Clausen Miller Victory Makes New Law: Illinois Joins the Majority of Jurisdictions In Holding That A Fidelity Bond Does Not Cover Third Party Liability Occasioned By Employee Dishonesty
March, 2004
by Randall I. Marmor and
The Illinois Appellate Court recently joined the majority of state and federal jurisdictions in holding that a fidelity bond does not cover an insured’s liability to a third party occasioned by employee dishonesty because such losses are not “direct” under the plain language of the bond. RBC Mortgage Co. v. Nat’l Union Fire Ins. Co of Pittsburgh, PA, No. 1-03-0776 (Ill. App. Ct. June 30, 2004).
Facts
In RBC, First City Financial Corp. brokered mortgages for Evergreen Moneysource Mortgage Company (EMMC). First City compiled financial documents into loan packages and then submitted the loan packages to EMMC, which would fund the loans and ultimately sell them to third party investors. Under the parties’ brokerage agreement, First City warranted that the loan packages did not contain any untrue statements and agreed to indemnify EMMC for any losses arising from breach of that warranty.
EMMC sued First City after it discovered that one of First City’s loan officers had compiled fraudulent loan packages. First City and its parent corporation, RBC Mortgage Company, settled the lawsuit and then sought indemnification under a fidelity bond for their contractual liability to EMMC. The bond, issued by National Union, covered losses “resulting directly from” employee dishonesty or fraud. National Union declined coverage and the insureds filed suit.
The trial court dismissed the complaint, finding that the fidelity bond did not cover the insureds’ contractual liability to EMMC. The appellate court affirmed, agreeing that fidelity bonds do not cover losses occurring as a consequence of a third party’s involvement.
Analysis
The appellate court held, as a matter of first impression in Illinois, that the language “loss resulting directly” from is clear and unambiguous. A “direct” loss signifies actual depletion of an insured’s funds caused by an employee’s dishonest acts, classically describing theft and embezzlement. In so holding, the court stated that “the law, as extrapolated from other jurisdictions, is resoundingly uniform on this issue.”
Because it found that the language was unambiguous, the court refused to apply the ordinary rules of contract construction. Nevertheless, the court went on to note that the insureds were “undeserving” of the usual rule that the policy is construed strictly against the insurer, as drafter of the policy, because there was no disparity in bargaining power. Additionally, the court rejected the insureds’ argument that “direct” should be construed according to a proximate cause analysis. The court reasoned that loss “resulting directly from” is a much narrower concept than “proximately caused” loss, and that equating the two is to give a strained reading to the plain language of the bond.
Learning Point:
This case definitively establishes that a fidelity bond does not cover an insured’s liability to a third party, even though an employee’s dishonesty is what sets into motion a chain of events culminating in that liability. An insured may not use a first party fidelity bond to deflect third party liability to its insurer. •
Editors Note:
This significant fidelity/surety case was defended by CM partner Randy Marmor in the trial court and Agelo Reppas of CM’s Appellate Practice Group before the Illinois Appellate Court, First District.
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