2005 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

10-3-2005

MBIA Ins Corp v. Royal Indemnity Co

Precedential or Non-Precedential: Precedential

Docket No. 03-4382

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PRECEDENTIAL

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 03-4382

No. 04-2207

MBIA INSURANCE CORPORATION; WELLS FARGO

BANK

MINNESOTA, N.A., as Trustee of SFC Grantor Trust, Series

2000-1,

SFC Grantor Trust, Series 2000-2, SFC Grantor Trust,

Series 2000-3, SFC Grantor Trust, Series 2000-4,

SFC Grantor Trust, Series 2001-1, SFC Grantor Trust

2001-2, SFC Owner Trust 2001-I and SFC Grantor Trust,

Series 2001-3

 v.

ROYAL INDEMNITY COMPANY,

 Appellant, No. 03-4382

 v.

ROYAL INDEMNITY COMPANY,

 Third-Party Plaintiff

 v.

PNC BANK, N.A.; STUDENT LOAN SERVICING LLC;

ANDREW N. YAO; SFC ACCEPTANCE II LLC;

SFC ACCEPTANCE III LLC; SFC ACCEPTANCE IV LLC;

SFC ACCEPTANCE V LLC; SFC ACCEPTANCE VIII LLC;

SFC ACCEPTANCE IX LLC; SFC FINANCIAL I LLC;

SFC FINANCIAL II LLC; SFC ACCEPTANCE VI LLC;

SFC ACCEPTANCE VII LLC,
2

 Third-Party Defendants

WILMINGTON TRUST OF PENNSYLVANIA

 v.

ROYAL INDEMNITY COMPANY,

 Appellant, No. 04-2207

 v.

ROYAL INDEMNITY COMPANY,

 Third-Party Plaintiff

 v.

SFC FINANCIAL I, LLC,

 Third-Party Defendant

ON APPEAL FROM THE UNITED STATES DISTRICT

COURT

FOR THE DISTRICT OF DELAWARE

District Court Nos. 02-cv-01294 and 02-cv-01361

District Court Judge: The Honorable Joseph J. Farnan, Jr.

Argued January 19, 2005

Before: ALITO, McKEE, and SMITH, Circuit Judges

(Filed: October 3, 2005)

LAWRENCE C. ASHBY
3

PHILIP TRAINER, JR.

Ashby & Geddes

222 Delaware Avenue

Wilmington, Delaware 19899

MICHAEL H. BARR (Argued)

KENNETH J. PFAEHLER

Sonnenschein Nath & Rosenthal LLP

1221 Avenue of the Americas

New York, New York 10020-1089

Counsel for Appellant

RONALD S. RAUCHBERG (Argued)

STEVEN E. OBUS

ANDRE G. CASTAYBERT

FRANK SCIBILIA

Proskauer Rose LLP

1585 Broadway

New York, New York 10036

DAVID C. McBRIDE

JOHN W. SHAW

Young Conaway Stargatt & Taylor, LLP

The Brandywine Building

1000 West Street

P.O. Box 391

Wilmington, Delaware 19899

Counsel for Appellees MBIA Insurance Corporation

 and Wells Fargo Bank Minnesota, N.A.

KEVIN R. SHANNON

Potter Anderson & Corroon LLP

Hercules Plaza

P.O. Box 951

Wilmington, Delaware 19899

DAVID H. PITTINSKY (Argued)

LAWRENCE D. BERGER
 A third appellee-beneficiary, PNC Bank, N.A., reached a 1

settlement with Royal prior to our decision. This opinion does not

discuss its policy with Royal or its claims thereon.

4

Ballard Spahr Andrews & Ingersoll, LLP

1735 Market Street, 51st Floor

Philadelphia, Pennsylvania 19103

Counsel for Appellee PNC Bank, N.A.

JOSEPH H. HUSTON, JR. (Argued)

THOMAS G. WHALEN, JR.

Stevens & Lee, P.C.

1105 North Market Street, 7th Floor

Wilmington, Delaware 19801

Counsel for Appellee Wilmington Trust

 of Pennsylvania

OPINION OF THE COURT

ALITO, Circuit Judge:

In these consolidated appeals, we are called upon to

construe a series of contracts. Appellant Royal Indemnity

Company (“Royal”) agreed in these contracts to insure the

repayment of principal and interest on several hundred million

dollars of student loans. The named beneficiaries of the policies,

Wells Fargo Bank Minnesota, N.A. (“Wells Fargo”) and

Wilmington Trust of Pennsylvania (“Wilmington Trust”), sued 1

after the loans went into default and Royal failed to pay the claims

they submitted. Royal defended on the ground that the lender on

the underlying obligations fraudulently induced it to issue the

policies and that this fraud entitled it to rescission.
5

The District Court entered summary judgment for the

beneficiaries, and this appeal followed. We agree with the District

Court that Royal’s policies unambiguously and effectively waive

defenses to its obligations based on fraud, but we conclude that

Royal has raised a triable issue as to whether all of the losses

claimed by the beneficiaries were covered under its policies. We

thus affirm in part and reverse in part.

I.

Student Finance Corporation (“SFC”) was founded in 1992

to cater to the vocational segment of the student loan market.

Some of the loans it originated itself; others it acquired from the

original lenders. Many of the loans were apparently made to

students at truck-driving schools. At all relevant times, SFC was

owned and controlled by its founder and chief executive officer,

Andrew N. Yao.

The capital for SFC’s business came from financial

institutions like Wilmington Trust and Wells Fargo. In 1999,

Wilmington Trust issued SFC a $75 million loan, taking a pool of

student loans as security. Wells Fargo, by contrast, helped finance

SFC by securitizing the older loans in its portfolio. In each

securitization, student loans were packaged and sold to a trust

settled for the specific purpose of holding title to the loans. Wells

Fargo, as trustee, funded the purchase by selling certificated shares

in the trust to institutional investors. The record reflects that Wells

Fargo raised approximately $450 million for SFC in eight

securitizations from 1999 to 2002.

To encourage Wilmington Trust and the investors in Wells

Fargo’s trusts to part with their capital, SFC contracted with Royal

to insure the repayment of interest and principal on the student

loans. At issue in this case are ten “Credit Risk Insurance Policies”

issued by Royal. Eight of them insured the loans held by the Wells

Fargo trusts (one per trust), and two of them insured the loans

pledged as collateral to Wilmington Trust. Each policy named

either Wells Fargo or Wilmington Trust as beneficiary. The

following table summarizes their terms:
6

Table 1. Summary of Policy Terms

Policy

Number

Beneficiary Inception Liability Limit

RST 293334 Wells Fargo 1/22/99 $50,000,000.00

RST 293309 Wells Fargo 12/3/99 $53,053,642.08

RST 147522 Wells Fargo 4/30/00 $48,459,255.76

RST 147524 Wells Fargo 8/30/00 $29,999,999.94

RST 147525 Wells Fargo 11/27/00 $55,616,550.00

RST 147526 Wells Fargo 1/31/01 $48,286,713.44

RST 147538 Wells Fargo 10/19/01 $120,000,000.0

0

RST 147536 Wells Fargo 11/15/01 $80,000,000.00

RST 321276 Wilmington

Trust

1/22/99 $75,000,000.00

RST 147533 Wilmington

Trust

8/17/01 $5,518,459.00

Royal alleges, and the beneficiaries do not dispute, that SFC

procured this insurance through a spectacular fraud. According to

Royal, SFC misrepresented the creditworthiness and employment

history of its student borrowers and conspired with schools to

generate as many loans as possible by altering or forging loan

documents. As loans went into default, SFC allegedly paid some

of them down by surreptitiously diverting the proceeds of later

loans. By thus masking the default rates of the older loans, SFC

allegedly induced Royal to insure still more loans, whose proceeds

then had to be applied in Ponziesque fashion to pay down the

earlier ones. According to Royal, some of the proceeds were also

diverted to Yao’s personal accounts.

SFC’s business proved unsustainable. In a March 2002

telephone call to Royal, Yao allegedly confessed that SFC had been

paying down defaulted loans and explained that this practice could
 MBIA issued a “Certificate Guaranty Insurance Policy” 2

guarantying the student loans held by the Wells Fargo trusts. Royal

and MBIA disagree about the function of this guaranty. MBIA

characterizes it as backstop insurance for a risk primarily insured

by Royal, while Royal characterizes it as supplemental coverage

protecting the trusts from risks not covered under the Royal

policies. Royal no longer disputes, however, that MBIA has

contractual standing to sue, so we assume that it is a proper

plaintiff-appellee.

7

no longer be continued. An investigation launched by Royal

revealed that SFC’s loans had been defaulting at rates – over 80%

in the case of one pool – well in excess of reported figures. Within

three months of Yao’s call, SFC was in Chapter 7 bankruptcy,

where it apparently remains to this day. With SFC no longer

paying down student loans, the defaults fell on the shoulders of

Wilmington Trust and Wells Fargo, who turned to Royal to make

good on its policies. Claims on those policies, which totaled only

$38.6 million between 1999 and the spring of 2002, had piled up

to $380 million by the end of 2002.

A flurry of lawsuits followed. Royal filed suit in Texas state

court to rescind the policies, but this case was dismissed after

limited discovery for lack of personal jurisdiction. In July 2002,

Wells Fargo and MBIA Insurance Corporation (“MBIA”) sued 2

Royal in the US District Court for the District of Delaware. Their

complaint, which invoked the Court’s diversity jurisdiction, alleged

that Royal had wrongfully repudiated the trusts’ eight policies by

filing the Texas action and sought relief in the form of specific

performance, a declaratory judgment that the policies were in

effect, and damages. Wilmington Trust filed its own suit in

Delaware federal court, alleging essentially the same claims.

Royal defended on the ground that SFC’s fraudulent

inducement entitled it to rescission. The beneficiaries countered

that the policies unambiguously waived this defense. In separate

opinions, the District Court entered summary judgment for the

beneficiaries. See MBIA Ins. Corp. v. Royal Indem. Co., 312 F.

Supp. 2d 583 (D. Del. 2004); MBIA Ins. Corp. v. Royal Indem.
8

Co., 286 F. Supp. 2d 347 (D. Del. 2003). It found that the ten

policies unambiguously waived fraud in the inducement as a

defense to payment, and it predicted that Delaware’s highest court

would enforce them. The Court acknowledged that Delaware law

was reluctant to enforce boilerplate waivers against unsophisticated

parties, but it believed a clear waiver negotiated by sophisticated

parties could be enforced. See 312 F. Supp. 2d at 586; 286 F.

Supp. 2d at 355.

Since the Court concluded that Royal’s waivers were

enforceable, and that they clearly covered the defense Royal sought

to present, it found further discovery on that defense unnecessary.

It awarded summary judgment to the beneficiaries, ordering Royal

to pay $269,851,527 plus interest to Wells Fargo and

$12,908,966.43 plus interest to Wilmington Trust, and it further

ordered Royal to pay subsequent claims as they came due. Royal

timely appealed to this Court.

II.

We review an award of summary judgment de novo,

applying the same test on review that the District Court should

have applied. In re Ikon Office Solutions, Inc., 277 F.3d 658, 665

(3d Cir. 2002). Summary judgment should be awarded when “the

pleadings, depositions, answers to interrogatories, and admissions

on file, together with the affidavits, if any, show that there is no

genuine issue as to any material fact and that the moving party is

entitled to a judgment as a matter of law.” Fed. R. Civ. P. 56(c).

All reasonable inferences from the record must be drawn in favor

of the nonmoving party. Brewer v. Quaker State Oil Refining

Corp., 72 F.3d 326, 333 (3d Cir. 1995). The Court may not weigh

the evidence or assess credibility. Boyle v. County of Allegheny

Pa., 139 F.3d 386, 393 (3d Cir. 1998).

Royal attacks the District Court’s award of summary

judgment on several grounds. It first argues that the Court erred in

finding that the text of its policies unambiguously waived its

defense to payment based on SFC’s fraud. It further argues that

waivers of the breadth and generality found in its policies are

unenforceable under Delaware law. Finally, it argues that triable
9

issues remain as to whether the policies covered all of the losses

claimed by the beneficiaries. Since it is undisputed that Delaware

provides the substantive law for this dispute, we turn to that state’s

law of contract to determine whether summary judgment was

properly awarded.

III.

A.

Delaware follows the objective theory of contract. See Haft

v. Haft, 671 A.2d 413, 417 (Del. Ch. 1995); Progressive Int’l Corp.

v. E.I. Du Pont de Nemours & Co., No. C.A. 19209, 2002 WL

1558382, at *7 (Del. Ch. 2002) (unpublished opinion). Although

the law of contract generally strives to enforce agreements in

accord with their makers’ intent, the objective theory considers

“objective acts (words, acts and context)” the best evidence of that

intent. Haft, 671 A.2d at 417. Unambiguous written agreements

should be enforced according to their terms, without using extrinsic

evidence “to interpret the intent of the parties, to vary the terms of

the contract or to create an ambiguity.” Eagle Indus., Inc. v.

DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 (Del. 1997); see

also City Investing Co. Liquidating Trust v. Cont’l Cas. Co., 624

A.2d 1191, 1198 (Del. 1993).

A contract is not ambiguous merely because the parties

disagree about its proper interpretation. Whether a contract is

ambiguous is determined according to an objective, reasonableperson standard and is a question of law. See Eagle Indus., 702

A.2d at 1233 n.8 (“The true test is what a reasonable person in the

position of the parties would have thought it meant.”). Words are

to be given their ordinary meaning and should not be “torture[d]”

to impart ambiguity where none exists. Rhone-Poulenc Basic

Chems. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1196 (Del.

1992).

The language of Royal’s waivers varies from policy to

policy, but we agree with the District Court that each policy

satisfies these standards of clarity. We consider the contracts in

reverse chronological order, beginning with the last two policies
 In Policy RST 147538, clause (C) appears as clause (D) 3

and follows a new clause (C), which leaves Royal liable

irrespective of “ANY FAILURE ON THE PART OF THE

INSURED, THE SERVICER OR THE BENEFICIARY TO

OBSERVE OR PERFORM ANY COVENANT OR

CONDITION.” App. at 2254.

10

Royal issued and considering the remaining eight in subsection 2

below.

1.

Policies RST 147536 and RST 147538 are the clearest.

Policy RST 147536 states in bold capital letters:

THE RIGHT OF THE BENEFICIARY TO

RECEIVE PAYMENT FOR LOSSES UNDER

THIS POLICY SHALL BE ABSOLUTE,

CONTINUING , IRREVOCABL E AND

UNCONDITIONAL IRRESPECTIVE OF (A)

ANY FRAUD WITH RESPECT TO THE

STUDENT LOANS, (B) THE GENUINENESS,

VALIDITY OR ENFORCEABILITY OF

ANY . . . STUDENT LOAN OR THE BREACH

OF ANY SUCH CONTRACT OR ANY

COVENANT OR REPRESENTATION OR

WARRANTY MADE THEREIN, OR (C) ANY

OTHER RIGHTS OR DEFENSES THAT MAY

BE AVAILABLE TO THE INSURER TO

AVOID PAYMENT OF ITS OBLIGATION

UNDER THIS POLICY (ALL OF WHICH

RIGHTS AND DEFENSES ARE HEREBY

E X P R E S S L Y W A I V E D B Y T H E

INSURER) . . . .

App. at 2221. The language of Policy RST 147538 is virtually

identical. See App. at 2253-54. The policies plainly strip Royal 3

of a defense to payment based on fraud, first by declaring that its

liability will be unaffected by “fraud with respect to the student
11

loans” and then by “expressly waiv[ing]” any other right or defense

it could marshal to avoid payment.

In the face of this clarion language, Royal contends that the

phrase “with respect to the student loans” contemplates only the

microfraud of individual schools or students, not the macrofraud of

SFC. The waivers were designed, argues Royal, only to protect

Wells Fargo from obstreperous litigation over the validity of

individual loan documents. In support of this position, Royal

points to clause (B), which homes in on “the genuineness, validity

or enforceability of any . . . student loan.” Invoking the expressio

unius and ejusdem generis canons, it argues that clause (B) waives

only a defense based on the “validity or enforceability” of a student

loan and that clause (A) should be given a commensurately narrow

meaning.

Aside from completely ignoring the blanket language of

clause (C) (clause (D) in Policy RST 147538), Royal’s argument

renders clause (A) surplusage. If clause (A) were limited to

individual cases of fraud by schools or students, it would sweep no

further than clause (B). The fraudulent inducement of a loan

agreement by a student or school would render the defrauded

party’s obligations under that agreement voidable. See

Restatement (Second) of Contracts § 164(1) (1981). In such a

case, the “genuineness, validity or enforceability” of the loan

would be affected. While the validity of the loans would not be

affected by SFC’s (or the schools’) fraud on Royal, this is precisely

the type of fraud that Royal now claims is not covered by clause

(A), despite the fact that it clearly occurs “with respect to” the

student loans within the ordinary meaning of those words. See

Webster’s Third New International Dictionary 1934 (Philip

Babcock Gove ed. in chief, unabr. ed. 1971). Since Royal’s

interpretation makes clause (A) surplusage and reads out clause (C)

(clause (D) in Policy RST 147538), it must be rejected.

Royal argues that the definition of “Student Loans” creates

a triable issue as to whether the defense of fraudulent inducement

was intended to be waived in a case such as this. The definition of

“Student Loans” is restricted by each policy to the loans covered

therein and does not include any earlier loans SFC may have
12

issued. Since the definition is so restricted, clause (A) could not be

read, Royal argues, as waiving defenses based on

misrepresentations about the earlier loans on which Royal relied.

Even if this policy wrinkle created a triable issue as to the

scope of clause (A), it would not follow that summary judgment

was unwarranted. To establish fraudulent inducement, Royal must

show reasonable and detrimental reliance on a misrepresentation

intentionally or recklessly made to induce action or inaction. See

Kronenberg v. Katz, 872 A.2d 568, 585 n.25 (Del. Ch. 2004);

Gloucester Holding Corp. v. U.S. Tape & Sticky Prods., LLC, 832

A.2d 116, 124 (Del. Ch. 2003). Even if clause (A) did not waive

a defense based on misrepresentations with respect to earlier loans,

Royal could not establish reliance on those representations in light

of the clear “anti-reliance” language of clause (C) (clause (D) in

Policy RST 147538). See Kronenberg, 872 A.2d at 593. It is

unfathomable that an insurer that intended to rely on

extracontractual representations would agree that its obligations are

“absolute, continuing, irrevocable and unconditional irrespective

of . . . any other rights or defenses that may be available to the

insurer . . . (all of which rights and defenses are hereby expressly

waived by the insurer).” App. at 2221, 2254 (emphasis omitted).

Royal cannot possibly claim that its reliance on those

representations was reasonable when it waived all defenses based

on reasonable reliance. Since Royal’s reliance was unreasonable

however “Student Loans” is defined, the definition of that term

does not create an ambiguity in the policies, and the District Court

did not err in finding Royal’s waiver unambiguous.

2.

Each of the remaining eight policies contains some variant

of the following language:

N OT W ITHSTANDIN G ANY OTH E R

PROVISION OF THIS POLICY TO THE

C ON TR AR Y, TH E RIGHT OF TH E

BENEFICIARY TO RECEIVE PAYMENT FOR

LOSS UNDER THIS POLICY AFTER

PAYMENT OF THE INITIAL PREMIUM BY
13

THE INSURED SHALL BE ABSOLUTE AND

UNCONDITIONAL, AND NO FAILURE ON

THE PART OF THE INSURED OR THE

BENEFICIARY TO OBSERVE OR PERFORM

A N Y C O VENA N T OR CON D ITIO N

CONTAINED IN THIS POLICY (INCLUDING

W I T H O U T L I M I T A T I O N TH O S E

CONTAINED IN ARTICLE III, ARTICLE IV

AND ARTICLE V) SHALL ENTITLE THE

INSURER TO ANY RIGHT OF SET-OFF,

COUNTERCLAIM OR DEFENSE AGAINST

THE BENEFICIARY OR ANY OTHER

PARTIES OR OTHERWISE RELIEVE THE

INSURER OF ANY LIABILITY TO MAKE

ANY SUCH PAYMENT FOR LOSS TO THE

BENEFICIARY UNDER THIS POLICY,

SUBJECT ONLY TO THE LIMIT OF

LIABILITY.

E.g., App. at 5485 (original emphasis). In addition, seven of the

policies contain some variant of the following language:

The Insurer’s obligation to pay any Claim made

under this Policy is absolute, unconditional and

irrevocable and shall not in anyway be affected,

mitigated or eliminated by (y) a breach of any

representation or warranty made by the Insured, the

Servicer, Student Finance Corporation or the

Beneficiary, or (z) the failure of the Insured or

Student Finance Corporation to comply with the

Underwriting Policies.

E.g., App. at 2021. The eighth policy, RST 321276, refers only to

“the Insured,” omitting mention of “the Servicer,” “Student

Finance Corporation,” and “the Beneficiary.” App. at 5499-500.

Though none of the eight policies uses the word “fraud,” no

reasonable interpretation can be teased from this language that

would preserve Royal’s defense. The policies all declare that, after

payment of the premium, Royal’s liability will become “absolute”
14

and “unconditional” and “subject only to the limit of liability.”

Though such language might not contemplate a fraud that induced

the policies in the first place, the policies also provide that Royal’s

liability will be unaffected by “a breach of any representation.”

Since a misrepresentation is an essential element of a fraud, it

follows that fraud cannot affect Royal’s liability. Finally, the

policies provide that Royal’s liability is unaffected by a

“failure . . . to comply with the Underwriting Policies.” This is a

significant recital because the alleged fraud had its genesis in

misrepresentations that SFC’s lending complied with certain

underwriting policies. Royal cannot claim that it was entitled to

rely on SFC’s representations about its lending when it agreed to

liability regardless of whether the lending conformed to those

representations.

Royal argues that a “breach of . . . representation” is not the

same thing as a “misrepresentation” but refers instead to the failure

of a condition set forth “in the contract or perhaps in specific

accompanying contracts.” Royal’s Br., No. 03-4382, at 41.

Although the policies do not list any “representations and

warranties” on which the parties may rely, Royal observes that the

term sheet for each policy declares that “the statements in this

Policy . . . are the agreements and representations of the Insured”

and that “this Policy embodies all agreements existing between the

Insured and the Insurer or any of its representatives.” E.g., App. at

5525. According to Royal, the phrase “breach of any

representation” must refer to representations in the policies, since

those are the only “agreements and representations of the Insured.”

It is ironic that Royal should look to an integration clause

for evidence that it was entitled to rely on SFC’s extracontractual

representations. Such an interpretation stands that clause on its

head. Even under Royal’s contorted reading, however, the clause

makes no mention of SFC’s representations. SFC and the Servicer

were not even parties to the policies, so their representations would

have to be found outside the four corners of the agreements. In

short, the phrase “breach of any representation . . . [by] Student

Finance Corporation” must refer to extracontractual

representations. Under the only reasonable interpretation of the

policies, Royal has agreed that its liability will be unaffected by
15

reliance on SFC’s extracontractual representations.

Royal argues that even if the analysis above is correct it has

not waived its defense of fraudulent inducement in Policy RST

321276 because that policy refers only to a breach of representation

by “the Insured.” The Insured on that policy was “SFC Financial

I, LLC,” a special purpose entity affiliated with SFC. App. at

5477. Royal argues that since it relied on the misrepresentations of

SFC rather than that special purpose entity, its common law

defense of fraud in the inducement is unaffected by the policy.

As we noted earlier, an agreement may foreclose a fraud

defense not only by waiving “fraud” but also by setting forth terms

clearly inconsistent with reasonable reliance on extracontractual

representations. Royal here has effectively disclaimed reliance on

SFC’s representations no less than those of SFC Financial I, LLC,

even though the former is not mentioned in the agreement. Royal

admits that both entities were under the ownership and control of

Andrew Yao. See, e.g., Royal’s Memorandum in Support of Its

Motion for an Order Appointing a Chapter 11 Trustee at 5, App. at

4395 (“Yao . . . owned and controlled [SFC] and all of its affiliates

at all times pertinent to this case.”). Since SFC Financial I, LLC,

was an alter ego of SFC separated only by corporate formalities,

Royal’s disclaimer of reliance on the former’s representations made

it unreasonable as a matter of law for it to rely on the

representations of the latter.

Finally, Royal argues that even if the policies waive

defenses based on fraud, they do not waive a defense based on the

invalidity of the policies themselves. This argument does not

identify a reasonable alternative construction of the policies so

much as an alternative characterization of Royal’s defense. Royal

supposes that the policies are invalid because it was fraudulently

induced to issue them. However recharacterized, this remains a

defense based on fraud and is waived no less than a defense that

invoked SFC’s “fraud with respect to the student loans” or “a

breach of [its] representation.”
 Royal asserts, citing several Third Circuit cases, that this 4

Court always considers extrinsic evidence in determining whether

an agreement is unambiguous. These cases, however, were not

decided under Delaware law. See, e.g., In re New Valley Corp., 89

F.3d 143, 149 (3d Cir. 1996) (“[a]pplying the federal common law

of contract”); Mellon Bank, N.A. v. Aetna Bus. Credit, Inc., 619

F.2d 1001, 1005 (3d Cir. 1980) (Pennsylvania law). Although no

text can be read in a vacuum, the Delaware Supreme Court has held

that in determining whether an ambiguity exists a court may

consider only “undisputed background facts to place the

contractual provision in its historical setting.” Eagle Indus., Inc. v.

DeVilbiss Health Care, Inc., 702 A.2d 1228, 1232 n.7 (Del. 1997).

“[U]ndisputed background facts” do not include the self-serving

parol evidence submitted by the parties, whose recollections as to

the intended meaning of the agreements predictably differ.

Even if we considered the sworn affidavit of Royal’s

employee, William Hibberd, it would not lend ambiguity to the

plain language of the Royal policies. Hibberd could state only that

it was his “understanding” that the policy language was not

intended to leave Royal liable in the case of a “widespread fraud

like the one that occurred here.” E.g., App. at 5345. Hibberd’s

subjective impression of what the parties meant, recollected years

after the events in question, is at very best a “scintilla” of evidence

in support of the objective reasonableness of Royal’s alternative

construction of the policies.

16

3.

Because we conclude that the agreements on their face

waive Royal’s fraud defense in unambiguous terms, we need not

consider the extrinsic evidence submitted by the parties. We also 4

need not discuss the doctrine of contra proferentem, which operates

against the insurer only when policy terms are ambiguous. See

Twin City Fire Ins. Co. v. Del. Racing Ass’n, 840 A.2d 624, 630

(Del. 2003). Finally, we need not decide whether the parties’

agreements are properly characterized as insurance policies or

guaranties, since the interpretive principles discussed above apply

to both and would yield the same result in either case. See

Westfield Ins. Group v. J.P.’s Wharf, Ltd., 859 A.2d 74, 76 (Del.
17

2004); Universal Studios Inc. v. Viacom Inc., 705 A.2d 579, 589

(Del. Ch. 1997); see also Restatement (Third) of the Law of

Suretyship and Guaranty §§ 1-2 (1996) (explaining that a finding

of suretyship status depends on the rights and obligations set forth

in the agreement, not the other way around). However

characterized, the policies on their face waive Royal’s defense to

payment of its obligations based on fraud, and the District Court

did not err in so finding.

B.

We next consider whether these waivers are enforceable.

The Delaware Supreme Court has not addressed the standards for

effective waiver of a defense based on fraud in the inducement, so

we must predict how it would decide this question. See Koppers

Co. v. Aetna Cas. & Sur. Co., 98 F.3d 1440, 1445 (3d Cir. 1996).

The District Court recognized that some authority had looked

askance at broad waivers in adhesive form agreements but

predicted that the Delaware Supreme Court would enforce an

unambiguous waiver negotiated by sophisticated parties. We

agree.

The Delaware Supreme Court’s closest precedent on this

question is its decision in Norton v. Poplos, 443 A.2d 1 (Del.

1982). In that case, the plaintiff sought to rescind a real estate

transaction by alleging that the seller had negligently

misrepresented the land’s zoning. The Court declined to find the

claim barred by a standard integration clause in the purchase

agreement reciting that the purchaser had not relied on

extracontractual representations. Id. at 3. The Court noted that

Delaware case law generally did not consider an integration clause

a reliable indicium of intent to waive a fraudulent inducement

defense. See id. at 6. It concluded, after a survey of cases from

other jurisdictions, that the better authorities extended this rule to

negligent misrepresentations, allowing the claim to proceed despite

the integration clause. See id.

The boilerplate nature of the parties’ agreement weighed

heavily in the Norton Court’s calculus. See id. at 7 (“We see no

reason why a court of equity should enforce a standard ‘boiler
18

plate’ provision that would permit one who makes a material

misrepresentation to retain the benefit resulting from that

misrepresentation at the expense of an innocent party.”). Since the

scope of Royal’s obligations turns not on a boilerplate merger

clause but on waivers sculpted by parties of exquisite legal and

financial sophistication, we do not believe Norton provides a

reliable guidepost for our decision. See Great Lakes Chem. Corp.

v. Pharmacia Corp., 788 A.2d 544, 555 (Del. Ch. 2001)

(distinguishing the agreements in Norton and its progeny as

“simple real estate contracts having boilerplate, unnegotiated

disclaimer language”).

More reliable guidance may be found in the Chancery

Court’s recent decision in Kronenberg v. Katz, 872 A.2d 568 (Del.

Ch. 2004). In a thoughtful opinion by Vice Chancellor Strine, the

Court reasoned that an enforceable waiver of fraud should have

“language that, when read together, can be said to add up to a clear

anti-reliance clause by which the plaintiff has contractually

promised that it did not rely upon statements outside the contract’s

four corners in deciding to sign the contract.” Kronenberg, 872

A.2d at 593. The Court acknowledged that an integration clause

could be read as a promise of nonreliance, since the clause recited

that the contract was the “entire agreement” and superseded all

prior “understandings” and “inducements.” See id. at 591. But it

found the integration clause also susceptible to a “more traditional

interpretation,” according to which the clause “simply operates to

police the variance of the agreement by parol evidence.” Id. at

591-92. Since these competing interpretations of the clause left the

parties’ intent in doubt, the Court declined to enforce it to bar a

fraud claim.

Royal protests that the sine qua non of enforceability is not

clarity but specificity. A waiver, argues Royal, is nothing but the

voluntary relinquishment of a known right. See Kallop v.

McAllister, 678 A.2d 526, 532 (Del. 1996). Since a waiver must

be voluntary, clear evidence of the party’s intent to waive is

required for enforcement. See Realty Growth Investors v. Council

of Unit Owners, 453 A.2d 450, 456 (Del. 1982); George v. Frank

A. Robino, Inc., 334 A.2d 223, 224 (Del. 1975). A requirement of

specificity serves this end by ensuring that parties do not, by
19

promising the moon, unintentionally waive rights they had not

really contemplated. Accordingly, Royal concludes, Delaware

courts will refuse to enforce even a clear waiver of fraud unless it

sets forth the particular representations on which the induced party

agreed not to rely.

Though this argument has some force, its conclusion finds

virtually no support in Delaware law. Cases have focused on the

function of the terms at issue, see DRR, L.L.C. v. Sears, Roebuck

& Co., 949 F. Supp. 1132, 1137 (D. Del. 1996) (holding that an “as

is” clause does not “insulate a seller from suit for its fraudulent

misrepresentations”); Traylor Eng’g & Mfg. Co. v. Nat’l Container

Corp., 70 A.2d 9, 13 (Del. 1949) (holding that a warranty cannot

serve to disclaim reliance on extracontractual representations for

purposes of a fraud claim); DCV Holdings, Inc. v. Conagra, Inc.,

No. 02-550, 2003 WL 2008199, at *3 (Del. Apr. 29, 2003)

(unpublished table decision) (finding an all-inclusive warranty

ambiguous with respect to waiver of fraud claims); Kronenberg,

872 A.2d at 592 (“[M]any learned authorities state that typical

integration clauses do not operate to bar fraud claims.”), or the

circumstances of their negotiation. See Norton, 443 A.2d at 7

(discounting “‘boiler plate’ found in the merger clause”); Great

Lakes, 788 A.2d at 555 (observing the “carefully negotiated

disclaimer language” crafted by “highly sophisticated parties,

assisted by industry consultants and experienced legal counsel”).

Although specificity and clarity often go hand in hand, we are

unaware of any Delaware case that has made specificity a

prerequisite to effective waiver.

In fact, a recent unpublished opinion of the Chancery Court

appears to have rejected the specificity requirement. See

Progressive Int’l Corp. v. E.I. Du Pont de Nemours & Co., No.

C.A. 19209, 2002 WL 1558382 (Del. Ch. July 9, 2002). The Court

there held that an integration clause reciting that neither party

would rely on extracontractual promises or representations

foreclosed rescission based on fraud. The allegedly defrauded

party protested that the clause did not identify the unreliable

representations or promises, but the Court found this omission

insignificant:
20

If adopted as law, Progressive’s argument would

impede commerce. It is not efficient for negotiators

to identify all the material issues that are not part of

the foundation of their relationship, and to list them

in a contractual schedule. Indeed, that exercise

would be wasteful and silly, as the integration clause

in the License Agreement shows. By simple and

unambiguous means, the parties to that Agreement

identified all the representations and statements that

could not have induced the execution of the

Agreement: all representations and statements not

included in the text of the Agreement itself.

Id. at *10; see also Debakey Corp. v. Raytheon Serv. Co., No.

14947, 2000 WL 1273317, at *27 (Del. Ch. Aug. 25, 2000)

(rejecting a fraud counterclaim because the aggrieved party could

have included the assurances on which it relied as representations

and warranties in the agreement). Although the Progressive

decision was not published, we believe its persuasive reasoning

provides a good model for the Delaware Supreme Court’s own

decision in this area.

The putative requirement of specificity seems rooted not in

Delaware case law but in a line of New York cases, and even there

it has been applied inconsistently. Although the Second Circuit in

Manufacturers Hanover Trust Co. v. Yanakas, 7 F.3d 310, 316 (2d

Cir. 1993), declared specificity the “touchstone” of enforceability,

other authority has focused on the clarity of the waiver rather than

its detail. See Valley Nat’l Bank v. Greenwich Ins. Co., 254 F.

Supp. 2d 448 (S.D.N.Y. 2003); Citibank, N.A. v. Plapinger, 485

N.E.2d 974 (N.Y. 1985). The Plapinger Court found the omission

of detail unimportant, deeming it “unrealistic in such circumstances

to expect an express stipulation that defendants were not relying on

a separate oral agreement.” 485 N.E.2d at 977. The Court in

Valley National Bank reached a similar conclusion, distinguishing

Yanakas as “less applicable . . . where the drafter and more

sophisticated party in the transaction now claims that the disclaimer

is too broad.” 254 F. Supp. 2d at 458.

Royal relies heavily on JPMorgan Chase Bank v. Liberty
21

Mutual Insurance Co., 189 F. Supp. 2d 24 (S.D.N.Y. 2002), a case

brought over a natural gas forward contract between Enron and one

of its affiliates. The affiliate borrowed money from plaintiff bank

to purchase the gas. Defendant surety guarantied that Enron would

deliver it. Unbeknownst to the surety, the bank had agreed with

Enron that the affiliate would subsequently repurchase the gas at a

higher price. This secret side agreement transformed the forward

contract into a simple loan. See id. at 26. The Southern District of

New York concluded that the surety could avoid payment on the

bond, rejecting the argument that “a general sweeping disclaimer

can serve to disclaim any and all extrinsic fraud between

sophisticated parties.” Id. at 27. It read Plapinger and Yanakas to

require “a clear indication that the disclaiming party has knowingly

disclaimed reliance on the specific representations that form the

basis of the fraud claim.” Id.

Were JPMorgan Chase a case of garden-variety fraud, its

analysis would be in tension with both Yanakas and Plapinger.

See, e.g., Yanakas, 7 F.3d at 317 (finding the disclaimer

insufficient in part because it contained “no blanket disclaimer of

the type found in Plapinger as to ‘any other circumstance which

might otherwise constitute a defense’ to the Guarantee”). We agree

with the District Court, however, that JPMorgan Chase is “an

unusual and extreme case [that] . . . provides little guidance.” 312

F. Supp. 2d at 589; 286 F. Supp. 2d at 358.

Though characterized as a fraudulent inducement, the

transaction in JPMorgan Chase bordered on a fraud in the factum

– “the sort of fraud that procures a party’s signature to an

instrument without knowledge of its true nature or contents.”

Langley v. Fed. Deposit Ins. Corp., 484 U.S. 86, 93 (1987) (citing

U.C.C. § 3-305(2)(c) cmt. 7 (1977)); see also Restatement (Second)

of Contracts § 163 (1981) (referring to a fraud with respect to the

“character or essential terms of a proposed contract”). The surety

was asked to insure the delivery of a commodity, when in fact it

was guarantying a loan. See JPMorgan Chase, 189 F. Supp. 2d at

28. In such a case, where the party does not even know the “true

nature” of what it is signing, it is unsurprising that the standards for

effective waiver would be stricter, if waiver is possible at all. Cf.

Restatement §§ 163-164 (explaining that a contract fraudulently
22

induced is voidable, whereas a “contract” procured through fraud

in the factum is no contract at all).

Unlike Liberty Mutual, Royal does not seriously question

the nature of the transactions covered by its policies. It

characterizes SFC’s business as a sham, but it does not deny that

SFC was issuing student loans and that the repayment of the

interest and principal on those loans was insured by Royal’s

policies. A fairly obvious risk of this insurance decision was that

SFC would misrepresent the quality of the loans. For the reasons

given above, the policies clearly assign this risk of fraud to Royal

when they declare that its liability will be unaffected by a “breach

of any representation” or “fraud with respect to the student loans.”

Because the risk of fraud was so obvious, it is unimaginable that a

party with Royal’s experience and knowledge would not have

realized it was assuming that risk when it agreed to that language.

Many of the remaining cases cited by Royal involved

alleged violations of the federal securities laws. See, e.g., Caiola

v. Citibank, N.A., 295 F.3d 312 (2d Cir. 2002); CP Kelco U.S., Inc.

v. Pharmacia Corp., No. CIV.A.01-240, 2002 WL 31230816 (D.

Del. Oct. 2, 2002). It is well known that the federal securities laws

provide broader fraud protection than the common law, having

been enacted in response to the common law’s perceived failure at

stamping out fraud in the securities markets. See, e.g., Herman &

MacLean v. Huddleston, 459 U.S. 375, 388-89 (1983); In re Data

Sys. Sec. Litig., 843 F.2d 1537, 1544 (3d Cir. 1988). Since the

analysis of cases like CP Kelco appears to have been colored by

federal securities law, we do not believe those cases provide

reliable guidance on this question of Delaware’s common law of

contract.

The lack of specificity in Royal’s waivers does not make

them any less clear. As the Progressive Court put it, a “method of

identification does not become unclear simply because it is terse.”

2002 WL 1558382, at *10. This is all the more true when the

method of identification is hammered out by sophisticated parties

aided by consummate legal professionals, who can be expected to

anticipate the subjects it will identify. Accordingly, we predict that

when sophisticated parties have inserted clear anti-reliance
23

language in their negotiated agreement, and when that language,

though broad, unambiguously coversthe fraud that actually occurs,

Delaware’s highest court will enforce it to bar a subsequent fraud

claim.

Royal asserts that this prediction risks giving protected

parties a “license to commit fraud,” CP Kelco, 2002 WL 31230816,

at *5, but the alternative poses its own danger. The danger is that

a contracting party may accept additional compensation for a risk

that it has no intention of actually bearing. This prevarication may

amount to a fraud all its own. See Progressive Int’l, 2002 WL

1558382, at *10 (“In essence, Progressive is saying to the court,

‘Believe us now when we tell you we made a false promise to

DuPont then.’”); Danann Realty Corp. v. Harris, 157 N.E.2d 597,

600 (N.Y. 1959) (“[T]he plaintiff made a representation in the

contract that it was not relying on specific representations not

embodied in the contract, while, it now asserts, it was in fact

relying on such oral representations. Plaintiff admits then that it is

guilty of deliberately misrepresenting to the seller its true

intention.”).

Given the potential for misrepresentation from each side of

the agreement, the safer route is to leave parties that can protect

themselves to their own devices, enforcing the agreement they

actually fashion. This rule will make for less prolix disclaimers

and reduce the likelihood that an intended allocation of the risk of

fraud will be frustrated by an unintentional omission from a long

and tedious list of representations. Such concerns have figured

prominently in recent Delaware case law. See Kronenberg, 872

A.2d at 593 (accommodating “contractual freedom and efficiency

concerns” as well as a “public policy . . . intolerant of fraud”);

Progressive Int’l, 2002 WL 1558382, at *10. When sophisticated

parties include a broad but unambiguous anti-reliance clause in

their agreement, the Delaware Supreme Court will likely indulge

the assumption that they said what they meant and meant what they

said.

It follows from the foregoing discussion that the Royal

waivers are in full force and effect. For the reasons given in

Section A of this opinion, those waivers unambiguously strip Royal
24

of the defense of fraud in the inducement. The District Court thus

did not err in awarding the beneficiaries summary judgment on

them, and it also did not err in denying Royal further discovery into

the beneficiaries’ knowledge of the fraud. The agreements

unambiguously waive Royal’s fraud defense whether or not the

beneficiaries had an inkling of the fraud before Royal, leaving

Royal with no remaining defense to payment that discoverable

evidence could support. To the extent set forth above, the

judgment of the District Court is accordingly affirmed.

C.

We turn now to consider the scope of Royal’s obligations

under the policies. The District Court ordered it to pay all claims

submitted by Wells Fargo and Wilmington Trust, including claims

that had been filed since the commencement of the lawsuit. Royal

argues that the Court overlooked triable issues regarding whether

all of the claimed losses were covered under the policies and

whether the beneficiaries’ claims had been properly documented.

The beneficiaries counter that they are entitled to immediate

payment under the policies and that Royal’s defense based on

SFC’s alleged misappropriation is waived along with its other

fraud defenses.

The scope of coverage is set forth in the first section of each

policy. The language differs from policy to policy, but the

substance is the same: Royal agrees to reimburse the insured or

beneficiary under the policy for a “Loss” that occurs during the

policy period. E.g., App. at 2247, 5479. Critically, “Loss” is

defined as “for any Student Loan as to which a Claim is made in

accordance herewith the Value as of the Default Date with respect

to such Student Loan.” E.g., App. at 2017, 5527. The “Value” of

a Student Loan is simply the “principal balance outstanding . . . as

of the Default Date plus accrued interest thereon.” E.g., App. at

2018, 5528. The “Default Date” is the first date of a “Default,”

e.g., App. at 2016, 5526, which in turn is defined as:

(i) a Student Loan becoming ninety (90) days or

more delinquent (treating payments made by a

Student but paid over to a bankruptcy court having
We recognize that by their terms the policies also extend 5

coverage to losses resulting from the impairment of the

beneficiaries’ rights in bankruptcy. SFC entered bankruptcy in

June 2002, but the parties have not discussed how this event affects

their rights and obligations under the policies. We leave this

interesting question to the District Court.

25

jurisdiction over the Student as a preference item as

not having been paid by the Student), with payments

made after a delinquency applied to the earliest

delinquency, or (ii) any impairment or avoidance of

the rights of the Beneficiary or the Insured in a

Student Loan arising out of the bankruptcy or similar

event or proceedings with respect to Student Finance

Corporation or the Insured, including without

limitation pursuant to Section 362 of the United

States Bankruptcy Code.

E.g., App. at 2032-33; see also, e.g., App. at 2016, 5479.

These provisions give rise to a reasonable inference, if not

an irresistible conclusion, that the “Loss” for which Royal agreed

to reimburse the beneficiaries was the nonpayment of interest and

principal on the student loans. If a loss may be traced to something

other than a “Default” – that is, “a Student Loan becoming ninety

(90) days or more delinquent” – it is not covered under the

policies. Under this highly reasonable interpretation, Royal need 5

not reimburse the beneficiaries for nonreceipt of loan proceeds

misappropriated by SFC.

Wells Fargo argues that SFC’s misappropriation is just

another form of fraud that Royal waived as a defense to payment.

This argument misses the point. Royal’s defense is not based on

SFC’s fraud per se but on the extent of coverage afforded by the

policies. The waivers themselves make this distinction clear. In

the first eight policies, Royal agreed that its “obligation to pay any

Claim” would be unaffected by a “breach of any representation.”

In the last two policies, it agreed to waive any defense that would

allow it “to avoid payment of its obligation under this policy.”
26

Wells Fargo’s argument begs the question of whether a loss due to

SFC’s conversion is one of Royal’s “obligation[s].”

We also reject Wilmington Trust’s argument that its policies

“require Royal to pay every Claim submitted to it upon the

submission of a conforming ‘Notice,’ without more.” Wilmington

Trust’s Br. at 40 (emphasis omitted). Although section III(A) of

the Wilmington Trust policies provides that “[a]ny Claim . . . shall

be paid by the Insurer within sixty (60) days,” App. at 5481, 5528,

other language appears to contemplate that Royal may challenge

claims prior to payment. Section III(C)(1) requires the insured or

beneficiary to deliver with notice of its claims a “written proof of

loss form . . . identifying the applicable Student Loans” and the

unpaid balance on them. App. at 5481, 5528. The policies also

require the insured to provide, upon Royal’s request, “evidence

reasonably available with respect to circumstances surrounding a

Loss.” Id. Requiring such evidence prior to payment would serve

no purpose if Royal were obligated to pay any claim upon receipt.

Arguably, section III(A) simply lays out a time frame for payment

of a claim that the parties have already agreed is valid.

To what extent SFC’s misappropriation contributed to the

beneficiaries’ losses remains unclear. Royal points to evidence that

Andrew Yao was receiving distributions from SFC at the rate of

approximately $1 million per month while serving as its director,

treasurer, and chief executive officer. See App. at 4405-07.

According to Royal, SFC’s tottering financial position at the time

makes it likely that some of this money was diverted from the

income streams due the beneficiaries. The beneficiaries have not

disputed this evidence on appeal, relying instead on the interpretive

arguments rejected above. Having found the ten policies

reasonably susceptible to an interpretation under which Royal

would not be liable for losses due to SFC’s misappropriation, we

conclude that further development of the record is necessary to

determine the extent of this misappropriation before Royal may be

ordered to pay the beneficiaries’ claims.

On remand, the District Court must first decide whether or

not the policies cover losses attributable to SFC’s alleged

conversion. If not, it must then determine the extent to which
27

SFC’s misappropriation contributed to those losses. Further

discovery may be necessary, but we caution that this remand is not

an opportunity for Royal to revive its rejected fraudulent

inducement defense. The proceedings should be limited to

deciding which of the losses claimed by the beneficiaries are

covered under the policies.

IV.

After careful consideration of the parties’ arguments and

submissions, we conclude that each of the ten Royal policies

unambiguously and effectively waived its defense to payment of its

obligations based on SFC’s fraud. The District Court correctly

denied Royal rescission, correctly declared the policiesin full force

and effect, and correctly ordered Royal to perform its obligations

under them. That part of the District Court’s decision is affirmed.

The remainder of the decision is vacated. Triable issues

regarding the scope of the policies’ coverage and the nature of the

beneficiaries’ losses preclude summary judgment. On remand, the

District Court must determine whether the policies cover all of the

losses claimed by the beneficiaries before ordering Royal to pay

them.