Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca10-89-05194/USCOURTS-ca10-89-05194-0/pdf.json

Nature of Suit Code: 110
Nature of Suit: Insurance
Cause of Action: 

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OFFICE OF THE CLERK 

United States Court of Appeals for the Tenth Circuit 

C-404 United States Courthouse 

1929 Stout Street 

Denver Colorado 80294 

December 23, 1991 

TO: ALL RECIPIENTS OF THE CAPTIONED OPINION 

RE: 89-5194, 89-5197, 90-5153 Adair State Bank v. American 

Casualty Company of Reading, Pennsylvania 

Filed November 25, 1991 by Judge McKay 

Attached is corrected page 20 to the captioned opinion. 

Please be advised that this correction supersedes the December 20, 

1991 notification and is as· follows: 

Page 20, second paragraph, first sentence "of 

"collusion," but the appellee" the word appellee has been 

corrected to read insurer. 

Enclosure 

Very truly yours, 

ROBERT L. HOECKER, Clerk 

By, /4 

Barbara 

lc«-

Schermerhorn 

h ~ Deputy Clerk 

Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 1 
The district court, searching for a popular definition of 

"collusion," cited the following definition from Black's Law 

Dictionary: 

An agreement between two or more persons to defraud a 

person of his rights by the forms of law, or to obtain 

an object forbidden by law. It implies the existence of 

fraud of some kind, the employment of fraudulent means, 

or of lawful means for the accomplishment of an unlawful 

purpose •..• A secret combination, conspiracy, or 

concert of action between two or more persons for fraudulent or deceitful purpose. 

Black's Law Dictionary 240 (5th ed. 1979) (citation omitted). The 

district court then concluded that officers Floyd, Hall, and Rice 

were aware of what each knew and what each was doing. The court 

concluded that they secretly participated toward the same unlawful 

purpose of concealing Mr. Dunham's activities. 

Neither party disagrees with the district court's definition 

of "collusion, 11 but the insurer takes issue with how the district 

court applied the term to Ms. Hall's activities. The insurer 

explains that when Ms. Hall learned of Mr. Dunham's dishonest and 

fraudulent acts, she did not have a secret agreement with him to 

further the scheme. It emphasizes Ms. Hall's assertion that she 

never spoke with Mr. Dunham concerning his overdrafts. The 

insurer complains that Ms. Hall remained silent not because she 

was a co-conspirator who intended to defraud the bank, but because 

she believed that she did not need to speak to anyone other than 

her superiors. 

We do not construe Ms. Hall's silence so benignly. The 

district court found, and we agree, that Ms. Hall's tender to the 

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OFFICE OF THE CLERK 

United States Court of Appeals for the Tenth Circuit 

C-404 United States Courthouse 

1929 Stout Street 

Denver Colorado 80294 

December 20, 1991 

TO: ALL RECIPIENTS OF THE CAPTIONED OPINION 

RE: 89-5194 Adair State Bank v. American Casualty Co. 

Filed 11/25/91 by Chief Judge McKay 

Please be advised of the following correction to the 

captioned opinion: 

Page 20, second paragraph, first sentence· 11 of 

"collusion," but the appellee" the word appellee has been 

corrected to read appellant. 

Enclosure 

A corrected page 20 is enclosed. 

Very truly yours, 

ROBERT L. HOECKER, Clerk 

., ,r 

By:~,:;/~ 

Barbara Schermerhorn 

Deputy Clerk 

Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 3 
The district court, searching for a popular definition of 

"collusion," cited the following definition from Black's Law 

Dictionary: 

An agreement between two or more persons to defraud a 

person of his rights by the forms of law, or to obtain 

an object forbidden by law. It implies the existence of 

fraud of some kind, the employment of fraudulent means, 

or of lawful means for the accomplishment of an unlawful 

purpose .... A secret combination, conspiracy, or 

concert of action between two or more persons for fraudulent or deceitful purpose. 

Black's Law Dictionary 240 (5th ed. 1979) (citation omitted). The 

district court then concluded that officers Floyd, Hall, and Rice 

were aware of what each knew and what each was doing. The court 

concluded that they secretly participated toward the same unlawful 

purpose of concealing Mr. Dunham's activities. 

Neither party disagrees with the district court's definition 

of "collusion," but the appellant takes issue with how the 

district court applied the term to Ms. Hall's activities. The 

insurer explains that when Ms. Hall learned of Mr. Dunham's 

dishonest and fraudulent acts, she did not have a secret agreement 

with him to further the scheme. It emphasizes Ms. Hall's 

assertion that she never spoke with Mr. Dunham concerning his 

overdrafts. The insurer complains that Ms. Hall remained silent 

not because she was a co-conspirator who intended to defraud the 

bank, but because she believed that she did not need to speak to 

anyone other than her superiors. 

We do not construe Ms. Hall's silence so benignly. The 

district court found, and we agree, that Ms. Hall's tender to the 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 4 
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PUBLISH 

FILED 

United States Coμrt qf Appeala Tenth C1rcmt 

UNITED STATES COURT OF APPEALS 

TENTH CIRCUIT 

NO\/ 2 5 1991 

ROBERT L. HOECKER 

Clerk 

ADAIR STATE BANK, an Oklahoma 

Banking Corporation, 

v. 

Plaintiff-Appellee/ 

Cross-Appellant, 

AMERICAN CASUALTY COMPANY OF 

READING, PENNSYLVANIA, 

Defendant-Appellant/ 

Cross-Appellee. 

ADAIR STATE BANK, an Oklahoma 

Banking Corporation, 

Plaintiff-Appellee, 

v. 

AMERICAN CASUALTY COMPANY OF 

READING, PENNSYLVANIA, 

Defendant-Appellant. 

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Nos. 89-5194 

89-5197 

No. 90-5153 

APPEAL FROM THE UNITED STATES DISTRICT COURT 

FOR THE NORTHERN DISTRICT OF OKLAHOMA 

(D.C •. 87-C-45-E) 

Thomas H. Crouch of Meagher & Geer, Minneapolis, Minnesota (Thomas 

M. Stieber and Charles H. Becker of Meagher & Geer, Minneapolis, 

Minnesota, and Michael Hill of Secrest & Hill, Tulsa, Oklahoma, 

with him on the briefs), for Defendant-Appellant/Cross Appellee. 

Robert w. Nelson of Ramey, Nelson & Brown, Yukon, Oklahoma (David 

w. Edmonds and Brian Husted of Edmonds, Cole, Hargrave, Givens & 

Witzke, Oklahoma City, Oklahoma, with him on the briefs), for 

Plaintiff-Appellee/Cross-Appellant. 

Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 5 
Before McKAY, Chief Judge, LOGAN, Circuit Judge, and WINDER, 1 

District Judge. 

McKAY, Chief Judge. 

An insurer in this diversity action challenges the judgment 

of the United States District Court for the Northern District of 

Oklahoma awarding•indemnity on an employee fidelity bond the 

insurer issued to a bank. The district court found that the bond 

covered the defalcation of the bank's chairman of the board. The 

insured cross-appeals the judgment of the district court in favor 

of the insurer on its claim that the insurer breached its duty of 

good faith and fair dealing. Finally, the insurer appeals the 

amount of attorney fees awarded by the district court to the 

insured under the state statute. We consolidate the appeals for 

purposes of our review. 

I. 

This case arose from a check-kiting scheme perpetrated 

against Adair State Bank by Harold Dunham, the chairman of the 

bank's board of directors, who co-owned the controlling shares of 

the bank's stock and maintained a checking account there. He also 

1 Honorable David K. Winder, United States District Judge for 

the District of Utah, sitting by designation. 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 6 
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maintained a checking account at the Bank of Chelsea, an affiliated bank of which he was also a co-owner. 

Mr. Dunham's scheme began in May 1985 when he wrote a $55,000 

check on his Adair checking account but had insufficient funds to 

cover it. He instructed a bank employee to hold the check and 

show it on the bank's books as a cash item. The bank honored the 

check, rather than returning it to the payee for insufficient 

funds, and Mr. Dunham's account was not shown as overdrawn. The 

chairman obtained funds the next day to cover the check. 

Overdrafts on Mr. Dunham's account soon became routine at 

Adair State Bank. In July 1985 Mr. Dunham wrote a check in excess 

of $100,000 for which his account held insufficient funds. This 

time, however, he was unable to come up with the funds after the 

check was placed on the books of Adair as a cash item. Mr. Dunham 

instead deposited into his Adair account a check drawn on his 

account at the Bank of Chelsea, for which there were also insufficient funds. To avoid an overdraft at Chelsea, Mr. Dunham then 

drew another check, for which there were insufficient funds, on 

his Adair account and deposited that check in his Chelsea account. 

When that check was returned to Adair for payment, it was placed 

in the cash items account. From July 1985 to March 1986, Mr. 

Dunham engaged in this scheme repeatedly. He would write a check 

on his Bank of Chelsea account at the end of each month to clear 

the bad checks being held on Adair's books as a cash item. The 

large amount would not show up on the end-of-the-month computer 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 7 
reports which went to the board of directors at Adair. At the 

beginning of each month he would cover the check he had written on 

his Chelsea account by writing a check on his Adair account. 

Hence, the last Adair check would not arrive at Adair for collection until after the end of the month, and the Chelsea check would 

not show up as an overdraft for review by the board of directors. 

By September or October his overdrafts exceeded $200,000, and by 

March 1986 they exceeded $500,000. 

To succeed in his scheme, Mr. Dunham required the assistance 

of a few of Adair's officers. The parties agree that three of the 

insured's officers knew about some or all of Mr. Dunham's scheme. 

In the summer of 1985, Marsha Hall, a vice president and cashier 

at the bank and cousin of Mr. Dunham, discovered a correlation 

between a list of overdrafts from Mr. Dunham's account and an 

unusually high balance in the bank's daily cash items report. She 

knew that Mr. Dunham had directed that the overdrafts be placed in 

cash items and that the checks were cleared from cash items at the 

end of the month. She also knew that the pattern recurred month 

after month. Ms. Hall questioned this practice in a conversation 

with Charles Floyd, the bank's president. Mr. Floyd admitted that 

he had spoken about the overdraft problem with Mr. Dunham, who had 

assured him that he would take care of the problem in a few 

months. Ms. Hall never brought the issue up with Mr. Dunham himself. 

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Neither did Ms. Hall bring the scheme to the attention of any 

other directors of the insured. In her role as secretary to the 

board of directors, Ms. Hall helped to prepare monthly reports for 

the board. Whereas the cash items figure for the month's end 

report was computer-generated, Ms. Hall had personal responsibility to account for all overdrafts in excess of one hundred dollars 

as of the last business day of each month. She verified the 

report for her supervisor, Barbara Rice, and prepared the minutes 

for and attended each board meeting. Ms. Hall testified that it 

was never her intent to defraud the insured and cause it to sustain a loss by not reporting Mr. Dunham's scheme to the directors. 

She felt that because she had already spoken to her superiors, Mr. 

Floyd and Ms. Rice, she need not have done anything further. At 

one point, however, the bank's president told her that if the 

scheme ever failed, he probably would end up in prison. 

Ms. Rice, another cousin to Mr. Dunham, was the senior vicepresident of Adair and manager of a branch office. As the bank's 

internal control officer, she was responsible for reviewing the 

insured's reports on cash items and overdrafts. She first noticed 

the check-kiting scheme in the summer of 1985, when she questioned 

Ms. Hall about a high balance in cash items. The secretary 

reported that the cash items were in fact Mr. Dunham's bad checks, 

and that she understood that Mr. Dunham was getting a large loan 

to remove those items. Though the items were removed at the end 

of that month, Ms. Rice noticed that the cash items returned to an 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 9 
inordinately high figure shortly afterward. Ms. Rice finally confronted the bank's president, Charles Floyd, about the checks, and 

he assured her that Mr. Dunham was obtaining a loan to take care 

of the matter. Ms. Rice knew that such a practice was against the 

bank's procedures and the law. After several conversations with 

the bank's president, and after watching the amount reported in 

cash items increase every month, the senior vice president spoke 

to Mr. Dunham when he visited the bank's branch office. He promised that the matter would be taken care of at the end of the 

month and requested that she not "pull the plug." (Record, Vol. 

1, Doc. 78, Ex. Q at 37.) Ms. Rice testified that because she was 

wary of the relationships among the chairman of the board and the 

other directors, she did not bring up the scheme to any of the 

board members. She had reported defalcations of an earlier bank 

president to one of the bank's directors, a man who was on the 

board during all time periods relevant here. Ms. Rice testified 

that she worried about her relatives inside and outside of the 

bank and about the effect on the family name if her cousin were 

exposed. However, she apparently spoke openly with persons outside of the bank concerning Mr. Dunham's overdrafts. Ms. Rice 

also discussed Mr. Dunham's overdrafts with fellow Adair officers 

Randy Abbott and Marilyn Palmer. 

On the eve of the FDIC's discovery of the scheme in March 

1986, Ms. Rice sold a block of the bank's stock. She did not tell 

the buyer about Mr. Dunham's bad checks or the extent of the 

bank's losses. She sold the stock at just under its quoted price. 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 10 
Shortly afterward, when the scheme was discovered, the stock's 

value plummeted. 

Charles Floyd, president of the insured and Mr. Dunham's 

half-brother, discovered the scheme no later than September 1985, 

when he noticed a high amount in cash items. He spoke with Ms. 

Hall about the figure, and she revealed that the items were Mr. 

Dunham's checks. The bank president had contacted Mr. Dunham on 

prior occasions when he noticed that Mr. Dunham was writing checks 

for which an insufficient fund report had been generated. Mr. 

Dunham had directed that the checks be placed in cash items and 

said that he would cover them. Mr. Floyd had written 11 hold 11 on 

many of the overdrafts to authorize their status as cash items. 

It apparently became common practice at the bank to report the 

overdrafts of the chairman under the cash items account. Mr. 

Floyd testified that until his conversation with Ms. Hall about 

the unexpectedly high amount in cash items in September 1985, he 

had assumed that Mr. Dunham was taking care of the bad checks. 

When Mr. Floyd learned in September 1985 that Mr. Dunham was 

not covering his bad checks, he called Mr. Dunham and demanded an 

explanation. Mr. Dunham advised the bank's president that he was 

attempting to get a loan to cover the checks. He also threatened 

that if Mr. Floyd did not keep quiet, he would ruin him financially. Mr. Floyd complied, at least for some time; he did not 

speak to any of the directors about the chairman's scheme. He 

did, however, send to the insured's co-owner and director, George 

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Appellate Case: 89-5194 Document: 010110097000 Date Filed: 11/25/1991 Page: 11 
Ramey, the insured's daily statement of conditions report for the 

fifteenth of each month, which reflected the large amount in cash 

items. He did not speak directly with Mr. Ramey about Mr. 

Dunham's scheme. Moreover, in July 1985 he reminded his halfbrother about the impending arrival of an outside auditor so that 

the latter could remove his overdrafts from the cash items account 

at Adair. 

Mr. Floyd worked only part-time at the insured during the 

fall of 1985 due to illness, and he left completely that winter 

for surgery, returning in early 1986. During his absence, he contacted a former white-collar crime investigator of the Oklahoma 

Bureau of Investigation concerning Mr. Dunham's scheme. The 

investigator advised Mr. Floyd to make an anonymous phone call to 

the Oklahoma Banking Commission. Mr. Floyd called the commission 

and indicated that it should investigate the insured, but he did 

not give any specifics of Mr. Dunham's scheme. The commission did 

conduct an examination of the bank and discover the high number of 

cash items. But the examiners did not inquire further. 

Upon Mr. Floyd's return to Adair, he discovered that Mr. 

Dunham's overdrafts had reached $500,000. Mr. Floyd testified 

that when he confronted Mr. Dunham, the latter threatened him with 

financial ruin and loss of his income and livelihood if he exposed 

the fraudulent transactions. Mr. Floyd then sought the advice of 

an attorney, who counseled him to report the check-kiting scheme 

to the authorities. The bank president, however, did not 

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immediately report Mr. Dunham's scheme. He instead sought new 

employment at three banks, telling each that he wanted to get away 

from illegal acts which were occurring at Adair and in which he 

took no part. 

Mr. Dunham's scheme ended on March 28, 1986, when the FDIC 

performed an examination at the Bank of Chelsea and discovered a 

check drawn by Mr. Dunham on his Adair account. The check was 

being held as a cash item at Chelsea. Mr. Dunham confessed his 

scheme that day, but only after he and Mr. Floyd made one last 

attempt to cover up the scheme. When informed of the examiner's 

discovery, the chairman wrote a check from his Adair account to 

cover the check at the Bank of Chelsea. When the examiner asked 

Mr. Floyd whether the check was good, the bank's president lied 

and said that it was. He then borrowed money to cover the check 

personally and deposited it in Mr. Dunham's account. The bank's 

chairman nevertheless broke down and revealed to the examiners his 

entire scheme. The examiners discovered $569,000 in checks drawn 

on Mr. Dunham's Adair account which were being held at Adair in 

cash items. 

Adair State Bank had purchased from American Casualty a 

Bankers Blanket Bond and an Excess Bank Employee Dishonesty 

Blanket Bond. The insured sought indemnity under the fidelity 

bonds issued by American Casualty for the loss incurred as a 

result of Mr. Dunham's scheme in a letter from Mr. Floyd dated 

March 28, 1986. The insurer denied coverage on September 19, 

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1986. The insurer rejected the claim on the grounds that coverage 

of Mr. Dunham's activities terminated with the initial discovery 

of the loss by the insured's officers Floyd, Hall, and Rice in the 

summer and fall of 1985. The insurer asserted that after this 

discovery the insured failed to give timely notice of its loss, 

which is a condition precedent to coverage under the policy. 

The insured brought suit in state court to recover under the 

bonds its losses sustained by Mr. Dunham's check-kiting scheme. 

The insured also sued for breach of duty of good faith and fair 

dealing. The insurer removed the case to the United States 

District Court for the Northern District of Oklahoma. The insurer 

filed a motion for summary judgment that raised policy defenses to 

coverage under the bonds and disputed the insured's allegation of 

bad faith. The district court granted summary judgment in favor 

of the insurer on the insured's claim of bad faith. It denied the 

insurer's motion on the policy coverage, and the suit for recovery 

on the insurance contracts was tried to the district court on 

stipulated facts. The district court found that the defalcations 

of Mr. Dunham were covered under the fidelity bonds and entered 

judgment in favor of the insured on its claim of breach of contract. The insurer appeals the judgment of the district court 

that it breached its contract with the insured. The insured 

cross-appeals the district court's summary judgment in favor of 

the insurer on its allegation of bad faith. Finally, the insurer 

contests the district court's award of attorney fees to the 

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insured. 

II. 

Interpretation of terms contained in an insurance contract 

are issues of law which we review de nova. See In re RutiSweetwater, Inc., 836 F.2d 1263, 1266 (10th Cir. 1988). When a 

case is submitted to the district court on stipulated facts, "the 

ordinary standard of review still inheres: findings of the trial 

court are set aside only if they are clearly erroneous." Sears v. 

Atchison, Topeka & Santa Fe Ry. Co., 645 F.2d 1365, 1370 (10th 

Cir. 1981) (citation omitted), cert. denied, 456 U.S. 964 (1982). 

We look to Oklahoma law to aid our interpretation of the fidelity 

bonds. Rhody v. State Farm Mut. Ins. Co., 771 F.2d 1416, 1420 

(10th Cir. 1985). Because the bond in question is required by 

statute, we review the bond in light of the statute and read its 

terms into the bond. Lum v. Lee Way Motor Freight, Inc., 757 P.2d 

810, 816 n.22 (Okla. 1987). The Oklahoma provision, which the 

terms of the bond closely mirror, requires: 

The directors of a bank or trust company shall require 

good and sufficient fidelity bonds on all active 

officers and employees .•. which bonds shall provide 

for indemnity to such bank or trust company on account 

of any losses sustained by it as the result of any dishonest, fraudulent or criminal conduct by them acting 

independently or in collusion or combination with any 

person or persons. 

Okla. Stat. Ann. tit. 6, § 713 (West 1984). 

Pursuant to the Oklahoma provision, the banker's blanket bond 

provides indemnity against losses caused by the dishonest or 

fraudulent acts of bank employees up to $300,000, with a $10,000 

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deductible, and an excess bond provides coverage over that amount 

up to $1,000,000. Both bonds afford coverage for "[l]oss resulting directly from dishonest or fraudulent acts of an Employee committed alone or in collusion with others," subject to specified 

terms, conditions, limitations, and exclusions. (Record, Vol. 1, 

Doc. 78, Ex. G.) The bonds further define coverage of an 

employee's "dishonest or fraudulent acts": 

only dishonest or fraudulent acts committed by such 

Employee with the manifest intent (a) to cause the 

Insured to sustain such loss, and (b) to obtain financial benefit for the Employee or for any other person or 

organization intended by the Employee to receive such 

benefit. 

Id. The parties do not disagree that Mr. Dunham committed a dishonest or fraudulent act with the manifest intent to cause the 

insured to sustain a loss and to obtain financial benefit for himself. At issue are the actions of officers Floyd, Rice, and Hall. 

Before we begin our analysis of the insured's claim for 

breach of contract, we emphasize that the district court couched 

in the alternative its judgment that the insured's loss was 

covered under the fidelity bonds. The district court held that 

because the other officers were in collusion with Mr. Dunham, 

their discovery would not be imputed to the insured for purposes 

of the bond's requirement that the insured give notice to the 

insurer within thirty days of its discovering the loss. In the 

alternative, the district court held that officers Dunham, Floyd, 

Rice, and Hall all committed independent acts which were dishonest 

or fraudulent and combined to produce the loss. We need only 

affirm the district court on one of the two conclusions to affirm 

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its decision. We first address the policy defenses asserted by 

the insurer. 

A. 

Coverage under both bonds is conditioned on timely notice. 

The bonds require the insured to give notice "[a]t the earliest 

practicable moment, not to exceed 30 days, after discovery of 

[the] loss." (Record, Vol. 1, Doc. 78, Ex. G.) The bond further 

states: 

Discovery occurs when the Insured becomes aware of facts 

which would cause a reasonable person to assume that a 

loss covered by the bond has been or will be incurred, 

even though the exact amount or details of loss may not 

then be known. 

Id. The insured provided notice to the insurer on March 28, 1986. 

The insurer argues that the insured discovered the loss more than 

thirty days prior to that date. If, as the insurer alleges, the 

insured did discover its loss prior to that time, then the insured 

failed to comply with a condition precedent for coverage, and 

liability under the fidelity bonds would not accrue. See Fidelity 

& Deposit Co. v. United States Fidelity & Guar. Co., 64 P.2d 672, 

674-75 (Okla. 1935). 

At issue under this provision is whether the knowledge of 

officers Floyd, Rice, and Hall may be imputed to the insured. The 

district court concluded, and neither party disagrees, that the 

officers' knowledge is imputed to the bank unless they participated in the wrongdoing that caused the loss. See Alfalfa Elec. 

Coop., Inc. v. Travelers Indem. Co., 376 F. Supp. 901, 907 (W.D. 

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Okla. 1973). We focus on whether the action or inaction of the 

officers at issue is sufficient to characterize them as "participants" in Mr. Dunham's scheme. 

We initially examine the actions of Mr. Floyd, the president 

of the bank. As the insured makes clear, Mr. Floyd's action 

included honoring checks for which there were insufficient funds 

and complying with his half-brother's request to place overdrafts 

on his account in cash items. Mr. Floyd's "participation" was 

essential for Mr. Dunham's scheme to work. See First Nat'l Bank 

v. Fidelity and Casualty Co., 634 F.2d 1000 (5th Cir. 1981) 

(allegation of conspiracy to defraud through a forgery and checkkiting scheme perpetrated by director and "facilitated" by bank 

( president, if true, asserts claim under employee fidelity bond); 

cf. Federal Deposit Ins. Corp. v. National Sur. Corp., 281 N.W.2d 

816 (Iowa 1979) (bank president whose· conduct included holding 

overdrafts as cash items committed dishonest and fraudulent acts); 

National Newark and Essex Bank v. American Ins. Co., 385 A.2d 1216 

(N.J. 1978) (repeated approval of unauthorized loans so that customer could cover overdrafts was dishonest and fraudulent). Mr. 

Floyd's anonymous request for an investigation of the bank does 

not mitigate his participation--he only attempted to escape blame 

by such action when it was clear that the overdrafts would eventually be discovered. Moreover, Mr. Floyd attempted to conceal Mr. 

Dunham's dishonesty until the very end, when he borrowed money to 

place in Mr. Dunham's account so that investigators would not 

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uncover the check-kiting scheme. 2 Mr. Floyd clearly put the 

interest of his half-brother above those of his employer. 

This court cannot ignore the action, and at times inaction, 

of Ms. Rice. Without aid from the person responsible for the 

insured's internal control, Mr. Dunham's scheme would have failed. 

Ms. Rice was directly responsible for overseeing the operation of 

the bank so that schemes like Mr. Dunham's would not occur. In 

fact, she had reported the defalcation of a prior president of the 

bank to a director before Mr. Dunham and his partner acquired a 

controlling interest in the insured. Yet in this case, Ms. Rice 

submitted to the board of directors reports which she knew hid 

damning facts of what had transpired during the preceding month. 

Courts in other circuits have found similar behavior to be dishonest and fraudulent. Federal Deposit Ins. Corp. v. Aetna 

Casualty and Sur. Co., 426 F.2d 729, 737 (5th Cir. 1970) ("[B]oth 

misrepresentation and deliberate deception by pretense and stealth 

constitute dishonest and fraudulent conduct.") (citations 

omitted); Citizens State Bank v. Transamerica Ins. Co., 452 F.2d 

2 The following Oklahoma provision was effective during the 

actions at issue: 

Any bank officer or employee who shall knowingly, 

willfully and fraudulently, for the purpose of defrauding the bank, pay out of the funds of said bank upon the 

check, order or draft of any individual, firm, corporation or association, which has not on deposit with such 

bank a sum equal to such check, order or draft, shall be 

personally liable to such a bank for the amount so paid 

and such liability shall be covered by his official 

bond. 

Okla. Stat. Ann. tit. 6, § 712(B) (West 1984). 

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199, 203 (7th Cir. 1971) (same). Even when it was clear that her 

cousin could not pay the overdrafts and it was only a matter of 

time before the scheme would be discovered, she sold her shares in 

the insured rather than report Mr. Dunham's fraudulent actions. 

She kept her word and did not "pull the plug" on Mr. Dunham, and 

in doing so she breached a duty she owed to the bank. We believe 

Ms. Rice's conduct sufficiently constituted "participation" in the 

scheme to preclude her knowledge from being imputed to the bank 

under Oklahoma law. She believed that it was in her best interest 

to conceal from her employer information which adversely affected 

its well-being. The doctrine of imputation therefore does not 

apply. See Puget Sound Nat'l Bank v. St. Paul Fire and Marine 

Ins. Co., 645 P.2d 1122, 1127 (Wash. Ct. App. 1982) (examining 

imputation doctrine and agency rules). 

Ms. Hall's behavior, as the insured's secretary and cashier, 

is very troubling. As the insurer points out, she had no conversation with Mr. Dunham concerning his overdrafts. She also indicated in her testimony that she had no fraudulent motive for her 

silence. The insurer therefore argues that, at worst, Ms. Hall's 

actions constituted negligence with no motive to participate in 

the scheme. We nevertheless believe that her conduct amounted to 

more than gross negligence or poor judgment. The district court 

correctly concluded from the stipulated facts that Ms. Hall was a 

"participant" in Mr. Dunham's scheme. As with the assistance of 

Mr. Floyd and Ms. Rice, Mr. Dunham's scheme would have failed 

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' ' 

without the assistance of Ms. Hall. She was responsible for preparing reports submitted to the board of directors, and she never 

reported the clear abuse by Mr. Dunham. 3 She followed Mr. Floyd's 

directions to hold the overdrafts in cash items. This action, 

which violated bank policy, and her preparation of reports which 

failed to detail Mr. Dunham's exorbitant overdrafts, are sufficient facts to support the district court's conclusion that Ms. 

Hall was a participant in Mr. Dunham's scheme. Cf. National Bank 

of Pakistan v. Basham, 531 N.Y.S.2d 250 (N.Y. App. Div. 1988), 

3 The insurer quotes the following scenario by a commentator 

reflecting on the bankers blanket bond at issue: 

An insured, attempting to avoid the imputation rules, 

may assert that an otherwise honest employee, by failing 

to report the dishonesty of a fellow employee, is either 

in collusion with the dishonest employee or acting 

adversely to the insured's interest. It would seem that 

the motive of the nonreporting employee is the key. If 

the employee fails to report because he expects to 

blackmail the defaulting employee or demand a portion of 

the "loot," he would be deemed to be either in collusion 

with the dishonest employee or acting adversely to his 

employer's interest. See Restatement§ 282, Comment a, 

Illustration 1. However, there are numerous reasons for 

not reporting that should not defeat imputation--~, 

intimidation by a fellow-employee or superior, or simply 

the agent's negligent failure to appreciate the significance of known facts. Certainly, the mere failure to 

report another employee's dishonesty without more would 

not constitute "collusion." 

Paul D. Schoonover, Discovery, Notice and Automatic Cancellation 

Under Revised Form 24, 16 Forum 962, 977 n.63 (1981). 

Even if we were to interpret the discovery clause in the 

manner urged by this commentator, we would find Ms. Hall in a much 

different role from the employee in the hypothetical. Unlike the 

employee who happened on the dishonesty of another employee and 

failed to report it, Ms. Hall had the job of reporting such a 

defalcation, and her discovery occurred while she was performing 

this job. She was not acting as an impartial observer who failed 

to report dishonesty out of negligence or fear. Rather, she willingly engaged in a scheme which could only have resulted adversely 

to her employer's interest. 

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aff'd, 541 N.Y.S.2d 345 (1989) (bank employee who intentionally 

chose not to debit account for dishonest checks and instead 

debited frozen account committed dishonest or fraudulent act with 

manifest intent to cause employee a loss); compare Federal Deposit 

Ins. Corp. v. St. Paul Fire and Marine Ins. Co., 942 F.2d 1032 

(6th Cir. 1991), and cases cited therein (officer did not have 

manifest intent to cause employer injury because evidence demonstrated intent to benefit the insured). 

In order for the scheme to succeed, it was necessary for each 

of the officers to perform certain actions and also remain silent 

in the face of their professional duty to report certain information to the board of directors. All three officers were repeatedly called upon to choose between the interests of the bank and 

the interests of Mr. Dunham. Each time, they chose to promote the 

welfare of Mr. Dunham to the detriment of their employer. The 

district court was not clearly erroneous when it concluded that 

officers Floyd, Hall, and Rice were participants in Mr. Dunham's 

check-kiting scheme. Their discovery of Mr. Dunham's dishonesty, 

therefore, should not be imputed to the insured. See Aetna 

Casualty, 426 F.2d at 739 (knowledge of defalcator "and the directors associated with him cannot be imputed to the Bank since they 

were acting adversely to its interests."). The proper date of 

discovery is therefore the date when the FDIC examiners reported 

Mr. Dunham's defalcations to the board of directors. 

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B. 

The insurer next argues that coverage for losses due to Mr. 

Dunham's defalcations ended once officers Floyd, Hall, and Rice 

knew of his dishonesty, and thus that insurer need not recompense 

the bank for losses subsequent to this time. The bond provision 

at issue states in relevant part: 

This bond shall be deemed terminated or canceled as to 

any Employee or any partner, officer or employee of any 

Processor - (a) as soon as any Insured, or any director 

or officer not in collusion with such person, shall 

learn of any dishonest or fraudulent act committed by 

such person at any time against the insured or any other 

person or entity. 

(Record, Vol. 1, Doc. 78, Ex. G.) 

The district court found that discovery of the scheme by 

officers Floyd, Rice, and Hall did not terminate the policy. 

Because the officers were in "collusion" with Mr. Dunham, the district court reasoned that the termination provision was never 

triggered. We address the meaning of "collusion" under the 

policy. 

Absent a definition in the policy, we are to discern the 

plain and ordinary meaning of a term. Okla. Stat. Ann. tit. 15, § 

160 (West 1966); Continental Oil Co. v. National Fire Ins. Co., 

541 P.2d 1315, 1320 (Okla. 1975). We therefore look to the meaning of "collusion" in its ordinary and popular sense, keeping in 

mind each clause of the contract to aid our interpretation. Okla. 

Stat. Ann. tit. 15, § 157 (West 1966). 

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The district court, searching for a popular definition of 

"collusion," cited the following definition from Black's Law 

Dictionary: 

An agreement between two or more persons to defraud a 

person of his rights by the forms of law, or to obtain 

an object forbidden by law. It implies the existence of 

fraud of some kind, the employment of fraudulent means, 

or of lawful means for the accomplishment of an unlawful 

purpose .•.. A secret combination, conspiracy, or 

concert of action between two or more persons for fraudulent or deceitful purpose. 

Black's Law Dictionary 240 (5th ed. 1979) (citation omitted). The 

district court then concluded that officers Floyd, Hall, and Rice 

were aware of what each knew and what each was doing. The court 

concluded that they secretly participated toward the same unlawful 

purpose of concealing Mr. Dunham's activities. 

Neither party disagrees with the district court's definition 

of "collusion," but the appellee takes issue with how the district 

court applied the term to Ms. Hall's activities. The insurer 

explains that when Ms. Hall learned of Mr. Dunham's dishonest and 

fraudulent acts, she did not have a secret agreement with him to 

further the scheme. It emphasizes Ms. Hall's assertion that she 

never spoke with Mr. Dunham concerning his overdrafts. The 

insurer complains that Ms. Hall remained silent not because she 

was a co-conspirator who intended to defraud the bank, but because 

she believed that she did not need to speak to anyone other than 

her superiors. 

We do not construe Ms. Hall's silence so benignly. The 

district court found, and we agree, that Ms. Hall's tender to the 

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board of directors of a month-end report which completely concealed the activities of its chairman was sufficient action to be 

fraudulent. Ms. Hall's silence, though perhaps understandable 

given her familial relationship with Mr. Dunham, is nonetheless 

sufficient for us to uphold the district court's finding that she 

was in "collusion" with the bank chairman. In reaching this decision, we also note Ms. Hall's involvement with holding the overdrafts in cash items. 

The insurer next argues that the bond's coverage terminated 

when one of the officers first discovered Mr. Dunham's dishonest 

acts. At the time of discovery, the insurer contends, the 

officers were not in collusion with Mr. Dunham, and any subsequent 

collusion does not negate the termination clause. This analysis 

would invoke the termination clause during the window of time 

between discovery and the officers' decision to hide Mr. Dunham's 

dishonest and illegal action from the board of directors. 

We reject the insurer's interpretation of the provision as 

inconsistent with the intent of the Oklahoma statute requiring a 

bank or trust to insure the fidelity of its officers and 

employees. Such an interpretation would effectively limit the 

definition of collusion to preexisting agreements to defraud the 

bank. For example, the bond under this interpretation would not 

apply to an employee who discovered a co-worker's defalcation and 

then used blackmail to acquire some of the illegally obtained 

funds. We do not believe that the Oklahoma legislature intended 

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to immunize the insurer from liability once one dishonest employee 

discovers the dishonesty of another. The intent of the termination provision clearly is to encourage the insured to release dishonest employees. See Alfalfa, 376 F. Supp. at 912 ("[I]t has 

been held to be a breach of good faith to maintain the agent in a 

position of trust after discovering his defalcations without 

notifying the fidelity carrier and giving it an opportunity to 

decide whether or not it desires to continue as insurer.") (citations omitted). In this case, where the insured never had the 

knowledge or the opportunity to release any of the officers from 

its employ, the termination clause did not take effect at the time 

argued by the insurer. 

We agree with the district court's finding that (1) the 

insured provided timely notice of its loss to the insurer, and (2) 

the termination clause was not triggered when other officers discovered Mr. Dunham's scheme. Because we agree with the district 

court that the policy defenses asserted by the insurer were not 

applicable, we need not reach the alternative holding that each 

officer committed a fraudulent or dishonest act with the manifest 

intent to cause loss to the insured. 

III. 

The insured cross-appeals the district court's summary judgment on its claim alleging bad faith by the insurer. The insured 

finds fault with the insurer's failure to investigate the case 

thoroughly, alleging that the insurer failed to inquire fully into 

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facts which might have supported coverage. The argument rests 

substantially on two assertions: first, that the insurer's very 

structure for claims management predisposes it to deny coverage, 

and second, that the insurer's investigation of this claim was 

inadequate. 

We review a grant of summary judgment under the same standard 

as the trial court. Summary judgment may be granted only if there 

is no genuine issue of material fact, and all evidence must be 

viewed in a light most favorable to the party opposing the motion. 

Osgood v. State Farm Mut. Auto. Ins. Co., 848 F.2d 141, 143 (10th 

Cir. 1988). 

Oklahoma tort law recognizes "a cause of action ••. against 

an insurer for a bad faith refusal to compensate its insured for a 

loss covered by the policy." Christian v. American Home Assurance 

Co., 577 P.2d 899, 901 (Okla. 1977) (citations omitted). To prevail with a claim of bad faith refusal to compensate, the insured 

must show that the insurer's actions were unreasonable. Conti v. 

Republic Underwriters Ins. Co., 782 P.2d 1357, 1360 (Okla. 1989) 

(insured must show unreasonableness of insurer); Mccorkle v. Great 

Atlantic Ins. Co., 637 P.2d 583, 587 (Okla. 1981) (insured has 

burden of proving elements of bad-faith tort). Where legitimate 

disputes exist regarding "matters such as insurable interest, 

extent of coverage, cause of loss, amount of loss, or breach of 

policy conditions .•. [r]esort to a judicial forum is not per se 

{ bad faith or unfair dealing on the part of the insurer." 

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Christian, 577 P.2d at 905. Regarding the quantum of proof 

required, "tort liability may be imposed only where there is a 

clear showing that the insurer unreasonably, and in bad faith, 

withholds payment of the claim of its insured." Id. (emphasis 

added). 

After thorough consideration of the pleadings and record 

before us, and viewing the evidence in the light most favorable to 

the insured, we conclude that the insured has not carried its burden of proving an unreasonable, bad-faith decision by the insurer 

not to pay a covered claim. To the contrary, it appears that a 

legitimate dispute existed over the terms included in the bond 

policy agreement which determined coverage, notably the word 

"collusion" and the concept of "participation." As a matter of 

law, then, the insurer's refusal to pay the claim was not unreasonable, and the insurer was entitled·to summary judgment on the 

claim of bad faith refusal to pay. 4 

As another part of its argument of bad faith, the insured 

emphasizes Oklahoma caselaw recognizing the insured's legitimate 

interest in having a claim processed promptly in order to avoid 

economic hardship. See Lewis v. Farmers Ins. Co., Inc., 681 P.2d 

67, 69 (Okla. 1983). The applicable statute in Oklahoma allows 

the insurer ninety days to respond to the insured after receiving 

4 While the facts of this case suggest that the insurer's 

claims management structure may be problematic and that this 

particular investigation of a claim may have been less than 

adequate, the facts as pleaded do not make out a case of bad-faith 

refusal to pay a claim. 

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a proof of loss. Okla. Stat. Ann. tit. 36, § 3629(B) (West 1990). 

Because in this case the insured acknowledges that the insurer 

formally responded to its proof of loss form within one month of 

receiving it, the insured's claim of unwarranted delay is without 

merit. 

We find that summary judgment on the claim of bad-faith 

refusal to pay was appropriate here, because the insured failed as 

a matter of law to prove that the insurer acted unreasonably or in 

bad faith. 

IV. 

Finally, the insurer appeals the award by the district court 

of $250,000 in attorney fees on its indemnity claim. It argues 

that the terms of the bonds specifically exclude attorney fees in 

an action to determine coverage, and that the amount of the 

attorney fees awarded to the insured is excessive. 

Oklahoma law requires that: 

It shall be the duty of the insurer, receiving a proof 

of loss, to submit a written offer of settlement or 

rejection of the claim to the insured within ninety (90) 

days of receipt of that proof of loss. Upon a judgment 

rendered to either party, costs and attorney fees shall 

be allowable to the prevailing party. For purposes of 

this section, the prevailing party is the insurer in 

those cases where judgment does not exceed written offer 

of settlement. In all other judgments the insured shall 

be the prevailing party. 

Okla. Stat. Ann. tit. 36, § 3629(B) (West 1990). The insurer 

argues that this statute does not mandate an award, but merely 

grants the court discretion to award attorney fees. It also 

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argues that the terms of the bonds themselves provide that 

attorney fees incurred by the insured in this action are excluded 

as an expense in establishing the existence of a loss covered 

under the bond. 

We focus initially on the Oklahoma statute in which attorney 

fees "shall be allowable." It is clear that the term "shall" 

denotes an affirmative mandate by the Oklahoma legislature. The 

term "is a word of command or mandate, with a compulsory and 

peremptory meaning. It denotes exclusion of discretion and signifies an enforceable duty." Davis v. Davis, 708 P.2d 1102, 1107 

n.23 (Okla. 1985). The insurer, however, focuses on the term 

"allowable," and argues that if the legislature wished attorney 

fees to be mandatory, it would have used the phrase "shall be 

allowed," as it has in other statutes. See,~, Okla. Stat. 

Ann. tit. 12, §§ 938-940 (West 1988). We find merit in the 

insurer's reasoning. Words in statutes should be understood in 

their ordinary sense unless a contrary intention plainly appears. 

See Okla. Stat. Ann. tit. 25, § 1 (West 1987). We believe that by 

using the term "allowable," the Oklahoma legislature intended to 

lodge discretion with the trial judge. The term "shall" indicates 

that the trial court always has discretion to award attorney fees 

subject to those limitations contained in the statute. 

Each bond provides that the insurer will not be liable for 

"costs, fees, and other expenses incurred by the Insured in establishing the existence of or amount of loss covered under this 

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I , 

bond." (Record, Vol. 1, Doc. 78, Ex. G.) The insurer argues that 

the attorney fees incurred by the insured in this action are 

excluded as expenses to establish the existence of a loss covered 

under the bonds. 

We note initially that exclusionary clauses in insurance 

policies are construed narrowly under Oklahoma law. See An-Son 

Corp. v. Holland-America Ins. Co., 767 F.2d 700, 703 (10th Cir. 

1985); Conner v. Transamerica Ins. Co., 496 P.2d 770, 774 (Okla. 

1972). Given this limitation, we do not believe that the provision cited by the insurer serves the purpose for which it is 

invoked. The exclusion is directed solely to costs and fees 

incurred to establish either the existence of a covered loss or 

the amount of the loss. In this case, the existence of a loss was 

known when Mr. Dunham confessed his activities to the FDIC 

examiners. The amount of the loss was determined by tallying the 

total amount of the overdrafts. The insured expended attorney 

fees to prove the existence or extent of coverage, not the existence or extent of loss; and fees paid for this purpose lie outside 

of the exclusion. This interpretation of the exclusionary clause 

is loyal to its plain meaning. The interpretation urged by the 

insurer, in contrast, would provide it an incentive to litigate 

all claims. The insurer's interpretation would also conflict with 

our holding that under the Oklahoma statute, attorney fees are 

always within the discretion of the trial judge. Because the 

district court awarded attorney fees under the mistaken belief 

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that they were mandatory, we remand the cause to the district 

court to award the fees in its discretion. 

The insurer also contests the amount of the attorney fees 

awarded, a figure which rests in the discretion of the trial 

judge. Cf. Ramos v. Lamm, 713 E.2d 546, 556 (10th Cir. 1983) 

(establishing guidelines for awarding attorney fees under 42 

u.s.c. § 1988). The insured was represented by two law firms, one 

of which has as a partner George Ramey, a co-owner with Mr. Dunham 

of the controlling shares of stock in the insured. In a meeting 

of the insured's board of directors, Mr. Ramey volunteered the 

services of his law firm in this litigation to help reduce legal 

expenses. The insurer argues that because the insured has not 

incurred any legal fees from Mr. Ramey's law firm, it should not 

be entitled to recover an award for the work performed by that 

firm. The insured argues that when it decided to bring suit for 

indemnity, it entered into a contingent fee agreement providing 

attorney fees of one-third of recovery. The insured further 

argues that the services volunteered by Mr. Ramey concerned other 

matters and were not relevant to the litigation over indemnity. 

We have before us no evidence of a contingent fee agreement 

between the insured and Mr. Ramey's firm. The board minutes of 

the insured merely contemplate such an agreement with a second 

firm, which also worked on this action. Absent evidence of a contingent fee agreement, we conclude that the insured incurred no 

legal fees for the work performed by Mr. Ramey's law firm under 

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the Oklahoma provision. See Securities and Exchange Comm'n v. 

Comserv Corp., 908 F.2d 1407, 1413-16 (8th Cir. 1990) ("fees are 

incurred when there is a legal obligation to pay them"). Unless 

Mr. Ramey's firm can offer proof, preferably in writing, of a contingent fee agreement between the insured and the firm, we believe 

it would be an abuse of discretion to award these fees on remand. 5 

The insurer also argues that the attorney fees award represented an unreasonable number of hours expended and an unreasonable hourly rate for certain attorneys. It questions the district 

court's downward adjustment of the attorney fees billed to the 

insured, claiming that the charges represent duplicate work and 

time expended on the insured's unsuccessful claim of bad-faith 

refusal to pay. We have reviewed the district court's judgment in 

light of our pronouncement in Ramos v. Lamm, 713 F.2d 546 (10th 

Cir. 1983), and conclude that the district court did not abuse its 

discretion except for those fees awarded for work done by Mr. 

Ramey's law firm. 

Because the district court awarded attorney fees under the 

belief that these fees were mandatory rather than within its discretion, and because fees for services rendered by Mr. Ramey's law 

5 Effective July 1, 1988, a contingent fee agreement in 

Oklahoma "shall be in writing and shall state the method by which 

the fee is to be determined, including the percentage or percentages that shall accrue to the lawyer in the event of settlement, 

trial or appeal, litigation and other expenses to be deducted from 

the recovery, and whether such expenses are to be deducted before 

or after the contingent fee is calculated." Okla. Stat. Ann. tit. 

5. ch. 1, App. 3-A (West 1992 Supp.). 

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firm were included within its award, the judgment of the district 

court awarding attorney fees is reversed. The cause is remanded 

for further proceedings on this matter consistent with this 

opinion. 

v. 

The judgment of the district court in favor of the insured on 

its claim for breach of contract is AFFIRMED. The judgment of the 

district court in favor of the insurer on the insured's claim of 

bad faith is AFFIRMED. The judgment of the district court awarding attorney fees in the amount of $250,000 is REVERSED. The 

cause in Number 90-5153 is REMANDED for further proceedings consistent with this opinion. 

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