Not What But How—FDIC v Loudermilk, Georgia Supreme Court (July 2014)—Business Judgment Rule Case

Introduction:

If you are a director of officer of a Georgia corporation, you should know about the recent Georgia Supreme Court case of FDIC v. Loudermilk.

The Case:

Like so many banks, Buckhead Bank failed in the Great Recession. The FDIC as receiver sued 9 former officers and directors, some of them well known in Atlanta, for approving $22 million in loans that later soured. The case came to the Supreme Court as a certified question from a federal court. The court overruled two Georgia Court of Appeals cases in clarifying the limits of Georgia’s longstanding “business judgment rule. “ The essence of that widespread rule, which provides a limited liability shield to directors and officers in performing their duties, is that courts must refuse to second guess or interfere with good faith business judgments of businesspeople. The underlying assumption of the rule is that risks are an inherent and essential part of profit- making, and businesspeople not courts are best-positioned to decide business risks and opportunities.

The court ruled (paraphrasing) that the rule is well settled Georgia common law, and it precludes ordinary negligence claims against directors and officers except to the extent made without deliberation, without requisite diligence to ascertain and assemble the relevant facts and circumstances, or in bad faith. The court amplified that the rule forecloses claims for ordinary negligence concerning only the wisdom of the judgment, but not claims to the extent that a business decision did not involve “judgment” because it did not meet the duty to exercise good faith and ordinary care. Although arising in the context of a bank receivership, the ruling clearly applies to Georgia corporations generally.

Observations:

1. The case carved out 3 aspects of board decision process (deliberation, diligence to ascertain and assemble relevant facts, and good faith) as bases for director or officer liability even though the level of negligence rose only to ordinary negligence and not higher (like gross negligence or recklessness). So it clearly leaves these three doors to the barn open — and the openings seem wide. They make the reader wonder what’s left?
2. One thing that’s left is that merely being wrong, without more — i.e. merely having loans go sour, deals go bad or decisions turn out to be plain wrong — is not enough to create liability.
3. Process is everything! The focus must shift not to a decision’s outcome but instead to how it was made. Showing the care and adequacy of the process, the review and careful consideration of all material information, and the effort associated with a decision, is paramount.
4. The Loudermilk case narrows the protection available to directors and officers with the result that a number of other states, including Delaware, provide greater protection. For example, Delaware has a gross negligence standard.

Practical Tips:

1. The Georgia Code allows corporate charters and bylaws to contain broad exculpatory provisions (exempting liability for all but intentional misconduct or knowing violation of law) for directors (but notably, not for officers) , and indemnity provisions for directors and officers. Make sure early that your corporation has maximum protective provisions in place.
2. Document all board and officer decisions with detailed minutes and/or memos showing the steps taken, independent advisors consulted, and documents, reports, information and studies relied on.
3. Confirm at the outset that, where appropriate, your corporation has directors and officers Indemnity insurance with a reasonable deductible and separate limits for liability and defense costs, and understand whether the coverage is occurrence- based or claims made and how coverage works.