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The Fidelity

Law Journal

published by The Fidelity Law Association

Volume XVI, October 2010

Cite as XVI Fid. L.J. ___ (2010)

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The Fidelity Law Journal is published annually. Additional copies may be purchased by writing to: The Fidelity Law Association, c/o Wolff & Samson PC, One Boland Drive, West Orange, New Jersey 07052.

The opinions and views expressed in the articles in this Journal are solely of the authors and do not necessarily reflect the views of the Fidelity Law Association or its members, nor of the authors’ firms or companies. Publication should not be deemed an endorsement by the Fidelity Law Association or its members, or the authors’ firms or companies, of any views or positions contained herein. The articles herein are for general informational purposes only. None of the information in the articles constitutes legal advice, nor is it intended to create any attorney-client relationship between the reader and any of the authors. The reader should not act or rely upon the information in this Journal concerning the meaning, interpretation, or effect of any particular contractual language or the resolution of any particular demand, claim, or suit without seeking the advice of your own attorney.

The information in this Journal does not amend, or otherwise affect, the terms, conditions or coverages of any insurance policy or bond issued by any of the authors’ companies or any other insurance company. The information in this Journal is not a representation that coverage does or does not exist for any particular claim or loss under any such policy or bond. Coverage depends upon the facts and circumstances involved in the claim or loss, all applicable policy or bond provisions, and any applicable law.

Copyright © 2010 Fidelity Law Association. All rights reserved. Printed in the USA. For additional information concerning the Fidelity Law Association or the Journal, please visit our website at http://www.fidelitylaw.org.

Information which is copyrighted by and proprietary to Insurance Services Office, Inc. (“ISO Material”) may be included in this publication. Use of the ISO Material is limited to ISO Participating Insurers and their Authorized Representatives. Use by ISO Participating Insurers is limited to use in those jurisdictions for which the insurer has an appropriate participation with ISO. Use of the ISO Material by Authorized Representatives is limited to use solely on behalf of one or more ISO Participating Insurers.

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Stephen M. Kranz is Senior Claim Counsel with Travelers Bond & Financial Products in Hunt Valley, Maryland. Patricia H. Thompson is a shareholder with Carlton Fields in Miami, Florida. Ashley M. Daugherty is an attorney with Carlton Fields in Miami, Florida. 153

CAN DIRECT MEAN DIRECT? UNTANGLING THE WEB OF CAUSATION IN

FIDELITY COVERAGE

Stephen M. Kranz Patricia H. Thompson Ashley M. Daugherty

Oh, what a tangled web we weave, When first we practice to deceive!

Sir Walter Scott, Marmion, Canto the Sixth

Fidelity bonds, such as the Financial Institution Bond,1 provide banks and businesses with protection against potentially calamitous dishonesty or fraud. The scope of the risk borne by the underwriter and the corresponding risk remaining on the shoulders of the insured are, by agreement of the parties to the Bond, allocated by its insuring agreements, exclusions and other relevant terms of the Bond. However, if the language in the Bond is treated as code words, whose special meanings are decipherable only by courts, or as vague approximations lacking in practical utility, then neither party can be certain of the real-life risk it bears. Although Bonds often use the term “direct” and limit their coverage to losses that “result directly from” certain acts, those words are not always interpreted by the courts with consistency. Clarity begets predictability, predictability begets certainty, and certainty begets peace of mind. Confusion breeds only unnecessary litigation. To those ends, the authors will try to untangle recent judicial decisions concerning

1 E.g., Financial Institution Bond, Std. Form No. 24 (Surety Ass’n of

Am.) [hereinafter Bond].

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154 Fidelity Law Journal, Vol. XVI, October 2010

the Bond's clear and unambiguous limitation of coverage to losses resulting directly from specified risks.2

I. DRAFTING THE BOND'S DEMANDS FOR DIRECTNESS TO

CLARIFY THE EXTENT OF THE INSURER'S LIABILITY

The Bond3 is a product of many years of experience by and communication between the Surety and Fidelity Association of America,4 the American Bankers Association, and other trade groups.5 “Insured financial institutions, both individually and collectively, are

2 This article supplements an earlier analysis of the same policy

language by Bogda Clark, Patricia H. Thompson, and Michael Shafir in “Loss Resulting Directly from . . . ” Causation Under the Financial Institution Bond and Similar Insurance Forms, 9 FID. L. J. 25 (2003), which should be reviewed for a discussion of case law on this issue prior to 2003.

3 With its 1986 revision, the Bankers Blanket Bond became the Financial Institution Bond. See Statement of Change, Financial Institution Bond, Std. Form No. 24 (Revised Jan., 1986, Surety Ass’n of Am.), in ANNOTATED FINANCIAL INSTITUTION BOND (Michael Keeley ed., 2d ed. 2004).

4 “The Surety & Fidelity Association of America (formerly known as The Surety Association of America) is a trade association consisting of companies that collectively write the majority of surety and fidelity bonds in the United States.” The Sur. & Fid. Ass’n of Am., http://www.surety.org (last visited June 4, 2010).

5 Edward G. Gallagaher, A Concise History of Standard Form No. 24, 1986 ed., in ANNOTATED FINANCIAL INSTITUTION BOND 6 (Michael Keeley ed., 2d ed. 2004) [hereinafter ANNOTATED FIB] (“The Surety Association obtains comments and suggestions from the American Bankers Association and other trade groups to assure that the standard forms will meet the needs of the marketplace.”); see also First State Bank of Monticello v. Ohio Cas. Ins. Co., 555 F.3d 564, 568 (7th Cir. 2009) (“Standard fidelity bonds are drafted by sophisticated parties (representatives of the banking and insurance industries)”); Statement of Change, supra note 3 (“The Surety Association of America, after discussion with the American Bankers Association, has revised the Bankers Blanket Bond, Standard Form No. 24 to January 1986.”); Statement of Change, Bankers Blanket Bond, Std. Form No. 24 (revised to July 1980, Surety Ass’n of Am.) in ANNOTATED FIB (“The Surety Association of America, in collaboration with the American Bankers Association, has revised the Bankers Blanket Bond to July 1980.”)

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156 Fidelity Law Journal, Vol. XVI, October 2010

involved conduct which would have caused a covered loss to the Insured in a similar amount in the absence of such damages.”11

Likewise, the scope of the Bond’s Covered Property narrowed from 1986 to 2004. The 1986 version of the Bond applied “to loss of Property (1) owned by the Insured, (2) held by the Insured in any capacity, or (3) for which the Insured is legally liable.”12 In 2004, that scope was again made clearer and more restrictive, so that the Bond would “apply to loss of Property (1) owned by the Insured, (2) held by the Insured in any capacity, or (3) owned and held by someone else under circumstances which make the Insured responsible for the Property prior to the occurrence of the loss.”13 Both versions of the Bond make explicit that “This bond shall be for the sole use and benefit of the Insured named in the Declarations.”14

However, although it is illuminative of the Bond’s overarching intended coverage and intentional changes in terms, the Bond’s drafting history is not a prerequisite to logically and consistently apply its terms as they exist in either the 1986 or the 2004 Bond.15

II. DIRECT SHOULD MEAN DIRECT

The Bond covers a loss “resulting directly from” an enumerated act or circumstance.16 By doing so, the Bond unequivocally (a) establishes that the link required between an action and the loss resulting therefrom must be “direct,” and (b) rejects all other possible terms or manner of describing the relationship between the loss and the act. The Bond can only speak through its written terms.17 Respecting

11 2004 Bond § 2 (t). 12 1986 Bond § 10. 13 2004 Bond § 12. 14 2004 Bond § 12; 1986 Bond § 10. 15 See, e.g., Private Bank & Trust Co. v. Progressive Cas. Ins. Co., 409

F.3d 814, 816 (7th Cir. 2005) (“Generalizations about the purpose of any insurance policy must always be evaluated in light of specific policy language.”)

16 2004 Bond, Insuring Agreements (A), (B), (C), (D), (E), (F); 1986 Bond, Insuring Agreements (A), (B), (C), (D), (E), (F).

17 See, e.g., In re Texas Commercial Energy, No. 08-40890, 2010 WL 1930254, at *6 (5th Cir. May 13, 2010) (“[T]he language of an agreement,

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Can Direct Mean Direct? 157 the Bond’s voice requires interpreting its mandates to mean what they say, such that direct must mean direct.18

A. Direct Means . . . Direct

By its dictionary definition, directly encompasses closeness in time (“At once; immediately. In a little while; soon.”) and in space (“with nothing or no one in between.”), as well as a sustained, undeviating focus (“without changing direction or stopping”).19 Likewise, a thesaurus notes that “directly” contains three concepts—“as soon as possible,” “the shortest route,” and “straightforwardly.”20 So, it

unless ambiguous, represents the parties’ intention.”); Law Debenture Trust Co. of N.Y. v. Maverick Tube Corp., 595 F.3d 458, 467 (2d Cir. 2010) (“The best evidence of what parties to a written agreement intend is what they say in their writing.”); Albemarle Corp. v. MEMC Elec. Materials, Inc., 685 F. Supp. 2d 652, 659 (S.D. Tex. 2010) (“The primary concern of courts is to ascertain and to give effect to the intentions of the parties as expressed in the instrument.”) (citation omitted); N & L Enterps., LLC v. Lioce Props., LLP, No. 1081516, 2010 WL 1837800, at *6 (Ala. May 7, 2010) (“[T]he intention of the parties is to be derived from the provisions of the contract itself . . . .”); Gibney v. Pillifant, 32 So. 3d 784, 785 (Fla. Dist. Ct. App. 2010) (“Absent an ambiguity, ‘the actual language used in the contract is the best evidence of the intent of the parties.’”).

18 See, e.g., Law Debenture Trust Co., 595 F.3d at 468 (“[C]ourts. . . may not distort the meaning of [the terms] used and thereby make a new contract for the parties under the guise of interpreting the writing.”); DL Resources, Inc. v. FirstEnergy Solutions Corp., 506 F.3d 209, 217 (3d Cir. 2007) (“We look to the plain and ordinary meaning of the language used in the policy unless another meaning is clearly apparent from the contents of the policy.”); Rias v. Safeco Ins. Co. of Am., 594 F. Supp. 2d 1090, 1095 (E.D. Mo. 2009) (“To determine the intent of the parties, the terms of a contract are read as a whole, and given their plain, ordinary, and usual meaning.”) (citation omitted); N & L Enterps., 2010 WL 1837800, at *6 (“[T]he words of a contract are to be given their ordinary meaning. . .”) (citation omitted); Gibney, 32 So. 3d at 785 (“[T]he plain meaning of that language controls.”) (citation omitted); Tuttle v. N.H. Med. Malpractice Joint Underwriting Ass’n, 992 A.2d 624, 636 (N.H. 2010) (“Contractual language is construed according to its common meaning.”) (citation omitted);.

19 See THE OXFORD COLLEGE DICTIONARY (2d ed. 2007). 20 See ROGET’S 21ST CENTURY THESAURUS (2d ed. 1999).

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should be undeniable that “directly” denotes closeness in time, in space, and in an unaltered path.

B. Direct Is Not Indirect

The Bond’s requirement that the loss result directly from a particular act is contrasted with its myriad exclusions for “loss resulting directly or indirectly.”21 Interpreting the Bond by looking at all of its provisions taken together,22 these exclusions make it abundantly clear that the Bond does not equate direct with indirect.23 Moreover, the Bond omitted indirect from its covered causation while using indirect to expansively describe certain exclusions. If direct were equivalent to indirect, or if direct losses encompassed indirect losses, then the Bond’s multiple references to “direct or indirect” would be superfluous, and such a reading of the Bond, like any contract, must be avoided.24

21 See 1986 Bond §§ 2 (a), (c), (d), (e), (i), (k), (n), (o), (p), (x); 2004

Bond §§ 2 (a), (c), (d), (e), (i), (k), (n), (o), (p), (x), (y). 22 See, e.g., Law Debenture Trust Co., 595 F.3d at 468 (stating courts

should read the contract “as a whole,” and “may not by construction add or excise terms”) (citation omitted)); Dubinsky v. Mermart, LLC, 595 F.3d 812, 816 (8th Cir. 2010) (“[T]erms of a contract should be read as a whole to determine the intent of the parties.”) (citation omitted); N & L Enterps., LLC, 2010 WL 1837800, at *6 (“[A] contract must be construed as a whole and, whenever possible, effect must be given to all its parts.”) (citation omitted); Beal v. Allstate Ins. Co., 989 A.2d 733, 741 (Me. 2010) (“Contractual terms should be read in context to give effect to the intention of the makers of the instrument.”) (citation omitted); Tuttle, 992 A.2d at 636 (“When interpreting contracts, the intent of the parties is determined based upon an objective reading of the agreement as a whole.”) (citation omitted).

23 See also THE OXFORD COLLEGE DICTIONARY (defining “indirect” as “not directly caused by or resulting from something . . . not done directly”).

24 See, e.g., Albemarle Corp., 685 F. Supp. 2d at 659-60 (“[C]ourts should examine and consider the entire writing in an effort to harmonize and give effect to all the provisions of the contract so that none will be rendered meaningless.”) (citation omitted); Dubinsky, 595 F.3d at 818 (stating that a contractual “construction that attributes a reasonable meaning to all the provisions of the agreement is preferred to one that leaves some of the provisions without function or sense”) (citation omitted); Summit Packaging Sys., Inc. v. Kenyon & Kenyon, 273 F.3d 9, 12 (1st Cir. 2001) (“[I]t is a basic principle of contract law that constructions that render contract terms

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Can Direct Mean Direct? 159 C. Directly Confining the Causal Universe

It has been suggested, in another context, that “Causation is not a chain, but a net. At each point, influences, forces, events, precedent and simultaneous, meet, and the radiation from each point extends indefinitely.”25 However, as Justice Cardozo noted nearly a century ago, although “[t]here are times when the law permits us to go far back in tracing events to causes,” when faced with a contract, the proper “inquiry for us is how far the parties to this contract intended us to go.”26

Of the universe of possible links between a loss and an act, among all the methods for determining whether a result will be attributed to an act, the Bond chose “resulting directly from.” That mandate necessarily casts aside all other possible descriptors that could have been used, all other standards lurking in the netherworld of causation. By choosing one path by which acts must lead to losses, the Bond necessarily rejected all others.27 The Bond did not require that an enumerated act be the “but for” cause of the loss, the “proximate” cause28 of the loss, or the “sole” cause of the loss. Yet, some of these standards have been applied by courts instead of the standard of direct causation required by the Bond’s terms. The awkwardness, if not the utter inappropriateness, of these alternative standards is demonstrated when jurists struggle to apply them to the already-complicated realm of fidelity insurance. Again, as observed by Justice Cardozo, “there is a tendency to go farther back in the search for causes [in the law of torts] than there meaningless should be avoided.”) (citation omitted); Americredit Fin. Servs., Inc. v. Oxford Mgmt. Servs., 627 F. Supp. 2d 85, 99 (E.D.N.Y. 2008) (“[A] contract should be interpreted so as not to render its terms nonsensical.”) (citation omitted).

25 Bird v. St. Paul Fire & Marine Ins. Co., 120 N.E. 86, 87 (N.Y. 1918) (quoting Leyland Shipping Co. v. Norwich Fire Ins. Co., [1917] 1 K.B. 73 (House of Lords) (A.C. 350)).

26 Bird, 120 N.E. at 87. 27 Cf. ROBERT FROST, The Road Not Taken (“Two roads diverged in a

yellow wood / And sorry I could not travel both / And be one traveler . . .”). 28 See, e.g., Palsgraf v. Long Island R. Co., 162 N.E. 99, 103 (N.Y.

1928) (J. Andrews, dissenting) (stating “[P]roximate” means that “because of convenience, of public policy, of a rough sense of justice, the law arbitrarily declines to trace a series of events beyond a certain point. That is not logic. It is practical politics.”).

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is in the law of contracts.”29 Accordingly, it can only lead to confusion when courts transpose the language of torts into the law the parties establish for themselves by contract.

III. WRANGLING WITH THE WEBS OF CAUSATION

A sampling of recent cases evaluating causation under the Bond reveals that courts are not entirely consistent in their understanding of the Bond’s “direct” requirements—some are emphatic that “direct means direct,” while others easily substitute “proximate cause” for direct. The practitioner should read these cases with a discerning eye, look past the court’s nomenclature to the actual analysis undertaken, and sort out courts’ intermingling of coverage and exclusion questions.

A. On Premises

The Seventh Circuit recently addressed losses claimed under the Bond’s “On Premises” Insuring Agreement,30 respecting the language of the Bond in the course of finding coverage in one case and non-coverage in the other.31 In both instances, the Financial Institution Bond at issue covered “Loss of Property resulting directly from . . . theft, false pretenses, common-law or statutory larceny, committed by a person present in an office or on the premises of the Insured while the Property is lodged or deposited within the offices or premises located anywhere.”32

In 2005, the Seventh Circuit determined that the bond’s On Premises coverage precluded an attenuated causal chain between on-premises acts and subsequent loss of funds by the insured.33 The court “decline[d] to adopt a rule of construction that would expand the bond’s

29 Bird, 120 N.E. at 88. 30 See 1986 Bond, Insuring Agreement (B); 2004 Bond, Insuring

Agreement (B). 31 See First State Bank of Monticello v. Ohio Cas. Ins. Co., 555 F.3d

564 (7th Cir. 2009); Private Bank & Trust Co., 409 F.3d at 814 (7th Cir. 2005). 32 First State Bank of Monticello, 555 F.3d at 568; Private Bank &

Trust Co., 409 F.3d at 815. 33 Private Bank & Trust Co., 409 F.3d at 814.

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Can Direct Mean Direct? 161 ‘on premises’ fraud coverage to include losses from off-premises transactions that are preceded by on-premises fraudulent acts.”34 The court found that “absent a policy irrevocably committing the bank to allowing withdrawals at the moment of deposit, a loss occurs . . . only when the person who withdraws the money is physically present on the bank’s premises at the time of the withdrawal.”35 The insured, Private Bank, had argued that “it was the fraudulent deposit,” made on bank premises, “not the subsequent telephonic withdrawal,” called in from off bank premises, “that ‘directly caused’ the bank’s loss.”36 The court rejected this contention, and denied the insured’s argument that its losses were covered provided “the ‘principal’ fraudulent acts or ‘most’ of the fraudulent scheme occurs on the bank’s premises.”37 The court declared that it would “decline to gloss the bond’s language in this way.”38 Accordingly, the court upheld summary judgment for the insurer.39

In 2009, the Seventh Circuit in First State Bank of Monticello v. Ohio Casualty Insurance found that an On Premises claim was covered, where the bad actor had presented worthless checks at the insured bank in exchange for money orders drawn on the insured bank.40 The underwriter did not dispute that the “fraudulent conduct . . . was committed on the bank’s premises;” instead, it argued that “First State Bank did not incur a ‘loss . . . resulting directly from . . . false pretenses.’”41 As a solid starting point, the court recognized that its “task is to interpret the parties’ agreement.”42 The court rejected “tort-causation concepts,” and declared that “Insuring Agreement B’s coverage of losses resulting ‘directly from’ on-premises false pretenses means what it says. The bond’s ‘direct loss’ requirement ‘must be afforded its plain and ordinary meaning; direct means direct.’”43 By providing money orders, the insured “bank disbursed immediately

34 Private Bank, 409 F.3d at 815. 35 Id. at 817. 36 Id. 37 Id. at 818. 38 Id. 39 Id. 40 First State Bank of Monticello, 555 F.3d at 566-67. 41 Id. at 568-69. 42 Id. at 570. 43 Id. at 570-571.

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available funds to [the bad actor],” and the checks given to the insured as payment for the money orders “were returned unpaid.”44 The court explained that “[t]his suffices to satisfy a common and ordinary understanding of a loss resulting directly from a fraud occurring on the bank’s premises. The slight gap in time between the money-order transactions and the non-payment of the checks makes no difference; the loss flowed directly from [the bad actor’s] on-premises fraud.”45 The court refused to follow the underwriter’s “arguments about intervening or contributing causes—such as [the bad actor’s] death, his corporation’s bankruptcy, and the bank officers’ failure to follow bank policy.”46 Finally, the loss was not foreclosed by an exclusion for loss “caused by an employee;” the bad actor’s “on-premises fraud was the actual and direct cause of the bank’s loss, and the bank employee’s failure to prevent the loss” did not equate to causing the loss.47

In each of these cases, the Seventh Circuit focused on applying the language of the bond, and in each case, the court required a tight causal connection between the on-premises dishonesty and the insured’s disbursal of funds comprising its loss. In Private Bank, the actor did not appear in person to obtain funds from the bank, and so performing the first step of his fraudulent plan on premises was not enough. Conversely, in First State Bank of Monticello, the bad actor obtained money orders while on the bank’s premises, and the insured’s exchange of good funds for bad checks was found to result directly in the insured’s loss.

B. Forgery

When not decided by the ineligibility of the underlying documents, cases disputing Bond coverage for Forgery or Alteration48 often hinge on questions of causation, including the insured’s actual reliance on the forgery and the directness of the link between the forged or altered document and the eventual loss.

44 Id. at 571. 45 Id. 46 Id. 47 Id. at 567, 571. 48 See 1986 Bond, Insuring Agreement (D); 2004 Bond, Insuring

Agreement (D).

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Can Direct Mean Direct? 163

In 2007 and 2008 the Sixth Circuit released an interesting pair of forgery coverage decisions. In the first, the court found coverage, relying on proximate causation and Tennessee law.49 In the latter, the court found the loss was not covered, requiring direct causation and relying on federal jurisprudence.50

In Union Planters, the operative policy provision stated: “The Insurer shall indemnify the . . . Insureds for Loss resulting directly from a[n] . . . Insured having in good faith: a. acted on an Original Financial Document which bears a Forgery or Alteration upon which the . . . Insureds relied . . . .”51 The bond excerpt cited in the Flagstar Bank decision provided coverage for “loss resulting directly from . . . Forgery on, or fraudulent material alteration of, any Negotiable Instrument”52 Thus, Union Planters required the insured to show that “the losses ‘resulted directly’ from the bank’s reliance on the forgeries,”53 and Flagstar Bank required that the “loss ‘result directly’ from forgery.”54

The Union Planters court found that the insured’s loss qualified for coverage, and affirmed an award of summary judgment in its favor.55 In doing so, the Sixth Circuit first considered whether the insured relied on the forgeries and then whether the loss resulted directly from the insured acting on the forgeries.56 The insured had “extended a . . . warehouse line of credit to Greatstone, a mortgage-banking company,” so that “[e]ach time Greatstone needed to finance a new mortgage, [the insured] advanced the funds to Greatstone” and then “Greatstone would send the collateral documentation” to the insured.57 Greatstone defaulted on its debt, and the insured “was left with worthless collateral (i.e., the forged promissory notes) for [over $20 million] in advances and was left

49 See Union Planters Bank, N.A. v. Cont’l Cas. Co., 478 F.3d 759 (6th

Cir. 2007). 50 See Flagstar Bank, F.S.B. v. Fed. Ins. Co., 260 Fed. Appx. 820 (6th

Cir. 2008). 51 Union Planters Bank, 478 F.3d at 763. 52 Flagstar Bank, 260 F. App’x. at 821 (ellipsis in original). 53 Union Planters Bank, 478 F.3d at 763. 54 Flagstar Bank, 260 F. App’x. at 824. 55 Union Planters Bank, 478 F.3d at 761, 763-65. 56 Id. at 763-65. 57 Id. at 761.

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empty-handed for an additional [$3.2 million] in advances.”58 Despite these facts—despite the fact that the insured advanced money before receiving the paper collateral for that transaction and despite the fact that the insured had advanced more than three million dollars without receiving any associated collateral, forged or not—the Sixth Circuit determined that the insured had “relied on the forgeries, continually possessed the forged collateral and incurred losses directly as a result of its reliance on the forged documents.”59 The court did so by broadly evaluating the insured’s reliance on the “revolving line of credit” rather than “each transaction by itself.”60 The best explanation for this approach was that “[t]he policy says only that the bank must rely on the forged documents in advancing funds. It does not say that the bank’s reliance has to relate only to funds connected to a particular piece of collateral.”61 The court pointed out that the “policy does not unambiguously exclude this form of reliance,” and seemed to get distracted from the policy’s terms by the idea that the insured’s actions were “commonplace.”62

The court’s tendency to paint with a wide brush in deciding Union Planters was particularly evident when it came time to apply the policy’s “loss resulting directly from” requirement.63 The court stated that once the insured’s “permissible reliance on the revolving collateral is established, there is little room for debate about the . . . ‘loss resulting directly from’ requirements of the policy . . . the losses directly resulted from loans extended on the basis of a pool of forged collateral.”64 The cases immediately cited were Tennessee Court of Appeals cases discussing proximate cause in the contexts of medical malpractice and homeowner’s insurance.65 Thus, without discussion, the court adopted

58 Id. at 762. 59 Id. at 763. 60 Id. at 764. 61 Id. 62 Id. 63 Id. 64 Id. (emphasis added). 65 Id. (citing White v. Methodist Hosp. South, 844 S.W.2d 642, 648

(Tenn. Ct. App. 1992); Am. Nat’l Prop. & Gas Co. v. Gray, 803 S.W.2d 693, 695 (Tenn. Ct. App. 1990)). White, a medical malpractice case, was cited for the proposition that it “defin[ed] ‘proximate cause’ as ‘the procuring and

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Can Direct Mean Direct? 165 and presumably used “proximate cause” as the appropriate standard to evaluate direct causation under the policy, and, without explication, decided that the losses satisfied the policy’s “resulting directly from” requirement.66

The Flagstar insured’s causation arguments did not meet with the same success: the Sixth Circuit affirmed summary judgment for the insurers on the ground that “Flagstar’s loss did not directly result from forgery.”67 Quite simply, the court determined that the “loss arose because of the fictitious character of collateral offered to secure a loan,” “the notes would not have held value even if they had authentic signatures;” thus the loss did not directly result from forgery.68 By contrast, in Union Planters, the court noted that “if the loans had borne legitimate signatures, they would have had value.”69 The Sixth Circuit found this to be an important distinction between Flagstar and Union Planters.70

The Sixth Circuit in Flagstar followed the specific causal standard established by the Bond, brushing aside other cases whose policies required loss “through” or “by reason of” forgery instead of “resulting directly from.”71 The court explained that the instant bond did

efficient cause of the plaintiff’s damage or injury . . . indicating nearness in causal relation’ but not necessarily ‘the last act, the one nearest to the injury or damage, or the sole cause.’” Union Planters Bank, 478 F.3d at 764. See also White, 844 S.W.2d at 648. American National was cited by Union Planters as “noting that the definition of ‘direct cause’ incorporates the overlapping concepts of ‘proximate cause’ and ‘efficient cause.’” Union Planters Bank, 478 F.3d at 764. American National was concerned with a motor vehicle exclusion to homeowner’s liability insurance, and recited: “Couch on Insurance . . . states in part: ‘A direct and proximate cause is the active and efficient cause.’” Am. Nat’l Prop. & Gas, 803 S.W.2d at 695. Moreover, the policy language at issue in American National addressed injuries “arising out of” the use of a vehicle, rather than requiring “direct” causation. Id.

66 Id. at 764. 67 Flagstar Bank, 260 F. App’x. at 825. 68 Id. at 822-23. 69 Union Planters Bank, 478 F.3d at 765. 70 Flagstar Bank at 822. 71 Id. at 823-24.

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not create a “proximate-cause standard and instead requires that [the insured’s] loss ‘result directly from forgery.’”72

It would be inappropriately simplistic to read Union Planters and Flagstar for the conclusion that applying a proximate cause standard leads to coverage whereas requiring direct causation will lead to non-coverage. The analysis by each court also differed in that each made opposite findings as to the significance of the forged signatures, concluding in Union Planters that the forgery was what rendered the collateral worthless, whereas in Flagstar the collateral would have been worthless even if the signature had been authentic. Another difference is the large number of transactions in the Union Planters case, which may have prevented that court from focusing on each loan transaction and the specific forged documents related thereto, and ascertaining reliance and causation with respect to a particular forgery, rather than focusing on a sea of millions of dollars in separate transactions and an equivalent mass of documents. Engaging in a direct causation inquiry—as with other elements of the Bond—requires a careful evaluation of each portion of the loss, asking what loss was directly caused by reliance on specific forged documentation.

Such a focused analysis was followed by the U.S. District Court for the Northern District of Florida in one of the most recent forgery decisions, Beach Community Bank v. St. Paul Mercury Insurance Co.73 This case concerned a ten million dollar loan made by the insured bank to a real estate investor and developer prior to Florida’s real estate collapse.74 The loan was secured by undeveloped real estate and guaranteed by the developer and his wife.75 Three years after the bank made the loan, the developer died, and the loan immediately went into default.76 After learning that the signature that appeared on the wife’s guarantee was a forgery, the bank filed a claim under Insuring Clause (E) of its bond, for the significant difference between the loan balance and

72 Id. at 824. 73 See Beach Cmty. Bank v. St. Paul Mercury Ins. Co., No. 5:09-cv-

106/RS-MD (N.D. Fla. 2010) (unreported). 74 Id. at 1. 75 Id. at 2. 76 Id.

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Can Direct Mean Direct? 167 the value of the collateral.77 The insurer denied the claim for several reasons, including that the bank’s loss was not directly caused by the forged guarantee.78 In granting the insurer’s motion for summary judgment, District Court agreed that the loss did not directly result from the forgery, because the bank would not have been able to collect on the loan even if the wife’s guarantee had not been forged: “it was not the forged guarantee that precluded [the bank] from collecting on the loan, but rather [the developer and his wife’s] diminished assets and the crashed real estate market that caused [the bank’s] loss. When [the bank] purchased the blanket banker’s bond from [the insurer], it was insuring itself against the risk of a forgery preventing it from collecting on a loan; it was not insuring itself against the risk of collateral becoming worthless or an unpredictable real estate market.”79 The court noted that a contrary holding would create an absurd result: “If Clause (E) applied to the facts presented, it would create a situation where bankers would hope for forgeries because forgeries would take all the economic risk out of the guarantee. Indeed, it is likely that [the bank] was relieved when it discovered the ‘fortuitous’ forged guarantee because [the bank] would otherwise not have been able to collect on the loan because [the wife] had insufficient assets to cover the loan amount.”80

As in the Beach Community Bank decision, non-existence of collateral was a significant reason why a Minnesota state court found no coverage for allegedly forged loan documents under Insuring Agreement (E) in Alerus Financial N.A. v. St. Paul Mercury Insurance Co.81 Despite the fact that five fraudulent loans all involved forged documents, the court found that the loss would have occurred regardless of the forgeries and if none of the documents had been forged.82

The Seventh Circuit also addressed a causation issue involving forgery coverage, but the bond at issue covered “loss by reason of,” not

77 Id. 78 Id. at 3. 79 Id. at 5. 80 Id. at 7. 81 Case No. 27-cv-09-3344 (Minn. Dist. Ct. for Hennepin County June

28, 2010) (unreported). 82 Id. The court also held that none of the forged documents were

among those listed in the insuring agreements.

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“loss resulting directly from.”83 The bond in First National Bank of Manitowoc covered “Loss by reason of the Insured (a) having in good faith and in the usual course of business . . . acted upon any security, document, or other written instrument which proves to have been a forgery or to have been altered or raised or counterfeited . . .”84 The insurer argued that this bond “cover[ed] only losses directly caused by forgery,” and “the forged signatures on the leases did not directly cause the Bank’s loss, the absence of collateral did.”85 The Seventh Circuit followed the bond’s terminology and rejected the insurer’s position, because its “argument ignores the plain language of Insuring Agreement . . . which covers ‘loss by reason of . . .’”86 The court refused to require a “direct” link between the forgery and the loss.87 Instead, it found that the “Bank’s loss easily comes within this language” of “loss by reason of,” as “the Bank sustained a loss because it extended credit . . . based on vehicle leases which proved to be forgeries.”88 Accordingly, the loss was covered.89

First National Bank of Manitowoc contains two points of interest. For one, it places a well-deserved emphasis on the terms actually used by the bond at issue, and focuses on applying the coverage created thereby. The Seventh Circuit noted that “[b]ecause there are several revisions of the Bond in circulation, courts initially ought to determine which version, if any, the policy in question adopts; case law interpreting one revision may be unhelpful or even irrelevant to the task of interpreting another.”90

Additionally, First National Bank of Manitowoc attributed no weight to the insurer’s argument that the forged documents were otherwise valueless. Flagstar and Union Planters demonstrated that even when courts approach forgery losses differently—and reach

83 First Nat’l Bank of Manitowoc v. Cincinnati Ins. Co., 485 F.3d 971,

975 (7th Cir. 2007). 84 Id. at 975. 85 Id. at 979. 86 Id. 87 Id. 88 Id. 89 Id. at 976. 90 Id. at 977.

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Can Direct Mean Direct? 169 differing coverage conclusions—they often agree on the principle that if the subject documents would have been worthless even if the forged signatures had been authentic, then the loss did not result from forgery, and would not be covered.91 By contrast, the Seventh Circuit in First National Bank of Manitowoc dismissed the insurer’s argument of non-coverage on those grounds, essentially replying that such a consideration was not relevant under the “by reason of” causation standard.92 Applying what amounted to a “but for” analysis, the Seventh Circuit found that “but for the forged documents purporting to verify the . . . collateral, credit would not have been extended . . ., and there would have been no loss.”93 Requiring more would contradict the “by reason of” standard of the bond.94 Thus, the First National Bank of Manitowoc bond’s use of “by reason of” in lieu of “directly” determined the course of coverage.

C. Employee Dishonesty

Recent cases that ostensibly interpret the bond’s “direct” causation language in Insuring Agreement A for Employee Dishonesty95 address this issue within the context of coverage for third party liability or other excluded types of loss.

1. Third Party’s Connection to Loss

Interestingly, even when a bond omitted the term “directly” from its coverage clause, the District of Utah applied the bond’s exclusions to require a “direct connection between the claimed loss and the insured event.”96 Direct Mortgage’s bond provided coverage for “loss resulting from dishonest or fraudulent acts . . .,” and excluded “indirect or

91 See Union Planters Bank, 478 F.3d at 765; Flagstar Bank, 260 F.

App’x. at 822-823. 92 First Nat’l Bank of Manitowoc, 485 F.3d at 979. 93 Id. at 980. 94 Id. 95 Insuring Agreement A of the Bond addresses “[l]oss resulting

directly from the dishonest or fraudulent acts” of an insured’s employee. 1986 Bond, Insuring Agreement (A); 2004 Bond, Insuring Agreement (A).

96 Direct Mortgage Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 625 F. Supp. 2d 1171, 1174, 1177 (D. Utah 2008).

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consequential loss of any nature.”97 The bond also excluded “damages of any type for which the Insured is legally liable, except compensatory damages . . . arising directly from a loss covered . . .”98 Direct Mortgage sought coverage under the bond for “its settlement obligations” with third parties arising from its contractual agreements to repurchase bad loans.99 The court read the two exclusions “together,” and “conclude[d] that coverage is limited to direct losses suffered by the insured.”100 The court explained at length that it rejected a “proximate cause” standard, which would be broader than direct.101 Instead, it agreed that “direct means direct,” and the “‘direct means direct’ approach requires a court to focus on whether the employer suffered actual depletion of funds as a direct (immediate) result of the employee’s conduct.” 102 The court found that “the cause of Direct Mortgage’s actual financial loss was third parties’ enforcement of the warranty and buy-back provisions.”103 The loss “was contingent on the occurrence of a series of events that were not inevitable, and such a contingency takes the loss outside the scope of the Fidelity Bond.”104 Accordingly, the claimed loss was not covered by the bond.105

In the similar case of Tri City National Bank v. Federal Insurance, the Wisconsin Court of Appeals was confronted with an insured bank seeking coverage under the 1986 Bond for settlement payments made to mortgage companies who were misled by a scheme involving dishonest bank employees.106 The court explicitly found no coverage “because the . . . bond . . . contained language limiting losses to those ‘resulting directly’ from an employee’s dishonest or fraudulent acts and the fraudulent acts here did not result in any direct losses to the

97 Id. at 1174 (emphasis added). 98 Id. at 1174. 99 Id. at 1173. 100 Id. at 1177. 101 Id. at 1175-76. 102 Id. 103 Id. at 1178. 104 Id. at 1176-1178. 105 Id. at 1178. 106 Tri City Nat’l Bank v. Fed. Ins. Co., 674 N.W.2d 617, 619-20 (Wis.

Ct. App. 2003).

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Can Direct Mean Direct? 171 bank.”107 The Court of Appeals acknowledged that the bond did not define “loss,” “resulting,” or “directly,” but found that the bond was “not ambiguous,” and “[t]his language is not susceptible to more than one meaning.”108 Quite simply, “the bond clearly restricts indemnification to those losses that occur as a direct result of an employee’s dishonest acts.”109 After considering the language of the bond, the court rejected the insured’s idea that “direct” should be interpreted to mean “proximate.”110 The court went on to explain that “Tri City’s losses-the settlements with the mortgage companies—are not the direct result of the employees’ dishonesty; the employees were dishonest by permitting . . . people to obtain mortgagees from other entities, not the [insured]. Thus, the bank initially lost nothing as a result of their dishonesty. It was only after the . . . mortgagees defaulted . . . and the mortgage companies sued Tri City that ‘losses’ resulted.”111 Without analyzing it further, the Tri City court acknowledged that the claimed losses “may also fall within” the bond’s exclusion for “indirect or consequential losses.”112 The Court of Appeals also noted that although “there are instances when third party losses may be covered under fidelity bonds, . . . that is not the issue here;” the issue presented was simply whether the losses “resulted directly from dishonest or fraudulent acts” of an employee.113

In evaluating whether the insured’s claimed loss was a “direct” result from the employee’s dishonesty, the Direct Mortgage and the Tri City courts shared a concern with the closeness in time of the loss to the bad acts (how soon the loss occurred after the dishonest acts), and the contingent nature of the loss (the extent to which the insured’s actual realization of a loss depending upon the occurrence of other events and other parties’ actions). In finding that the bank’s loss was not direct, the Tri City court explained that it “was only after the mortgage defaults occurred, some three years after the employees’ deceitful actions, that [the insured’s] liability to the mortgage companies came into being.”114

107 Id. at 619. 108 Id. at 623. 109 Id. 110 Id. at 624-25. 111 Id. at 626. 112 Id. at 624 n.5. 113 Id. at 626 n.9. 114 Id. at 623.

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The Direct Mortgage court also evidenced a concern with the closeness in time, as it equated a direct loss with one suffered “as a direct (immediate) result,” and found that the “losses were not immediate or readily ascertainable at the time of Mr. Rutherford’s actions.”115 The Direct Mortgage court also found that the insured’s loss “was contingent on the occurrence of a series of events that were not inevitable, and such a contingency takes the loss outside the scope of the Fidelity Bond.”116 Specifically, “if the third parties never discovered the fraud or if they chose not to enforce the clauses, Direct Mortgage would not have suffered the loss it now claims.”117 Likewise, in Tri City the court explained that the losses “did not result directly from” the employee’s dishonest acts since the “losses did not exist until the . . . holders defaulted on their loans and the mortgage companies sued” the insured.118

Although the Northern District of Ohio recently took a different tact, interpreting “resulting directly from” as calling for a “proximate cause” standard, it did share the Tri City and Direct Mortgage courts’ interest in the time elapsed between the bad act and the loss, and the loss’s dependence on other actors to come to fruition.119 The insured in First Defiance sought coverage under its bond for the over $900,000 it paid to “restore” funds to its customers after its employee had removed funds from customers’ brokerage accounts.120 A rider to the First Defiance bond provided coverage for “loss resulting directly from dishonest or fraudulent acts committed by an Employee . . .”121 The insurer claimed the loss was not covered because the employee took only third party customers’ funds, not any funds of the insured, and so the loss was not “resulting directly from” the dishonesty.122 The First Defiance court first looked to a somewhat wordy investment advisory exclusion in

115 Direct Mortgage Corp., 625 F. Supp. 2d at 1175, 1178. 116 Id. at 1176-78. 117 Id. at 1178. 118 Tri City Nat’l Bank, 674 N.W.2d at 623. 119 See First Defiance Fin. Corp. v. Progressive Cas. Ins. Co., 688 F.

Supp. 2d 703 (N.D. Ohio 2010). 120 688 F. Supp. 2d at 705. 121 Id. at 706-07. 122 Id. at 707.

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Can Direct Mean Direct? 173 the bond,123 and concluded that “[t]here must be some instance where, in the brokerage or investment . . . context, an employee’s theft from a customer’s account constitutes a ‘direct loss’ under the fidelity language.”124 The court then rejected the insurer’s interpretation of “loss resulting directly from” as “overly-literal,” and adopted instead “an interpretation calling for a proximate causation analysis [as] the better approach.”125 As reasoning therefor, the court asserted that “[v]arious courts across the country have adopted a proximate cause test for determining whether a loss was ‘direct.’”126 The court did not explain what a “proximate cause test” required, but concluded “that [the employee’s] theft proximately caused [the insured’s] loss and therefore the loss resulted directly from [the employee’s] actions.”127 The court found that the employee’s “theft and the reimbursements by [the insured] are not so attenuated as to break the causal connection.”128 Thus, the court seemed to begin with the idea that the employee’s acts caused the loss, and required something to break that link in order to defeat coverage, rather than first evaluating the connection between the act and the loss to determine if coverage existed.129 The court also explained, apparently in support of its causal analysis, that the insured “stepped in and, promptly after the thefts were discovered, on its own, paid customers and notified” the insurer.130 The relevance of the insurer’s promptness in payment or notification to its insurer to the question of whether the payments were a “direct loss” is not explained. However, despite the other concerns raised by this opinion, First Defiance at least

123 “This bond does not cover . . . for the purpose of providing

brokerage or investment advisory services only, loss resulting directly or indirectly from transactions in a customer’s account, whether authorized or unauthorized, except the unlawful withdrawal and conversion of Money . . . directly from a customer’s account by an Employee provided such unlawful withdrawal and conversion is covered under [fidelity language] .” First Defiance Fin. Corp., 688 F. Supp. 2d at 707.

124 Id. at 707-708. 125 Id. at 708. 126 Id. (citing Auto Lenders Acceptance Corp. v. Gentilini Ford, Inc.,

854 A.2d 378 (N.J. 2004)). 127 Id. 128 Id. 129 See id. 130 Id.

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points to a superficial interest in the timing of the loss and the involvement of other parties or events.

2. Directly Resulting Losses

Although other Bond provisions address the types of losses that may be covered, the Bond’s language of “loss resulting directly from” in Insuring Agreement A gives rise to arguments by insurers that particular items or types of loss did not result “directly” and arguments by insureds that the same were direct results of the covered dishonesty. Accordingly, one must read such cases carefully, because the finding of coverage or non-coverage may rely on the interpretation of “directly resulting from” as well as relevant exclusions, such as those similar to the Bond’s exclusions (v), for “indirect or consequential loss of any nature,” and (t), regarding “damages . . . for which the Insured is legally liable . . . .131

One such example, Patrick Schaumburg Automobiles v. Hanover Insurance, involved a commercial crime insurance policy, which covered “loss of, and . . . to, Property resulting directly from” an enumerated cause, and excluded “Indirect Loss: Loss that is an indirect result” of an otherwise-covered act.132 Patrick Schaumburg’s dishonest employee “sold [the insured’s] cars to accomplice wholesalers for an amount less than the cars’ worth and bought cars from accomplice wholesalers for more than the cars’ worth.”133 The parties did not “dispute that [the insured’s] loss was caused by” this employee.134 The court read the indirect loss exclusion “together with the term defining a Covered Loss as ‘loss of . . . Covered Property resulting directly from . . .’” to mean that the policy “draws a distinction between the loss of the intrinsic value of the asset, which is Covered Property, and the loss of the asset’s potential for generating income . . . which is excluded.”135 Accordingly, the insured’s payments to wholesalers for the purchase of cars, which amounts the insured “would not have paid but for [the employee’s]

131 1986 Bond §§ 2 (t), (v); 2004 Bond §§ 2 (t), (v). 132 Patrick Schaumburg Autos., Inc. v. Hanover Ins. Co., 452 F. Supp.

2d 857, 862 (N.D. Ill. 2006). 133 Id. at 860. 134 Id. at 871 n.11. 135 Id. at 872.

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Can Direct Mean Direct? 175 dishonest activity [,] is a covered loss.”136 Likewise, the insured’s sale of an “asset for less than its intrinsic value is a ‘direct loss.’”137 In the end, the court denied summary judgment, and emphasized that the insured bore the burden of establishing the existence and amount of its covered losses.138

Similarly, in Citizens Bank & Trust Co. v. St. Paul Mercury Ins. Co., the Southern District of Georgia looked to the Bond’s coverage for “loss resulting directly from” dishonesty in order to evaluate the proper amount of loss.139 The Bond in Citizens Bank also excluded “indirect or consequential loss” and loss of “potential income.”140 The insured had been compensated under the Bond for the “net cash amount” by which its accounts had been depleted by the employee’s scheme; the remaining issue was whether the insured was entitled to coverage for “the amounts of [the employee’s] outstanding fraudulent loans which represent accrued interest on prior notes.”141 The court used the coverage language in concert with an exclusion to find that this disputed balance was “not a ‘direct loss.’”142 The court emphasized that “the phrase ‘loss resulting directly from’ is not ambiguous,” and requires an actual withdrawal of funds or similar pecuniary loss.143 The flip side of this finding was that the employee’s “potential civil liability” to the insured “is not the measure of ‘direct loss’ under the contract.”144 In the end, however, the relevance of the “resulting directly from” coverage term to the claimed loss was unclear, as the court segued to explain that it was “not to say that the Disputed Balance is not a loss . . . the Court holds that this type of ‘indirect’ loss” was explicitly excluded as “potential income.”145 The exclusion carried the day. Yet, when it came time to deny the insured’s

136 Id. at 873. 137 Id. 138 Id. at 873-74, 876. 139 Citizens Bank & Trust Co. v. St. Paul Mercury Ins. Co., No.

CV305-167, 2007 WL 4973847 at *1 (S.D. Ga. Sept. 14, 2007). 140 Id. at *1. 141 Id. at *1-3. 142 Id. at *5. 143 Id. at *4 (citation omitted). 144 Id. 145 Id. at *5.

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motion for summary judgment, the court closed with, “Therefore, the Court holds that the Disputed Balance . . . is not a ‘direct loss.’”146

In Frontline Processing Corp. v. Am. Economy Ins. Co., the Montana Supreme Court was asked to set the standard for determining which losses are “direct” and which are “indirect,” but did so under unique policy terms.147 Frontline Processing Corp.’s policy was a “special Businessowner’s Policy,” with “optional coverage for employee dishonesty.”148 The dishonesty provision stated that the insurer “will pay for direct loss of or damage to . . . Property . . . resulting from dishonest acts.”149 Thus, unlike the standard Bond insuring agreements, this policy covered (a) a “direct loss of . . . Property” that (b) simply “result[ed] from dishonest acts.”150 Among other amounts, the insured sought “costs, interest, penalties, and fees assessed by the . . . IRS . . . as a result of [the employee’s] alleged deliberate failure to pay” taxes.151 Without addressing whether any or all of the insured’s claimed losses actually qualified for coverage, the Montana court decided that “direct loss” “applie[d] to consequential damages incurred by the insured that were proximately caused by the alleged dishonesty.”152

IV. CONCLUSION

The Bond explicitly and repeatedly requires that a loss must result directly from a covered act in order to reach coverage under the Bond. Courts interpreting the Bond should be faithful to the language of the parties’ agreement, and require a direct causal connection between the covered act and the loss. Tackling Bond coverage with the tools of tort law is unnecessary, confusing, and unfaithful to the Bond. Whereas a jurist faced with a question of tort liability is charged with establishing public policy, the court’s task in evaluating Bond coverage is, first and

146 Id. 147 Frontline Processing Corp. v. Am. Economy Ins. Co., 149 P.3d 906

(Mont. 2006). 148 Id. 149 Id. at 908. 150 Id. 151 Id. 152 Id. at 911.

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Can Direct Mean Direct? 177 foremost, applying the terms of the parties’ agreement. Unlike tort law, in which society relies on the courts to draw the lines of individuals’ responsibility for their unintended actions, the Bond presents the Courts with the lines of liability already drawn, with the court’s task to apply those lines to the—often ugly, disputed, or complicated—facts at hand. Undeniably, webs of causation are sticky things. However, the Bond streamlines the maze and simply requires that the bad act lead directly to the loss. Several courts have recently heeded this calling, understanding that direct means direct.