How Extensive Will the FDIC’s Claims Against Failed Banks’ Outside Professionals Be?

If a lawsuit filed on Feb. 7, 2011, in the Northern District of Georgia is any indication, the Federal Deposit Insurance Corp.’s (FDIC) efforts to pursue liability claims will not only include suits against the directors and officers of failed banks, but will also include in at least some instances the failed institutions’ outside law firms. The FDIC’s actions so far raise the question of how extensive the FDIC’s pursuit of these kinds of claims ultimately may prove to be.

The FDIC’s recent suit was filed against a Henry County, Ga., law firm, Smith Welch & Brittain, and J. Mark Brittain, in connection with the firm’s legal services on behalf of Neighborhood Community Bank, a Newnan, Ga., bank that failed on June 26, 2009.

In its complaint, the FDIC as receiver for the failed bank seeks to recover damages “in excess of $6 million” plus legal fees, based on the defendants’ alleged legal malpractice in connection with the law firm’s handling of certain loans the bank made to a local real estate developer between 2005 and 2007. The complaint alleges that the bank hired the firm to process the documents for the bank’s loans to the developer, who allegedly was also a client of the law firm. The suit alleges the developer obtained loans based on inflated property values. The individual defendant allegedly facilitated this, among other things, by creating two sets of settlement statements.

The lawsuit is the third liability suit filed in Georgia against a failed bank’s outside law firm. On Oct. 19, 2010, the FDIC filed two separate lawsuits in the Northern District of Georgia against outside law firms for the failed Integrity Bank of Alpharetta, Ga. (In January, the FDIC filed a separate suit against former directors and officers of Integrity Bank.) The defendants in one of these two lawsuits also include a title insurance company.

The FDIC has made no secret of the fact that it may pursue claims against the failed banks’ gatekeepers — not just banks’ former directors and officers, but also, according to the FDIC’s Web site, the banks’ “attorneys, accountants, appraisers, brokers, or others.” The Web site also states that as of Feb. 10, 2011, the FDIC has “authorized seven fidelity bond, attorney malpractice and appraiser malpractice lawsuits,” which presumably includes the suits described above. (The FDIC has to date filed five lawsuits against the directors and officers of failed banks as part of the current wave of bank failures.)

The FDIC’s pursuit of claims against lawyers and other outside professionals is entirely consistent with the actions the agency took during the FDIC crisis. According to NERA Economic Consulting’s August 2010 report about failed bank litigation, in connection with the 2,744 institutions that failed as part of the savings and loan crisis of the late ’80s and early ’90s, the FDIC (or the Resolution Trust Corp.) filed a total of 205 legal malpractice claims and 139 accounting malpractice claims (about 7.5 percent and 5 percent of failed banks, respectively).

The outcome of the FDIC’s professional liability claims during the S&L crisis, more than anything else, explains the FDIC’s present actions to pursue these claims in connection with the current round of bank failures. According to the NERA report, as a result of the FDIC’s S&L crisis legal malpractice claims, the FDIC recovered $500 million, and as a result of its accounting malpractice claims, the FDIC recovered $1.1 billion. (By way of contrast, the FDIC’s S&L crisis related claims against the former directors and officers of failed banks resulted in recoveries of $1.3 billion). Given this track record, it is hardly surprising that the FDIC is pursing claims of the type described now.

One question that all of this information raises is whether the FDIC will as part of the current round of bank failures pursue claims against the failed institutions’ accountants, as the FDIC did during the S&L crisis. The FDIC’s Web site does not specify whether or not the agency’s board has so far authorized any claims against accountants or accounting firms.

Although the FDIC has not yet pursued (or indeed, apparently, authorized) claims against the accounting firms of failed banks, it may only be a matter of time until these claims emerge, at least according to a Feb. 8, 2011, Legal Intelligencer article entitled, “FDIC Professional Liability Group Set to Pursue Audit Firms.” The article lays out the legal theories on which the FDIC is likely to proceed in its claims against outside accounting firms, and also reviews the firms’ likely defenses.

There have only been a few legal malpractice claims to date, and as yet no accounting malpractice claims — yet this process has really only just gotten started. The FDIC’s Web site describes an 18-month process that precedes the authorization for the filing of these types of claims. Indeed, the lawsuits discussed above were filed nearly two years after the failure of the related institution. Given that the current bank failure wave really started to gain momentum in the second half of 2009, it seems likely that as this year progresses — and on into 2012 — we could be seeing a steadily growing number of these types of gatekeeper claims.

The fact that the first attorney malpractice claims were filed in Georgia may simply be a reflection of the fact that as part of the current found of bank failures, more banks have failed in Georgia than in any other state. Of the 336 banks that failed between Jan. 1, 2008, and Feb. 4, 2011, 51 have been located in Georgia (including four of the 14 banks that have failed in 2011).

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