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O'Donoghue v. Inland Bank and Trust

United States District Court, N.D. Illinois, Eastern Division

November 27, 2017

BRIAN J. O'DONOGHUE, as authorized representative, Plaintiff,
v.
INLAND BANK AND TRUST, LAWRENCE AARON, MATTHEW FIASCONE, NICHOLAS HELMER, HOWARD A. JAFFE, HARRY L. LUKENS, JR., JOEL SIMMONS, and PAUL J. WHEELER, Defendants.

          OPINION AND ORDER

          SARA L. ELLIS UNITED STATES DISTRICT JUDGE

         Brian J. O'Donoghue, as an authorized representative of College Savings Bank (“CSB”), brings this suit against Inland Bank and Trust (“IBT”), and IBT's directors, Lawrence Aaron, Matthew Fiascone, Nicholas Helmer, Howard A. Jaffe, Harry L. Lukens, Jr., Joel Simmons, and Paul Wheeler (collectively, the “Directors”). After the close of fact discovery, O'Donoghue filed a first amended complaint, alleging that IBT and the Directors committed fraud and IBT breached its contract with CSB in connection with the failed merger of the two banks in 2015.[1]

         IBT and the Directors move to dismiss the fraud claims in full, and IBT also seeks to dismiss CSB's breach of contract claim with respect to IBT's failure to diligently pursue in good faith all regulatory approvals and requirements necessary to consummate the parties' merger agreement as required by Section 5.6 of that agreement. The Court finds that CSB has sufficiently pleaded the fraudulent inducement claims against IBT and the Directors, except that those claims may not proceed to the extent they are based on the representation made in the Merger Agreement concerning regulatory approvals or Jaffe's statements contained in ¶ 31 of the first amended complaint. CSB's fraud claim against IBT may also proceed. But the Court dismisses CSB's breach of contract claim premised on the regulatory approval clause because CSB cannot establish that IBT breached that clause.

         BACKGROUND[2]

         CSB was a New Jersey-based bank that specialized in certificates of deposit under college savings programs. NexBank SSB acquired CSB on or about December 1, 2015. Prior to this acquisition, CSB entered into a contract with IBT (the “Merger Agreement”) on or about October 22, 2014, providing for IBT to acquire CSB. The Directors approved of the acquisition of CSB by Inland on or about July 28, 2014. The merger was never consummated, however, resulting in this lawsuit.

         Jaffe executed the Merger Agreement on IBT's behalf as its then-CEO.[3] The Merger Agreement included various terms and conditions that IBT had to meet prior to the consummation of the transaction. See Doc. 61-1 § 10.2 (“IBT shall have performed or complied with all covenants and obligations to be performed or complied with by them under the terms of this Agreement on or prior to the Closing Date”). Because IBT was subject to a 2012 FDIC consent order, IBT needed regulatory approval of the acquisition and so agreed to obtain that approval from the New Jersey Department of Banking and Insurance, the Illinois Department of Financial and Professional Regulation, and the FDIC as a precondition to closing. IBT also represented that as of October 22, 2014, there was “no reason why the granting of any of the Regulatory approvals required to be obtained by [IBT] to consummate the Contemplated Transactions would be denied or unduly delayed” more than five months thereafter. Id. § 5.6. IBT further covenanted that it would use its best efforts to obtain the required approvals, agreeing to “diligently pursue in good faith, and use its Best Efforts to obtain and/or satisfy all regulatory approvals and requirements necessary to consummate the Contemplated Transactions.” Id. § 8.1(b). Both IBT and CSB agreed to “exercise good faith and use [their] Best Efforts to satisfy the various covenants and conditions to Closing in [the Merger] Agreement, and to consummate the Contemplated Transactions hereby as promptly as possible.” Id. § 8.5. The Merger Agreement defined “best efforts” as “the efforts that a prudent Person desirous of achieving a result would use in similar circumstances to ensure that such result is achieved as expeditiously as possible.” Id. § 1.1(c). Additionally, IBT stated it would not “take any affirmative action, or fail to take any reasonable action within its control, the effect of which would be to materially impair, delay or otherwise prevent the consummation of the Contemplated Transaction.” Id. § 7.5(b).

         IBT also agreed to keep CSB informed of the status of the intended acquisition. Thus, the Merger Agreement included a “prompt notification” clause:

Between the Agreement Date and the Closing Date, [IBT] shall promptly notify CSB in writing . . . if [IBT] becomes aware of the occurrence after the Agreement Date of any fact or condition that would (except as expressly contemplated by this Agreement) cause or constitute a Breach of any [IBT] representation or warranty had such representation or warranty been made as of the time of occurrence or discovery of such fact or condition. During the same period, [IBT] will promptly notify CSB of the occurrence of any Breach of any covenant of [IBT] or CSB in this Agreement or of the occurrence of any event that might reasonably be expected to make the satisfaction of the conditions in Article 10 impossible or unlikely.

Id. § 7.1.[4] Under § 7.2, IBT indicated that none of the information it provided to CSB or any regulatory agency would, at the time of filing, “be false or misleading with respect to any material fact, or omit to state any material fact necessary in order to make the statements therein not misleading.” Id. § 7.2. IBT also agreed not to “take any affirmative action, or fail to take any reasonable action within its control, the effect of which would be to materially impair, delay or otherwise prevent the consummation of the Contemplated Transactions.” Id. § 7.5(b). In § 8.1(b), IBT agreed “promptly to advise CSB and its counsel of, and share with them, any material communication received by [IBT] or its counsel from any Regulatory Authorities with respect to the non-confidential portions of such filings.” Id. § 8.1(b).

         CSB had to satisfy several conditions prior to the closing of the merger as well, principally, to sell all of its investment assets, comprised mainly of federally guaranteed student loans and mortgage-backed debt securities. Because the sale of these assets would put CSB in a significantly disadvantaged economic position, the sale was to take place only after IBT had satisfied its obligations, with the closing then occurring no more than two days after the sale of CSB's assets.

         In connection with the negotiation of the Merger Agreement and thereafter, IBT orally represented to CSB that it knew of no reason why the relevant regulatory authorities would not approve the merger. For example, Jaffe repeatedly told CSB President Gilbert Johnson that Jaffe had “an outstanding relationship with the regulators, that the regulators believed that Inland had a clean and sound balance sheet, and that there were no reasons why the regulators would disapprove of the merger.” Doc. 49 ¶ 31. But, according to CSB, at the time IBT negotiated and consummated the Merger Agreement, it knew its actions in expanding IBT's leveraged loan portfolio threatened the FDIC's approval of the merger. IBT and its Directors had begun purchasing high-risk leveraged lending participations in 2013.[5] The FDIC and other federal agencies issued guidance on leveraged lending in March 2013 (the “Interagency Guidance”). The Interagency Guidance noted that community banks involved in leveraged lending activities “should discuss with their primary regulator the implementation of cost-effective controls appropriate for the complexity of their exposures and activities.” Doc. 61-2 at 21. The Interagency Guidance also states that “[a] lack of robust risk management processes and controls at a financial institution with significant leveraged lending activities could contribute to supervisory findings that the financial institution is engaged in unsafe-and-unsound banking practices.” Id. The Directors, as well as Deborah Bartelt, IBT's Senior Vice President of Regulatory Compliance Management, read and understood the Interagency Guidance but IBT did not contact the FDIC to discuss implementation of proper risk controls when it began purchasing leveraged lending participations. On or around September 15, 2014, the Directors voted to allow IBT to purchase an increased number of leveraged lending participations, increasing the limit to 200% of risk weighted capital without a full presentation of the loans IBT intended to purchase. IBT also amended its loan policy to allow it to approve loans up to $7 million without requiring Directors Loan Committee approval, lessening oversight and increasing the speed with which large leveraged loans could be approved. These actions led Inland's senior compliance officer to send Jaffe an email on October 14, 2014 expressing concern about IBT's growth goals and the potential that “examiners [would] see . . . excessive growth funded by volatile, noncore sources.” Doc. 50 ¶ 58. He therefore recommended that IBT stop pursuing leveraged loan participations, noting that “[t]hey are not relationship based and do not add value to the overall company.” Id. Jaffe also received warnings from two principals of Sandler O'Neill, an investment banking firm, that although leveraged loans were lucrative, regulators disapproved of them as an asset class. But IBT continued increasing these loan participations, with its leveraged loan portfolio growing 611% in the twelve-month period ending March 31, 2015.

         Upon execution of the Merger Agreement, IBT set out to obtain the required regulatory approvals. In its applications, IBT made no mention of the growth of its leveraged loan portfolio. The FDIC approved the merger on December 23, 2014, and IBT obtained the other required approvals thereafter. CSB then sought to comply with its obligations under the Merger Agreement, including by selling its investment assets. Before doing so, it again sought assurances from IBT that IBT had satisfied all of its obligations and that a closing date was imminent. IBT made such assurances during a May 5, 2015 telephone call, instructing CSB to sell its investment assets. Although IBT suggested a closing date of May 12, CSB asked for additional time to finalize the sale, with the parties agreeing to a closing date of May 15. IBT then advised the Illinois Department of Financial and Professional Regulation Division of Banking on May 6 of the closing date.

         On May 8, however, IBT received a formal letter from the FDIC stating that the FDIC had suspended its approval of the merger. Although the letter was sent on May 8, IBT had apparently known of the FDIC's intention to take this action earlier, because the FDIC had commenced an onsite examination of IBT's banking practices in early April 2015 that continued into May. During this examination, the FDIC regulators spoke daily with IBT employees about IBT's leveraged loan portfolio, expressing concerns to senior management. As of April 20, 2015, IBT's senior compliance officer understood that the FDIC examiners had concerns concerning IBT's leveraged loan portfolio and how IBT would use the funds it would gain from CSB if the merger went through. IBT senior management also inquired of the FDIC examiner in charge at least twice whether the exam's findings would impact the merger's regulatory approval, with the examiner in charge indicating “it very well could.” Id. ¶ 80. The examiner in charge referred IBT senior management to the FDIC's assistant regional director, but senior management did not follow up with the assistant regional director. The FDIC ultimately concluded that the growth of IBT's leveraged loan portfolio was “imprudent, ” especially given the lack of sufficient leveraged lending policies and risk management practices. Id. ¶ 64. On May 7, the FDIC examiner in charge informed Bartelt that IBT would be downgraded as a result of the exam findings and that the CSB merger would be affected as a result. The next day, the FDIC assistant regional director informed Jaffe that the FDIC was indefinitely suspending the merger, formalized in a letter sent to IBT's board of directors later that day.

         Despite all this, IBT did not notify CSB of the likelihood of suspension on the May 5 phone call. And it also delayed in informing CSB of the FDIC's formal suspension letter, only relaying that information to CSB on May 12, by which time CSB had already sold its investment assets. CSB, however, had learned of the suspension by that point from an agent of the New Jersey Department of Banking and Insurance. IBT also refused to inform CSB of the reason for the FDIC's issuance of the May 8 letter.

         Despite losing the FDIC's regulatory approval, meaning the transaction could not close on May 15, IBT indicated in a May 20 letter that it “continue[d] to diligently pursue in good faith, and use its Best Efforts to obtain and/or satisfy all regulatory approvals and requirements necessary to consummate the Contemplated Transactions prior to the Termination Date.” Id. ¶ 102. But the FDIC repeatedly told Jaffe that approval would not be forthcoming. Instead of notifying CSB of the FDIC's final decision, on June 2, IBT signed a waiver allowing CSB to shop itself to others and then also informed CSB it was terminating the Merger Agreement, claiming CSB had not complied with the Merger Agreement's conditions. CSB rejected the termination on June 4, demanding that IBT use its best efforts to obtain FDIC approval. IBT did not respond, precipitating this lawsuit.

         LEGAL ...


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