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Federal Deposit Insurance Corporation, As Receiver of Heritage Community Bank v. John M. Saphir; Patrick G. Fanning; Stephen L. Faydash; William E.

September 1, 2011


The opinion of the court was delivered by: Judge Rebecca R. Pallmeyer


Plaintiff, the Federal Deposit Insurance Corporation ("FDIC" or "Plaintiff"), as Receiver for Heritage Community Bank ("Heritage"), filed a nine-count complaint against eleven former directors and officers of Heritage. Named Defendants include John M. Saphir, a former President, Chief Executive Officer, and Chairman of the Board of Directors for Heritage and its holding company, Heritage Community Bancorporation, Inc. ("HCBI"); Patrick G. Fanning, a former Senior Vice President, Chief Lending Officer, and President of Heritage, and a member of the Board of Directors of Heritage and HCBI; Stephen L. Faydash, a former Chief Financial Officer ("CFO") for Heritage and a 6 percent shareholder of HCBI; William E. Hetler, a former Senior Vice President of Lending, a compliance officer for Heritage's commercial real estate ("CRE") lending program, and a member of Heritage's Loan Committee; Thomas Jelinek, a former CRE lending officer and member of the Loan Committee; Lori A. Moseley, a former Vice President of Loan Operations and member of the Loan Committee; Stephen Anthony, a former member of Heritage's Board of Directors, Chairman of the Audit Committee, and a .489 percent shareholder of HCBI; Jerry C. Brucer, a former member of the Heritage and HCBI Board of Directors and a 13.435 percent shareholder in HCBI; James K. Champion, a former member of the Heritage Board of Directors and a 1.285 percent shareholder in HCBI; Andrew B. Nathan, a former member of the Heritage Board of Directors and the Loan Committee, and a 9.331 percent shareholder in HCBI (personally and through trusts controlled by his family); and Mary C. Mills, a former member of the Heritage Board of Directors and a 12.913 percent shareholder of HCBI (personally and through trusts controlled by her family). The FDIC's complaint divides these Defendants into three categories: (1) Director Defendants (Saphir, Fanning, Nathan, Anthony, Brucer, Champion, and Mills); (2) Loan Committee Defendants (Saphir, Fanning, Nathan, Hetler, Jelinek, and Moseley); and (3) Defendant Faydash. The FDIC alleges claims for gross negligence, negligence, and breach of fiduciary duty against each category of Defendants. Counts I-III are directed against the Director Defendants. Counts IV-VI are directed against the Loan Committee Defendants. Counts VII-IX are directed against Defendant Faydash.

Before the court are motions to dismiss filed by Defendants Nathan [58], Saphir [61], Brucer [62], Faydash [81], Mills [76], Champion and Anthony [75], and Hetler, Moseley, and Jelinek [57]. Fanning joined in Saphir's motion to dismiss. Saphir also filed a motion for leave to file a document under seal [72]. All eleven Defendants seek dismissal of the claims against them pursuant to FED. R. CIV. P. 12(b)(6) for failure to state a claim upon which relief can be granted. Several Defendants have also moved pursuant to FED. R. CIV. P. 12(f) for an order striking the negligence or breach of fiduciary duty claims as redundant.


Heritage was founded in 1969, and has its headquarters in Glenwood, Illinois. (Compl. ¶ 21.) The Illinois Department of Financial and Professional Regulation ordered Heritage closed on February 27, 2009. (Id. ¶ 6.) Thereafter, the FDIC was appointed Receiver for Heritage. Id. According to the complaint, the FDIC is seeking to recover at least $20 million it claims Heritage lost due to the Defendants' failure to properly manage and supervise Heritage and its CRE lending program. (Id. ¶ 5.) That loss figure includes more than $8.5 million in losses on CRE lending and $11.075 million in allegedly unjustified dividend payments to HCBI and incentive compensation payments to Defendants Saphir, Fanning, Faydash, and Jelinek. (Id. ¶ 5, 45.) Heritage began its CRE lending program in the early 2000s. According to the FDIC, from the outset of the program, the "Defendants failed to protect [Heritage] from the substantial inherent risks of large-scale CRE lending." (Id. ¶ 2.) Heritage "routinely financed CRE projects, . . . without any meaningful analysis of their economic viability" and without adequate appraisals. (Id.) "Defendants failed to structure the CRE Lending Program to let credit analysts do their jobs." (Id.) According to Plaintiff, Defendant Fanning personally originated most of Heritage's CRE loans. (Id.)

The FDIC alleges that "Defendants failed to preserve [Heritage's] capital, and failed to provide sufficient reserves to absorb losses . . . when poorly-underwritten CRE loans" did not perform. (Id. ¶ 3.) Instead, Defendants allegedly depleted Heritage's capital by "making millions of dollars in dividend payments to [HCBI] and paying generous incentive awards to senior management." (Id.) By December 1, 2006, Plaintiff asserts, each Defendant "knew that Heritage's CRE lending program was failing and threatening [Heritage's] viability," yet Defendants failed to take adequate steps to correct the mounting problems. (Id. ¶ 4.)

Heritage's Board of Directors was responsible for "establishing appropriate risk limits, monitoring exposure, and evaluating the effectiveness of [Heritage's] efforts to manage and control risk." (Id. ¶ 22.) The FDIC alleges that the Director Defendants knew or should have known that "CRE lending is a specialized field with unique risks that require thorough understanding and close management." (Id.) With the exception of Fanning, however, the Director Defendants "had virtually no experience in CRE lending and little or no idea of the risks inherent in [CRE] loans." (Id. ¶ 23.) The Director Defendants nevertheless "did not consult anyone with expertise as to how to establish, structure, or operate" a CRE lending program and did not "implement the most basic controls to mitigate the inherent risks in CRE loans." (Id.)

At Heritage, credit analysts prepared loan "write-ups" for potential CRE loans. (Id. ¶ 24.)

Those loan write-ups had to be approved by the Loan Committee and then by the Board of Directors. (Id.) If credit analysts were not available to analyze a potential CRE loan and prepare write-ups, Heritage loan officers themselves would prepare write-ups for loans they originated. (Id.

¶ 25.) Some of Heritage's loan write-ups lacked a "global analysis" of potential borrowers' and/or guarantors' creditworthiness, or any verification of the information in the write-ups. Id.

The Director Defendants also allegedly "failed to segregate the loan administration functions, including credit analysis, from the Bank's loan origination functions." (Id. ¶ 26.) In other words, Heritage employees, including Fanning, who were responsible for generating or "selling" a loan, were also allowed to prepare the loan write-up. (Id.) The incentive awards Heritage offered for loan origination provided Fanning and others with a motive to ensure that the Loan Committee and Board of Directors approved the loans they originated. (Id.) Plaintiff alleges that Defendant Fanning originated most of the problematic CRE loans at issue in this case, and, because he was Heritage's principal CRE loan originator, its President, and a member of the Loan Committee and Board of Directors, his loans only received cursory reviews. (Id. ¶ 27.)

Plaintiff alleges that the Defendants engaged in or allowed a host of sloppy practices relating to the CRE loans. For example, the principal source of funds for repayment of a number of Heritage's CRE loans was the sale of the completed commercial buildings. (Id. ¶ 28.) Heritage nevertheless often approved the CRE loans without verified pre-sales of the completed commercial units. (Id.) Heritage also extended CRE loans with excessive loan-to-value ("LTV") ratios. (Id. ¶ 29.) Heritage's loan policy provided that CRE loans were not to exceed 80 percent of the value of the property and, for projects that included land development, that limit was reduced to 75 percent. (Id.) Heritage's CRE loans routinely exceeded those policy limits, a matter that drew criticism from the Illinois Department of Financial and Professional Regulation as early as 2006. (Id. ¶¶ 29-30.)

Heritage's loan policy and regulatory standards required that properties be appraised before CRE loans were approved, "but Heritage made CRE loans on projects with patently deficient appraisals, or [with] appraisals that did not support the feasibility of the [proposed] projects." (Id. ¶ 31.) Regulators repeatedly criticized Heritage for non-compliance with regulatory standards relating to appraisals. (Id.) Then, once the CRE loans were made, the Loan Committee and Director Defendants failed to implement an effective system to monitor those loans and to determine whether projects continued to be feasible as originally underwritten. (Id. ¶ 33.) The Board of Directors further failed to timely commission any independent review of Heritage's CRE loans to determine weaknesses in the CRE loan portfolio. (Id. ¶ 35.) All Defendants "failed to heed regulatory criticism warning them to control [Heritage's] CRE lending and [failed to] set appropriate limits to avoid over-concentration" of loans to CRE projects. (Id. ¶ 38.)

Defendants' practices enriched HCBI and certain of the Defendants themselves, at the expense of the lender. Thus, Plaintiff alleges that the Director Defendants and Faydash used faulty profitability calculations to justify substantial dividend payments to HCBI and generous incentive compensations payments to Saphir, Fanning, and Faydash. (Id.) The Director Defendants and Faydash also failed to maintain sufficient reserves, known as "Allowance for Loan and Lease Losses" or "ALLL," on CRE loans. (Id. ΒΆ 37.) As a result, Heritage's financial condition was ...

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