by Christopher J. Graham and Joseph P. Kelly

FDIC v. Denson, Civil Action No. 3:11CV498TSL-MTP (S.D. Miss., November 7, 2012):

Fraudster Denson was a teller employed by Bank. On November 14, 2006, a dual, verified count at a branch revealed a $209,500 shortage in the branch vault and a $172,104.49 shortage in the teller cash dispenser. These losses were traced to Fraudster, who eventually pled guilty to falsifying bank records. Bank made a claim under Insuring agreement A (Fidelity) of a Financial Institution Bond issued by Progressive.

The Bank provided the following answers in its Bond application: “Cash controls: a) Are all currency shipments prepared, received, and counted under dual control? Yes b) Are the main and reserve cash vaults in each location maintained under dual control? Yes c) Maximum cash held in main vault of any location $750,000.” It also affirmed in the application “that reasonable efforts have been made to obtain sufficient information from each and every individual or entity proposed for this insurance to facilitate the proper and accurate completion of this Application.” The Bond provided: “The insured represents that the information furnished in the application for this bond is complete and correct. Such application constitutes part of this bond” and “Any intentional misrepresentation, omission, concealment or incorrect statement of a material fact, in the application or otherwise, shall be grounds for rescission of this bond.”

The Bond’s discovery provision provided:

This Bond applies to loss first discovered by the Insured during the Bond Period. Discovery occurs when the Insured first becomes aware of facts which would cause a reasonable person to assume that a loss of a type covered by this bond has been or will be incurred, regardless of when the act or acts causing or contributing to such loss occurred, even though the exact amount or details of the loss may not then be known. … This bond terminates as an entirety upon occurrence of any of the following: This bond terminates as to any Employee (a) as soon as any Insured, or any director or officer of an Insured who is not in collusion with such person, learns of any dishonest or fraudulent act committed by such person at any time, whether in the employment of the Insured or otherwise, whether or not of the type covered under Insuring Agreement (A), against the Insured or any other person or entity, without prejudice to the loss of any Property then in transit in the custody of such person…

Termination of this bond as to any Insured terminates liability for any loss sustained by such Insured which is discovered after the effective date of such termination. Termination of this bond as to any Employee terminates liability for any loss caused by a fraudulent or dishonest act committed by such person after the date of such termination.

Bank sued Progressive for failing to pay the claim. FDIC became plaintiff after Bank failed and FDIC was appointed its receiver. The Court, applying Mississippi law, denied Progressive’s motion for summary judgment and addressed these issues:

Issue #1: Did undisputed material facts establish, as Progressive argued, that the Bank made a material misrepresentation in answering “Yes” when asked in the Bond application by Progressive: “Are the main and reserve cash vaults in each location maintained under dual control?” No.

It was undisputed that the Bank had a dual control policy. But Progressive argued the undisputed material facts proved the Bank was ignoring that policy when the application answer was provided. Progressive claimed that dual cash counts were not being done for at least six weeks before the application answer. It cited two tally sheets dated February 2006 which had Fraudster’s initials plus the forged initials of another teller. So, per Progressive, answering that the Bank had a dual control policy was a false statement. But the Court held that there was a genuine issue of material fact on this issue. It emphasized that that Progressive’s investigator, after almost a year’s investigation, thought the Bank’s answers were accurate, and that there was not enough information in the record to decide whether the Bank had made “reasonable efforts” to ensure the dual control policy was in force, or even if those reasonable efforts would have discovered the fraud.

Issue #2: Did the undisputed material facts establish that after Bank personnel discovered in March 2006 that cash was missing from the vault, Bank failed to comply with the Bond’s notice and proof of loss provisions? No.

It was undisputed that on March 23, 2006, Sheila Craig, teller operations officer for the Bank, appeared at the Highway 16 Branch unannounced for the purpose of auditing vault cash. Craig’s audit found a shortage of approximately $30,000. When Craig inquired of Denson regarding the shortage, Denson explained that the amount of the shortage in the vault had been overloaded into the teller cash dispenser, and she showed Craig a cash out ticket she had prepared but not yet run that was in the same amount as the shortage from the vault. Craig accepted Denson’s explanation and made no further investigation.

Progressive argued that a reasonable person in Craig’s position would not have accepted Denson’s story and made an investigation that would have revealed Denson’s lies. Bank therefore had discovered a loss on March 23, which was not timely reported, and per the terms of the Bond coverage for Denson’s actions terminated on that date. The Court disagreed, citing U.S. Supreme Court precedent that “although an insured `may have had suspicions of irregularities; he may have had suspicions of fraud, but he was not bound to act until he had acquired knowledge of some specific fraudulent or dishonest act which might involve the defendant in liability for the misconduct.'”) (quoting American Sur. Co. of New York v. Pauly, 170 U.S. 133, 145, 18 S. Ct. 552, 42 L. Ed. 977 (1898).”

The Court held that under the circumstances, a reasonable jury could find either way on the issue, so summary judgment must be denied.