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July 12, 2017 Articles

Georgia Legislature Stands Behind Business Judgment Rule

Although Georgia’s Supreme Court began to move in the opposite direction, the state’s legislature has passed a bill to return the state to the traditional business judgment rule.

By W. Scott Sorrels, Yvonne Williams-Wass, and Rebekah Runyon

A national crisis, such as the Great Recession, will often leave in its wake a shake-up of previously well-established legal principles that are swallowed up by a tide of bad facts. While we expected the Great Recession to upend the way financial institutions were regulated and capitalized, few of us imagined that the fundamental tenets of director and officer conduct would be tossed in the air.

Among the victims of the Great Recession were community banks; over 400 failed nationwide. Georgia was at the center of the community banking crisis, topping the list for the number of community bank failures with more than 90 total failures across the state. What followed were approximately two dozen professional liability lawsuits brought by the Federal Deposit Insurance Corporation (FDIC) against directors and officers of failed Georgia banks—almost all of which involved claims that turned on an application of the business judgment rule and whether officers and directors of banks could be liable for ordinary negligence. The FDIC’s suits challenged what was presumed to be a foundational part of corporate law: the presumption of good faith and ordinary care afforded to directors and officers in the performance of their duties by the business judgment rule.

FDIC: Ordinary Negligence Standard in Director and Officer Cases
The purpose of the business judgment rule in American corporate law is to ensure that a company’s directors and officers are protected from liability when decisions that they made in good faith turn out to be the “wrong” decisions for the company. This principle dates back to at least the early nineteenth century as a public policy designed to help companies pursue innovation and generally allow corporate directors and officers to take risks to pursue profits.

In the FDIC’s professional liability cases against Georgia’s community banking directors and officers, the agency asserted claims both for gross negligence under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, 12 U.S.C. § 1811 (1989), and for ordinary negligence based on Georgia law. Director and officer defendants, in turn, invoked the business judgment rule as a defense, citing earlier cases involving nonbank officers and directors in which the Georgia Court of Appeals applied a business judgment rule that “forecloses liability in officers and directors for ordinary negligence in discharging their duties.” Flexible Prods. Co. v. Ervast, 284 Ga. App. 178, 182 (2007); see also Brock Built, LLC v. Blake, 300 Ga. App. 816 (2009). Relying on these cases, several federal district courts dismissed ordinary negligence claims, reasoning that there was an absolute bar on all claims against corporate or bank officers and directors premised on ordinary negligence.

Supreme Court of Georgia: Bifurcated Analysis of Business Judgment Rule
Two certified questions made their way to the Supreme Court of Georgia, asking whether the business judgment rule could be reconciled with the ordinary prudence standard of care contained in Georgia’s Banking Code. In 2014, Georgia’s Supreme Court responded with a clarification of the business judgment rule that applied a bifurcated analysis. Fed. Deposit Ins. Corp. v. Loudermilk, 295 Ga. 579 (2014).

The Loudermilk court recognized that the business judgment rule was settled law and was not abrogated by either the language in the banking code or similar standard of care provisions in Georgia’s corporate code. The court held that directors and officers can only be liable when there is evidence of gross negligence regarding the wisdom of the decisions made. The court carved out a role for ordinary negligence, however, finding that the more lenient standard can be applied to assess the process by which the decisions are made. While the Loudermilk decision arose in the context of a failed Georgia bank, the analysis applies equally to Georgia corporations.

The concern of the business and banking communities following the decision in Loudermilk was that the bifurcated analysis would allow for claims against an entity’s directors and officers to more easily reach a jury where verdicts could be imposed based on hindsight, an outcome the business judgment rule was designed to protect against. Indeed, the Loudermilk opinion seemed to invite the legislature to consider whether “more protection for officers and directors is desirable” and address such concerns accordingly.

The implications of Loudermilk’s bifurcated analysis were brought to bear last October when the FDIC was awarded a verdict of $4.98 million in the underlying case against the former directors and officers of the failed Buckhead Community Bank. FDIC v. Loudermilk, Civ. No. 1:12-cv-4156 (N.D. Ga. Oct. 25, 2016). The FDIC had asserted claims based on the decision-making process, alleging that defendants engaged in “numerous, repeated, and obvious breaches and violations of the Bank’s loan policy, underwriting requirements and banking regulations, and prudent and sound banking practices.” The jury considered 10 loans made by the loan committee and ultimately returned a verdict in favor of the FDIC as to four of the loans. The attorneys representing the director and officer defendants commented publicly after the verdict, confirming the fears of many in the business community: “[T]he jury went beyond the evaluation of the loan approval process and questioned the wisdom of the defendants’ decisions to approve them.”

The case is being appealed to the Eleventh Circuit on three grounds, one of which is that the district court created a new and impossible standard of care by allowing the jury to find defendants liable for decisions made at board or committee meetings at which they are not in attendance.

Georgia Legislature: Return to Traditional Business Judgment Rule
Georgia’s legislature has acted to return Georgia to a traditional business judgment rule. On July 1, 2017, Georgia’s “new” codification of the business judgment rule, House Bill 192, took effect. The legislation purports to modernize Georgia’s business judgment rule and enhance liability protection for the decision-making process by codifying a gross negligence standard. The bill amends code provisions of governing banks and bank trust companies as well as those addressing the standards of conduct for directors and officers of corporations. Many view this “new” statutory approach as a return to the well-established “old” approach to the business judgment rule presumption, following a brief—though high-profile—departure.

The most significant provision of the bill is the presumption that the process undertaken has been conducted in good faith unless evidence that demonstrates gross negligence is presented. Almost identical language is used for both the banking and the corporate codes:

There shall be a presumption that the process directors and officers followed in arriving at decisions was done in good faith and that such directors and officers have exercised ordinary care; provided, however, that this presumption may be rebutted by evidence that such process constitutes gross negligence by being a gross deviation of the standard of care of a director or officer in a like position under similar circumstances.

Ga. Code Ann. §§ 7-1-490(c), 14-2-830(c), 14-2-842(c). One noticeable change from Georgia’s traditional business judgment rule is the removal of language that would allow a director or officer to rely in good faith on “a committee of the board upon which the director or officer does not serve.” The provisions do still allow directors and officers to rely on “officers, employees, or agents” of the company, though.

The Georgia Bankers Association, the Georgia Chamber of Commerce, and others supporting the legislation voiced concerns that it would be difficult to recruit and retain directors who feared liability for decisions that did not yield successful results. There also were concerns that directors who were willing to serve would demand to be removed from certain levels of decisions so that their decision-making process would not potentially be second-guessed by courts and juries. The Georgia Chamber of Commerce included the passage of House Bill 192 as one of its legislative priorities during the 2017 session, noting that the 2014 Loudermilk decision “has placed business at a greater risk of losing qualified directors and officers who serve on corporate boards” and vowing that “the bill brings the standard of care for officers and directors in Georgia back in line with the standard in 35 other states.”

Georgia Rule: Motivation for Companies to Incorporate in State?
In addition to combating the reluctance of talented individuals to serve as officers and directors of corporations and banks, the new law could encourage more companies to incorporate in Georgia just as business-friendly statutes and standards in other states have encouraged incorporation those states. For example, Florida and Texas have statutes that expressly establish a standard of at least gross negligence (and possibly a higher standard), and those statutes are viewed as successfully encouraging the incorporation of more companies in each of these states.

In Florida, a director is not personally liable unless the director breaches his duties to the corporation. Fla. Stat. § 607.0831. In describing what constitutes a breach, the Florida statute includes the language conscious disregard, willful misconduct, recklessness, and bad faith. Such language clearly equates to a standard of at least gross negligence.

The language of the Texas Finance Code explicitly provides that the threshold for liability of bank directors and officers is gross negligence:

The provisions of the Business Organizations Code regarding liability, defenses, and indemnification of a director, officer, agent, or employee of a corporation apply to a director, officer, agent, or employee of a depository institution in this state. Except as limited by those provisions, a disinterested director, officer, or employee of a depository institution may not be held personally liable in an action seeking monetary damages arising from the conduct of the depository institution’s affairs unless the damages resulted from the gross negligence or willful or intentional misconduct of the person during the person’s term of office or service with the depository institution.

Tex. Fin. Code § 31.006(a) (emphasis added).

In light of the stronger protections under the Texas statute, it may not be surprising that—in contrast to the nearly two dozen Georgia bank failure lawsuits filed as a result of the Great Recession—the FDIC filed no professional liability lawsuits following the 10 failures of Texas banks during the same time. Similarly, while Florida saw more than 70 bank failures, the FDIC brought only a dozen professional liability lawsuits involving those banks.

Other states have established a similar business-friendly standard by case law, again leading to the incorporation of more companies in these states. In Delaware, for example, directors and officers can be held personally liable for violating their duty of care only if their actions amount to gross negligence. See Brehm v. Eisner, 746 A.2d 244, 259 (Del. 2000). This standard, as well as other favorable business and tax laws, has led to the incorporation of more companies in Delaware than in other states.

Overall, Georgia’s newly codified business judgment rule provides protection for directors and officers against liability arising out of ordinary negligence. The new law encourages directors and officers to employ a sound decision-making process that could combat a claim for gross negligence rather than discouraging these individuals from making decisions or accepting decision-making positions out of fear that they will be unable to combat a claim for ordinary negligence.

W. Scott Sorrels is a partner, Yvonne Williams-Wass is counsel, and Rebekah Runyon is an associate at Eversheds Sutherland (US) LLP in Atlanta, Georgia.

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