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United States: Hunton Insurance Recovery Blog: Federal Court Rejects Insurer's Narrow Interpretation Of Securities Insuring Agreement And Applies Notice-Prejudice Rule To Financial Institution Bond
A federal court last month turned away an insurer's legal
arguments seeking to avoid financial institution bond coverage for
a bank's losses resulting from a borrower's use of forged
documents to obtain a $3.6 million loan. In doing so, the Arizona
court rejected Everest National Insurance Company's narrow
construction of the bond's "Securities" insuring
agreement and ruled that the notice-prejudice rule applies to a
financial institution bond.
In MBP Collection LLC v. Everest
National Insurance Co., No. CV-17-04022-PHX-GMS, 2019 WL
110987 (D. Ariz. Jan. 4, 2019), the bank loaned $3.6 million to
Global Medical Equipment of Arizona, Inc. to fund part of its
purchase of two other medical equipment companies. Because the loan
did not cover the entire purchase price, the bank required the
borrower to agree that it would not make any additional payments to
the sellers for a four-year period. The bank also obtained standby
creditor's agreements that it believed were signed by the
sellers, which required the sellers to pay to the bank any payments
they received from the borrower during the four-year period.
As with nearly all financial institution bonds, the bank's
bonds applied to loss discovered during the bond periods (2013-2014
and 2014-2017), required notice within 30 days of discovery, and a
proof of loss within six months. Following the borrower's
default and the institution of a receivership, the bank discovered
that the creditor's agreements had been forged. In 2016, the
bank gave Everest notice and later proof of loss under its
2014-2017 bond.
Everest denied the claim and the bank filed suit. Everest moved
for summary judgment and the bank moved for partial summary
judgment. The motions presented two issues. The first issue was
whether the forged standby creditor's agreements constituted a
"Guarantee" under the bond's "Securities"
insuring agreement, and the second issue was whether the
notice-prejudice rule applies to a financial institution bond.
The bond's "Securities" insuring agreement
covered, among other things, "[l]oss resulting directly from
[the bank] having, in good faith,...extended value...on the faith
of, any...personal Guarantee...." Dismissing Everest's
arguments, the court held that the creditor's agreements fell
within the bond's definition of "Guarantee": a
"[w]ritten undertaking obligating the signer to pay the debt
of another, to the Insured...if the debt is not paid in accordance
with its terms." The court noted that a guarantee does not
have to create an obligation to pay the entire debt.
The court also ruled in the bank's favor on the second
issue—whether the notice-prejudice rule applies to the notice
requirement under a financial institution bond. Although the timing
of the bank's discovery of loss was contested—with
Everest contending it occurred before the inception of the
2014-2017 bond and the bank contending it occurred during the bond
period—the bank's 2016 notice was admittedly not given
within 30 days of discovery as prescribed by the bond. Everest
argued that such untimely notice precluded coverage, but the court
disagreed, holding that the notice-prejudice rule applies. The
court rejected Everest's argument (frequently made by insurers)
that applying the notice-prejudice rule would convert such bonds
into occurrence policies. The court noted that the bond is neither
an occurrence policy nor a claims-made policy, but instead
"applies to loss first discovered during the policy
period." The court reasoned that, because discovery
triggers coverage, the traditional rationale for not extending the
notice-prejudice rule to claims-made policies does not apply.
Although the Arizona federal court left certain coverage issues
to be decided at trial, its rejection of Everest's narrow
interpretation of the bond's "Securities" insuring
agreement and its application of the notice-prejudice rule to a
financial institution bond was a significant win for the
policyholder. The opinion should provide a useful precedent for
financial institutions to cite when confronting similar arguments
by insurers in the future.
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