CIT Group Inc.

As the financial crisis unfolds, the impact on U.S. financial institutions of all sizes continues to grow. The Federal Deposit Insurance Corporation (FDIC) took over 140 failed banks in 2009 at a cost of $27.8 billion to the Deposit Insurance Fund, a new high since the end of the savings and loan crisis of the late 80s and early 90s. For 2010, the FDIC is preparing for even more bank failures, increasing its budget by 35 percent and adding more than 1,600 to its staff.

Directors of California corporations have, for years, struggled to understand the scope of their fiduciary duties when a corporation is insolvent versus when a corporation is in the “zone of insolvency.” While other states (particularly Delaware) have provided some recent guidance in this area[1], the California Court of Appeal recently provided some much needed clarification – including providing comfort to the decision making processes of directors who are considering various alternatives when a corporation enters into a zone of insolvency.

On October 29, 2009, the California Court of Appeal, Sixth District, in Berg & Berg Enterprises, LLC v. Boyle, et al., unequivocally ruled that, under California law, directors of either an insolvent corporation or a corporation in the more elusively defined “zone of insolvency” do not owe a fiduciary duty of care or loyalty to creditors. In so ruling, California joins Delaware in clarifying directors’ duties when the corporation is insolvent or in the zone of insolvency.

Background

The U.S. Court of Appeals for the Fifth Circuit held on Feb. 10, 2010, that a corporate debtor’s pre-bankruptcy severance payments to its former chief executive officer (“CEO”) were fraudulent transfers. In re Transtexas Gas Corp., ____ F.3d _____, 2010 BL 28145 (5th Cir. 2/10/10). Because of its holding “that the payments were fraudulent under the Bankruptcy Code,” the court did “not consider other possible violations, including [the Texas Uniform Fraudulent Transfer Act] or [Bankruptcy Code] Section 547(b) [preferences].” Id. at *5.

In 2009, there were 140 failed banks. So far this year, 16 more banks have been seized by the FDIC. There are 702 banks currently on the FDIC's troubled banks list, and regulators and analysts predict that several hundred of those likely will fail over the next two years.

Introduction

The FDIC has adopted final rules which provide that the FDIC, as receiver of a covered financial company, may recover from senior executives and directors who were substantially responsible for the failed condition of the company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud.

The Federal Deposit Insurance Corporation (“FDIC”) has approved a final rule authorizing it to clawback any compensation senior executives and directors received within two years of the FDIC being appointed receiver, if the FDIC finds they were “substantially responsible” for the failed condition of a covered financial company. Of particular concern, the rule (implementing section 210(s) of the Dodd-Frank Act):

On July 6, 2011 the Federal Deposit Insurance Corporation's ("FDIC's") Board of Directors met in open session, voting unanimously to approve a final rule addressing the claims process and other aspects of the FDIC's orderly liquidation authority under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank").  The Board also discussed the FDIC's progress in preparing final rules with respect to both resolution planning under Dodd-Frank and the FDIC's own proposal, issued prior to the enactment of Dodd-Frank, separately calling for certain large insured de