CHAPTER 1
EMPLOYEE DISHONESTY:
THE ESSENTIAL ELEMENTS OF COVERAGE
UNDER INSURING AGREEMENT (A)
Michael Keeley1, Strasburger & Price, LLP
Christopher A. Nelson, Travelers
I.
Introduction
Financial Institution Bonds have been available to banks in one form
or another for over 100 years.2 As with all forms of insurance, such
1.
This chapter is a continuation of a body of work first begun by the lead
author in 1995 with his distinguished colleague, Harvey Koch, a partner
with the law firm Montgomery Barnett LLP in New Orleans, Louisiana,
and thereafter continued and expanded upon with another distinguished
colleague, Lisa Block, Claim Director for CNA Insurance Company in
Cranbury, New Jersey. See Harvey C. Koch and Michael Keeley,
Employee Dishonesty: The Essential Elements of Coverage Under
Insuring Agreement A, in FINANCIAL INSTITUTION BONDS 27 (Duncan L.
Clore ed., 1995); Michael Keeley, Employee Dishonesty Claims:
Discerning the Employee’s Manifest Intent, XXX TORT & INS. L.J. 915
(Summer 1995); Michael Keeley and Harvey Koch, Employee
Dishonesty: The Essential Elements of Coverage Under Insuring
Agreement (A); Where are We Now With Manifest Intent?, in FINANCIAL
INSTITUTION BONDS 4 (Duncan L. Clore ed., 2d ed. 1998) [hereinafter
1998
Chapter]; Michael Keeley and Lisa Block, Loan Loss Coverage Under
Insuring Agreement (A), in LOAN LOSS COVERAGE UNDER FINANCIAL
1
2
Financial Institution Bonds
fidelity bonds create a risk sharing arrangement, with insurers assuming
the risk of certain losses that are difficult for banks to protect against, and
banks maintaining the risk of common business losses. For example,
banks are in the business of making loans, and thus they are in the best
position to avoid the risk of loss due to unpaid loans, whether due to a
customer’s financial problems or fraud. Therefore, fidelity bonds
specifically exclude coverage for loan losses except under very limited
circumstances where the loss is caused by employee dishonesty. On the
other hand, banks are not as equipped to avoid the risk of loss resulting
directly from embezzlement, forged or counterfeit securities, or forged or
altered negotiable instruments. As a result, the multi-peril Financial
Institution Bond has been providing limited forms of insurance against
such losses since 1916.3
From the very beginning, coverage for a bank’s loss due to employee
dishonesty has been intended to be narrow, limited to embezzlement and
embezzlement type acts.4 For just as long, insured banks looking for
relief from significant employee dishonesty losses have disagreed over
the scope of coverage for such losses. As a result, over the years insurers,
led by the Surety and Fidelity Association of American,5 have
continually modified the standard form bond to clarify the narrow scope
2.
3.
4.
5.
INSTITUTION BONDS 1 (Gilbert J. Schroeder and John J. Tomaine eds.,
2007). The authors are continuing and expanding this earlier body of
work in this most recent chapter discussing coverage under Insuring
Agreement (A) of the Financial Institution Bond. The authors would like
to thank Mr. Koch and Ms. Block for their earlier contributions, as well as
Melinda Newman, an associate with Strasburger & Price, LLP, in Dallas,
Texas, for her assistance in updating this chapter.
Frank Skillern, Jr., The New Definition of Dishonesty in Financial
Institution Bonds, 14 FORUM 339 (1978); Frank Skillern, Jr., Fidelity
Coverage: What Is Dishonesty? in BANKERS AND OTHER FINANCIAL
INSTITUTION BONDS 24 (1979).
Robin Weldy, A Survey of Recent Changes In Financial Institution Bonds,
12 FORUM 895 (1977); see also Robin Weldy, History of Financial
Institution Bonds, in FINANCIAL INSTITUTION BONDS 1 (Harvey Koch ed.,
1989).
Weldy, A Survey of Recent Changes in Financial Institution Bonds, supra
note 3, at 896.
Previously known as the Surety Association of America [hereinafter
SFAA].
Employee Dishonesty
3
of coverage. In 1976 the industry added the manifest intent requirement
with the use of a rider,6 and then by revision to the standard form
Bankers Blanket Bond in 1980,7 requiring proof that the employee acted
with the manifest intent to cause the insured to sustain a loss. The 1980
standard form Bankers Blanket Bond also included a requirement that the
employee act with the manifest intent to obtain a financial benefit for
either herself or any other person or organization.8 And, in 1986 the
standard form Financial Institution Bond was revised again, this time to
preclude coverage under Insuring Agreement (A) for a loss resulting
directly from a loan unless the dishonest employee also acted in
collusion with one or more parties to the transaction and received a
financial benefit with a value of at least $2500.9
When this chapter was written for the second edition of this book in
1998, it was pointed out that the firestorm of controversy in employee
dishonesty claims revolved around the meaning of the term “manifest
intent.”10 At that time, certain courts were applying a wholly objective
standard in addressing the manifest intent issue, essentially equating
manifest intent with recklessness, finding that an employee acted with
the manifest intent to cause the bank to suffer a loss if the natural and
probable consequences of the employee’s acts were a loss.11 As the
authors stated in that original chapter, those decisions were
fundamentally unsound, either because they were based upon earlier
bond forms that were no longer applicable, or because they were based
upon inapplicable criminal or tort law cases. The authors maintained that
the term manifest intent should instead be defined to mean specific
6.
7.
8.
9.
10.
11.
SFAA, Rider No. 6019, reprinted in STANDARD FORMS OF THE SURETY
ASS’N OF AMERICA [hereinafter Standard Forms].
Bankers Blanket Bond, Standard Form No. 24 (Revised July 1980),
reprinted in Standard Forms.
Id. Insuring Agreement (A).
Financial Institution Bond, Standard Form No. 24 (Revised to Jan. 1986)
[hereinafter 1986 Bond], reprinted in Standard Forms. The SFAA also
modified the name of the bond in 1986 from Bankers Blanket Bond to
Financial Institution Bond in order to counteract the tendency of some
courts to construe the bond broadly because the word “blanket” was
contained in the title.
1998 Chapter, supra note 1, at 1.
Id. at 2.
4
Financial Institution Bonds
intent; that is, acting with the conscious desire to achieve a particular
result.
Ten years later, as we are in the middle of another financial crisis,
the flames of controversy over the intended scope of coverage under
Insuring Agreement A have waned, but there continues to be
disagreement between policy holders, insurers, and brokers, and some
confusion among the courts, as to the precise scope of coverage under
Insuring Agreement A. It is safe to say that most, although not all, courts
now recognize that losses caused by negligence or recklessness are not
covered by the bond. But in recent years debate has centered upon
whether an insured must establish that its employee acted with the
“specific intent” or “purpose” to cause the insured to sustain a loss, or
whether it is adequate to show that the employee knew that a loss was
“substantially certain” to follow from his or her actions. A significant
minority of courts have applied what the authors have referred to as the
substantial certainty test.12 Rather than requiring a showing of specific
intent, these courts find that the manifest intent requirements is satisfied
as long as the dishonest employee knew a loss to the employer was
substantially certain to occur. The better reasoned decisions, however,
apply what the lead author has characterized as the specific intent
standard, requiring proof that the employee acted with the conscious
purpose to cause his or her employer to suffer a loss.13
12.
13.
See, e.g., Peoples Bank & Trust Co. v. Aetna Cas. & Sur. Co., 113 F.3d
629, 635 (6th Cir. 1997); FDIC v. Oldenburg, 34 F.3d 1529, 1539 (10th
Cir. 1994); FDIC v. United Pac. Ins. Co., 20 F.3d 1070, 1078 (10th Cir.
1994); Heller Int’l Corp. v. Sharp, 974 F.2d 850, 859 (7th Cir. 1992); First
Fed. Sav. & Loan Ass’n v. Transamerica Ins. Co., 935 F.2d 1164 (10th
Cir. 1991); FDIC v. St. Paul Fire & Marine Ins. Co., 942 F.2d 1032, 1035
(6th Cir. 1991); Phillip R. Seaver Title Co., Inc. v. Great Am. Ins. Co.,
No. 08-CV-11004, 2008 WL 4427582 (E.D. Mich. Sept. 30, 2008); Lynch
Properties, Inc. v. Potomac Ins. Co. of Ill., 962 F. Supp. 956, 962 (N.D.
Tex. 1996).
See, e.g., FDIC v. Nat’l Union Fire Ins. Co., No. 01-2524, 2003 WL
262502 (3d Cir. 2003); RTC v. Fid. & Deposit Co. of Md., 205 F.2d 615,
638 (3rd Cir. 2000); FDIC v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa.,
205 F.3d 66, 72 (2nd Cir. 2000); Gen. Analytics Corp. v. CNA Ins. Cos.,
86 F.3d 51, 54 (4th Cir. 1996); Glusband v. Fittin Cunningham & Lauzon,
Inc., 892 F.2d 208, 212 (2nd Cir. 1989); Cont’l Bank v. Aetna Cas. & Sur.
Co., No. 024780/91 (N.Y. Sup. Ct. Feb. 17, 1994); J.T. Moran Fin. Corp.
Employee Dishonesty
5
While most policies in use today include the manifest intent
language of the bond, and thus the meaning of this term is as relevant
today as it was ten years ago, many polices include a modified intent
standard, using the word “intent” instead of “manifest intent.” At the
same time, other insurers have begun using either the 2004 SFAA14 or
2005 Insurance Services Office15 versions of the standard form policies,
replacing the term manifest intent with language that is hoped to leave no
question about the limited scope of coverage.
In this updated chapter, the authors further examine the history of
employee dishonesty coverage and the intent requirements of the bond,
and analyze the meaning of these terms in light of the plain language of
the bond and the meaning of intent in other areas of the law. It is
suggested that the plain meaning of the bond, as well as the history and
purpose of the manifest intent provision, require the application of a
specific intent standard, requiring a showing that the employee acted
with the obvious, conscious desire or purpose to cause the insured to
sustain a loss. Regardless of how manifest intent is defined, a jury
attempting to discern an employee’s manifest intent must be instructed to
discern the employee’s subjective state of mind, based upon the full
range of relevant evidentiary circumstances, rather than utilizing an
objective standard that allows an inference of manifest intent based only
upon the fact of a loss, or based upon what a reasonable person would
have intended under the circumstances. Such an objective standard
would inappropriately turn the bond into errors and omissions insurance,
rather than fidelity coverage, by providing coverage for an employee’s
negligent or reckless acts. With respect to the 2004 version of the
standard form policies, the authors suggest that there should be no
disagreement at all about the limited scope of coverage under the bond.
This chapter also addresses the less controversial, although no less
important, issues of collusion and financial benefit. These elements often
14.
15.
v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 147 B.R. 335, 339 (S.D.
N.Y. 1992); Verex Assurance, Inc. v. Gate City Mortgage Co., No.
C-83-0506W, 1984 WL 2918 (D. Utah Dec. 4, 1984).
Financial Institution Bond, Standard Form No. 24 (Revised April 2004)
[hereinafter 2004 Bond], reprinted in Master Appendix at Exhibit ____.
Hereinafter ISO. See Financial Institution Crime Policy for Banks and
Savings Institutions (Non-Aggregate Form) No. FI 00 10 05 08 (ISO
2007), reprinted in Master Appendix at Exhibit ___ [hereinafter FICP].
6
Financial Institution Bonds
assume paramount importance in analyzing loan loss claims. Under
Insuring Agreement (A) an insured must establish that an employee not
only had the manifest intent to cause the insured to sustain a loss, but that
she acted in collusion with one or more parties to the loan transactions,
and actually received a financial benefit with a value of at least $2500.
Issues often arise concerning the meaning of collusion, and the character,
value, and timing of the financial benefit required to be received by the
employee. These and similar issues also are addressed in this chapter.
II.
History
A. Origins of Modern Employee Dishonesty Coverage
Modern fidelity coverage had its origins in the latter part of the
nineteenth century.16 These early fidelity bonds indemnified against loss
“through” the fraud or dishonesty of either an employee identified by
name or by a specific job designation. The first “blanket bond” was
underwritten by Lloyd’s of London in 1908.17 The word “blanket” was
used to signify that a uniform dollar amount of coverage applied to each
insuring agreement, rather than to mean that blanket coverage was being
provided.
B. Beginnings of Standard Form Policies
In 1916, Standard Form No. 1 was created by SFAA, the Bond and
Surety Underwriters Trade Association and the American Bankers
Association.18 By 1941 Standard Form No. 1 had evolved into what is
known today as Standard Form No. 24, with further revisions being
made in 1946, 1951, 1969, 1980, 1986, and most recently, 2004.
Standard Form No. 1 continued to indemnify the insured against loss
“through any dishonest act of any of the Employees wherever
16.
17.
18.
Skillern, The New Definition of Dishonesty in Financial Institution
Bonds, supra note 2, at 339; Skillern, Fidelity Coverage: What Is
Dishonesty?, supra note 2, at 23.
Skillern, Fidelity Coverage: What Is Dishonesty?, supra note 2, at 24.
Weldy, History of Financial Institution Bonds, supra note 3, at 1.
Employee Dishonesty
7
committed, and whether committed directly or by collusion with
others.”19
In subsequent years the words “fraudulent” and “criminal” were
added to the fidelity insuring agreement. In fact, the first version of the
present Insuring Agreement (A) appeared in 1936 in Standard Form
No. 8 as an insuring clause providing coverage for: “Any loss through
any dishonest, fraudulent, or criminal act of any of the Employees,
including loss of property, through any such act of any of the Employees,
wherever any such act may be committed and whether committed
directly or by collusion with others.”20 In the 1986 standard form bond,
the “loss through” language was changed to “loss resulting directly
from,” and the term “dishonest and fraudulent acts” was expressly
limited to those dishonest and fraudulent acts specifically committed
with the manifest intent to cause the bank a loss and to obtain a financial
benefit.21
C. Adverse Decisions Lead to Sky Rocketing Loss Ratios
From early on courts seemed predisposed to construe fidelity bonds
in favor of coverage, leading to a broad construction of the term
“dishonesty.” Insurers were held liable for losses caused by an
employee’s actions that “evinced a want of integrity and an intentional
breach of trust . . . whether for the benefit of [the employee] or of
another”;22 that were “reckless, willful, and wanton . . . [or] manifestly
unfair to the employer”;23 and that were “done in breach of the officer’s
duty to the bank and [were] willful omissions.”24 Remarkably, one court
concluded:
19.
20.
21.
22.
23.
24.
Harvey C. Koch, Insuring Agreement (A)—Fidelity Coverage Today, in
FINANCIAL INSTITUTION BONDS 101 (Duncan L. Clore and Harvey C.
Koch eds., 1992).
Id. at 102.
1986 Bond, supra note 9, Insuring Agreement (A).
U. S. Fid. & Guar. Co. v. Bank of Thorsby, 46 F.2d 950, 951-52 (5th Cir.
1931).
London & Lancashire Indem. Co. of Am. v. People’s Nat’l Bank & Trust
Co., 59 F.2d 149, 152 (7th Cir. 1932) (emphasis added).
Fidelity & Deposit Co. of Md. v. Bates, 76 F.2d 160, 166 (8th Cir. 1935).
8
Financial Institution Bonds
[The bond guarantees] openness and fair dealing on the part of the
bank’s officers. It is intended to, it does, underwrite that the bank’s
officers shall act with common honesty and an eye single to its
interests. It guarantees that the bank shall at all times have the benefit
of the unbiased, critical, and disinterested judgment of the president in
regard to the loans it makes.25
As one commentator noted:
The cases seemed to look for a way to find dishonesty or to give the
jury instructions on the definition of dishonesty which minimized the
element of intent to commit the wrongful act. A snowballing effect
resulted, with more claims resulting from the publicity given to the
cases unfavorable to the surety industry and those claims bringing
about more unfavorable results.26
In other words, contrary to the intent of the industry, courts were turning
the bond into credit insurance.
By the mid 1970s adverse court decisions had taken their toll on
insurers. The industry’s loss ratio for the eleven year period from 1967
through 1977 ranged from 61.4 percent to 125 percent, with ratios
exceeding 100 percent in 1969, 1974, 1976, and 1977.27
Not
surprisingly, a number of insurers were forced to reduce the volume of
their business, while others stopped offering fidelity bonds entirely.28 By
the late 1970s a mere dozen or so companies wrote a significant amount
of fidelity bond business, while only fifteen years earlier there had been
25.
26.
27.
28.
Maryland Cas. Co. v. Am. Trust Co., 71 F.2d 137, 138 (5th Cir. 1934)
cert. denied, 293 U.S. 582 (1934); see also Miami Nat’l Bank v. Pa. Ins.
Co., 314 F. Supp. 858, 862 (S.D. Fla. 1970) (employee acting with
reckless disregard engages in dishonest conduct); Home Indem. Co. v.
Reynolds & Co., 187 N.E.2d 274, 281-82 (Ill. Ct. App. 1962) (technical
violation of an Illinois statute which made it a misdemeanor to solicit sale
of unregistered securities could be a criminal act covered under the bond).
Skillern, The New Definition of Dishonesty in Financial Institution
Bonds, supra note 2, at 340 (emphasis added).
Loss ratio is the percent of premiums used for claim payments. In
general, a loss ratio must not be above fifty-two percent for the insurer to
realize a five percent profit. See Weldy, History of Financial Institution
Bonds, supra note 3, at 21.
Id.
Employee Dishonesty
9
many times more.29 Such losses and the resulting tightening of the bond
market eventually caused the SFAA to react with a series of
modifications to the bond.
D. SFAA’s Revisions to Counteract Decisions, Including Rider
6019, and 1980 and 1986 Revisions
Beginning in 1976, the SFAA made available a rider that limited
coverage for dishonest acts to those acts committed by the employee
with the “manifest intent” to cause the insured to sustain a loss and to
obtain a financial benefit for himself or another person or organization.30
The rider also replaced the “loss through” language of Insuring
Agreement (A) with the narrower phrase, “resulting directly from.”31 The
changes became permanent when the bond was formally revised in
1980.32
Although loss ratios decreased after addition of the manifest intent
requirement, by the mid 1980s they again were out of hand. At the same
time, the country was in the midst of what then was the largest financial
institution crisis in history. With the number of claims again increasing
and loss ratios of 83.6, 105.4, 140.0, and 69.9 for the years 1982 through
1985,33 the SFAA again acted to modify the terms of the standard form
bond. In 1986 the SFAA added some real teeth to the financial benefit
requirement, requiring proof that the employee actually receive a
financial benefit of at least $2,500 in connection with a loan, and
requiring proof and that the employee acted in collusion with one or
more parties to the loan transaction. The title of the bond was changed
from Bankers Blanket Bond to Financial Institution Bond in order to
29.
30.
31.
32.
33.
Id.
Rider No. 6019, supra note 6.
Insuring Agreement (A) of the 1969 Bankers Blanket Bond, Standard
Form No. 24, covered “[l]oss through any dishonest or fraudulent act of
any of the Employees.” Bankers Blanket Bond, Standard Form No. 24
(April 1969), reprinted in Standard Forms.
1980 Bond.
Surety Ass’n of America, 12 Year Loss Experience Data Summary of
Fidelity Claims for Years 1979-1990 (1991) (available from SFAA).
10
Financial Institution Bonds
counteract those decisions that had relied upon the term “blanket” in
holding that coverage under the bond was intended to be very broad.34
E. Overview of Decisions Construing “Manifest Intent” Provision
While courts readily accepted the fact that the SFAA added the
manifest intent language to the bond in order to limit coverage for
dishonesty claims to embezzlement-type acts, there was a great
divergence of opinion in the courts as to the precise meaning of the term
manifest intent. Early on, some courts concluded that a purely objective
standard should be followed in defining the term “manifest intent,” such
that an employee could be found to have the manifest intent to cause the
insured a loss if the natural consequences of the employee’s actions was
a loss.35 Few recent cases have adopted this standard. Rather, in recent
years, debate has centered upon whether an insured must establish that its
employee acted with the “specific intent” or “purpose” to cause the
insured to sustain a loss, or whether it is adequate to show that the
employee knew that a loss was “substantially certain” to follow from the
employee’s actions.36 While the first standard—the specific intent test—
is purely a subjective one, the latter standard—the substantial certainty
test—employs a fiction to allow a finding of manifest intent regardless of
the employee’s actual subjective intent or purpose. To date, the Second,
Third, Fourth, and Fifth Circuits have adopted the specific intent test.
34.
35.
36.
Robin V. Weldy, History of the Bankers Blanket Bond and the Financial
Institution Bond, Standard Form No. 24 with Comments on the Drafting
Process, in ANNOTATED FINANCIAL INSTITUTION BOND, Second
Supplement (Formerly BANKERS BLANKET BOND) 3, 6 (Harvey C. Koch
ed., 1988); see Mortgage Corp. of N.J. v. Aetna Cas. & Sur. Co., 115 A.2d
43, 46 (N.J. 1955). The revised title also facilitates use of the bond by
savings and loan associations and savings banks, with the use of riders.
See, e.g., Transamerica Ins. Co. v FDIC, 465 N.W.2d 713 (Minn. Ct.
App. 1991), rev’d in part on other grounds, 489 N.W.2d 224 (Minn.
1992) (holding that a person is deemed to intend the natural consequences
of his or her actions).
RTC v. Fid. & Deposit Co. of Md., 205 F.2d 615, 642 (3d Cir. 2000)
(adopting specific intent test); Peoples Bank & Trust Co. v. Aetna Cas. &
Sur. Co., 113 F.3d 629, 635 (6th Cir. 1997) (adopting substantial
certainty test).
Employee Dishonesty
11
The Sixth, Seventh, and Tenth Circuits appear to have adopted the
substantial certainty test.
F. Most Recent Revisions to Standard Form Policies
The industry acted again in 2004 because certain courts continued to
refuse to recognize that the purpose of the manifest intent language of
the bond was to limit coverage to employees acting with the specific
intent to cause the bank a loss. At that time the SFAA and ISO once
again revised Insuring Agreement (A) in an effort to remove any
remaining doubt about the limitation of coverage to embezzlement-type
acts. The SFAA substituted the term “active and conscious purpose” for
the manifest intent language of the bond. Thus, Insuring Agreement (A)
of the 2004 SFAA standard form Financial Institution Bond37 covers:
“Loss resulting directly from dishonest or fraudulent acts committed by
an Employee, acting alone or in collusion with others, with the active and
conscious purpose to cause the Insured to sustain such loss.” Edward
Gallagher, General Counsel to the SFAA, explained that this revision
was made because some courts “incorrectly equated ‘manifest intent’
with substantially certain to result or with the natural and probable
consequences of the act.”38 According to Gallagher, the SFAA
considered using the term “specific intent,” but chose the term
“conscious purpose” because it is the Model Penal Code’s highest
standard of intent.39 Indeed, this revision should leave no doubt that
coverage is limited to those situations where the purpose of the bank
employee’s actions was to cause the bank a financial loss; in other
words, a scheme where the employee either directly embezzled money
from the bank, or concocted a scheme where the employee’s active and
conscious purpose was to steal from the bank.
This revision makes it clear, for instance, that there is no coverage
where a loan officer violates bank policy by making a loan to a customer
who does not have qualifying credit scores, or where the collateral is
“inadequate,” but where the loan officer believes the customer
37.
38.
39.
2004 Bond, supra note 14.
Edward G. Gallagher and Robert J. Duke, A Concise History of Fidelity
Insurance, in HANDLING FIDELITY BOND CLAIMS 9 (Michael Keeley and
Sean Duffy eds. 2005) [hereinafter Handling].
Id. at 10 (citing Model Penal Code § 2.02 (1985) [hereinafter MPC]).
12
Financial Institution Bonds
nevertheless will repay the loan. There would be coverage for such a
loss only when the bank officer colluded with the customer to steal
money from the bank under the guise of a loan, always intending that the
bank would never by repaid.
At the same time as the SFAA made its changes, ISO promulgated
its own form of financial institution bond with similar, but different
language. ISO decided to utilize the term “specific intent” in the FICP.40
The term “specific intent” was a natural choice because it already had
been used by those courts adopting what the authors have characterized
as the specific intent test. In essence, it is a shorthand for the SFAA’s
“active and conscious purpose” requirement. In criminal law, the
requirement that the defendant actually intend or desire the results of his
actions was known as the concept of “specific intent.”41 Thus, although
using a different term, both the FICP and the 2004 SFAA Bond were
designed to leave no doubt that in order for there to be coverage under
Insuring Agreement (A), the dishonest employee must have actually
desired to cause the bank to sustain a loss. If not, there can be no
coverage under the bond.
III.
Dishonest and Fraudulent Acts
The 1980 Bond defined the term “dishonest or fraudulent acts” to
“mean only dishonest or fraudulent acts committed by such Employee
with the manifest intent to cause the Insured to sustain such loss.”
Importantly, the 1986 Bond does not contain such a “definition” of the
term. Instead it provides two separate requirements, or “triggers,” for
coverage. First, it provides coverage for loss “resulting directly from
dishonest or fraudulent acts.” It then requires that such “dishonest or
fraudulent acts must be committed by the Employee with the manifest
intent” to cause a loss to the Insured and the manifest intent to obtain a
financial benefit for the Employee. Although this change may seem
academic, it is important to understand that the 1986 Bond does not
actually define the term “dishonest and fraudulent acts,” but instead,
requires a showing that the employee acted dishonestly or fraudulently
40.
41.
Supra note 15, Insuring Agreement A.
See, e.g., Holloway v. McElroy, 632 F.2d 605, 618 (5th Cir. 1980);
United States v. Busic, 592 F.2d 13, 21 (2d Cir. 1978).
Employee Dishonesty
13
and separately requires that such dishonest or fraudulent conduct be
committed with a certain manifest intent.
At least one published decision highlights the importance of this
seemingly minor change from the 1980 Bond to the 1986 Bond. In
Airport Motors, Inc. v. Universal Underwriters Insurance Co.,42 the
court found the termination provision of the bond ambiguous because it
did not define the term “fraudulent and dishonest,” while this term was
defined in the Insuring Agreement. As a result, the court concluded that
the insured might reasonably have read the definition to pertain not only
to the Insuring Agreement, but also to the termination provision of the
bond, and thus required a showing that the insured had previously
discovered that the employee had acted not only dishonestly, but also
with the manifest intent to cause a loss in order to terminate coverage.
This reasoning no longer applies under the 1986 standard form bond, nor
the newer versions of Insuring Agreement (A).
It is arguable that the term “dishonest or fraudulent acts” itself
requires a showing of willfulness and intent to deceive, and there is
support in the cases for this position.43 In Eglin National Bank v. Home
Indemnity Co.,44 for instance, the court discussed the issue thusly:
Fidelity bonds covering losses caused by “dishonest or fraudulent acts”
are to be broadly construed, and, as with other insurance contracts, any
ambiguity is construed most strongly against the underwriter. The
employee’s acts need not be criminal, nor is it necessary that the
employee personally benefit nor have intended to benefit from his
wrongful conduct. Nevertheless, as the cases universally recognize, in
order for their to be liability on the bond, there must be something more
than negligence, mistake, carelessness, or incompetence.
Case law has established that willfulness and an intent to deceive are
necessary elements for an employee’s acts to be “dishonest and
42.
43.
44.
No. 01-0375, 2002 Mass. Super. LEXIS 321 (Mass. Super. Aug. 21,
2002).
See, e.g., Rock Island Bank v. Aetna Cas. & Sur. Co., 706 F.2d 219, 220
(7th Cir. 1983); Eglin Nat’l Bank v. Home Indem. Co., 583 F.2d 1281,
1285 (5th Cir. 1978); Arlington Trust Co. v. Hawkeye-Security Ins. Co.,
301 F. Supp. 854, 858 (E.D. Va. 1969); see also 13 COUCH ON
INSURANCE SECOND § 46:55 (Anderson ed. 1965).
583 F.2d 1281 (5th Cir. 1978).
14
Financial Institution Bonds
fraudulent”: “in order to constitute fraud or dishonesty, it is necessary
that the employee have the intent to deceive or cheat the employer.”45
Nevertheless, most cases construing the term, particularly, those
decided before adoption of the manifest intent language, construed it
broadly.46 Thus, prior to imposition of the manifest intent requirement of
the bond, courts found coverage when the employees’ conduct “evinced
a want of integrity and an intentional breach of trust . . . whether for the
benefit of [the employee] or of another”;47 was “reckless, willful, and
wanton . . . [or] manifestly unfair to the employer”;48 and was “done in
breach of the officer’s duty to the bank and [or] willful omissions.”49 It
was this tendency of courts to broadly construe this term that led the
SFAA to adopt the manifest intent language in 1976. Thus, while the
meaning of the term “dishonest or fraudulent acts” is not completely
academic, as evidenced by the Massachusetts court’s decision in Airport
Motors, Inc.,50 the more important issue is the meaning of the manifest
intent provision of the bond. The next section of this chapter discusses
this issue in depth.
IV.
Manifest Intent Requirement
Perhaps the single most important change in the history of Insuring
Agreement (A) was the addition of the manifest intent requirement.
While previously an insured needed to establish only that the employee
acted dishonestly or fraudulently, the bond was changed to require that
the employee not only act dishonestly or fraudulently, but also that his
dishonest acts were committed with the manifest intent to cause the
45.
46.
47.
48.
49.
50.
Id. at 1285.
Scirex Corp. v. Fed. Ins. Co., 313 F.3d 841, 847-48 (3d Cir. 2002);
London & Lancashire Indem. Co. of Am. v. Peoples Nat’l Bank & Trust
Co., 59 F.2d 149, 152 (7th Cir. 1932); Oxford Bank & Trust v. Hartford
Acc. & Indem. Co., 698 N.E.2d 204, 208 (Ill. App. 1998); Mortgage
Corp. of N.J. v. Aetna Cas. & Sur. Co., 115 A.2d 43, 46 (N.J. 1955).
United States Fid. & Guar. Co. v. Bank of Thorsby, 46 F.2d 950, 951-52
(5th Cir. 1931).
London & Lancashire Indem. Co. of Am., 59 F.2d at 152.
Fid. & Deposit Co. of Md. v. Bates, 76 F.2d 160, 166 (8th Cir. 1935).
Airport Motors, No. 01-0375, at *3.
Employee Dishonesty
15
insured to sustain a loss and to obtain a financial benefit for the
employee or another person or entity.
A. Purpose of the Manifest Intent Requirement
The manifest intent requirement was added to the standard form
bond in order to clarify the SFAA’s long standing intent, dating back to
Standard Form No. 1 in 1916, to limit employee dishonesty coverage to
claims in which the culpable employee acted with the subjective intent or
purpose to gain a benefit at the expense of his employer; in other words,
those claims where the employee intended to defraud the insured bank of
money. The covered conduct contemplated under Insuring Agreement
(A) is a form of embezzlement.51 An actual embezzlement involves the
direct theft of money. In the context of a loan, the bank employee,
usually a loan officer, manipulates the lending process to disguise her
embezzlement by making it appear that the bank has made a legitimate
loan. This can take a number of forms, such as so-called “straw man”
loans, or loans to persons acting in collusion with the loan officer made
solely for the purpose of allowing the loan officer to embezzle money
from the bank. Regardless of the form, the employee’s intent must be to
embezzle money from the bank.
Comments by Robin Weldy, the former Assistant Secretary of the
SFAA, confirm that the addition of the manifest intent language was not
intended to change the scope of coverage, but were meant to “clarify
traditional bond coverage as it had been intended by the underwriters for
the last three quarters of a century.”52 Weldy explained that the industry
was “trying to stress the obvious—this coverage insures against loss
caused by a thief who happens to be an employee of the insured.”53
Comments by Edward Gallagher, the current General Counsel of the
SFAA, leave no doubt that the most recent changes to the 2004 Bond
were similarly intended, and made to correct court decisions applying
anything other than the specific intent test to Insuring Agreement (A).54
51.
52.
53.
54.
Weldy, A Survey of Recent Changes in Financial Institution Bonds, supra
note 3, at 895.
Id.
Id. at 896-97.
Gallagher and Duke, supra note 38, at 9-10.
16
Financial Institution Bonds
B. The Meaning of “Manifest Intent”
Before the ink was dry on the 1976 Rider, some in the industry
doubted that it would have its intended effect. One commentator, Frank
Skillern, questioned the meaning of the term “manifest intent” and
suggested that the drafters should have used “apparent” or “obvious”
instead of “manifest.”55 Yet, while Skillern’s comments proved prophetic
in light of the SFAA’s recent change to Insuring Agreement (A), the most
recent change should have been unnecessary because the term manifest
intent should have been construed narrowly as it was intended. In
hindsight, it is evident that courts, many of which had little experience
with fidelity bond cases, became confused by the fictional construction
of the term intent in tort and older criminal cases.
1. Dictionary Definition
A cardinal rule of contract construction requires that words in an
agreement be given their ordinary and plain meaning unless it is clear the
parties intended otherwise, or unless the words have a technical
meaning.56 Although the dictionary definition of a word is not
controlling, it generally is accepted as the common meaning of a word.57
Merriam-Webster’s Collegiate Dictionary defines “manifest” as follows:
1
manifest (adj.) 1: readily perceived by the senses and esp. by sight 2:
easily understood or recognized by the mind: OBVIOUS.
2
manifest: to make evident or certain by showing or displaying.58
The word “intent” similarly is easy to understand:
1(a): the act or fact of intending: PURPOSE, esp: the design or
purpose to commit a wrongful or criminal act. (b): the state of mind
with which an act is done: VOLITION.
2: a usu. clearly formulated or planned intention: AIM. 59
55.
56.
57.
58.
Skillern, The New Definition of Dishonesty in Financial Institution
Bonds, supra note 2, at 344.
17A AM. JUR. 2D Contracts § 359 (1991); see, e.g., Reilly v. Rangers
Mgmt. Inc., 727 S.W. 2d 527 (Tex. 1987).
17A AM. JUR. 2D Contracts, supra note 56 § 360.
MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY 707 (10th ed. 1998).
Employee Dishonesty
17
Synonyms for the word “intention” include “intent, purpose, design, aim,
end, object, objective, and goal.”60
When the two terms are used in combination—manifest intent—their
dictionary definition would seem to lead to the conclusion that the term
means a person’s obvious or overt purpose or design. As applied to the
Financial Institution Bond, this definition clearly requires insureds to
prove that the employee’s obvious purpose or design was to cause the
bank to sustain a loss and to obtain a financial benefit for himself or
another. Thus, addition of the manifest intent requirement supported the
SFAA’s efforts to limit coverage to embezzlement or embezzlement type
acts. This has been the conclusion reached by most courts addressing the
manifest intent issue.61 However, certain courts addressing the issue have
stopped short of this conclusion and instead reasoned that the term does
not require that the employee actively desire that the insured sustain a
loss.62 These courts have found that the requirement was satisfied if the
employee knew that a loss was substantially certain to occur.63
Interestingly, these courts usually did not rely upon the dictionary for a
definition of intent, stopping once they determined the dictionary
59.
60.
61.
62.
63.
Id. at 608.
Id.
See, e.g., RTC v. Fid. & Deposit Co. of Md., 205 F.2d 615, 638 (3d Cir.
2000); FDIC v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 205 F.3d 66,
72 (2d Cir. 2000); Gen. Analytics Corp. v. CNA Ins. Cos., 86 F.3d 51, 54
(4th Cir. 1996); First Nat’l Bank v. Lustig, 961 F.2d 1166, 67 (5th Cir.
1992); Glusband v. Fittin Cunningham & Lauzon, Inc., 892 F.2d 208, 212
(2d Cir. 1989); Cont’l Bank v. Aetna Cas. & Sur. Co., No. 024780/91
(N.Y. Sup. Ct. Feb. 17, 1994); J.T. Moran Fin. Corp. v. Nat’l Union Fire
Ins. Co. of Pittsburgh, Pa., 147 B.R. 335, 339 (S.D. N.Y. 1992); Verex
Assurance, Inc. v. Gate City Mortgage Co., No. C-83-0506W, 1984 WL
2918 (D. Utah Dec. 4, 1984).
See, e.g., Peoples Bank & Trust Co. v. Aetna Cas. & Sur. Co., 113 F.3d
629, 635 (6th Cir. 1997); FDIC v. Oldenburg, 34 F.3d 1529, 1539 (10th
Cir. 1994); Heller Int’l Corp. v. Sharp, 974 F.2d 850, 859 (7th Cir. 1992);
FDIC v. St. Paul Fire & Marine Ins. Co., 942 F.2d 1032, 1035 (6th Cir.
1991).
See, e.g., Peoples Bank & Trust Co., 113 F.3d at 365; FDIC v. United Pac.
Ins. Co., 20 F.3d 1070, 1078 (10th Cir. 1994); St. Paul Fire, 942 F.2d at
1035.
18
Financial Institution Bonds
meaning of the term “manifest.”64 Yet, the critical inquiry in these cases
is the meaning of “intent,” not “manifest,” as the term “manifest” is
merely an adjective modifying the “intent” requirement of its policy.
Thus, in a very real sense these courts examined only one-half of the
equation. For instance, in Lynch Properties, Inc. v. Potomac Insurance
Co. of Ill.,65 the district court observed:
Manifest intent has been defined in the fidelity insurance context as
intent that is ‘apparent or obvious.’ . . . Manifest intent does not
require that the employee actively wish for or desire a particular result;
rather, manifest intent exists where a particular result is substantially
certain to follow from the employees conduct.
Yet, because these courts considered only half the equation, their
analysis is only half correct. In Lynch Properties, the court was correct in
saying that “manifest intent” is intent that is apparent or obvious.
Problematically, it failed to consider the meaning of “intent.”
Importantly, those decisions equating manifest intent with something
less than embezzlement generally relied upon the meaning of the word
“intent” under tort or older criminal law cases for their conclusion that
intent meant something less than purpose.66 Indeed, one such decision,
Affiliated Bank/Morton Grove v. Hartford Accident & Indemnity Co.,67
openly adopted the tort definition of “intent” in place of the bond’s
contractual requirement of “manifest intent.”
Opinions discussing the definition of “intent” in tort law, as well as
in criminal law prior to adoption by most states of the Model Penal Code,
employ a legal fiction, finding that a defendant who acted with the
knowledge that the results of her actions were “substantially certain” to
occur acted with the “intent” to cause the results. Although this legal
fiction has historical support in both tort and criminal law, it has no place
in the foundation of the “manifest intent” requirement of the bond. The
64.
65.
66.
67.
See, e.g., RTC v. Fid. & Deposit Co. of Md., No. 92-1003, 1998 U.S.
LEXIS 3431, 17 (D.N.J. 1998).
962 F. Supp. 956, 962 (N.D. Tex. 1996).
See, e.g., Affiliated Bank/Morton Grove v. Hartford Accident and Indem.
Co., No. 91-C-4446, 1992 WL 91761 (N.D. Ill. April 23, 1992); Hanson
PLC v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 794 P.2d 62, 72
(Wash. Ct. App. 1990).
No. 91-C-4446, 1992 WL 91761, at *4 (N.D. Ill. Apr. 23, 1992).
Employee Dishonesty
19
fallacy in relying upon older tort and criminal law cases is apparent from
a review of applicable precedent.
2. Criminal Law Construction of “Intent”
At common law a crime required two elements: an evil-meaning
mind (intent) and an evil-doing hand (act).68 This view is expressed by
the maxim actus non facit reum nisi mens sit reu, an act does not render
one guilty unless the mind is guilty.69 Over the years various terms have
been employed to describe the state of mind a person must have to be
guilty of a crime.70 Although the term “intent” has been used in such a
manner, it has not always been used in the sense of its common
dictionary definition. Intent was instead viewed more in terms of
“knowledge.”71 According to one popular treatise, the traditional view in
criminal law was that a person “intends” the results of his actions under
two different circumstances: “(1) when he consciously desires that result,
whatever the likelihood of that result happening from his conduct; and
(2) when he knows that the result is practically certain to follow from his
conduct, whatever his desire may be as to that result.”72 The failure to
distinguish between intent (as it is strictly defined, requiring a conscious
desire for a result) and knowledge is of little consequence in many areas
of criminal law because, for most crimes, “there is good reason for
imposing liability when the defendant desired or merely knew of the
practical certainty of the result[s].”73 The more modern view, however,
recognizes that there are circumstances in which the distinction between
68.
69.
70.
71.
72.
73.
United States v. Bailey, 444 U.S. 394, 402 (1980); Morissette v. United
States, 342 U.S. 246, 251 (1952); see generally 21 AM. JUR. 2D Criminal
Law § 129 (1981).
See, e.g., id. at 262-63.
See, e.g., EDGAR J. DEWITT et al., FEDERAL JURY PRACTICE AND
INSTRUCTIONS, CRIMINAL § 17.01 595 (1990).
WAYNE R. LAFAVE & AUSTIN W. SCOTT, JR., HANDBOOK ON CRIMINAL
LAW § 3.5(b) 218 (2d ed. 1986).
Id. at 217; see also Rollin M. Perkins, A Rationale of Mens Rea, 52 HARV.
L. REV. 905, 910-11 (1939).
Bailey, 444 U.S. at 404 (emphasis added), quoting LAFAVE & SCOTT,
HANDBOOK ON CRIMINAL LAW 197 (1972); United States v. U.S.
Gypsum Co., 438 U.S. 422, 445 (1978).
20
Financial Institution Bonds
intent and knowledge is not only relevant, but important, particularly
with respect to crimes such as homicide, treason, and conspiracy.74
The older view of intent in criminal law, which required only that the
defendant knew the result was practically certain or substantially certain
to occur, was known as the concept of general intent.75 The requirement
that a defendant actually intend or desire the results of his actions was
known as the concept of specific intent.76 A case demonstrating the
distinction between the two views is State v. Daniels.77 In Daniels the
court considered the statutory definition of the crime of public
intimidation, which made it illegal to use force upon a public employee
“with intent to influence his conduct in relation to his position,
employment, or duty.”78 The court explained the intent requirement as
follows: “The statutory crime [public intimidation] is thus not the
intentional use of force or threats upon a public employee, but rather the
use of force or threats upon him with the specific intent to influence his
conduct in relation to his duties.”79 Thus, the crime of public intimidation
had two elements: the use of force upon a public official and the specific
intent to influence the public official’s conduct in relation to his duties.
The court noted that “specific intent is present when from the
circumstances the offender must have subjectively desired the prohibited
result; whereas general intent exists when from the circumstances the
prohibited result may reasonably be expected to follow from the
74.
75.
76.
77.
78.
79.
Bailey, 444 U.S. at 405; see generally LAFAVE & SCOTT, supra note 73,
§ 3.5(b), at 218.
See, e.g., Holloway v. McElroy, 632 F.2d 605, 618 (5th Cir. 1980); United
States v. Busic, 592 F.2d 13, 21 (2d Cir. 1978); United States v.
Haldeman, 559 F.2d 31, 114, n. 226 (D.C. Cir. 1976); Beltran v. State,
593 S.W.2d 688, 689 (Tex. Crim. App. 1980); Hooker v. State, 387
N.E.2d 1354, 1358, n. 1 (Ind. App. 1979); Russell v. State, 373 So.2d 97,
98 (Fla. App. 1979); People v. Battin, 143 Cal. Rptr. 731, 746, n. 19 (Cal.
Ct. App. 1978); People v. Spry, 254 N.W.2d 782, 787 (Mich. Ct. App.
1977); State v. Gowin, 554 P.2d 944, 945-46 (Idaho 1976).
See cases id.
109 So. 2d 896 (La. 1959).
Id. at 898 (emphasis in original).
Id. (emphasis in original).
Employee Dishonesty
21
offender’s voluntary act, irrespective of any subjective desire to have
accomplished such result.”80
3. Model Penal Code Construction of Intent
The distinction between general intent and specific intent was the
source of a good deal of confusion at common law.81 As a result, criminal
law moved away from the traditional dichotomy of intent and toward an
analysis of mens rea. This approach is exemplified by the American Law
Institute’s Model Penal Code, which uses the terms “purposely,”
“knowingly,” “recklessly,” and “negligently” to differentiate between
levels of culpability.82 Purposely is essentially equivalent to “specific
intent under the common law.”83 Under the Model Penal Code, a person
acts purposely concerning the result of his conduct if it is “his conscious
object” to “cause such a result”84 In other words, a person who causes a
particular result is said to act purposely if he “consciously desires that
result, whatever the likelihood of that result happening from his
conduct.”85 “Knowingly” is essentially equivalent to general intent.86 A
person acts knowingly under the Model Penal Code if he is aware that “it
is practically certain that his conduct will cause such a loss.”87 Thus, a
person is said to act knowingly if he is aware “that a result is practically
certain to follow from his conduct, whatever his desire may be as to that
result.”88
Most states have adopted the Model Penal Code’s four culpability
standards.89 Importantly (although perhaps surprisingly in light of the
American Law Institute’s choice of the term purposely over intentionally
in order to avoid the confusion that had developed over the term intent),
80.
81.
82.
83.
84.
85.
86.
87.
88.
89.
Id. at 899 (emphasis added); 21 AM. JUR. 2D Criminal Law, supra note 68
§ 130, at 264, n. 18.
See Morissette v. United States, 342 U.S. 246, 252 (1952).
MPC § 2.02 (1985).
Bailey, 444 U.S. at 405.
MPC § 2.02(2)(a)(i).
Bailey, 444 U.S. at 404.
Id. at 405.
MPC § 2.02(2)(b)(ii).
Bailey, 444 U.S. at 404.
See MPC § 2.02.
22
Financial Institution Bonds
however, the overwhelming majority of states adopting the Code’s
culpability requirements have chosen the term intentionally, not
purposely, to describe the highest level of culpability.90 Thus, in Texas
for instance, the Penal Code specifies that a person “intends” a result
“when it is his conscious objective or desire to . . . cause the result.”91 If
he acts with the knowledge that his conduct “is reasonably certain to
cause a result,” he is said to have acted “knowingly.”92 And when intent
is specified as the culpable mental state, a person cannot be convicted of
the crime when “he acts with the lesser degree of culpability described
[in the statute].”93
Inasmuch as the SFAA added the manifest intent requirement to the
bond to clarify that coverage is limited to embezzlement type acts or
losses caused by a thief, the culpability requirement for these crimes
under the Model Penal Code is of more than just passing interest. Under
section 22.31 of the Model Code, embezzlement and various other theft
offenses are consolidated into a single crime of Theft.94 Importantly, the
Code’s culpability requirement for theft offenses is “purpose.” Thus, a
90.
91.
92.
93.
94.
See, e.g., ALA. CODE § 13A-2-2(1) & (2) (1994); ARIZ. REV. STAT. ANN. §
13-105(5)(a)-(b) (Michie 1994); COLO. REV. STAT. ANN. § 18-1-501(5)(6) (West 1990); CONN. GEN. STAT. § 53(a)-3(11) & (12) (1995); DEL.
CODE ANN. Tit. 11, § 231(a)-(b) (1994); HAW. REV. STAT. § 702-206(1)(2) (Michie Supp. 1994); ILL. ANN. STAT. ch. 720 §§ 9/4-4, 9/4-5 (West
1993); IND. CODE ANN. § 35-41-2-2(a)-(b) (Burns Supp. 1994); KY. REV.
STAT. ANN. § 501.020(1)-(2) (Michie/Bobbs-Merrill 1994); ME. REV.
STAT. ANN. Tit. 17-A, § 10(1) -(2) (West 1994); N.H. REV. STAT. ANN. §
626:2(II)(a)-(b) (Butterworth Supp. 1994); N.J. REV. STAT. ANN. § 2C:
2-2(b)(1)-(2) (West Supp. 1995); N.Y. PENAL LAW §§ 15.05(1)-(2)
(McKinney Supp.); N.D. CENT. CODE § 12.1-02.02(1)(a)-(b) (Michie
Supp. 1993); OR. REV. STAT. § 161.085(7)-(8) (Butterworth 1992); PA.
CONS. STAT. Tit. 18, § 302B(1)-(2) (West Supp. 1995); S.D. CODIFIED
LAWS ANN. § 22-1-2(1)(a), (b)-(c) (Michie 1994); TEX. PENAL CODE
ANN. § 6.03(a)-(b) (Vernon 1994); UTAH CODE ANN. § 2-103(1)-(2)
(Michie 1995); WASH. REV. CODE ANN. § A.08.010(1)(a)-(b) (West Supp.
1995).
TEX. PENAL CODE ANN. § 6.03 (a) (1994).
Id.
Kuntschik v. State, 636 S.W. 2d 744, 747 (Tex. App.─Corpus Christi
1982, no writ).
MPC § 223.1 (1).
Employee Dishonesty
23
person is guilty of theft by unlawful taking, for instance, “if he
unlawfully takes, or exercises unlawful control over, movable property of
another with purpose to deprive him thereof.”95 Under the Texas Penal
Code, which specifically incorporates embezzlement into the theft
offenses, a person commits theft “if he unlawfully appropriates property
with intent [defined as “specific intent”] to deprive the owner of the
property.”96 Thus, while reliance upon pre-Model Penal Code cases
might explain (although certainly not justify) why some courts have been
inclined to require less than “specific intent” under the Financial
Institution Bond, the Model Code supports the opposite conclusion—that
manifest intent is equal to the highest culpability requirement: purpose or
“specific intent.” Therefore, if criminal law is consulted for guidance in
construing the manifest intent requirement, it requires a finding that the
employee acted with the conscious desire or object to cause the insured
to sustain a loss.
4. Tort Law Construction of “Intent”
The law of torts also developed a dichotomy between degrees of
intent. The typical tort case holds that a “specific intent to injure is not an
essential element of an intentional tort where the actor proceeds despite a
perceived threat of harm to others which is substantially certain, not
merely likely, to occur.”97
The legal fiction of intent in tort law has its foundation in the
Restatement of Torts. Section 8A of the Restatement (Second) of Torts
provides: “The word ‘intent’ is used throughout the Restatement of this
Subject to denote that the actor desires to cause the consequences of his
act, or that he believes that the consequences are substantially certain to
result from it.”98 Comment b specifically notes that intent is not limited
to desired consequences and further provides that if the “actor knows that
the consequences are certain, or substantially certain, to result from his
act, and still goes ahead, he is treated by the law as if he had in fact
desired to produce the result.”99
95.
96.
97.
98.
99.
Id. (emphasis added).
TEX. PENAL CODE ANN. §§ 31.02, 31.03 (a).
Jones v. VIP Dev. Co., 472 N.E.2d 1046, 1051 (Ohio 1984).
RESTATEMENT (SECOND) OF TORTS § 8A (1977).
Id. cmt. b.
24
Financial Institution Bonds
Comment d to section 13 of the original Restatement of Torts
provides even greater insight by explaining that a tortfeasor can be liable
even if his conduct was a practical joke with no intent to harm, and that a
surgeon who performs an operation upon a patient who has refused to
submit to it is not relieved from liability by the fact that he honestly and
justifiably believes the operation to be necessary to save the patient’s
life.100
As with criminal law, however, specific intent also has its place in
tort law. And, as in criminal law, it is in focusing on the punishment or
remedy applicable. Thus, in measuring the amount of damages a victim
may be entitled to recover from the wrongdoer, the wrongdoer’s state of
mind is at issue. If his conduct was “intentional” or “deliberate,” he may
be liable for exemplary damages.101
Also as with criminal law, the reason for this dichotomy is that tort
law is not concerned so much with the actor’s mental state or even the
harm that is done. Instead, it is concerned with the fact that there was an
intent to bring about a result which invades the interests of another in a
way that the law will not sanction.102 As with punishment in criminal law,
liability in tort is based upon conduct that is “socially unreasonable.” 103
Professors Prosser and Keaton have stated:
The tort-feasor usually is held liable for acting with an intention that
the law treats as unjustified, or acting in a way that departs from a
reasonable standard of care. . . .
But socially unreasonable conduct is broader than this, and the law
looks beyond the actor’s own state of mind and the appearances which
the actor’s own conduct presented, or should have presented to the
actor. Often it measures acts, and the harm an actor has done, by an
objective, disinterested and social standard. It may consider that the
actor’s behavior, although entirely reasonable in itself from the point of
view of anyone in the actor’s position, has created a risk or has resulted
in harm to neighbors which is so far unreasonable that the actor should
nevertheless pay for harm done . . . . [T]he law of torts is concerned not
100. RESTATEMENT OF TORTS, § 13 cmt. d (1934).
101. WILLIAM L. PROSSER et al., PROSSER AND KEETON ON THE LAW OF
TORTS, § 2, at 9 (5th ed. 1984) [hereinafter “PROSSER & KEETON”].
102. Id. at 36.
103. Id. at 6.
Employee Dishonesty
25
solely with individually questionable conduct, but as well with acts
which are unreasonable, or socially harmful, from the point of view of
the community as a whole.104
Thus, the law of torts has adopted the standard of general intent
because it is concerned with whether the defendant’s conduct is socially
harmful. The emphasis in measuring the defendant’s conduct, therefore,
is from the standpoint of the reasonable person, not the individual
defendant.
Affiliated Bank/Morton Grove v. Hartford Accident & Indemnity
105
Co. is illustrative of those cases wrongly relying upon tort law in
construing the meaning of manifest intent. In Morton Grove a bank’s
Vice President allegedly devised a plan to conceal the financial problems
of one of the bank’s customers by suggesting that the customer
participate in a check kiting scheme and by making certain intrabank
transfers of funds between the customer’s account and others to prevent
the customer from appearing on the bank’s overdraft report. Hartford
filed a motion for summary judgment on the basis that the bank had
failed to submit any evidence that the officer “had the specific intent that
the bank actually suffer losses.”106 Hartford introduced evidence
indicating that the bank officer was “hoping for a happy ending” and that
he did not intend for the bank to lose any money.107
The court specifically rejected Hartford’s argument that “‘manifest
intent’ means the specific intent or conscious desire to cause Affiliated to
lose money,” and instead found that the employee “need only have acted
with the same degree of intent as is required by the law of intentional
torts in order to have acted with the ‘manifest intent to cause the Insured
to sustain such loss.’”108 Inexplicably, in the court’s view, “[b]orrowing
the definition of intent from tort law makes sense because the purpose of
the Bankers Blanket Bond is to insure the bank from losses stemming
from the intentional torts committed by bank employees.”109 As a result,
the court denied Hartford’s motion, finding that a question of fact existed
104.
105.
106.
107.
108.
109.
Id. at 6-7 (emphasis added).
No. 91-C-4446, 1992 WL 91761 (N.D. Ill. Apr. 23, 1992).
Id. at *3.
Id.
Id. at *3-*4.
Id. at *5.
26
Financial Institution Bonds
as to whether the bank’s vice president had acted knowing that “there
was a substantial certainty that the bank would suffer losses.”110
The Morton Grove court’s reasoning is patently unsound. The
purpose of the bond is not to insure the bank for its employees’ torts. If it
was, there would have been no reason to add the manifest intent
requirement to the bond because the courts already treated the bond as
essentially providing insurance for an employee’s torts.111 Thus, such
reasoning wholly ignores, and in essence eviscerates, the manifest intent
requirement of the bond. In actuality, Insuring Agreement (A) operates to
indemnify the bank for losses directly resulting from a specific subset of
dishonesty, a type of activity that may be similar to the tort of conversion
or the federal crime of misapplication of bank funds, but which is
defined differently than both.
Blind reliance upon tort law also fails to consider the premise upon
which the legal fiction of “intent” is based in the law of torts. Had the
drafters intended such a broad construction of the term, they easily could
have extended coverage to the “employee’s intentional torts” or to
“conversion,” “larceny,” or “bank fraud.” Or, as suggested above, they
simply could have left the bond as it was. Instead, the drafters added the
manifest intent requirement, a revision that has little or no effect unless it
is construed to mean specific intent rather than general intent.
The fallacy of the reasoning in Morton Grove also is apparent in the
court’s attempt to distinguish several decisions which concluded that an
employee did not act with the manifest intent to cause a bank a loss when
the employee’s conscious desire was to benefit the bank. 112 Those cases,
the court reasoned, did not consider the “ambiguous situation in which
the bank employee prefers that no harm will come to the bank (perhaps
even that the bank will benefit) yet acts with the knowledge that they will
create a substantial certainty that the bank will suffer a loss.”113 Such a
110. Id. (emphasis added).
111. See, e.g., Fidelity & Deposit Co. v. Bates, 76 F.2d 160, 166 (8th Cir.
1935); London & Lanceshire Indem. Co. of Am. v. Peoples Nat’l Bank &
Trust Co., 59 F.2d 149, 152 (7th Cir. 1932).
112. Morton Grove, 1992 WL 91761 at *3-*4 (citing First Fed. Sav. and Loan
Assoc. v. Transamerica, 935 F.2d 1164 (10th Cir. 1991); Glusband v.
Fittin Cunningham & Lauzon, Inc., 892 F.2d 208 (2d Cir. 1989); and
Mun. Sec. Inc. v. Ins. Co. of N. Am., 892 F.2d 7 (6th Cir. 1987)).
113. Id. at 3.
Employee Dishonesty
27
circumstance is not, however, ambiguous. Although the employee’s
actions may be reckless if he acts with the knowledge that his actions are
substantially certain to cause the bank to suffer a loss, they are not
“intentional” if he prefers no harm to befall the bank.
There can be many situations in which an employee acts in a
negligent or reckless manner, but does not intend to cause a loss. For
instance, a loan officer who disguises a rice farmer’s default on a crop
loan for several years because the farmer has hit “hard times” and then
loans him an additional $10,000 for living expenses, may indeed have
acted “recklessly.” He certainly has not acted with intent to cause the
bank a loss. To the contrary, his desire is simply to keep the farmer on his
feet until he recovers and is able to repay his loans.
Importantly, knowledge that the result of a person’s actions are
substantially certain to occur is, at most, a higher degree of probability
than recklessness, yet less than a certain or conscious desire to achieve
the result. Intent as a general matter does not deal in probabilities.
Instead, it deals with certainty; that is, the fact that the employee had the
definite desire or purpose to cause the insured to sustain a loss.
If it is acknowledged that the bond no longer covers reckless
conduct, how does one distinguish acting in a reckless manner from
acting with the substantial certainty that a result will follow? Are these
two standards not simply different degrees on the objective/
reasonableness scale? According to Prosser, the usual meaning of
“reckless” is that “the actor has intentionally done an act of unreasonable
character in disregard of a known or obvious risk that was so great as to
make it highly probable that harm would follow, and which thus is
usually accompanied by a conscious indifference to the consequences.”114
How is this standard different from substantial certainty? It would
appear to be a matter of degree: “substantial certainty” versus “high
probability.” Perhaps substantial certainty can be equated to “gross
recklessness.” Regardless, when compared to specific intent, it can only
be considered a fiction. Thus, the fallacy of the many recent cases
applying the substantial certainty test is that they ignore the true meaning
of intent. And, while the results of these cases often are favorable to
114. PROSSER & KEETON, supra note 101; see Roberts v. Brown, 384 So. 2d
1047, 1049 (Ala. 1980); Bernesak v. Catholic Bishop of Chicago, 409
N.E.2d 287, 291 (Ill. App. Ct. 1980).
28
Financial Institution Bonds
insurers, there should be a concern to the industry because they can be
applied in a way far from that intended by the drafters of the 1976 Rider.
5. Contractual Construction of the Term “Manifest Intent” Under
the Financial Institution Bond
The concern under the Financial Institution Bond is not whether the
employee’s conduct is socially acceptable or how a reasonable person
would, or should, have acted. Rather, it is in defining the type of
dishonest conduct that is intended to be covered. Unlike tort or criminal
law, there is no social standard that the bond seeks to protect. Thus, there
is no reason to employ a fiction in construing the “manifest intent”
language.
Very importantly, the bond is a contract that has been developed and
refined over time with the input of the many sophisticated parties to the
fidelity bond industry: banks, brokers, insurance companies, the SFAA,
more recently ISO, and the American Bankers Association. Therefore, it
must be given effect as written.115 Those courts that have overlooked the
cardinal rules of contract construction and instead relied upon older
criminal law cases or tort cases in fictionalizing the meaning of intent
have ignored this reality.116 It is axiomatic that when construing a
contract, a court’s primary concern is to give effect to the intentions of
the parties as expressed in the instrument.117 The same rules of
construction apply to insurance policies.118 If a contract is written so that
it can be given a definite or certain legal meaning, the court must
construe the contract as a matter of law given the terms that are plain,
ordinary, and generally accepted meaning.119
Here, there can be no reasonable dispute about the plain, ordinary,
and generally accepted meaning of the word “intent.” As noted above,
115. See Nat’l R.R. Passenger Corp. v. Atchison, Topeka and Santa Fe Ry. Co.,
470 U.S. 451, 471-72 (1985).
116. See, e.g., Hanssen v. Quantas Airways, Ltd., 904 F.2d 267, 269 (5th Cir.
1990).
117. See, e.g., Kelley-Coppedge, Inc. v. Highlands Ins. Co., 980 S.W.2d 462,
464 (Tex. 1998).
118. Mustang Tractor & Equip. Co. v. Liberty Mut. Ins. Co., 76 F.3d 89, 91
(5th Cir. 1996).
119. Hanssen, 904 F.2d at 269.
Employee Dishonesty
29
the common dictionary definition of “intent” is “the act or fact of
intending,” including “the design or purpose to commit a wrongful or
criminal act.”120 “Intent” being the act of intending, “intending” means
“to have in mind as a purpose or goal,” or “to design for a specified use
or future.”121 In other words, “intent” means what most ordinary people
would defined it to mean: acting with the conscious purpose to
accomplish a result. In the context of the Financial Institution Bond,
then, it means acting with the conscious purpose to cause the bank to
sustain a loss. No other plain, ordinary, or generally accepted meaning of
the word “intent” makes sense in the context of the Financial Institution
Bond.
C. Important Cases Construing the Manifest Intent Provision
A significant body of case law has developed since the manifest
intent requirement first was adopted by the SFAA in 1976. These cases
have adopted one of three tests. First, the natural and probable
consequences test, which allows a jury to conclude that an employee
acted with “manifest intent” to cause a loss if the natural and probable
consequences of his actions was loss to the employer. Second, the
substantial certainty test, which allows a jury to find “manifest intent”
where the employee knew his actions were substantially certain to cause
a loss. And finally, what Harvey Koch and the lead author long ago
called the “specific intent” test, requiring proof that the employee act
with the conscious purpose or desire to cause his or her employer a
loss.122 Only the specific intent test satisfies the intention of the industry,
whereas the other two tests adopt a fiction to allow a jury to conclude
that an employee acted “intentionally,” even if he did not. The cases
discussed below are the more important or more recent ones discussing
these three tests.
120. MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY 608 (10th ed. 1998).
121. Id.
122. See Keeley and Koch, Employee Dishonesty: The Essential Elements of
Coverage Under Insuring Agreement (A); Where Are We Now With
“Manifest Intent”?, supra note 1, at 27.
30
Financial Institution Bonds
1. Natural and Probable Consequences Test
The natural and probable consequences test is a wholly objective,
fictional test, allowing a jury to find that an employee had the “manifest
intent” to cause a loss regardless of the employee’s actual subjective state
of mind, provided that the natural and probable consequences of the
employee’s actions was a loss. Transamerica Insurance Co. v. FDIC123
is an example of a case adopting this test. In Transamerica Myron Kruse
purchased the majority of the stock in Beaver Creek State Bank,
eventually owning 93.5 percent of the stock of the bank, and became its
President and Chairman of its Board of Directors. In 1984 a regulatory
examination of the bank revealed “problem loans” which the regulators
instructed Kruse to write off or write down. Instead, Kruse sold
$400,000 in Certificates of Deposit, deposited the funds into a
correspondent bank account, and utilized part of the money to make
payments on the “problem loans,” all while disguising his actions and
taking other inappropriate steps. In assessing whether Kruse had the
manifest intent to cause the bank to sustain a loss, the court explained
that “Kruse’s conduct demonstrates an intolerable disregard for
established banking rules, regulations, and laws. As a person is deemed
to intend the natural consequences of his actions, and as here the natural
consequences of Kruse’s bank fraud was a loss to the bank, we see no
possibility for genuine dispute regarding whether Kruse’s actions are
covered by the bond.”124 This statement essentially equates intent with
the “nature and consequences” of one’s actions.
That it is reasonable to infer that a person ordinarily intends the
natural and probable consequences of acts knowingly done is a maxim
dating back before the turn of the prior century.125 Nevertheless, similar
123. 465 N.W.2d 713 (Minn. Ct. App. 1991), rev’d in part on other grounds,
489 N.W.2d 224 (Minn. 1992); see also Liberty Nat’l Bank v. Aetna Life
Ins. Co., 568 F. Supp. 860, 868 (D.N.J. 1983) (intent to injure may be
inferred from the fact of injury, if injury is the natural result of a
voluntary act on the part of the employee).
124. Transamerica Ins. Co., 465 N.W. 2d at 716.
125. See, e.g., Agnew v. United States, 165 U.S. 36, 53 (1897).
Employee Dishonesty
31
instructions have been criticized in criminal cases.126 And, as the Second
Circuit has commented, “utterance of the quoted platitude serves no
useful purpose, since insofar as the statement has logical validity the jury
would know it anyhow; more important, in a bribery case it creates a
serious risk that the jury might think the Government’s burden of
showing the requested specific intent could be met by proof of payment
alone . . . .”127
In the context of determining intent under a Financial Institution
Bond, such an instruction allows the jury to find intent based merely
upon the occurrence of a loss. This is precisely the effect of FSLIC v.
McCuin.128 In McCuin, a former employee of the insured was convicted
of various crimes relating to loans he had made, including misapplication
of bank funds and receiving benefits from loans obtained by fraud. The
insurer argued that the employee’s conviction did not satisfy the manifest
intent requirement of the bond because it did not establish that the
employee had acted with the intent to cause the insured to sustain a loss.
The court relied upon objective standard cases in reasoning that if “intent
to injure can be inferred from the fact of injury, then plaintiff need only
establish intent to benefit financially to meet the constructive definition
of dishonesty set forth in the bond.”129 The court’s decision is an amazing
demonstration of the danger of an objective standard.
More recently, in BancInsure, Inc. v. BNC National Bank,130 the bank
sought to recoup its losses from various loan and credit transactions
handled by former employees under the terms of a financial institution
bond. The Eighth Circuit approved use of a jury instruction adopting an
objective standard based upon an earlier Eighth Circuit decision, as
follows:
126. See, e.g., Cohen v. United States, 378 F.2d 751, 755 (9th Cir. 1967);
United States v. Barash, 365 F.2d 395, 402 (2d Cir. 1966); Mann v.
United States, 319 F.2d 404, 409 (5th Cir. 1963).
127. Barash, 365 F.2d at 402.
128. No. C85-1428Z, 1988 U.S. Dist. LEXIS 19500 (W.D. Wash. July 20,
1988).
129. Id. slip op. at 11.
130. 263 F.3d 766 (8th Cir. 2001); see also Oriental Fin. Group v. Fed. Ins.
Co., 309 F. Supp. 216, 233 (D. Puerto Rico 2004) (“[I]t is a sensiblesounding principle that ‘one is presumed to intend the natural and
probable consequences of one’s actions.’”).
32
Financial Institution Bonds
You may consider any statement made or act done or omitted by a party
whose intent is an issue, and all the facts and circumstances which
indicate his state of mind. . . . You may consider it reasonable to draw
the inference and find that a person intends the natural and probable
consequences of acts knowingly done or knowingly omitted. 131
The court’s decision allows a finding of intent based upon what
normally would be considered reckless conduct. Rather than requiring
the jury to determine the purpose of the allegedly dishonest employee’s
actions, it permits a finding of intent regardless of the employee’s
purpose in acting. Once again, while such a standard might have a place
in the law of torts or certain criminal statutes, it is clearly misplaced in
construing the manifest intent requirement of the Financial Institution
Bond.
2. Substantial Certainty Test
The substantial certainty test also employs a legal fiction, allowing a
jury to find that an employee intended to harm the bank when her actions
were substantially certain to cause a loss, regardless of her subjective
state of mind. The Sixth, Seventh, and Tenth Circuits, as well as various
district courts, appear to have adopted the substantial certainty test.
In Peoples Bank & Trust Co. v. Aetna Casualty & Surety Co.,132 the
Sixth Circuit left no doubt that it would not apply a specific intent
standard, but instead would utilize the substantial certainty test in
attempting to discern an employee’s manifest intent. Two customers of
the bank sued Peoples, along with several other officers and directors,
resulting from a fraudulent scheme by the directors and officers to sell to
the customers a restaurant and lounge owned by two of the bank’s
directors (one of whom also was the bank’s lawyer) and to earn a
“finder’s fee” for two of the officers. Contrary to representations that the
restaurant and lounge were very profitable businesses and could be
purchased for below market value, the two customers almost
131. Id. at 770-71, citing First Dakota Nat’l Bank v. St. Paul Fire and Marine
Ins. Co., 2 F.3d 801, 813 (8th Cir. 1993); see also First Nat’l Bank of
Fulda v. BancInsure, Inc., No. 00-2002, 2001 U.S. Dist. LEXIS 21967
(D. Minn. Dec. 21, 2001).
132. 113 F.3d 629 (6th Cir. 1997).
Employee Dishonesty
33
immediately lost money, and thus filed suit alleging that they had been
defrauded into purchasing the business at an extremely inflated price,
that the restaurant had never been a profitable business, and that it was of
little value.133 The lawsuit was settled on the eve of trial by Peoples
paying the customers $350,000.00. Bond claims previously had been
made with two insurers, both of which were denied, and Peoples filed
suit. The trial court entered summary judgment in favor of the insurers,
finding that there was nothing in the record to even remotely suggest that
the employees had the manifest intent to defraud the bank, but that to the
contrary, the bank employees took affirmative steps to protect the bank
by obtaining a small business administration guarantee of ninety percent
of the loan.
The Sixth Circuit affirmed the trial court’s decision, reasoning:
Although the concept of ‘manifest intent’ does not necessarily require
that the employee actively wish for or desire a particular result, it does
require more than a mere probability. . . . [M]anifest intent exists when
a particular result is ‘substantially certain’ to follow from conduct.
When Harris and his co-conspirators cheated the Nobles, there was no
substantial certainty that a loss would flow to Peoples Bank.134
Thus, the court made it quite clear that it applied the substantial
certainty, rather than the specific intent standard, in discerning an
employee’s manifest intent. Yet, while certainly not as liberal as the
natural and probable consequences test, the substantial certainty test
nevertheless is a fictional objective test, ignoring any inquiry into the
employee’s motives or true purpose.
FDIC v. St. Paul Fire & Marine Insurance Co.135 is another
illustrative case by the Sixth Circuit. In this case Ramsey, a shareholder,
board member, President, and CEO of the insured bank, authorized loans
to friends or entities in which he had a financial stake. According to the
FDIC, the loans were substantially more risky than normal procedure
allowed. The trial court found that Ramsey had acted dishonestly and
that he had done so in order to obtain benefits other than those to which
he would normally be entitled. However, the trial court concluded that
133. Id. at 632.
134. Id. at 635.
135. 942 F.2d 1032 (6th Cir. 1991).
34
Financial Institution Bonds
Ramsey had not acted with the “manifest intent” to cause the bank to
sustain a loss because his “manifest intent was to make money, not to
cause [his] employer to lose money.”136 The trial court relied upon the
Sixth Circuit’s earlier decision in Municipal Securities, Inc. v. Insurance
Co. of North America,137 and noted that the manifest intent requirement
of the bond “excludes bond coverage for an employee who does not
intend to cause her employer to suffer a permanent deprivation of funds,
but instead intends for her employer to recoup its losses.”138
On appeal the Sixth Circuit affirmed the trial court’s conclusion,
noting that “its findings on the ‘manifest intent’ issue are essentially
correct,” but also explaining that its own methodology in reaching its
conclusion differed somewhat from that of the district court.139 Although
the Sixth Circuit similarly rejected the FDIC’s objective standard
argument that “one is presumed to intend the natural and probable
consequences of one’s actions,” it went on to examine the wide range of
evidence of Ramsey’s intent, noting:
[I]ntent is really shorthand for a complicated serious of inferences all of
which are rooted in tangible manifestations of behavior. For us, the
external behavior ordinarily thought to manifest internal mental states
is all that matters. We need not concern ourselves with the question of
whether mental states actually exist, as an ontological matter.140
Thus, the Sixth Circuit concluded that the trier of fact must attempt to
determine the subjective intent of the employee based upon the objective
manifestations of that intent.
The Seventh Circuit seemingly also has adopted the substantial
certainty test. In Heller International Corp. v. Sharp,141 the manager of
136. FDIC v. St. Paul Fire and Marine Ins. Co., 738 F. Supp. 1146, 1159
(M.D.Tenn. 1990) (citation omitted), aff’d in part, vacated in part, and
remanded, 942 F.2d 1032 (6th Cir. 1991); see also Cont’l Bank v. Aetna
Cas. & Sur. Co., No. 024780/91, WL 294588, at *2 (N.Y.S.Ct. Feb. 17,
1995) (“The manifest intent of these scoundrels was to make money, not
to cause Moore & Schley to lose money.”)
137. 829 F.2d 7 (6th Cir. 1987).
138. St. Paul Fire, 738 F. Supp. at 1158.
139. St. Paul Fire, 942 F.2d at 1035.
140. Id. (emphasis in original).
141. 974 F.2d 850 (7th Cir. 1992).
Employee Dishonesty
35
the plaintiff commercial finance company’s branch office allowed a loan
customer’s line of credit to exceed $15 million without proper approvals.
After the court refused the insured’s requested jury instructions defining
various terms, including “manifest” and “intent,” the jury returned a
verdict for the defendants on the insured’s main claim. The Seventh
Circuit began its analysis by noting that there were no Illinois state court
decisions directly on point, but that an Illinois Court decision, Aetna
Casualty & Surety Co. v. Freyer,142 addressed the meaning of an
exclusion for intentional acts in a general liability policy. In Freyer the
court referred to the substantial certainty test of tort law in its decision to
exclude from coverage damages for injuries caused by a violent
assault.143 The Seventh Circuit then noted that other courts had
developed similar interpretations of “manifest intent,” and concluded that
on remand the jury should be instructed “on ‘manifest intent’ pursuant to
these authorities, together with Freyer’s definition of intent.”144
The Tenth Circuit has had three occasions to consider the manifest
intent issue. In First Federal Savings & Loan Ass’n v. Transamerica
Insurance Co.145 the bank’s loan officer allowed three customers, whose
mortgage loan applications had been rejected by the bank, to assume
loans the officer made to three other borrowers. The loans were secured
by the same pieces of real estate the three customers originally attempted
to purchase. The officer received $2,000 of the origination fee from one
of the loans, which he used to make rental payments on his home,
although he apparently later returned the money to the bank. The
borrowers defaulted on the loans, leading the bank to submit a bond
claim. Upon cross motions for summary judgment the district court
denied the bank’s motion, but granted Transamerica’s, finding that the
loan officer had not acted with manifest intent to cause the bank to
sustain a loss. The Tenth Circuit, at least somewhat surprisingly, affirmed
the trial court’s summary judgment with little discussion. The court did
explain that the loan officer had attempted to arrange transactions that he
hoped would be to the mutual benefit of both the bank and the
borrowers.146
142.
143.
144.
145.
146.
411 N.E.2d 1157 (Ill. App. Ct. 1980).
Id. at 1159.
Id.
935 F.2d 1164 (10th Cir. 1991).
Id. at 1167.
36
Financial Institution Bonds
In its next encounter with manifest intent, the Tenth Circuit was not
nearly as generous. In FDIC v. United Pacific Insurance Co.147 the bank
sustained large loan losses at the hands of its president, who was also a
major shareholder. The jury found for the bank, and United Pacific
appealed, challenging five separate jury instructions addressing the
question of manifest intent.
The first two jury instructions instructed the jury on the definition of
manifest intent, explaining that manifest intent “does not require that the
employee wish for or desire a particular result, but it does require that the
results be substantially certain to happen.”148 Without attempting to
distinguish its prior decision in Transamerica, the court relied upon the
Sixth and Seventh Circuit decisions in St. Paul Fire149 and Heller in
finding that manifest intent “does not require that the employee actively
wish for or desire a particular result.”150 The court upheld the
instructions, holding that “manifest intent exists when a particular result
is substantially certain to follow from the employee’s conduct.”151 The
court’s decision is troubling in that it offers no explanation for adopting
the substantial certainty test and in no way attempts to distinguish its
earlier opinion in Transamerica.
The court’s approval of Instructions 36 and 37 is even more
problematic. These instructions provided, in pertinent part:
Instruction 36: . . . You may consider it reasonable to draw the
inference and find that a person intends the natural and probable
consequences of acts knowingly done and knowingly omitted.
Instruction 37: . . . There was an intent to cause the bank to sustain a
loss if the natural result of [the president’s] conduct would be to injure
the bank even though it may not have been his motive.152
The court’s explanation of its approval of Instructions 36 and 37 is
confusing at best. It first observed that the instructions correctly
permitted the jury to infer intent from results that were the “natural and
147.
148.
149.
150.
151.
152.
20 F.3d 1070 (10th Cir. 1994).
Id. at 1077.
St. Paul Fire, 942 F.2d 1032.
Id. at 1078.
Id.
Id. at 1077-78.
Employee Dishonesty
37
probable consequences of acts knowingly done,” but then noted that the
jury was correctly “required to find [the president’s] intent to cause a
loss, and benefit himself ‘as plainly or palpably evident or certain,
apparent or obvious.’”153 Yet, approval of Instructions 36 and 37
arguably permits a jury to find manifest intent without attempting to
search the employee’s state of mind. In fact, Instruction 37 appears to
rise to the level of an impermissible mandatory instruction.
The court’s approval of Instruction 38 is even more troublesome.
This instruction provided, in pertinent part:
Instruction 38: If a person lacks knowledge that a statement is false
only because he closes his eyes to the truth, or otherwise displays a
reckless disregard for the truth, you may reasonably infer that person
acted with manifest intent. In other words, you may infer a willful
intent based upon a person’s reckless indifference to the truth. 154
The Tenth Circuit had occasion to revisit the issue most recently in
FDIC v. Oldenburg.155 Oldenburg involved an effort by senior officers
and directors of State Savings and Loan Association of Salt Lake City to
save a failing real estate finance company owned by the new owner of
State Savings by having State Savings purchase a $4.1 million piece of
real estate from the company for nearly $56 million. After a bench trial,
the court ruled in favor of the FDIC, finding that both the president and
the general counsel of State Savings had acted with the manifest intent to
cause the institution to sustain a loss. After quoting from its prior
opinions in Transamerica and United Pacific, essentially to the effect
that manifest intent may be established by showing that the particular
result is substantially certain to follow from the employee’s conduct, the
court reviewed in some detail the evidence in support of the trial court’s
finding that the general counsel had acted with the manifest intent to
cause the institution to sustain a loss. Then, without any explanation, the
court noted: “Because even ‘evidence of reckless conduct can support an
inference of manifest intent,’ we think the evidence is sufficient to
153. Id.
154. Id. at 1078.
155. 34 F.3d 1529 (10th Cir. 1994).
38
Financial Institution Bonds
support the district court’s finding that [the general counsel] acted with
the manifest intent to cause State Savings to suffer a loss.”156
While the court’s pronouncement should not be surprising in light of
its decision in United Pacific, it is slightly more troublesome. The court’s
opinion in United Pacific could be explained, to some extent, by the fact
that underlying the court’s decision was its finding that the instructions,
when viewed in their entirety, accurately instructed the jury.157 However,
the court’s decision in Oldenburg will likely be cited for the proposition
that recklessness alone can support an inference of manifest intent.
Whether the Tenth Circuit truly intended to go so far remains to be seen,
but is at least questionable given the court’s review of the record, which
it found supported the district court’s decision.
3. Specific Intent Test
The specific intent test is the only test that requires the insured to
establish that its employee acted with the true subjective intent, desire, or
purpose to cause a loss. The better reasoned decisions, including those
by the Second, Third, Fourth and Fifth Circuits, as well as various district
courts, have adopted the specific intent test.
Perhaps the most thorough analysis of the differing tests is found in
the Third Circuit’s decision in Resolution Trust Corp. v. Fidelity &
Deposit Co. of Maryland,158 in which the court adopted the specific
intent standard. The Third Circuit began its consideration of the manifest
intent issue by reviewing the purpose and history behind this provision of
the bond. In so doing, the court acknowledged that the SFAA introduced
the manifest intent provision “to ameliorate the effect of previous cases
in which the courts expanded the concept of employee dishonesty to the
point where the term included any act of the employee (or any failure to
act), regardless of motive.”159 Important to the court’s analysis was the
fact that the SFAA added the manifest intent language to the bond in
order to “clarify the SFAA’s long-standing intent, dating back to Standard
Form No. 1 in 1916, to limit loan losses to claims in which the culpable
employee acted with the intent or purpose to gain a benefit at the
156.
157.
158.
159.
Id. at 1541 (citation omitted).
United Pac., 20 F.3d at 1078.
205 F.2d 615 (3d Cir. 2000).
Id. at 638.
Employee Dishonesty
39
expense of his employer—in other words, when the employee intended
to defraud the insured bank of money.”160
With the above background in mind, the court correctly noted that
the primary divergence of opinion in the case law had been on the
question of whether the intent part of the manifest intent provision
“requires an inquiry into the employee’s actual purpose in engaging in
the conduct at issue.”161As the court observed, other circuits appear
equally split between the specific intent test and the more relaxed
substantial certainty test. In reviewing these decisions and various
scholarly articles, the court observed that the substantial certainty test is
equivalent to the tort or criminal law standard of “general intent,” while
the test requiring a showing of specific intent or purpose “may be
analogized loosely to the concept of ‘specific intent’ in the criminal law
context.”162 In reaching this conclusion, the court relied upon an article
by one of the authors in which it was also suggested that courts adopting
anything other than the “specific intent” test in defining the term
manifest intent employ a legal fiction.163 This is due to the fact that the
common, everyday dictionary definition of “intent” is straightforward; it
means a person’s purpose or design.164 Any other construction of the
term must be fictional.
The Third Circuit carefully considered the distinction between the
differing standards, including adoption of the general intent and specific
intent standards in older criminal law cases and in tort law, as well as
under the Model Penal Code, and agreed that the specific intent standard
should be applied to the bond.165 The court held:
We agree with the approach espoused by the Courts of Appeals for the
Second, Fourth, and Fifth Circuits, and hold that the term “manifest
intent” as it is used in the fidelity provision requires the insured to
prove that the employee engaged in dishonest or fraudulent acts with
160.
161.
162.
163.
Id. (emphasis added).
Id. at 637.
Id. at 639, 640.
Id. at 638-40 (citing Michael Keeley, Employee Dishonesty Claims:
Discerning the Employee’s Manifest Intent, XXX TORT & INS. L.J. 915,
927 (Summer 1995)).
164. Id. at 921 (citing WEBSTER’S THIRD NEW INTERNATIONAL DICTIONARY
1375 (1976)).
165. Id. at 639.
40
Financial Institution Bonds
the specific purpose, object or desire both to cause a loss and to obtain
a financial benefit.166
The court explained its decision as follows:
Inasmuch as we equate the “substantially certain to result” standard
with the mental state “knowingly,” we are of the view that “purposely”
rather than “knowingly” better captures the meaning of “intent” as it
[is] used in the fidelity provisions, given the history that prompted its
inclusion in the dishonesty definition and its stated purpose. Indeed,
we believe that our construction strikes an appropriate balance because
it comports with the drafters’ obvious intent to limit the types of
employee misconduct covered by this provision but ensures that proof
of the employee’s recklessness and the substantial likelihood of loss
factor into the ultimate inquiry into the employee’s subjective state of
mind.167
The court’s holding truly is right on the money. Intuitively, it seems
easy to apply the specific intent standard to the bond, particularly given
the clear, simple, everyday meaning of the term “intent.” However,
courts have struggled with doing so, perhaps because it is equally
attractive to hold a person responsible for actions that were “substantially
certain” to lead to a particular result. As the Third Circuit points out, an
employee’s actual subjective state of mind virtually is impossible to
prove, absent resort to circumstantial evidence — that is, objective
indicia of intent.168 Thus, in order to prove the employee’s subjective
purpose, the insured should be permitted to introduce objective evidence
of the employee’s intent. And, “inasmuch as proof of recklessness
and/or the employee’s knowledge of the likelihood that a loss was to
result both serve as manifestations of the employee’s purpose or design,”
those factors may be considered, along with any other objective indicia
of intent, in ascertaining the employee’s state of mind.169 Thus, while the
specific intent standard does require an ultimate finding that the
dishonest employee acted with the specific intent, or purpose, to cause
his or her employer to sustain a loss, this standard does indeed strike an
166.
167.
168.
169.
Id. at 642.
Id.
Id.
Id. at 643.
Employee Dishonesty
41
acceptable balance because it permits the fact finder to consider evidence
that the employee acted recklessly and with the knowledge that harm was
substantially certain to follow. It is important to recognize, though, that
in reaching its conclusion, the court was by no means equating
recklessness with manifest intent. Far from it, the court was careful to
warn that “neither an employee’s recklessness or his knowledge that a
result was substantially certain to occur would satisfy the language of the
policy, absent that inference of specific intent.”170
Unfortunately, while the court’s actual holding seems to leave no
question that it adopted the specific intent test, as is all too often the case,
the application of this test of the facts seems to muddy the waters. In
analyzing whether the district court properly denied F&D’s motion for
summary judgment on the issue of employee dishonesty, the court
explained that it had made a complete study of the record to determine
whether there was sufficient evidence from which a jury could conclude
that the allegedly dishonest employees acted with the purpose or desire
of causing the insured to sustain a loss.171 The Third Circuit agreed with
the district court’s ultimate conclusion that the circumstances of the case
presented a genuine issue of material fact concerning the allegedly
dishonest employee’s manifest intent. The court reasoned that, given
“the unique facts of this case, there are many possible conclusions that
could be drawn concerning the employee’s purpose.” Problematically,
the court went on to observe:
As we have held that a jury may consider evidence tending to establish
an employee’s reckless behavior, as well as circumstantial proof of the
substantial likelihood of loss, and infer from those circumstances an
intent to cause a loss, we believe that the facts of this case are such that
a reasonable jury could draw the conclusion that the employees
intended for [the insured] to be saddled with the Northwest loan
loss . . . . Put simply, a jury would be required to consider all of the
evidence in reaching its ultimate finding regarding the employee’s
subjective intent in engaging in the conduct that they did, and we will
not pretermit the jury’s ability to do so.172
170. Id. at 642.
171. Id. at 652.
172. Id. at 653.
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Financial Institution Bonds
Given the court’s earlier finding that there were “many possible
conclusions that could be drawn concerning the employee’s purpose,”
the above comments by the Third Circuit are unnecessary to its ultimate
conclusion, and thus constitute dicta. Nevertheless, they are bothersome
in that, although ultimately concluding that a jury must consider “all of
the evidence,” the court nevertheless suggests that a jury could infer from
evidence of recklessness as well as circumstantial proof of the substantial
likelihood of a loss, that the employee acted with the purpose to cause
the loss. This dicta is directly contrary to the court’s holding that
“neither an employee’s recklessness nor his knowledge that a result was
substantially certain to occur would satisfy the language of the policy,
absent that inference of specific intent.173
Almost exactly one month following the Third Circuit’s decision in
RTC, and in at least partial reliance upon the Third Circuit’s decision, the
Second Circuit appeared to reach a similar conclusion in Federal Deposit
Insurance Corp. v. National Union Fire Insurance Co. of Pittsburgh,
PA.174 In this case, the district court entered summary judgment in favor
of the FDIC, finding that the former bank employee did have the
manifest intent to cause the bank to sustain a loss. The Second Circuit
began its analysis by recognizing that the test to be used is “essentially
subjective with a necessary objective requirement in that an employee’s
actions can circumstantially establish that the employee acted with the
manifest intent to cause the insured a loss.”175 While not conducting
nearly the in depth analysis that led to the Third Circuit’s decision, the
Second Circuit nevertheless considered several of its prior opinions, as
well as opinions by the New York Court of Appeals, in reaching what
appeared to be its final holding, as follows:
Having determined that a court should examine objective indicia of
intent and that recovery under a fidelity bond requires that the
employee acted with the purpose or desire of causing his employer a
loss, we now examine the related issue of what evidence
173. Id. at 441-42.
174. 205 F.3d 66 (2d Cir. 2000).
175. Id. at 72.
Employee Dishonesty
43
circumstantially demonstrates that the employee acted with the specific
purpose to cause the insured harm.176
Problematically, the court went on to conclude: “Finally, manifest
intent does not require that the employee actively wish for or desire a
particular result, but can exist when a particular result is substantially
certain to follow from the employee’s conduct.”177 At this point, the
careful reader of the court’s opinion must be left shaking his or her head.
Obviously, this part of the court’s holding is entirely inconsistent with
the first part of its holding, which appears at the beginning of the very
same paragraph of the court’s opinion.
One could speculate about the reason for this internal inconsistency
in the court’s opinion. It is also tempting to dismiss the concluding
remark by the court as mere dicta. Yet, the court’s concluding comment
cannot be so easily disregarded. The court’s opinion is perhaps even
more disturbing because it cites to the Third Circuit’s opinion in RTC v.
Fidelity & Deposit Co. of Maryland,178 in which the Third Circuit
specifically lists the Second Circuit as being one which already had
adopted the specific intent standard.179
If the Second Circuit truly intended to adopt the substantial certainty
or general intent standard, one must ask why, after considering the
evidence on the issue of manifest intent and affirming summary
judgment in favor of the FDIC, the court felt compelled to point out that
the insured’s employee acted with “personal certainty” that a loss would
result: “This evidence demonstrates that Folks’s intent toward the Bank
was ignoble, rather than just improvident and reckless. Folks did more
than risk a loss—he acted with the personal certainty that loss would
result.”180 Why, one must ask, would the court go to the trouble of
making this point if it did not intend to require a showing that the
employee acted with the purpose of causing the insured to sustain a loss?
176.
177.
178.
179.
Id. at 73-74 (emphasis added).
Id. (emphasis added).
205 F.2d 615.
Id. at 639 (citing Glusband v. Fitten Cunningham & Lauzon, Inc., 892
F.2d 208, 210-12 (2d Cir. 1989)).
180. 205 F.3d at 75.
44
Financial Institution Bonds
Another thorough discussion of the manifest intent issue is the Fifth
Circuit’s opinion in First National Bank v. Lustig.181 In Lustig the Fifth
Circuit reversed a summary judgment that had been granted in favor of
the insured bank based largely upon a withdrawn plea of guilty to
making false entries in bank records. A young commercial real estate
loan officer allegedly altered numbers on his analyses of loans, distorted
credit histories, lied about loan approvals, and otherwise failed to follow
established procedures. Eight of his loans eventually failed. The officer
ultimately admitted that he had fabricated credit references on the eight
loans. In a handwritten statement he acknowledged that he had “falsified
the information to make good loans and get recognition at FNBL, not to
get personal gain from customers.”182 The insured lost $20 million as a
result.
As to whether the officer possessed the manifest intent to cause the
bank a loss, the Fifth Circuit addressed this element as a continuum
consisting of three zones.183 The first zone covers acts of embezzlement
which, it held, always demonstrate an intent to cause the bank a loss
because his gains come only at the bank’s expense.184 The third, or
opposite zone, covers dishonest acts by employees which can only
benefit the employee if the bank also benefits. Such acts do not show a
manifest intent to cause the bank a loss.185 The second zone, lying
between the other two, covers all other possibilities. “In these situations
intent becomes a question of fact which will generally not be subject to
summary judgment.”186
In rejecting the district court’s reliance upon an earlier Fifth Circuit
case, Merchants & Farmers State Bank v. Fidelity & Casualty Co.,187 the
court pointed out that the bond in the Merchants & Farmers case did not
have a manifest intent requirement, and as a result, the holding in that
case—that “it was enough that the employee had a manifest intent to
deceive, even if there was no intent to cause a loss”—was not
181.
182.
183.
184.
185.
186.
187.
961 F.2d 1166, 1167 (5th Cir. 1992).
Id. at 1164.
Id. at 1165.
Id. at 1166.
Id. at 1167.
Id.
791 F.2d 1141 (5th Cir. 1981).
Employee Dishonesty
45
applicable.188 Without explicitly stating as much, the court appears to
have recognized that the “manifest intent” requirement of the bond
requires “specific intent” to cause a loss.
As an example of a case in which the employee did intend to deceive
the bank, but did not have the manifest intent to cause the bank a loss,
the court paraphrased the Tenth Circuit’s holding in First Federal
Savings & Loan v. Transamerica:189
The court found that the employee’s poor judgment in making these
loans was not evidence of his manifest intent to cause the bank a loss,
however likely such a loss may be where the undisputed evidence
demonstrated that the employee hoped that the loans would benefit
both the bank and the borrower.190
The Lustig court’s paraphrasing of the Tenth Circuit’s decision is
important because it appears to preclude reliance upon the general intent
standard of tort and criminal law. As demonstrated by the Morton Grove
decision, using such a test allows a finding of manifest intent when the
employee knows that his actions are substantially certain to cause a loss,
regardless of whether the employee prefers that the bank not be harmed,
or even prefers the bank to benefit.191 The Fifth Circuit’s comments seem
to indicate that manifest intent to harm cannot be found when the
employee hoped to benefit the bank, regardless of the likelihood, or
certainty, of a loss.
The Fifth Circuit went on to explain that, in assessing an employee’s
state of mind to determine whether he acted with manifest intent, one
must not look solely to the employee’s explanation:
The jury should be instructed that in answering the question of intended
loss it should consider the range of evidentiary circumstances,
including the relationship between the borrowers and the employee, the
employee’s knowledge of the likelihood that the loans would not be
188.
189.
190.
191.
Lustig, 961 F.2d at 1166.
935 F.2d 1164 (10th Cir. 1991).
Lustig, 961 F.2d at 1166 (emphasis added).
Morton Grove, 1992 WL 91761, at *4.
46
Financial Institution Bonds
repaid, and all the other surrounding circumstances bearing on the
employee’s purpose.192
By focusing on the employee’s purpose, the court again arguably
recognizes the specific intent requirement of the bond. And by
recognizing that the jury must look beyond direct evidence of manifest
intent to all of the surrounding circumstances, the court simply
recognized the obvious: modern science has not progressed so far that
one can look into a person’s mind and accurately assess his mental state.
Instead, in order to determine intent, one must consider all of the facts
and circumstances relevant to an assessment of the employee’s state of
mind.
The Fifth Circuit’s decision in Lustig has been criticized as falling
within the objective standard camp because the court recognized that
intent could be inferred from the employee’s reckless conduct, thereby
purportedly expanding the scope of coverage well beyond the confines of
embezzlement to an area loosely labeled “fiduciary compromise.”193
Although such a conclusion may be understandable if one focuses solely
upon that part of the court’s opinion suggesting that manifest intent may
be inferred from an employee’s “reckless conduct and surrounding
circumstances,” it overlooks the remainder of the court’s opinion,
particularly the part explaining that “in answering the question of
intended loss,” the jury “should consider the range of evidentiary
circumstances.”194 Thus, far from following an objective test, the court
clearly emphasized the employee’s subjective state of mind. The court
simply recognized that divining state of mind necessarily involves
reliance upon inferences from tangible manifestations of behavior.195
An excellent example of the differing results that can occur when
one test is chosen over the other is the district court’s decision in
Progressive Casualty Insurance Co. v. First Bank.196 In First Bank the
insured lost over $2 million as a result of losses on loans made by its
192. Lustig, 961 F.2d at 1166-1167 (emphasis added).
193. Christopher Kirwan, Mischief or “Manifest Intent?” Looking for
Employee Dishonesty in the Unchartered World of Fiduciary Misconduct,
XXX TORT & INS. L.J. 183, 193 (1994).
194. Lustig, 961 F.2d at 1166-67.
195. Id. at 1166.
196. 828 F. Supp. 473 (S.D. Tex. 1993).
Employee Dishonesty
47
former president. The court specifically recognized that the former
president had made loans either without adequate documentation or
without any documentation, without loan committee approval, and to
personal friends on favorable terms, that when other borrowers fell into
difficulty he had lowered their interest rates and extended maturity dates,
that he had failed to take possession of stock pledged to the bank, that he
had misrepresented the financial condition of borrowers and overvalued
collateral, and that he had released collateral on certain outstanding
loans. After twenty months of litigation, Progressive filed a motion for
summary judgment, arguing that the bank had failed to submit any
evidence that the former president had the manifest intent to cause the
bank to sustain a loss. The bank essentially argued for application of an
objective standard, maintaining that the former president “would have
acted the way he did only if he had a secret gain.”197
The court could have concluded that the loan officer had acted
“dishonesty” by violating bank policies and found coverage. Instead, the
court recognized that the mere violation of bank policies is not
tantamount to dishonest conduct. The court reasoned:
[The former president] may have been imprudent in taking improper
risks and in making loans to friends, and he was clearly wrong in not
disclosing material facts to the board and in not recording all
transactions in the proper records, but without more, only speculation
can turn that conduct into dishonesty or malice.198
The court’s analysis of why reckless conduct alone is not enough for
coverage is particularly insightful:
The bank infers that [the former president] would have acted the way
he did only if he had a secret gain. On the contrary, in every period of
excess, like a boom, the hard lessons of experience and training, as well
as common sense, are ignored. Sound practices give way to loose
practices. The collapse of oil prices in 1986 produced a banking crisis.
Many of the honest loans—loans made in what then passed for the
normal course of business in Texas banks—were speculative to
impossible credit risks. . . .
197. Id. at 474.
198. Id.
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Financial Institution Bonds
There is simply no evidence that [the former president] received a
financial benefit or that he intended for the bank to sustain a loss . . . .
The bond is not credit insurance to protect the lender against
improvident or reckless extensions of credit. 199
If manifest intent could be inferred from recklessness alone, surely
the former president of First Bank would have been found to have acted
with the manifest intent to cause First Bank to sustain a loss. As both the
district court and the Fifth Circuit in Lustig reasoned, however,
recklessness alone is not enough. Rather, all surrounding circumstances
must be viewed in determining the employee’s manifest intent. In First
Bank those circumstances revealed no evidence of an intent to cause the
bank a loss.
The Fourth Circuit has also adopted the specific intent standard. In
General Analytics Corp. v. CNA Insurance Cos.,200 a disgruntled
employee of General Analytics altered purchase orders in which the
Internal Revenue Service attempted to purchase certain computer
equipment from General Analytics. An employee altered the forms to
change the “product, quantity, and price information” to make it appear
that the IRS was ordering Pioneer Research Corporation products when it
actually was ordering a different brand. When General Analytics shipped
the Pioneer products to the IRS, the IRS refused to accept delivery. And,
because Pioneer refused return of the products, and General Analytics
could not sell them to other customers, General Analytics sustained a loss
of approximately $100,000.00. The district court entered summary
judgment in favor of General Analytics, but the Fourth Circuit reversed.
In adopting the insurer’s position that a showing of specific intent is
necessary under Insuring Agreement (A), the court began its analysis by
noting that the bond is designed to “provide coverage for a specific type
of loss characterized by embezzlement, which involves the direct theft of
money.”201 Importantly, the court explained that Insuring Agreement (A)
199. Id. (citations omitted).
200. 86 F.3d 51 (4th Cir. 1996).
201. Id. at 53, citing Michael Keeley, Employee Dishonesty Claims:
Discerning the Employee’s Manifest Intent, XXX TORT. & INS. L.J. 915,
919 (1995).
Employee Dishonesty
49
of the bond requires the insured to establish a specific intent, “analogous
to that required by the criminal law.”202 The court explained:
Thus, if a dishonest act has the unintended effect of causing a loss to
the employer or providing a benefit to the employee, the act is not
covered by the policy. Stated succinctly, employee dishonesty coverage
insures against ‘loss caused by a thief,’ as opposed to a fool or
saboteur, ‘who happens to be an employee of the insured.’ 203
The court then went on to recognize that, in attempting to discern an
employee’s manifest intent, a subjective test must be utilized:
As a state of mind, intent is often difficult to prove, and because it is
abstract and private, intent is revealed only by its connection with
words and conduct. (citation omitted). Thus, evidence of both words
and conduct is probative of intent (citation omitted), and, because
context illuminates the meaning of words and conduct, evidence of the
circumstances surrounding such words or conduct, including the motive
of the speaker or actor, similarly is admissible. 204
The court then offered the following example:
Thus, for example, the mere fact that a person discharges a firearm,
killing a bystander, does not establish that the person holding the
firearm shot the bystander with the intent to kill him. On the other hand,
evidence that the person had just quarreled with the bystander (motive),
that the person said, after shooting the bystander, ‘he deserved it’
(subjective expression), and that the person was seen aiming the
firearm at the bystander (conduct), tends to establish the person’s intent
to kill the bystander.205
In conclusion, the court noted that it “is readily apparent that
determining intent is fact-intensive, and when the circumstantial
evidence of a person’s intent is ambiguous, the question of intent cannot
be resolved on summary judgment.”206
202.
203.
204.
205.
206.
Gen. Analytics Corp., 86 F.3d at 54.
Id.
Id.
Id.
Id.
50
a.
Financial Institution Bonds
Other Recent Cases
Several other recent cases are instructive.
In Federal Deposit Insurance Corp. v. St. Paul Fire and Marine
Insurance Co.,207 Ramsey was a shareholder of the parent corporation of
Farmers Bank & Trust, as well as the President and a board member of
the bank. Ramsey approved loans for several friends and business
associates without making normal credit checks and without going
through the normal mechanisms for approving loans. Ramsey also had
an interest in each of the projects that the loan proceeds were to be used
for. On appeal, the FDIC, which had taken over the failed bank, argued
that the “financial suicide” approach employed by the district court in
finding for the insurer had to be wrong because Ramsey also had been
found to have embezzled money from the bank. The Sixth Circuit
disagreed, reasoning as follows:
[W]e think the district court correctly determined that it was highly
unlikely that Ramsey had the “manifest intent” to cause a significant
injury to an entity in which he had a major financial stake.
Furthermore, the loans approved by Ramsey went to help his friends
invest in enterprises that he had a financial stake in. If the phrase “put
your money where your mouth is” says anything about you in nature, it
means that Ramsey sincerely hoped that those enterprises would
flourish, and supply the needed stream of income to pay off the loans.
He turned out to be wrong. This mistake is, however, no different
qualitatively from the mistakes in Municipal Securities, Glusband, or
First Federal. Like the FDIC, we are disturbed by Ramsey’s apparent
indifference for the distinction between his own personal affairs and
those of [the bank]. His actions may have constituted a grave breach of
his fiduciary duty. Nonetheless, we do not believe that they fall within
the operative language of the fidelity bond. And the district court was
right about one thing, when the whole house of cards came crashing
down, Ramsey was the one pinned under the wreckage. 208
207. 942 F.2d 1032 (6th Cir. 1991).
208. Id. at 1037.
Employee Dishonesty
51
In Investors Trading Corp. v. Fidelity & Deposit Co. of Maryland,209
two employees of the insured retail securities broker violated the
insured’s policy prohibiting the trading of uncovered index options in an
employee’s personal trading account by making very risky trades that the
employer ultimately suffered the loss on because neither employee was
able to meet the margin calls that resulted. The insured argued that
because the employees knew that any losses resulting from their trades
would be borne by the insured, a fact issue existed as to the employees’
manifest intent. The court disagreed, reasoning as follows:
[K]nowledge that an employer will bear responsibility for losses an
employee sustains in excess of its resources is not the same thing as
intending to cause a loss to an employer. In this case, the undisputed
facts are that neither [of the employees] desired to cause a loss to [the
insured]. On the contrary, both employees wanted to make money off
their trading activities. The knowledge that [the insured] would bear
the losses, if any, simply created the security blanket for them to allow
them to engage in the trades.210
In Shoemaker v. Lumbermens Mutual Casualty Co.211, the insured
company provided guardianship services to the deceased prior to his
death. After his death, an employee of the insured was appointed
administrator of the estate. The insured paid the administrator
$93,639.22, which he deposited into an account in the name of the
deceased’s estate. The administrator then illegally wrote fraudulent
checks from the account that were payable to him and other parties for
services that were never actually rendered to the estate. The court noted
that when looking at the point in time when the administrator’s acts were
committed, there was no basis for concluding that he intended to cause a
loss to anyone other than the Ross Estate. Given that the evidence could
show “no inference of specific intent or purpose to cause [the insured] a
loss,” the court granted summary judgment in the insurer’s favor.212
209. No. 3:12-CV-2176-P, 2004 U.S. Dist. LEXIS 25906 (N.D. Tex. Dec. 22,
2004).
210. Id. at *6.
211. 176 F. Supp. 2d 449 (W.D. Penn. 2001).
212. Id. at 455.
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Financial Institution Bonds
Finally, in Fireman’s Fund Insurance Co. v. Special Olympics
International, Inc.,213 an area manager for a charity engaged in a
purported fundraising campaign using the charity’s name, but without its
knowledge, and absconded with the money. The First Circuit concluded
that this fact scenario “falls outside even a broad interpretation of what it
means for an employee to have ‘manifest intent to . . . [c]ause [the
employer] to sustain a loss.’ Contrary to [the insured’s] assertion, [the
employee’s] obvious intention to enrich himself reflects neither an
expectation that his dishonesty would inflict the loss on his employer nor
the inevitability of such an outcome.”214
4. Secondary Mortgage Market Claims
The recent financial and lending crisis has led to significant loan
losses in the secondary mortgage market. An interesting issue that can
arise when an insured seeks recovery for such a loss is whether an
employee of a mortgage originator, such as a bank, mortgage company
or mortgage broker, acted dishonestly and with the manifest intent to
cause his or her employer to sustain a loss when he or she fabricates
certain loan documents so that the loan can be originated and sold on the
secondary market. For instance, in Direct Mortgage Corp. v. National
Union Fire Insurance Co.,215 the insured originated mortgages through
its broker network and sold them to financial institutions on the
secondary market. The insured was obligated under the sales agreements
to repurchase any loans later discovered to have been fraudulently
conveyed. After discovering that an employee of the originating bank
had falsified various documents necessary to close some of the loans, the
purchasing financial institutions demanded that the insured repurchase
them. After settling with the institutions, the originating lender made a
claim under its fidelity bond for the loss incurred from repurchasing the
loans. The court ultimately found that there was no coverage because the
insured’s loss was indirect. The court adopted a "direct means direct"
standard, holding that the policy covered only actual depletion of the
insured's assets and not the insured's liability to a third party. The issue
213. 346 F.3d 259 (1st Cir. 2003).
214. Id. at 263.
215. No. 2:06-CV-534-TC, 2008 WL 3539804 (D. Utah 2008).
Employee Dishonesty
53
of the employee’s manifest intent was not raised, but certainly could
have been.
Similarly, in RBC Mortgage Co. v. National Union Fire Insurance
Co.,216 a loan officer for the insured mortgage broker prepared fraudulent
loan packages, including counterfeit credit reports, falsified appraisals
and forged income verifications from straw borrowers. The employee
submitted the loan packages to a mortgage company, which funded the
loans and ultimately sold them to investors. After discovery of the fraud,
the mortgage company sued the insured. The insured settled the lawsuit
and then submitted a claim under its fidelity bond. The court upheld a
motion to dismiss in favor of the insurer, finding that the insured's losses
did not result directly from the employee's conduct but from the insured's
breach of the warranty contained in the brokerage agreement.
Although neither court addressed the "manifest intent" standard, the
insured in both cases could likely have argued that the employees did not
have requisite intent to cause the insured a loss. Obviously it is
guesswork to determine the employee’s intent without knowing the
actual underlying facts. However, it is easy to imagine a situation where
an employee was fabricating loan documents to help his or her employer
sell loans, and thereby earn a profit. In that situation it would seem to be
a stretch to argue that the employee intended to cause his or her
employer to sustain a loss. And, what about the situation where the
employee fabricated loan documents in order to earn additional
commissions? Aside from the fact that the commissions would
constitute an emolument of employment, and thus the loss not be
covered, could it fairly be said that the employee acted with the manifest
intent to cause his or her employer a loss? Where the employee knew
that the originating lender was going to be selling the loans on the
secondary market, it certainly is arguable that his or her conduct was not
committed with the intent to cause the originating lender a loss. This is
especially true where, as in RBC Mortgage, the employee works for a
brokerage company that does not actually lend any funds, and who is
arguably less likely to expect that his company will be held liable to the
downstream purchaser of his fictitious loan packages.
216. 812 N.E.2d 728, 715 (D. Ill. 2004).
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Financial Institution Bonds
D. Active and Conscious Purpose Provision of 2004 Bond
As indicated above, the SFAA revised the 2004 Bond by substituting
“active and conscious purpose” for the term “manifest intent.” The
revised Insuring Agreement (A) now covers: “Loss resulting directly
from dishonest or fraudulent acts committed by an Employee, acting
alone or in collusion with others, with the active and conscious purpose
to cause the Insured to sustain such loss.”217 The new form retains the
$2,500 financial benefit requirement for loan losses, and it strengthens
the financial benefit requirement by clarifying that “financial benefit”
does not include any type of employee benefit, leaving out the “earned in
the normal course of employment” language which some courts initially
struggled with. The new Insuring Agreement also specifies that “loss
does not include any employee benefits . . . .”
As Edward Gallagher, the General Counsel for the SFAA has
explained, the SFAA considered using the term “specific intent” instead
of manifest intent.218 However, it chose “active and conscious purpose”
because it is the Model Penal Code’s highest standard of intent.219
Although the revised language of the 2004 Bond appears crystal
clear, it seems inevitable that debate will occur concerning its precise
meaning. Any such debate should be short lived, however, given the
clear meaning of this term under the Model Penal Code, in light of the
United States Supreme Court’s comments about this section of the Code,
and because the same or similar terms have been utilized by various
courts in applying the specific intent test in construing the manifest intent
requirement.
As discussed above, the Model Penal Code has four levels of
culpability. The highest level uses the term “purposely,” although some
states that have adopted the Model Penal Code have substituted the term
“intentionally” for the term “purposely.” Regardless, the Model Penal
Code specifically provides that a person acts purposely concerning the
result of his conduct if it is “his conscious object” to “cause such a
result.”220 Importantly, in discussing the culpability levels of the Model
Penal Code, the United States Supreme Court has explained that “a
217.
218.
219.
220.
2004 Bond, Insuring Agreement (A).
Gallagher and Duke, supra note 38, at 9-10.
Id. at 10 (citing MPC § 2.02).
MPC § 2.02(2)(a)(i).
Employee Dishonesty
55
person who causes a particular result is said to act purposely if ‘he
consciously desires that result, whatever the likelihood of that result
happening from his conduct . . . .’”221 And, in another case discussing a
possible criminal antitrust violation, the Court explained the distinction
between the purpose and knowledge levels of culpability of the Model
Penal Code as follows:
[T]he Code enumerates four possible levels of intent – purpose,
knowledge, recklessness, and negligence. In dealing with the kinds of
business decisions upon which the antitrust laws focus, the concepts of
recklessness and negligence have no place. Our question instead is
whether a criminal violation of the antitrust law requires, in addition to
proof of anti-competitive effects, a demonstration that the disputed
conduct was undertaken with the “conscious object” of producing such
effects, or whether it is sufficient that the conduct is shown to have
been undertaken with knowledge that the prescribed effects would most
likely follow.222
Finally, while the above decisions by the United States Supreme
Court should avoid any serious debate concerning the meaning of “active
and conscious purpose,” it also is noteworthy that various courts that
have considered the meaning of the manifest intent provision of Insuring
Agreement (A) have included a discussion of the purposeful and
knowing requirements of the Model Penal Code.223 These decisions
essentially recognize that purposeful is the highest level of culpability
and require a showing that the employee acted with the conscious
purpose to cause her employer a loss.
E. Specific Intent Provision of the FICP
As noted above, ISO chose to utilize the term “specific intent” for
the FICP. In some respects, one might expect courts to have even less
difficulty construing the specific intent provision because many courts
have used this term as one of the three tests for defining manifest
221. U.S. v. Bailey, 444 U.S. 394, 404 (1980).
222. U.S. v. U.S. Gypsum Co., 438 U.S. 422, 444 (1978).
223. See, e.g, RTC, 205 F.3d at 642; Nat’l Fire Ins. Co., 205 F.3d at 72; Gen.
Analytics Corp., 86 F.3d at 54.
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intent.224 For instance, in discussing the meaning of manifest intent, the
Fourth Circuit explained: “Because employee dishonesty policies like
CNA Insurance’s require proof that the employee have acted to
accomplish a particular result, they require that the insured establish a
specific intent, analogous to that required by the criminal law.225
Similarly, the Third Circuit has noted that the “‘manifest intent’
requirement may be analogized loosely to the concept of ‘specific intent’
in the criminal context.226 Further , various scholarly articles relied upon
by those courts construing the term manifest intent discuss the general
intent/specific intent dichotomy and conclude that the term manifest
intent is equivalent to the common law requirement of specific intent,
requiring proof that the employee desired the results of his conduct.227
While there clearly was confusion over the distinction between
general intent and specific intent at common law,228 in hindsight it is
clear that the term specific intent requires proof that the actor
consciously desired the result of his conduct. In U.S. v. Bailey,229 the
Supreme Court recognized the confusion that existed at common law
between the terms general intent and specific intent, but went on to note
that specific intent essentially was equivalent to the Model Penal Code’s
highest level of culpability, “purpose.”230 The court explained: “In a
general sense, ‘purpose’ corresponds loosely with the common-law
concept of specific intent, while “knowledge” corresponds loosely with
the concept of general intent.”231
224. See, e.g., RTC, 205 F.2d at 639-642; Gen. Analytics Corp., 86 F.3d at 54.
225. 86 F.3d at 54.
226. RTC, 205 F.3d at 639; see also FDIC v. Nat’l Union Fir Ins. Co. of
Pittsburgh, Pa., 146 F. Supp. 2d 541, 550-51 (D.N.J. 2001).
227. See, e.g., Keeley and Koch, Employee Dishonesty: The Essential
Elements of Coverage Under Insuring Agreement (A); Where Are We
Now With “Manifest Intent”?, supra note 1, at 53-60.
228. See supra text accompanying note 81.
229. 444 U.S. 394.
230. Id. at 404.
231. Id.
Employee Dishonesty
57
F. “Intent” Provision of Certain Proprietary Forms
Certain insurers have modified their proprietary policy forms by
deleting the word “manifest” from Insuring Agreement (A) and instead
simply requiring proof that the employee acted with the “intent” to cause
the insured to sustain a loss. Some insureds have argued that by deleting
the word “manifest,” insurers must have intended to broaden coverage.
It would be unfair for the authors to purport to speak for all insurers, but
based upon their knowledge and experience, this argument simply has no
basis in fact.
First, deleting the word “manifest” simply eliminates an adjective
modifying the type of intent that is necessary. Doing so does not in any
way affect the meaning of the separate word “intent.” Rather, deletion of
the adjective “manifest” simply means that the requisite “intent” need not
be apparent, obvious, or readily perceived—all terms falling within the
plain, ordinary, and generally accepted meaning of the word
“manifest.”232
Second, many of the cases discussing the meaning of “manifest
intent” analyze the meaning of the word “intent” separately from the
word “manifest.” As a result, these cases already have construed the
term “intent” for purposes of Insuring Agreement (A). Indeed, this is
precisely what the Third Circuit did in Resolution Trust Corp. v.
Fidelity & Deposit Co. of Maryland. After first recognizing that the term
“manifest” denotes that the intent of the employee must be “apparent or
obvious,” the court then recognized that the real issue was the meaning
of intent.233 The court explained:
The divergence of opinion, however, stems from the issue of whether
the “intent” aspect of the phrase “manifest intent” requires an inquiry
into the employee’s actual purpose in engaging in the conduct at issue.
While the fidelity provision covers only those dishonest or fraudulent
acts undertaken with the manifest intent . . ., the question of the
meaning of “intent” usually arises in the context of determining
whether the proofs show that the former requirement has been satisfied.
Indeed, in virtually all of the cases interpreting the term “intent,” the
232. See, e.g., Gen. Analytics Corp., 86 F.3d at 54; First Fed. Sav. & Loan
Assoc. v. Transamerica Ins. Co., 935 F.2d 1164, 1167 (10th Cir. 1991);
MERRIAM-WEBSTER’S COLLEGIATE DICTIONARY 707 (10th ed. 1998).
233. 205 F.3d at 637.
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analysis has focused on whether the evidence showed that the
employees possessed a “manifest intent” to cause the insured a loss. Of
course, this is not surprising, given the fact that most cases turn on this
element, as it presents difficult proof problems for the insured.234
Similarly, in Federal Deposit Insurance Corp. v. National Union
Fire Insurance Co. of Pittsburgh, Pa., the Second Circuit explained that
in construing the term “manifest intent,” it would first “examine how a
court should discern whether the employee acted with the intent required
under a fidelity bond.”235 And, in General Analytics Corp. v. CNA
Insurance Cos., the Fourth Circuit, also construing the term “manifest
intent,” indicated that: “Establishing intent is central to proving coverage
under employee dishonesty policies.”236
Finally, an effort by an insured to testify that it believed coverage
was expanded by the deletion of the word “manifest” should fail because
the parole evidence rule prohibits evidence of a party’s intent to establish
the meaning of a provision of an insurance policy unless the policy is
ambiguous.237 The authors are not aware of any case finding that
Insuring Agreement (A) is ambiguous. In fact, after discussing the
lengthy history and background of the manifest intent provision of the
policy, the Third Circuit in Resolution Trust Corp. v. Fidelity & Deposit
Co. of Maryland found just the opposite.238 In this decision, the Third
Circuit noted that it had “not overlooked the possibility that one could
argue that given the divergence of opinion concerning the correct
standard for determining the employee’s ‘manifest intent,’ the term is
ambiguous, thus requiring us to invoke the principal of contra
proferentum.”239
234.
235.
236.
237.
Id. at 637-38.
205 F.3d at 71.
86 F.3d 853.
See, e.g., Kelley-Coppedge, Inc. v. Highlands Ins. Co., 980 S.W.2d 462,
464 (Tex. 1998); Balandran v. Safeco Ins. Co., 972 S.W.2d 738, 741
(Tex. 1998).
238. 205 F.3d at 643.
239. Id. Of course, the doctrine of contra proferentum should not be utilized in
any case because the standard form Financial Institution Bond was
finalized only after input from the American Bankers Association. Thus,
courts construing the term “intent to cause a loss” must follow the normal
Employee Dishonesty
59
V.
Collusion and Financial Benefit
While the issue of manifest intent has been the most hotly contested issue
in employee dishonesty claims, proof of collusion and financial benefit
are no less significant, particularly in connection with loan loss claims.
Unless an insured is able to establish that the employee acted in collusion
with another person in connection with the loan, and that the employee
received a financial benefit, it will be unnecessary to reach the often
times more troublesome question of manifest intent. On the other hand,
while proof of collusion and a financial benefit will often be strong
evidence of dishonesty, they do not automatically follow that the
employee acted with the manifest intent to cause a loss, as was noted by
the Sixth Circuit in FDIC v. St. Paul.240
A. Collusion
Unlike the manifest intent requirements of the bond, the collusion
requirement sets forth a more or less objective element that may be
looked to in assessing whether an employee’s actions are intended to be
covered by the bond. Nevertheless, disputes continue to arise concerning
this issue. For instance, is an employee who remains silent about his
knowledge of another’s dishonesty automatically acting in collusion with
his co-worker?
The term collusion is actually found in two places in the bond:
Insuring Agreement (A), and section 12, the termination provision.241
Under Insuring Agreement (A), if some or all of the insured’s loss results
directly or indirectly from loans, that portion of the loss is not covered
“unless the Employee was in collusion with one or more parties to the
transactions . . . .”242 Under section 12, the bond terminates as to any
rules of policy construction. See, e.g., Sharp v. FSLIC, 858 F.2d 1042,
1046 (5th Cir. 1988).
240. 942 F.2d at 1037.
241. 1986 Bond, supra note 9. Section 12 provides that the bond “terminates
as to any Employee . . . as soon as any Insured, or any director or officer
not in collusion with such person learns of any dishonest act committed
by such person at any time . . . .”
242. Id. Insuring Agreement A.
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employee “as soon as any Insured, or any director or officer not in
collusion with such person, learns of such dishonest or fraudulent act
committed by such a person . . . .”243
Although the term collusion is not defined in the bond, it is easily
understood. Webster’s defines “collusion” as: “a secret agreement or
cooperation esp. for an illegal or deceitful purpose.”244 The few cases
considering the issue seem to agree. For instance, in Adair State Bank v.
American Casualty Co., the Tenth Circuit, by its silence, approved the
district court’s specific reliance upon this definition from Black’s Law
Dictionary.245
The collusion requirement of Insuring Agreement (A) emphasizes
that the dishonest employee must have received a financial benefit—a
kickback—from someone; that someone is the person with whom he
colludes in making a dishonest loan. This will typically be the borrower,
although theoretically persons with whom the dishonest employee
colludes are limited only to the employee’s imagination. For instance, a
loan officer might make a perfectly valid loan to a customer, but collude
with a participating bank to cause a loss to the insured.246
In the typical bond claim involving a loan loss, the insured often
presumes that there was collusion between the loan officer and borrower.
However, as a number of courts have pointed out, this is not necessarily
the case. For instance, in Progressive Casualty Insurance Co. v. First
Bank,247 the court explained that, even though the former president of the
bank made loans to personal friends in violation of bank policy,
misrepresented the financial condition of borrowers, and otherwise
improperly made loans, the bond required more: “There must be
collusion, at least inferable, from the banker’s personal secret gain.”248 In
243.
244.
245.
246.
Id.
MERRIAM-WEBSTER’S, supra note 58, at 226.
949 F.2d 1067, 1075-76 (10th Cir. 1991).
For example, a loan officer might make a $1 million loan to Company A,
and sell a $500,000 participation interest to Bank B. If the officer
colludes with Bank B to buy back all or a portion of the participation in
violation of the executive loan committee’s instructions, solely in
consideration for a kickback from Bank B, the loan officer would be
considered to have acted in collusion with Bank B.
247. 828 F. Supp. 473 (S.D. Texas 1993).
248. Id. at 476.
Employee Dishonesty
61
the court’s mind, it was necessary that the borrowers actually be
implicated in the officer’s wrongdoing: “The bank does not allege
borrower dishonesty. The bank’s only complaint is that [the former
president] violated loan policies and violated other bank policies in
covering his original improper actions. These violations in no way
implicate the borrower. Even brothers-in-law may borrow if someone
will lend, when all others will not. Being a bad credit risk is not
dishonesty.”249
Similarly, in Standard Chartered Bank v. Milus,250 the loan officer
allegedly made millions of dollars in uncollateralized loans to two
financially illiquid borrowers in order to ensure that the borrowers did
not default on other loans. The insured claimed that the officer’s
motivation arose from the then pending purchase of the bank by a
subsidiary of the insured. The officer apparently stood to gain personally
from the sale because he owned many shares of the bank’s stock as a
result of the bank’s stock option plan. Though the officer’s stock had
increased in value as a result of the pending sale, it would have decreased
substantially if the sale fell though. The officer apparently felt that if the
loans to the two customers were written off, it would jeopardize the
pending sale of the bank.
USF&G argued that Milus was not in collusion with the borrowers.
The district court agreed, finding that neither a conspiracy nor collusion
existed between the officer and the customers, and noting that “loans are
not a commodity inherently susceptible to illegal abuse . . . [and that] the
mere act of procuring a loan, even one given negligently or recklessly by
the loan officer, does not inherently place a borrower on notice of
possible illegal activity on the part of the loan officer.”251
249. Id. at 475.
250. Civ. No. 89-0039, 1990 WL 504830 (D. Ariz. Aug. 14, 1990) aff’d
Standard Charter Bank v. USF&G, No. 91-16558, 1993 U.S. App. LEXIS
3654 (9th Cir. Feb. 23, 1993).
251. Id. at *2; Two other issues argued on appeal by USF&G but not reached
by the court raise intriguing questions. USF&G argued that there was no
coverage under Insuring Agreement (A) because Milus did not receive a
financial benefit from the customers. It maintained that the term “in
connection therewith” required the financial benefit to be derived directly
from the customer. Insuring Agreement (A) provides that the portion of
the insured’s loss arising from loans is not covered “unless the Employee
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Insureds occasionally argue that an employee’s silence about a coworker’s dishonesty establishes collusion. Although silence is one factor
among many that should be considered in determining the issue, silence
certainly is not tantamount to collusion. The Sixth Circuit decided as
much in FDIC v. Aetna Casualty & Surety Co.252 In this case, Aetna
contended that the trial court had improperly instructed the jury that mere
silence could constitute collusion. The district court had approved the
following jury instruction: “In determining whether a director or officer
was in collusion with [the employee], you may consider the silence of
that person or his or her failure to report the dishonesty to the Board of
Directors or regulatory authorities as evidence of collusion.”253 The Sixth
Circuit agreed with the district court’s finding that the instruction did not
“equate silence with collusion: it simply states the logical conclusion that
silence may be considered as evidence of such collusion.”254 Thus, while
silence is one of many factors to be considered in determining the issue
of collusion, just as the fact of a loss does not require a finding of
manifest intent, silence does not require a finding of collusion. Clearly,
was in collusion with one or more parties to the transactions and has
received, in connection therewith, a financial benefit with a value of at
least $2,500.” Nothing in the Insuring Agreement requires that the money
come directly from the customers, although this is of course the logical
source. Theoretically the parties could collude to obtain dishonest loans
with the employee receiving a financial benefit from a source other than
those with whom he colluded. However, receipt of a financial benefit
clearly must be within the contemplation of the parties involved in the
collusion. In Milus, query whether the profits Milus made from his stock
options were received “in connection” with the loan transactions at issue?
Arguably they were not since the loans were completely unrelated to the
employee’s stock options. Indeed, whether the loans would have had any
effect one way or the other appears speculative, at best. Yet, this is not the
first time the authors have seen this type of an argument made. USF&G
also argued that the enhanced value of the stock constituted an “employee
benefit earned in the normal course of business,” and thus, did not meet
the financial benefit requirement. Stock options usually are considered a
part of a company’s profit sharing plan, and would normally be an
employee benefit specifically excepted by the bond.
252. 947 F.2d 196, 210 (6th Cir. 1992).
253. Id.
254. Id.
Employee Dishonesty
63
there can be many reasons an employee remains silent, collusion being
only one of them.
B. Financial Benefit Requirement of Insuring Agreement (A)
As with the collusion requirement of Insuring Agreement (A), the
financial benefit requirement adds an objective condition to coverage. In
connection with a loss involving loans, the insured must establish that the
allegedly dishonest employee received “a financial benefit with a value
of at least $2500.”
There is no particular magic to the amount of the requirement. It was
intended to establish a minimum threshold in order to avoid the fairly
common situation where a loan officer, especially in the commercial
context, receives from customers small favors or gratuities, such as meals
or tickets to sporting events.255 By requiring a minimum of $2500, it is
more likely that the bank employee’s actions were wrongfully influenced
by the person from whom he received the financial benefit.
A recent case discussing the financial benefit requirement is
Mortgage Associates, Inc. v. Fidelity & Deposit Co. of Maryland.256 In
this case, the court of appeals sustained a summary judgment for the
insurer because, although the bank “believed” that the employees of the
insured mortgage banking company obtained financial benefits in
connection with their allegedly dishonest scheme, the insured failed to
introduce evidence of any such financial benefit. Interestingly, on appeal
the insured acknowledge that it did not have any evidence that its former
employees received a financial benefit, but argued that the financial
benefit requirement of Insuring Agreement (A) was in the form of an
exclusion rather than a limitation on coverage and that the burden was on
the insurer to prove that the employees did not receive a $2500 financial
benefit. The court rejected the insured’s argument and commented as
follows concerning the financial benefit requirement of the bond:
The financial benefit requirement protects the insurer from claims
where the employee’s motivation is either undeterminable or intangible.
The employee must, instead, have acted dishonestly with the intent or
motivation to receive financial gain for himself or for some third party.
255. Weldy, History of Financial Institution Bonds, supra note 3, at 4-5.
256. 129 Cal. Rptr. 2d 365 (Ct. App. 2002).
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Financial Institution Bonds
It is this additional financial motivation which implicates coverage
under the employee dishonesty coverage provisions. Not only does the
financial benefit requirement limit coverage to that intended under the
policy or bond, it also helps to focus coverage on truly dishonest
conduct and not conduct which is merely improper, negligent, or
incompetent. An employee [who] causes his employer to incur a loss
without receipt of any financial benefit rarely acts with the intent or
malice which is implicit in the employee dishonesty coverage.” “The
financial institution bond is not intended to guarantee against bad loans
made by the insured . . . . The $2500 minimum excludes claims where
a loan officer received a small gift which is less likely to motivate the
employee to make a fraudulent loan.257
1. Type and Value of Financial Benefit
The bond does not specifically limit the financial benefit requirement
to cash or a cash equivalent, but would appear to extend it to any
economic gain, provided the gain is actually realized by the employee.258
Thus, it would appear that the type of financial benefit is limited only by
the minds of the employee and loan customer. Under the Federal Bribery
Statute, for instance, a bank director’s solicitation of sexual favors in
return for influencing a banking transaction was considered a benefit of
value.259 Nevertheless, the benefit must be a financial one. Thus, in First
Bank of Marietta v. Hartford Underwriters Mutual Insurance Co.,260 the
district court found that “enhancement in the eyes of the local
community and enhancement in the eyes of First Bank – are not financial
benefits at all, and thus, do not fall within the scope of the coverage by
the Insuring Agreement.”261 On the other hand, in First Guarantee
257. Id. at 369 (citing Charles M. Armentrout, Jeffrey S. Price, Financial
Benefit Requirement (Including Discussion of Employee Salary,
Commissions and Fees Exclusion) 4 (unpublished paper presented at
2002 Annual Midwinter Meeting of the Fidelity & Surety Law
Committee of the ABA, New York, New York, January 2002)).
258. See United States v. Tunnell, 667 F.2d 1182, 1185 (5th Cir. 1982) (under
Texas Bribery Statute, a financial benefit is anything reasonably regarded
as economic gain).
259. United States v. Brunson, 882 F.2d 151, 155 (5th Cir. 1989) (applying 18
U.S.C. § 215 (1984)).
260. 997 F. Supp. 934 (S.D. Ohio 1998).
261. Id. at 938.
Employee Dishonesty
65
Bank v. BancInsure, Inc.,262 the court denied the insured’s motion for
summary judgment, concluding that a genuine issue of material fact
existed as to whether the loan officer received an improper financial
benefit when she received a free personal appraisal from an appraiser
allegedly involved in the mortgage loan scheme involved in the case.
Depending upon the type of benefit received, calculation of its value
may present an issue. For instance, how does one value a gift of art work,
such as a marble statue? Is the value the cost to the customer who
obtained it wholesale, the retail value, or the intrinsic value to the
employee? What if the art work is valuable, but one which the employee
simply does not care for? Or, what if the benefit is less tangible, such as a
five percent partnership interest in a limited partnership which will prove
beneficial only if the project for which the loan is obtained is successful?
Insuring Agreement (A) does not set forth a formula for calculating
the value of the financial benefit. However, because the Insuring
Agreement speaks in terms of the financial benefit received, the
emphasis appears to be on the actual value of the item, not its cost.
Indeed, value is defined as “the monetary worth of something:
marketable price.”263 Thus, regardless of the amount a customer paid, or
perhaps did not pay for an item, the starting point for determining value
should be the item’s fair market value. However, what about the case
where an employee receives something he dislikes, although it does have
a market value, such as a purple marble statue. Assume the employee
displays the statue in his office for his customer to see, but truly dislikes
the statue, despite its “value.” The answer here would seem to be that,
even assuming the statue has some market value, it clearly could not
have been received as part of a “collusive” agreement with the customer,
and “in connection” with a dishonest act, if the employee truly dislikes it.
In other words, the employee obviously would not accept as a bribe a
statue he disliked. Thus, the collusion and financial benefits elements
work in unison.
In a similar vein, it must be shown that the employee actually
realized a benefit from the item he received. In the scenario above, for
instance, if the employee rejects the statue, or gives it back after
receiving it, the employee clearly did not realize a benefit.
262. No. 06-3497, 2007 WL 1232212, *2 (E.D. La. Apr. 25, 2007).
263. MERRIAM-WEBSTER’S, supra note 58, at 1305.
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In First Dakota National Bank v. St. Paul Fire & Marine Insurance
Co.,264 the Eighth Circuit had the opportunity to consider this issue. In
First Dakota the former president of the bank arranged for a loan to be
made to a company in which he had purchased stock. Several months
later the president sold his stock to the company’s attorney for the same
price he originally paid. On appeal, the insured argued that the former
president received a financial benefit of at least $2,500 because the stock
he purchased “actually appreciated in value from $13,500 to $21,750, as
reflected in the value [the former president] placed on the stock in a
financial statement [he] furnished to the bank.”265 St. Paul argued that
the employee did not receive a financial benefit because he sold the stock
for the same price at which he originally purchased it. The Eighth
Circuit agreed with St. Paul, concluding:
No reasonable juror could have found that [the former president]
received any financial benefit, let alone a financial benefit of at least
$2,500. [The former president] bought the stock for $13,500, and sold
the stock for $13,500. Although [the former president] may have
thought the value of the stock increased in the interim period while [he]
owned it, we conclude that unrealized gain does not constitute a
financial benefit for the purposes of the bond. Because [he] sold the
stock for the same price that he bought it, he did not receive a financial
benefit from his holding of [the] stock.266
In Progressive Casualty Insurance Co. v. First Bank267 the bank
admitted that it had no tangible evidence of gain by the allegedly
dishonest employee, but insisted that “the totality of the circumstances
compel a conclusion of dishonesty. Because the banker has no acceptable
explanation for his acts, the bank theorizes he must have received a
direct benefit.”268 The district court rejected the bank’s argument, noting
that judgments “do not rest on evidence that does not go beyond
264.
265.
266.
267.
2 F.3d 801 (8th Cir. 1993).
Id. at 810.
Id.
828 F. Supp. 473 (S.D. Tex.1993); accord First Philson Bank v. Hartford
Fire Ins. Co., 727 A.2d 584 (Penn. Sup. Ct. 1999) (adopting First
Dakota’s reasoning that unrealized gain on a stock purchase and sale does
not constitute a financial benefit).
268. Id. at 475.
Employee Dishonesty
67
conjecture.”269 The court went on to reason that the “bank’s approach,
‘we must have been cheated because we lost a lot of money,’ is
unfortunately all too common in this era of freedom from accountability.
The magnitude of [the employee’s] errors equals the board’s in hiring
him.”270
2.
“In Connection Therewith”
Insuring Agreement (A) requires not only that the officer receive a
financial benefit, but that the financial benefit be received “in
connection” with the allegedly dishonest transactions. Insuring
Agreement (A) provides that a loss resulting from a loan “is not covered
unless the Employee was in collusion with one or more persons to the
transactions and has received, in connection therewith, a financial
benefit . . . .” As noted above, the difficulty with the situation in which
the bank officer does not like the benefit received is that it is less likely
that the officer’s objectivity has been influenced by something the officer
does not particularly care for. The fact that an employee is allergic to
roses or does not care for a particular piece of art work may not affect the
actual value of the benefit received, but it certainly is evidence that the
benefit was not received in connection with an alleged collusive
agreement between the loan officer and the customer to make a dishonest
loan. Similarly, a gift given to an employee as an afterthought is not
received “in connection with” the collusively made loan. Thus, the
simple receipt of a benefit is not enough. It must have been received in
connection with the employee’s collusive agreement to make a dishonest
loan.
3. Timing of Financial Benefits
A not too infrequent argument made by insureds is that offers of
employment, loans, or other benefits received by the employee after he
terminates his employment with the insured constitute the requisite
financial benefit. It may be that the insured discovers that the employee
is receiving the free use of office space or has received a loan from one
of the bank’s defaulting loan customers. Or, the employee may have gone
269. Id.
270. Id.
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to work for the bank’s customer. Each of these incidents may be totally
innocent, or they could have been part of a collusive scheme. It is only
the latter situation against which the bond insures.
Insuring Agreement (A) requires that the employee must have had
the manifest intent to financially benefit at the time he committed the
dishonest acts. It also provides that the financial benefit must have been
received in connection with the employee’s collusive agreement to make
dishonest loans. A benefit that is eventually received, but was not
expected and agreed upon by the employee and those with whom he is in
collusion, would not appear to satisfy these requirements.
The more remote in time the financial benefit is from the loan
transactions, the less likely it is that the benefit was agreed upon at the
time of the transaction. Thus, although an insured may argue that a
former employee who goes to work for a loan customer has thereby
received a financial benefit, the requirement of the bond has not been
met unless the employment was a quid pro quo for the dishonestly made
loan. As the Second Circuit has recognized: “It is common for business
relationships to develop in such a way that they result in the employment
of one party by the other.”271 Thus, although the financial benefit need
not necessarily be received at the time the loan is made,272 the agreement
to obtain the benefit must have been made at that time. This was
essentially the holding by the Fifth Circuit in Lustig,273 in which the court
found that the question of whether the allegedly dishonest loan officer
had received a financial benefit was for the jury when it was shown that
he received a $40,000 loan from a customer at the time he left the bank’s
employ.
4. Unrelated Loans in a Single Claim
A fairly common bond claim will involve a bank seeking recovery
for loan losses resulting from numerous loans made by a former loan
officer to various unrelated customers. Occasionally the insured in these
claims will maintain that it need only establish that the officer received a
271. Leucadia, Inc. v. Reliance Ins. Co., 864 F.2d at 974.
272. See United States v. Etheridge, 414 F. Supp. 609, 611 (E.D. Va. 1976)
(payment of fees after loan made satisfies benefit requirement of bank
bribery statute).
273. 961 F.2d at 1167.
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$2,500 benefit from one of the customers, or else a total of $2,500 in
benefits from more than one customer, in order for all losses to be
covered. Although there does not appear to be any published opinions
addressing this issue, it should not present a problem for the courts in
light of the “in connection therewith” requirement of the bond. Assume
that the employee makes loans to five separate, admittedly unrelated
entities. Assume also that the insured is able to establish that the
employee acted in collusion with and received a financial benefit from
Customer A. Without more, such evidence does not establish that the
officer was in collusion with Customers B, C, D, or E. Further, receiving
a financial benefit in connection with the loan to Customer A cannot
fairly be considered a financial benefit received in connection with loans
to the other customers. If Customer A is unrelated to Customer D, and
has no connection to the loan received by Customer D, then the fact that
the Employee acted in collusion with Customer A does not equate to
being in collusion with a party to the loan to Customer D. This argument
is a red herring that should be flushed out through simple written
discovery and resolved by way of summary judgment.
5. Emoluments of Employment
Insuring Agreement (A) provides that “financial benefit does not
include any employee benefits earned in the normal course of
employment, including: salaries, commissions, fees, bonuses,
promotions, awards, profit sharing or pensions.” Insureds occasionally
argue that a dishonest employee’s salary or some other benefit does
qualify because the salary or other benefits of a dishonest employee are
not “earned in the normal course of employment.” Those cases
considering this issue have consistently found that the term “earned in
the normal course of employment” refers to all normal emoluments of
employment, whether earned “honestly” or not.274
274. Hudson United Bank v. Progressive Cas. Ins. Co., 112 Fed. Appx. 170,
174 (3d Cir. 2004); Performance Autoplex II, Ltd. v. Mid-Continent Cas.
Co., 322 F.3d 847, 857 (5th Cir. 2003); RTC v. Fid. & Deposit Co. of
Md., 205 F.3d 615, 646-47 (3d Cir. 2000); Mun. Sec., Inc. v. Ins. Co. of
N. Am. 829 F.2d at 9; FDIC v. Nat’l Union Fire Ins. Co. of Pittsburgh,
Pa., 146 F. Supp. 2d 541, 555 (D.N.J. 2001); Verex Assurance, Inc. v.
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Financial Institution Bonds
For example, in Palm Hill Properties, L.L.C. v. Continental
Insurance Co.,275 the insured alleged that its apartment complex
manager, who received salary, commissions and bonuses of fifteen
percent of the gross profit generated through rentals, concealed and
misrepresented apartment rentals to obtain additional salary and bonuses.
Finding that the employee acted with the intent to obtain salary and
bonuses alone, the court concluded that the financial benefit requirement
was not met and, therefore, granted the insurer’s motion to dismiss the
insured’s claim for loss of rental income.
Another case on point is Resolution Trust Corp. v. Fidelity & Deposit
Co. of Maryland,276 in which the insured argued that golden handcuff
payments did not qualify as a financial benefit earned in the normal
course of employment. The Third Circuit disagreed. It began its
analysis by concluding that the phrase “earned in the normal course of
employment” is unambiguous, and thus the presumption of construing
the phrase narrowly did not apply.277 The court went on to explain:
Our analysis begins with the review of the plain language of
subsection (b). First, we note that the position of the phrase “earned in
the normal course of employment” strongly indicates that that phrase
was meant to modify the language “other employee benefits,” as the
Gate City Mortgage, 1984 WL 2918, slip op. at 2 (D. Utah 1984);
Glusband v. Fittin Cunningham & Lauzon, Inc., 892 F.2d at 210; Hartford
Accident & Indem. Co. v. Washington Nat’l Ins. Co., 638 F. Supp. 78, 83
(N.D. Ill. 1986) (all types of commissions and salaries are excluded from
indemnity coverage, even commissions and salaries which have been
earned in the normal course of employment); Mortell v. Ins. Co. of N.
Am., 458 N.E. 2d 922, 929 (Ill. App. 1983) (no liability under similar
policy language where only evidence was the “salesman did not gain
anything except a commission from the unauthorized trading alleged in
the customer complaints”); ABC Imaging of Wash., Inc. v. Travelers
Indem. Co., 820 A.2d 628, 633-35 (Md. App. 2003); Klyn v. Travelers
Indem. Co., 709 N.Y.S.2d 780 (App. Div. 2000); Dickson v. State Farm
Lloyds, 944 S.W.2d 666, 668 (Tex. Civ. App. 1997) (employee dishonesty
aimed only at obtaining additional wages by lying about the amount of
time worked clearly outside policy).
275. No. 07-668-RET-SCR, 2008 WL 4303817 (M.D. La. July 23, 2008).
276. 205 F.3d 615 (3d Cir. 2000).
277. Id. at 646.
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71
modifying language directly follows that phrase and describes the types
of employee benefits falling within the exclusion. Moreover, as there is
no comma between the two phrases, it is clear that they should be read
together, so that the “earned in the normal course of employment”
modifies only the general phrase “other employee benefits” rather than
the other specific types of employee benefits previously enumerated.
[O]ne article explains:
Attempts to limit the exclusion to financial benefits [such as
salaries and commissions] earned in the normal course of
employment have been rejected. The words ‘earned in the normal
course of employment’ do not modify the enumerated exclusions
that precede them, but are intended to include in the list of
excluded benefits other benefits typically earned by employees.
Foster, et al., supra at 789. Thus, under the plain language of the bond,
the phrase “earned in the normal course of employment” cannot be
viewed as a limitation on the exclusion. Rather, it is reasonable to
conclude that the drafters included the phrase to provide a broader
exclusion, thereby shrinking the bounds of coverage under the fidelity
provision. This construction clearly undermines the district court’s
reliance on the last phrase of the exclusionary clause to conclude that
the handcuff payments were not within the exclusion.278
Similarly, in James B. Lansing Sound, Inc. v. National Union Fire
Insurance Co. of Pittsburgh, Pa.,279 the Ninth Circuit reasoned that a
contrary interpretation would render the policy language meaningless
because “fraud or dishonest acts are not usually part of a normal course
of business.”
Two courts have held that fraudulently obtained salaries did not fall
within the salaries and benefits exclusion. In Cincinnati Insurance Co. v.
Tuscaloosa County Parking and Transit Authority,280 the insured argued
that the losses from two employees’ embezzlement by issuing payroll
checks to themselves in excess of their salaries did not qualify as a
financial benefit earned in the normal course of employment. The
Alabama Supreme Court agreed. It first considered the dictionary
meaning of “salaries,” and determined that the embezzled funds could
not be part of either employee’s “salary” because the funds exceed the
278. Id. at 646-47 (citations omitted).
279. 801 F.2d 1560, 1567 (9th Cir. 1986).
280. 827 So. 2d 765 (Ala. 2002).
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Financial Institution Bonds
“fixed compensation that was to be paid for the services provided.” 281
The court then considered the dictionary meaning of “earn,” concluding
that because the embezzled funds were not “earned” but rather were
stolen, the loss of the funds was covered under the policy.282
Likewise, in Klyn v. Travelers Indemnity Co.,283 the insured’s
comptroller embezzled funds from a payroll account over which he had
sole control by secretly and fraudulently paying himself unauthorized
and excessive salary, commissions and bonuses. In rejecting Traveler’s
argument that recovery was barred by the exclusion, the court held:
[W]here employer does not knowingly pay funds to its employee under
the belief that the funds have been honestly earned but is instead
unaware of the employee’s receipt of the funds or pays the lost funds
for some purpose other than the employee’s compensation, the
employee has committed pure embezzlement which is recoverable
under the [policy].284
Yet, as the Supreme Court of New York has correctly pointed out,
“[t]he exclusion depends not on the employee’s entitlement to or receipt
of a bonus or other normal form of employee financial benefit, but on the
employee’s ‘manifest intent’ to obtain such a benefit.”285 Thus, where an
employee’s dishonesty in creating forged purchase orders for nonexistent
transactions was motivated by the hope of obtaining some form of extra
compensation for the extra volume, the court held that the exclusion
applied, despite the fact that the employee was misinformed about the
fact that his company did not pay employee bonuses.286
281.
282.
283.
284.
Id. at 768.
Id.
273 A.d.2d 931 (N.Y.A.D. 2000).
Id. at 781 (quoting FDIC v. St. Paul Fire & Marine Ins. Co., 738 F. Supp.
1146, 1160 (M.D. Tenn. 1990), mod. on other grounds, 942 F.2d 1032
(6th Cir. 1991); cf. ABC Imaging of Wash., Inc. v. Travelers Indem. Co.
of Am., 820 A.2d 628, 635 (Md. Ct. Spec. App. 2003) (distinguishing
Klyn on the ground that huge overpayment to employee was due to
payroll error rather than an overt dishonest act by the employee).
285. Jamie Brooke, Inc. v. Zurich-Am. Ins. Co., 298 A.d.2d. 145, 145 (N.Y.
App. Div. 2002).
286. Id.
Employee Dishonesty
73
VI.
Conclusion
The risk sharing arrangement of insurance presents the proverbial
two-way street. For it to work in the Financial Institution Bond world,
banks must receive value for their premiums by reducing their risk of
loss from employee dishonesty. At the same time, bond insurers must be
able to maintain a profitable business. History has demonstrated that
insurers cannot successfully insure banks against the negligence of their
employees. Yet, both the natural and probable consequences test and the
substantial certainty test essentially transform the Financial Institution
Bond into first-party negligence insurance. While few courts are
continuing to adopt the natural and probable consequences test, many
still apply the substantial certainty test. Yet, as the above discussion
demonstrates, it is a purely objective test, and one which bond insurers
have never intended to apply.
Cases such as General Analytics Corp, Lustig, St. Paul, and
Susquehanna are cause for optimism with the courts. However, cases
like BancInsure, United Pacific and Oldenburg are continuing reason for
concern. While the new bond forms promulgated by the SFAA and ISO
leave no doubt that the specific intent standard must be applied in
determining coverage under Insuring Agreement (A), most bonds in use
today contain the older manifest intent language. If courts are fully
educated on the background of the manifest intent language, it would
seem difficult for them not to apply the specific intent test. Only time
will tell.