agrees with the other courts in this district, which have found that these
allegations are sufficient to render the business judgment rule inapplicable at this stage of the
case, and that the allegations adequately state a claim of gross negligence under Illinois law.
With respect to the decision to retain preferred stock in Fannie Mae and Freddie Mac,
here, too, the FDIC alleges that Defendants were warned by the bank’s independent accountants
that there was no objective basis to conclude that the stock’s value would recover within a
reasonable period of time.

The FDIC alleges that, under the bank’s own policies, then,

Defendants were required to sell these securities, but that they failed to do so. The FDIC alleges

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that this decision was not the result of any rational decision-making process, but was rather
motivated by wishful thinking and a fear that selling the stock might adversely affect the bank’s
earnings and its ability to pay dividends. As with the FDIC’s loan claims, these allegations are
sufficient at this stage of the case.
D. Duplicative Counts
Finally, Defendants argue that the FDIC’s negligence claims are duplicative of their
breach of fiduciary duty claims and should therefore be dismissed, relying on Spangler. In that
case, the court dismissed the breach of fiduciary duty claim as duplicative of the negligence
claim, but the court did so without prejudice, and gave the FDIC leave to “replead if it wishes to
include both claims in the alternative.” Spangler, 836 F. Supp. 2d at 793. After Spangler, courts
have permitted the FDIC to plead both negligence and fiduciary duty claims, so long as one
claim is pleaded in the alternative to another. See, e.g., Elmore, 2013 WL 6185236, at *7. The
FDIC has done that here, and so it may proceed on both counts.
IV. CONCLUSION
For the foregoing reasons, the court denies Defendants’ motion to dismiss.
ENTER:

/s/
JOAN B. GOTTSCHALL
United States District Judge
DATED: March 19, 2014

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