Elliott Levin v. William Miller

In the

United States Court of Appeals

For the Seventh Circuit

____________________

No. 17-1775

ELLIOTT D. LEVIN, as Chapter 7 Trustee for

Irwin Financial Corporation,

Plaintiff-Appellant,

v.

WILLIAM I. MILLER,

GREGORY F. EHLINGER, and

THOMAS D. WASHBURN,

Defendants-Appellees.

____________________

Appeal from the United States District Court for the

Southern District of Indiana, Indianapolis Division.

No. 1:11-cv-01264-SEB-MPB — Sarah Evans Barker, Judge.

____________________

ARGUED OCTOBER 25, 2017 — DECIDED AUGUST 17, 2018

____________________

Before KANNE and SYKES, Circuit Judges, and DARROW,

District Judge.*

* Of the Central District of Illinois, sitting by designation.

2 No. 17-1775

SYKES, Circuit Judge. Irwin Financial Corporation was a

holding company for two banks that failed in the wake of

the 2007–2008 financial crisis. When the crisis began, regula-

tors and Irwin’s outside legal counsel both advised the

company to buoy up its sinking subsidiaries. Irwin’s Board

of Directors therefore instructed the officers to do everything

they could to save the banks. The officers tried to raise

capital and applied for government aid, but the chances of

success were slim. Private investors showed little interest in

the company, and federal regulators signaled that a bailout

was unlikely.

A small glimmer of hope flickered in 2009: Irwin received

a $76 million tax refund. The Board authorized Irwin’s

officers to transfer the refund to the subsidiary banks and for

good reason: The Board believed that the refund legally

belonged to the banks and hoped the cash infusion would

keep them above water long enough for help to arrive. But

the refund was not enough to save the day. Management

could not raise sufficient capital, the hoped-for government

relief never materialized, the banks failed, and Irwin filed for

bankruptcy.

Elliott Levin was appointed as Chapter 7 trustee for Ir-

win’s bankruptcy estate, and he promptly filed suit against

three of Irwin’s former officers. The suit alleged, among

other things, that the officers breached their fiduciary duty

to provide the Board with material information concerning

the tax refund. Levin’s legal theory rested on an elaborate

chain of assertions. He claimed the officers should have

known the banks were going to fail, so they should have

investigated alternatives to transferring the tax refund—

specifically, an earlier bankruptcy—despite the Board’s clear

No. 17-1775 3

directive to support the banks. Had the officers done so, they

would have discovered that Irwin might be able to claim the

$76 million tax refund as an asset in bankruptcy. And if the

officers had presented this information to the Board, the

Board would have declared bankruptcy before transferring

the refund to the banks, thereby maximizing the holding

company’s value for creditors.

The district judge didn’t buy Levin’s speculative theory

and neither do we. Corporate officers have a duty to furnish

the Board of Directors with material information, but that

duty is subject to the Board’s contrary directives. The record

clearly establishes that on the advice of government regula-

tors and expert outside legal counsel, the Board had priori-

tized saving the banks. The officers had no authority to

second-guess the Board’s judgment with their own inde-

pendent investigation. We affirm.

I. Background

Before its bankruptcy, Irwin was the holding company

for two subsidiary banks: Irwin Union Bank and Trust

Company, which we’ll call the “Bank and Trust,” and Irwin

Union Bank, FSB, which we’ll call the “Savings Bank.”

William Miller was Irwin’s CEO and Gregory Ehlinger was

its CFO. Irwin’s Board of Directors was largely independent:

A supermajority of ten members were independent outside

directors, and the Board held an executive session without

Irwin’s officers after each meeting. At the executive sessions,

the directors discussed concerns and developed recommen-

dations for management. Lance Odden, the designated lead

director, would pass along these directives to Irwin’s offic-

ers.

4 No. 17-1775

As financial institutions, Irwin and the banks were, of

course, subject to considerable governmental oversight.

Irwin was registered as a bank holding company with the

Board of Governors of the Federal Reserve System. As a

state-chartered member of the Federal Reserve System, the

Band and Trust answered to both the Federal Reserve and

the Indiana Department of Financial Institutions. The Sav-

ings Bank was a federally chartered savings bank regulated

by the Office of Thrift Supervision. Finally, because the

banks held federally insured deposits, both fell under the

supervision of the FDIC.

In the midst of the 2007–2008 financial crisis, the Bank

and Trust began to flounder. Regulators insisted that Irwin

had a duty to support its struggling subsidiary. On

February 28, 2008, a representative from the Federal Reserve

Bank of Chicago attended a board meeting to discuss “regu-

latory concerns about [the Bank and Trust’s] liquidity and

[Irwin’s] expected role as a source of strength for the

[b]ank[s].” The representative “emphasized the preservation

of capital at the [b]ank and the need to maintain liquidity.”

Heeding the regulator’s advice, Irwin adopted a resolu-

tion affirming its commitment to keeping the Bank and Trust

capitalized. Among other things, the resolution emphasized

“the importance of ensuring that the enterprise maintains

adequate capital to support its business operations.”

As the crisis raged on, Irwin turned to independent legal

counsel for advice. The Board retained Rodgin Cohen and

other attorneys at Sullivan & Cromwell for advice on the

Board’s duties in the fraught regulatory landscape. The

Board began meeting every Friday with outside counsel

present. Cohen and his colleagues reported directly to the

No. 17-1775 5

Board, and the Board expected Irwin’s management to

follow their advice.

Cohen urged the Board to support the banks. He advised

the directors of their duty under the Source of Strength

Doctrine, which requires bank holding companies to provide

assistance to subsidiaries in times of financial distress. The

Board members apparently took his advice to heart. Accord-

ing to one director, the Board was committed to saving the

banks because it “was the prudent course of action and

consistent with our fiduciary duties based on Mr. Cohen’s

counsel [and] statements from regulators.”

That commitment was soon put to the test. In May 2008

the Chicago Federal Reserve and Indiana Department of

Financial Institutions advised Irwin that the Bank and Trust

was in trouble and supervisory action would follow. Two

months later the regulators sent a Memorandum of Under-

standing demanding that Irwin obtain a $50 million cash

infusion by the end of August. On Cohen’s advice the Board

directed management to sign and deliver the memorandum.

Irwin failed to raise $50 million by the deadline. Regula-

tors then sent the Board a formal Written Agreement requir-

ing Irwin and the Bank and Trust to develop a plan to

“improve management of [their] liquidity positions” and

“maintain sufficient capital.” Faced with these demands and

uncertain of its duties, the Board again turned to outside

counsel for advice. At the October 10, 2008 meeting, counsel

advised the Board to “be actively engaged in doing whatev-

er [it] can to ensure the bank remains solvent.” That same

day the Board approved the Written Agreement and author-

ized Miller, the CEO, to execute it.

6 No. 17-1775

In the meantime Irwin began looking to federal programs

for relief. In October 2008 Congress created the Troubled

Asset Relief Program (“TARP”), which authorized the

Treasury Department to purchase troubled assets from

financial institutions after considering various factors,

including the “long-term viability of the financial institu-

tion.” 12 U.S.C. § 5213(4). The standard for analyzing a

bank’s viability was left to the discretion of regulatory

agencies, which included the discretion to decide whether

TARP funds should be included in the analysis. In

November 2008 the Board authorized and submitted an

application for $148 million in TARP funds.

The application faced an uphill battle. On November 21

the Board learned that a bank with a financial health rating

of 4 or 5 would receive TARP funding only as part of an

acquisition by another bank. Irwin had a rating of 4, and the

prospects of a buyout looked grim.

The Board continued to prioritize the Bank and Trust’s

capitalization. During the December 4 meeting, the Board

affirmed that the Written Agreement’s capital-sufficiency

requirement was “of critical importance and should remain

a primary focus of management.” The Board then “author-

ized management to move additional equity capital from

[Irwin] into [the Bank and Trust],” and the officers duly

transferred $14 million.

Yet the Bank and Trust’s fortunes continued to decline.

At the December 17 meeting, the Board learned that the

Reserve Bank had downgraded its financial health rating to

a 5. While ominous, the downgrade didn’t mean certain

failure. The bank remained adequately capitalized, and

Cohen reassured the Board that he had seen banks with a 5

No. 17-1775 7

rating survive with additional capital. And the possibility of

a government bailout was still on the table. A representative

from the Federal Reserve explained that the TARP eligibility

criteria were not static, and although it would be “extremely

challenging” for Irwin to receive approval, the Federal

Reserve remained “receptive to listening.” The representa-

tive advised that the Board’s plan to raise $50 million in

equity could be a game changer and would make TARP

funding more likely.

To stand a chance, Irwin believed it needed the Federal

Reserve to endorse its TARP application. In January 2009

Miller and Odden reached out to the Federal Reserve and

asked what Irwin needed to do to win support. After several

weeks of silence, the Federal Reserve finally responded. The

demands were staggering. Among other things, Irwin would

need to raise $150 million in capital and appoint a new CEO.

And even with the Federal Reserve’s support, there was no

guarantee that the Treasury Department would approve

Irwin’s application. In a subsequent board meeting, Irwin’s

investment-banking advisor dismissed the possibility of

raising $150 million as “remote” and cautioned against

basing future plans on that possibility. Unless the govern-

ment changed the policy, the TARP application was certain

to fail. Irwin accordingly lobbied the Treasury to enact a

policy more favorable to its application.

Around this same time the Board approved the 2009 Tax

Allocation Agreement that lies at the heart of this controver-

sy. The agreement provided, as it had since 1999, that Irwin

would file consolidated federal income-tax returns on behalf

of itself and the banks. Under the agreement if a bank would

have been entitled to a tax refund had it filed separately,

8 No. 17-1775

Irwin would transfer the appropriate amount after receiving

the consolidated refund from the IRS. Miller projected that

Irwin would receive $90 million in tax refunds, most of

which would be owed to the banks.

Irwin believed that the refunds were the banks’ property,

and it held the refunds in trust on their behalf. That was

consistent with nonbinding regulatory guidance issued in

1998. See Interagency Policy Statement on Income Tax Allocation

in a Holding Company Structure, 63 FR 64757-01 (Nov. 23,

1998). Several years after regulators issued this guidance,

however, a bankruptcy judge in New York issued a contrary

ruling, holding that a consolidated refund belonged to the

parent and any payment owed to a subsidiary merely consti-

tuted a debt that became an unsecured claim in the parent’s

bankruptcy estate. See Superintendent of Ins. for the State of

N.Y. v. First Cent. Fin. Corp. (In re First Cent. Fin. Corp.),

269 B.R. 481 (Bankr. E.D.N.Y. 2001), aff’d sub nom. Superinten-

dent of Ins. for the State of N.Y. v. Ochs (In re First Cent. Fin.

Corp.), 377 F.3d 209 (2d Cir. 2004).

Regulators continued to urge the Board to prop up the

Bank and Trust. On May 7, 2009, just weeks before the

disputed tax refund arrived, the Board’s independent direc-

tors met in executive session with outside counsel and

representatives from the Indiana Department of Financial

Institutions, the FDIC, and the Chicago Federal Reserve.

During the meeting, the Indiana Department of Financial

Institutions warned of the consequences if the bank dropped

below the “adequately capitalized” status. The FDIC ex-

plained its resolution process for managing the assets of

insured banks that declare bankruptcy and urged Irwin to

protect depositors by moving uninsured deposits into

No. 17-1775 9

insured status. The Chicago Federal Reserve expressed

concern about the bank’s liquidity but suggested that the

anticipated tax refund could help. Finally, the FDIC advised

Irwin to continue efforts to raise capital—especially by

lobbying for changes in the TARP program—while the FDIC

prepared for a possible resolution.

The Board agreed and once more directed the officers to

keep the banks solvent. After excusing the regulators, the

Board called Miller and the other officers back into the

meeting and declared a dual-track strategy: Irwin would

seek to “secure new capital with a government partnership,”

or should that endeavor fail, “manage a resolution process.”

The Board accordingly directed the officers “to pursue its

policy approach with the US Treasury” and “mitigate nega-

tive outcomes of a[n] [FDIC] resolution for stakeholders.”

The Board also directed management to “focus[] on convert-

ing as much of the remaining uninsured deposit base as

possible to fully insured status.” In order to accomplish this

task, the officers needed to financially support the banks

long enough to convert uninsured deposits into insured

status.

Shortly before the refund arrived, the Board faced yet

another setback. Irwin had previously hired the accounting

firm Ernst & Young to assist with the year-end 2008 audit,

and the audit indicated that the Bank and Trust remained

adequately capitalized. However, that result rested on a

particular accounting assumption that Ernst & Young urged

Irwin to confirm with the SEC. The SEC then issued guid-

ance that contradicted Irwin’s assumption and cast doubt on

the bank’s status. In a March 31, 2009 letter, Ernst & Young

informed Irwin that after correcting the mistaken assump-

10 No. 17-1775

tion, the bank was no longer considered well capitalized. As

a result, Irwin’s ability to continue as a going concern was in

serious doubt.

On June 2, 2009, Irwin received mixed messages from the

Indiana Department of Financial Institutions and the Chica-

go Federal Reserve. In a joint letter to the Board, the regula-

tors advised that the banks needed substantially more than

$150 million to remain viable; Irwin’s plan to raise

$50 million was inadequate, and without capital infusion,

the Bank and Trust’s “likelihood of failure [was] imminent.”

Later that day, however, Cohen reported that after discuss-

ing the letter with the Chicago Federal Reserve, the regula-

tors clarified that they were “not saying the [Bank and Trust]

is in imminent danger of failure.” Cohen also advised that

the bank needed to remain adequately capitalized through

June 30 to buy enough time to negotiate the TARP applica-

tion with the Treasury. Although the negotiation might not

succeed, Cohen said “there [was] a reasonable possibility.”

Two days later Miller informed the Board that Irwin had

received the consolidated tax refund, which he described as

“great news for liquidity.” On June 11 Irwin transferred the

$76 million refund to the banks. Just over $74 million went to

the Bank and Trust; the remainder went to the Savings Bank.

Irwin and its subsidiaries continued to hold out hope. In

July Irwin received encouraging news that the Treasury had

expressed interest in helping small- and medium-sized

banks. Later that month the Board asked Cohen “if there was

an alternative course of action that ha[d] not been identified

by management.” Cohen responded “that he [did] not know

of additional things that could be done now other than what

No. 17-1775 11

management [was] doing.” As late as August 13, 2009,

Cohen maintained that there was hope for TARP funds.

But the TARP application was never approved. The

banks closed and Irwin filed for bankruptcy on

September 18, 2009. Levin was appointed Chapter 7 trustee

of Irwin’s bankruptcy estate while the FDIC was named

receiver for the banks.

In September 2011 Levin filed suit in district court, see

28 U.S.C. § 1334(b), raising seven claims under Indiana law

for breach of fiduciary duty against Miller, Ehlinger, and a

third former Irwin officer.1 The district judge initially dis-

missed the complaint for lack of standing because she be-

lieved that every count was derivative of claims that

belonged to the FDIC as receiver for the banks. We affirmed

in part and reversed in part, holding that Levin had standing

to assert two of his claims. Levin v. Miller, 763 F.3d 667 (7th

Cir. 2014).

On remand Levin filed an amended complaint limiting

his claims to the two he had standing pursue. As relevant

here, he alleged that Miller and Ehlinger breached their duty

to provide the Board with material information. The trustee

maintained that Miller and Ehlinger should have informed

the Board that Irwin could maximize its value if it had

declared bankruptcy before transferring the tax refund to the

banks. The judge entered summary judgment for the offic-

ers, and Levin appealed.

1 Thomas Washburn, who served as Irwin’s Executive Vice President

from 2000 until January 2008, was named as the third defendant, but the

claims against him are not at issue here.

12 No. 17-1775

II. Discussion

We review the summary judgment de novo, drawing all

reasonable inferences in Levin’s favor. Pain Ctr. of Se. Ind.

LLC v. Origin Healthcare Sols. LLC, 893 F.3d 454, 459 (7th Cir.

2018).

To prevail on a claim for breach of fiduciary duty, a

plaintiff must show: “(1) the existence of a fiduciary relation-

ship; (2) a breach of the duty owed by the fiduciary to the

beneficiary; and (3) harm to the beneficiary.” Good v. Ind.

Teachers Ret. Fund, 31 N.E.3d 978, 983 (Ind. Ct. App. 2015)

(internal quotation marks omitted). No one disputes that a

fiduciary relationship existed; officers owe fiduciary duties

to the corporation they serve. See, e.g., Biberstine v. N.Y.

Blower Co., 625 N.E.2d 1308, 1318 (Ind. Ct. App. 1993).

Levin claims that the officers breached their duty to pro-

vide information to the Board. In Indiana an officer’s duties

are “determined by common law rules of agency,” Winkler v.

V.G. Reed & Sons, Inc., 638 N.E.2d 1228, 1231 (Ind. 1994), and

according to these rules, an agent has a duty to provide

relevant information to the principal, see RESTATEMENT

(THIRD) OF AGENCY § 8.11 (AM. LAW INST. 2006). To fulfill this

duty, officers must “use reasonable effort to provide the

principal with facts that the agent … should know when …

the agent … has reason to know that the principal would

wish to have the facts or the facts are material to the agent’s

duties to the principal.” Id.

Levin faults the officers for failing to inform the Board

that an earlier bankruptcy could have maximized Irwin’s

value. His theory rests on a series of assumptions: (1) the

officers should have seen the writing on the wall and real-

No. 17-1775 13

ized that the banks were doomed to fail and that transferring

the tax refund would be a waste; (2) they should have

investigated whether filing for bankruptcy earlier was a

better option; (3) had they investigated, they would have

hired a tax and bankruptcy expert who would have advised

that Irwin could claim the refund as an asset in bankruptcy

(based on the New York bankruptcy judge’s decision); and

(4) had the officers reported this information, the Board

would have declared bankruptcy earlier, before transferring

the tax refund, thereby maximizing Irwin’s value and the

size of the bankruptcy estate for the creditors.

Even on its own terms, Levin’s complicated theory is du-

bious. The argument’s intricate chain of inferences rests on a

series of speculative and increasingly questionable links—

especially the assertion that, contrary to both regulatory

guidance and Irwin’s years-long understanding (memorial-

ized in a written agreement), the Board would have tried to

claim the tax refund as its own asset in bankruptcy. Color us

skeptical.

Nevertheless, Levin’s theory fails for a more fundamental

reason. The duty to provide information is not absolute; it is

qualified by the duty to obey the Board’s lawful instructions.

Corporate “officers are chosen by, report to[,] and are subject

to the direction of the board of directors.” IND. CODE § 23-1-

36-2 official cmt. Under the rules of agency, they have “a

duty to comply with all lawful instructions” received from

the Board, and they must comply with those instructions

even if they “believe[] that doing otherwise would be better

for the principal.” RESTATEMENT (THIRD) OF AGENCY § 8.09(2)

(AM. LAW. INST. 2006); id. cmt. c. Crucially, the duty to

comply supersedes the duty to inform: An agent’s obligation

14 No. 17-1775

to provide information is “subject to any manifestation by

the principal.” Id. § 8.11.

As the financial crisis deepened, the Board clearly mani-

fested the intention to save the banks and directed the

officers accordingly. In February 2008 the Board resolved to

keep the Bank and Trust well capitalized. Later that year the

Board authorized Miller to execute the written agreement

requiring Irwin to maintain sufficient capital at the bank.

The Board ordered Miller to make a $14 million capital

contribution to the bank in December, and in May 2009 it

directed the officers to continue trying to raise capital while

preparing the bank’s deposit accounts for a possible resolu-

tion.

As agents of the Board, the officers had a duty to execute

the Board’s strategy and directives. And that strategy was

plainly incompatible with declaring bankruptcy. Insolvency

would have killed any chance of government relief and cut

short efforts to insure deposit accounts. The officers had no

right—much less a duty—to pursue a course of action that

directly contradicted the Board’s clear instructions.

Nor did the officers have a fiduciary duty to hire an ex-

pert to second-guess the Board’s judgment. The Board made

its decisions based on the advice of regulatory agencies and

deeply experienced outside counsel. The Chicago Federal

Reserve, Indiana Department of Financial Institutions, and

the FDIC all urged the Board to financially support its

subsidiaries. The lawyers from Sullivan & Cromwell, whom

the Board specifically retained for advice on fiduciary duties,

agreed. The officers were not obligated to retain their own

expert to challenge regulators, counsel, and the Board itself.

No. 17-1775 15

Levin insists that the Board never manifested a desire to

not receive information about Irwin’s potential value in

bankruptcy. He claims the Board was not irrevocably com-

mitted to propping up the banks and that it may have

changed course had it known that an earlier bankruptcy

could maximize value. It would only be logical, Levin

argues, for the directors to be interested in such information.

Without it, he argues, the Board “hardly could have mani-

fested a desire not to receive such information.”

This argument rests on speculation and cannot be recon-

ciled with the record. The Board’s response to the crisis was

driven by the demands of federal and state regulators and

guided by expert outside counsel. Taking account of the

regulatory directives and expert legal advice, the Board

exercised its judgment and chose to devote its resources to

saving the banks. As agents, the officers had no right to

spend company resources pursuing a different strategy.

AFFIRMED.