The American Trust and Savings Bank, Dubuque, Iowa (bank) purchased a banker’s blanket bond from United States Fidelity and Guaranty Company (insurer). The bond protected the bank from various specified losses including those directly resulting from dishonest or fraudulеnt acts of the bank’s employees. The fighting issue in this case is the extent to which the terms of the bond require the insurer to reimburse the bank by reason of an employee’s embezzlement scheme. The district court
In 1985, Fred Pape, a senior vice-president of the bank, wаs discovered to have committed a series of embezzlements from the bank commencing in 1969. Pape would obtain money from the bank by forging notes purporting to be loan agreements of bank customers. To conceal his embezzlement he would pay off these notes as they came due, in part with money obtained from newly forged notes. Over this period of time Pape’s roll-over scheme involved approximately 496 forged notes. All but twelve of these had been paid off by the time his scheme was discovered. These twelve notes had a face amount totalling $4,305,500.
An audit prepared for the bank showed that of this amount, $2,075,351.64 represented money that Pape had used to mаke interest payments on the prior fraudulent notes. Bank records show the accrual and payment of interest in that amount. However, the money Pape obtained from the bank in order to pay interest to the bank does nоt represent an actual depletion of bank funds. The “total cash out” of the bank resulting from Pape’s scheme is actually $2,230,148.36. The insurer has already paid this amount less deductible to the bank. The dispute in this case is whether the insurer must also pay the portion of the face amount of the outstanding notes which represents interest paid on prior fraudulent notes. The bank commenced this action against the insurer demanding payment of the portion of thе notes attributable to interest. The parties agree on the facts and each sought summary judgment in its favor.
Officers and employees of state-chartered banks are required to provide:
a good and sufficient bond ... indemnifying the stаte bank against losses, which may be incurred by reason of any act or acts of fraud, dishonesty, forgery, theft, larceny, embezzlement, ... or other unlawful acts committed by such officer or employee ... until all of the officer’s or employee’s accounts with the state bank shall havé been fully settled and satisfied.
Iowa Code § 524.705. In this instance the bank acted for its employees in securing the banker’s blanket bond. Although designated a “bond,” the banker’s blanket bond is in fact а contract of indemnity requiring the insurer, for a premium, to indemnify the bank for certain losses. One risk covered by this contract is, “[l]oss resulting directly from dishonest or fraudulent acts of an [ejmployee.... ” The parties agree that Papе’s defalcation was a covered risk under the terms of the bond, but disagree on the amount of the loss.
Although the insurer argues to the contrary, we conclude that the bond in question is a statutory bond governed by Iowa Code section 524.705. See State Surety Co. v. Lensing,
Both the statute and the bond itself speak of “losses”, the key word in this dispute. The statute requires that the bond indemnify the bank against “losses” resulting from various acts of the bank officer or employee, including embezzlement and forgery, “until all of the officer’s or employee’s accounts with the state bank shall have been fully settled and satisfied.” Iowa Code § 524.705. The bond provides indemnity for “[l]oss resulting directly
The insurer insists that the court was wrong in concluding that the loss is determined from the face of the fictitious notes created by Pape rather than by thе actual depletion of the bank’s funds. The bank maintains that Pape is liable to the bank for the face amount of the twelve outstanding notes, see Iowa Code § 554.3404(1) (one who signs name of another, without authorization, is liable on note). It thеn claims that the bonding company’s liability is coextensive with that of the defalcating employee.
We believe that the terms “losses” under the statute and “loss” under the bond refer to the actual depletion of bank funds caused by the employee’s dishonest acts and not to the eventual personal liability of the employee to the bank. Stated otherwise, the covered loss is that which arises at the time and place that the specified miscоnduct occurred. Citizen’s Bank of Oregon v. American Ins. Co.,
In this bond the word “loss” means the deprivatiоn or dispossession of money or property of the bank due to the dishonest, criminal or fraudulent acts of its officers, regardless of the security the bank has for the loss, and that the “loss” occurred and was suffered by the plaintiff, without regard to its possible remedies, when its funds in fact were diverted ... through the fraud and dishonesty of its treasurer.
Fitchburg Savings Bank v. Massachusetts Bonding & Ins. Co.,
In passing on a scheme similar to Pape’s, where new money was diverted to pay off and conceal prior diversions, a federal district court addressed the issue of which of two successive insurance policies сovered the loss. See John B. White Inc. v. Providence Washington Ins. Co.,
overlooks the admitted fact that these funds were used to cover previous shortages in other customer accounts as well as the fact that the embezzlement was continuing, and, as the calculations show, waxing during the period of the Prov-Wash Policy.
Id. at 330. While these cases address a different issue, we find them instructive. We believe that the covered loss under the bond and statute at issue is that which occurs at the time of the original wrongdoing. Thus, “loss” does not include that portion of the outstanding notes which represents interest payments made to cover up prior embezzlements.
The next question is whether Iowa Code section 524.705 requires the insurer tо indemnify the bank beyond its loss. The bank points to the statutory language requiring the bond to indemnify “the state bank against losses ... until all of the officer’s or employee’s accounts with the state bank shall have been fully settled and satisfied.” The bаnk urges that this language makes the insurer’s liability under the bond co-extensive with Pape’s. It further argues that the funds Pape fraudulently obtained to pay interest on prior notes affected the bank’s balance sheets, lending limits, and reserves tо the same extent as the funds Pape used to pay the principle on the prior notes or for his own purposes. They also point out they have
Even assuming that Pape was liable for the face amount of the twelve notes outstanding at the time he was discovered, we believe that the coverage required under section 524.705 is for loss caused by the sрecified acts. The required coverage should not be extended to cover interest that accumulated on the forged instruments. When newly forged notes were used to pay interest, the bank suffered no loss because its assets were not diminished in fact, nor did the phony interest payments increase the bank’s assets, although its books showed otherwise. The payment of income tax on the theoretical gain did not result from the defalcation, rather it was a consequence of Pape’s subsequent cover-up of the prior embezzlements. Thus, this alleged loss was not a loss from the specified acts.
We believe that our interpretation of “losses” under section 524.705 is equally aрplicable to the terms of the bond. The bond specifically covers loss resulting directly from the specified dishonest acts. Losses resulting from failure to repay real or legitimate notes are expressly excluded in the policy. If Pape is liable to the bank for the face amount of the twelve notes it is because of his signatures on them. We believe that this bad loan exclusion would prevent the insurer from being liable for Pape’s civil liability beyond his аctual defalcation.
We acknowledge that our holding in this case is contrary to authority cited by the bank. See St. Paul Fire & Marine Ins. Co. v. Branch Bank & Trust Co.,
In construing Iowa Code section 524.705 and the banker’s blanket bond as we have, we are not unmindful of the result had we adopted the bank’s interpretation. If we were to allow recovеry of the full face amount of the twelve outstanding notes the bank would in fact profit from the dishonest acts of its own employee. Such an interpretation of the statute and the bond would be unreasonable.
We believe that thе insurer rather than the bank was entitled to summary judgment, but that the insurer’s judgment should be limited. The insurer claims that it should not be required to pay any interest on the stolen funds. We disagree. We have previously stated, “Up to the face of a private bond the surety is liable for interest the same as the principal.” Mechanicsville Trust & Savings Bank v. Hawkeye-Security Ins. Co.,
We hold that the bank is entitled tо the interest specified in section 535.2(1) from the date of each defalcation until the date this action was commenced. From the date the action was commenced the bank is entitled to the interest under Iowa Code section 535.3.
We remand this matter for a determination of the amount of interest owed the bank.
REVERSED AND REMANDED.