Seventh Circuit Provides Lesson on Bank Bonds
April 07, 2009
The 7th U.S. Circuit Court of Appeals recently held that a financial institution bond that was issued to a bank and that provided insurance coverage for losses "directly from" fraud engaged in by a person present on the bank premises, covered bank losses from bad checks written to the bank even though the failure to honor the checks occurred at a different bank well after the check writer left the premises of the bank to which the bond was issued. First State Bank of Monticello v. Ohio Casualty Insurance Co., 2009 FL 259676 (Feb. 5).
The bank making claim under the bond, First State, was represented by Tracy C. Litzinger of Howard & Howard P.C. in Peoria. Clausen, Miller P.C. represented the bonding company, Ohio Casualty.
For several months in 2002 and 2003, James Stilwell carried on an extensive scheme of writing and cashing worthless checks. He would draw checks on the Tuscola National Bank, where he had several accounts, and tender them, apparently in person, to First State in return for bank money orders backed by the resources of First State.
His accounts at Tuscola, however, were empty or had a negative balances, although Tuscola nevertheless paid some of the checks. When asked about the transactions at First State, he concocted a cover story.
The scheme collapsed in early 2003, when Tuscola froze his accounts. First State at that time was left holding worthless checks totaling $307,000. Although it tried to collect the money from Stilwell, he died before paying. First State then filed a claim with its insurer, Ohio Casualty.
Ohio Casualty had issued a Standard Form No. 24 Financial Institution Bond to First State. Agreement B of that bond provided coverage for "on-premises" fraud. Basically it obligated Ohio Casualty to indemnify First State for the loss of property "resulting directly from ... false pretenses ... committed by a person present in an office or on the premises of the Insured."
Ohio Casualty denied coverage, and First State brought this coverage action in Illinois state court, which then was removed to federal court. On cross motions for summary judgment, the district court found in favor of First State with respect to coverage under the bond, but found against it on its claim for prejudgment interest. Ohio Casualty took this appeal, and First State cross appealed on the interest issue.
In an opinion by Judge Diane S. Sykes, the 7th Circuit affirmed. She initially provided a brief history of standard financial-institution bonds, noting that they were initially developed by Lloyd's of London and that Standard Form No. 1 Banker's Blanket Bond was introduced in the United States in 1916. The bond issued by Ohio Casualty to First State, Standard Form No. 24, was a descendant of that first bond.
She then turned to Ohio Casualty's arguments on appeal. It initially contended that First State did not actually suffer a "loss ... resulting directly" from "false pretenses" on its "premises" under Agreement B of the bond, because it received a valid and enforceable check from Stilwell, and the loss that occurred did not take place until later when Tuscola refused to honor the check.
Sykes acknowledged that First State did not experience a loss at the precise moment Stilwell exchanged his checks for the bank's money orders, that it was not certain that the checks would be returned unpaid, and that any loss to the bank from acquiring Stilwell's checks was "theoretical" at the time of the exchange. Nevertheless, said Sykes, once Tuscola refused to honor the checks First State necessarily had fewer assets, so that the fact that nonpayment occurred "off premises" was of no moment. Agreement B required only that the "false pretenses" be committed by a person on First State's premises, and that is what occurred here.
Ohio Casualty further contended that "false pretenses" required criminal conduct under Illinois law. Sykes observed, however, that 720 ILCS 5/17- 1(B)(d) makes it a crime for one to issue a check "knowing that it will not be paid by the depository," and that having insufficient funds "is prima facie evidence that the offender knows that it will not be paid." Since Stilwell knew that he did not have any funds at Tuscola, this requirement therefore was met.
Ohio Casualty further argued that the loss to First State did not result "directly from" Stilwell's false pretenses because of various intervening or contributing causes, such as Stilwell's death, his company's bankruptcy, and bank officers' failure to follow First State's procedures in accepting his checks.
Sykes countered with the view that the "directly from" requirement of the bond was not governed by tort-causation concepts of proximate cause. Rather contract principles would apply to determine loss causation. Under contract principles, moreover, the "direct loss" requirement would be afforded its plain meaning, so that "direct" means "direct."
Here, First State disbursed immediately available funds to Stilwell; his account at Tuscola was frozen and empty; and the checks were returned unpaid. These factors, according to Sykes, were sufficient to satisfy a common and ordinary understanding of a loss resulting directly from a fraud occurring on the bank's premises. The slight gap in time between Stilwell's writing the checks and their non-payment made no difference. What was important was that without his on-premises misconduct, First State would not have suffered a loss.
Ohio Casualty raised a related argument with respect to a potentially applicable exclusion that excluded coverage for loss caused by an employee of the bank, based on bank personnel's failure to follow proper procedure. Sykes rejected this argument because it was based on an overbroad reading of the exclusion, and because bank employees' "failure to prevent" the loss would not trigger the exclusion. According to Sykes, if the exclusion were to apply here, then "there might never be coverage for any on-premises fraudulent transaction."
Sykes also briefly addressed First State's cross appeal, noting that its argument for prejudgment interest was not raised until the filing of its Rule 59(e) motion to alter or amend the judgment. She said that the district court was entitled to conclude that raising the issue in such a motion for the first time was too late.
Accordingly, the 7th Circuit affirmed the district court's judgment finding coverage and denying prejudgment interest.
