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.