Opinion ID: 363827
Heading Depth: 1
Heading Rank: 2

Heading: The Fidelity Bond.

Text: 16 In a third party action the Clinton State Bank sought recovery for any possible loss to Perkins under its fidelity bond with Fidelity & Deposit Company of Maryland. The insuring agreement provided protection for: 17 Loss of Property (Occurring with or without negligence or violence) through . . . false pretenses . . . while the Property is (or is supposed to be) lodged or deposited within any offices or premises (is an insured event) . . . . 18 (Emphasis added.) 19 The district court denied the Bank recovery on the bond because the Bank failed to give timely notice of the loss. The notice provision of the bonding agreement provides that (a)t the earliest practicable moment after Discovery of any loss hereunder the Insured shall give the Underwriter written notice thereof . . . . (Emphasis added.) 5 The trial court held that the letter sent by Mrs. Perkins' attorney to the Bank on June 18, 1974, contained sufficient information when coupled with the knowledge McKnight had, to place the Bank on notice that it had sustained an insured loss. The district court additionally found that at a minimum this letter required the Bank to inquire further into the Perkins-Daugherty escrow arrangement, and its own transactions with Mr. Daugherty, to determine its potential liability. 20 We respectfully disagree and reverse the judgment denying the Bank recovery under the policy. 21 On June 18, Mr. Carden, Mrs. Perkins' attorney, wrote to Howard Johnson, the president of the Clinton State Bank, as follows: 22 I have been contacted by Mrs. Mary Perkins, widow of Mr. T. O. Perkins, of Dallas, Texas, in regards to the possible filing of legal actions against Mr. G. C. Daugherty and the G. C. Daugherty Properties, Inc., for failure to comply with a certain contract of sales involving the sale of approximately 800 acres of land in Searcy County, Arkansas. The contract and escrow agreement was entered into on February 12th, 1973. Since the Clinton State Bank serves as escrow agent, I am sure that you will be a necessary party, if it becomes eminent (sic) that there is a need for filing suit.I would like to know what documents you still have in your escrow file at the bank. It is my understanding that you should have a warranty deed, as well as a quitclaim deed, abstract of title and promissory notes on the 800 acres of land. Further, I understand that you also have in your possession certain warranty deeds and quitclaim deeds from G. C. Daugherty and the G. C. Daugherty Properties, Inc., on a certain tract or parcel of land located in San Antonio, Bexar County, Texas. 23 An addendum was added to the original contract on April 10th, 1973. By its terms, you were to hold the deeds, etc., on the San Antonio property until proceeds of at least $80,000 were paid to you by Mr. Daugherty. At that time, by the terms of the Escrow Agreement, your duty was to release the San Antonio property, as well as the Arkansas property. However, all interest had to first be paid from said land sales before you were to give any type of total release. 24 Mrs. Perkins is of the opinion that your bank may have released some or all of the properties before the sum of $80,000 plus the interest at the rate of Eight (8%) per cent per annum has been paid. 25 Further, Mrs. Perkins has received no funds from said land sale, except the initial down payment. She feels, as do I, that Mr. Daugherty has totally failed to comply with the terms of said agreement. Therefore, it is her very strong desire to pursue this matter, and file the appropriate action against all parties who are liable in any way, in regards to their duties, obligations, etc. 26 Therefore, if you would forward to me a list of all papers pertinent to the matters in your file, and any other information you might have in regards to the whereabouts of Mr. Daugherty, or any other matters relevant, I would be most appreciative. Then, I can begin to go about the task of attempting to determine where the liabilities lie in this case. 27 The trial court found the June 18 letter triggered discovery by the Bank since when the letter was received, McKnight knew or should have known that 28 (1) the January 15th installment had not been paid; (2) Mrs. Perkins had made an inquiry regarding the payment of the first installment under the note; and (3) the Bank had released escrowed documents which were being held as security for Mrs. Perkins. Additionally, he knew, firsthand, the representations of Mr. Daugherty and their inconsistency with Mrs. Perkins's inquiries. 29 In so holding the court applied a standard of objective reasonableness on the part of the insured in fulfilling the timely notice requirement. Thus the court held that the test was whether a reasonable recipient of the June 18 letter would have interpreted it to mean the release of the escrowed documents was secured by false pretenses and that as such it constituted a loss of property under the policy. 30 The meaning of discovery in timely notice provisions has been judicially construed in several cases dealing with losses due to dishonest employees. See, e. g., American Surety Co. v. Pauly, 170 U.S. 133, 144-47, 18 S.Ct. 552, 42 L.Ed. 977 (1898); United States Fidelity & Guaranty Co. v. Empire State Bank, 448 F.2d 360, 364-65 (8th Cir. 1971); Federal Deposit Insurance Corp. v. Aetna Casualty & Surety Co., 426 F.2d 729, 738-39 (5th Cir. 1970); Hidden Splendor Mining Co. v. General Insurance Co., 370 F.2d 515, 519 (10th Cir. 1966); American Employers' Insurance Co. v. Cable, 108 F.2d 225, 226-27 (5th Cir. 1939); Midland Bank & Trust Co. v. Fidelity & Deposit Co., 442 F.Supp. 960, 971-73 (D.N.J.1977); Alfalfa Electric Cooperative, Inc. v. Travelers Indemnity Co., 376 F.Supp. 901, 906 (W.D.Okl. 1973); National Mutual Casualty Co. v. Cypret, 207 Ark. 11, 179 S.W.2d 161, 164 (1944); Fidelity & Deposit Co. v. Cunningham, 181 Ark. 954, 28 S.W.2d 715, 719 (1930). Arkansas law accords with the generally accepted definition of discovery as construed in connection with blanket employee fidelity bonds, and has been stated by the Arkansas Supreme Court as follows:Under the terms of a bond indemnifying the assured against the larceny or embezzlement of the principal and requiring notice by the assured to the insurer on their becoming aware of same, to render the notice necessary, more than mere suspicion is required; circumstances must have existed and been known by the assured, which would have induced the belief in an ordinarily prudent person that a larceny or embezzlement had been committed. 31 Fidelity & Deposit Co. v. Cunningham, 181 Ark. 954, 28 S.W.2d at 719. 32 From the foregoing authorities, discovery of fraud or dishonesty is deemed to occur when the insured actually becomes aware of sufficient facts which would lead a reasonable person to believe that an insured loss has occurred. Mere suspicion of an insured loss by the insured is not sufficient to trigger the notice requirement. See Federal Deposit Insurance Corp. v. Lott, 460 F.2d 82, 86-87 (5th Cir. 1972). Contrary to the district court's holding, it appears settled that absent specific terms of the bond the insured has no obligation to exercise diligence to search out facts which might lead to discovery. See, e. g., American Employers' Insurance Co. v. Cable, 108 F.2d at 227; Midland Bank & Trust Co. v. Fidelity & Deposit Co., 442 F.Supp. at 972. 6 The well established rule is that the insured under a blanket employee's fidelity bond is not bound to give notice until he has acquired knowledge of some specific fraudulent or dishonest act. As early stated: 33 (N)either negligence nor inattention, nor any failure to discover what by diligence might have been discovered, nothing, in fact, short of actual discovery by the bank of dishonesty or a positive breach of an imperative condition, will defeat claims for loss caused by that dishonesty, unless it is otherwise provided in the contract. 34 American Employers' Insurance Co. v. Cable, 108 F.2d at 227. 35 As Judge Bright observed in United States Fidelity & Guaranty Co. v. Empire State Bank, supra, it is not only knowledge of the facts but the facts must be such that a reasonable insured would understand the significance of them connoting the commission of a fraud. 448 F.2d at 365. 36 Under Arkansas law, insurance contracts are to be construed according to general contract principles. Thus, in construing the bonding agreement the notice provision must be considered in connection with the type of loss covered. See Shepherd v. Mutual Life Insurance Co., 63 F.2d 578, 579 (8th Cir. 1933); Haskins v. Occidental Life Insurance Co., 349 F.Supp. 1192, 1198 (E.D.Ark.1972). Cf. American Surety Co. v. Pauly, 170 U.S. at 144, 18 S.Ct. 552 (object of contract in insuring against employee defalcations must not be defeated by narrow interpretation of notice provision). Thus, it is appropriate to examine the precise type of loss which the bonding agreement provides protection against. 37 Fidelity & Deposit Company argued in the trial court that the Bank's loss was not an insured event since an experienced escrow agent would not have been taken in by Mr. Daugherty's representations concerning the escrow agreement and addendum. The trial court explicitly rejected the proposition that the level of competence of an experienced escrow agent should be used as an objective standard for determining whether an insured loss occurred. The relevant insuring language of the agreement intended the bonding agreement to cover losses sustained as the result of false pretenses even if the insured negligently released the insured property. More specifically, although a reasonable prudent person may have had or should have had knowledge sufficient to provide notice that releasing the originally escrowed documents was inconsistent with the original escrow agreement, under the terms of the bond, McKnight's negligent failure to comprehend the significance of these facts did not preclude the loss from being an insured event. 38 If the moment of discovery is ascertained by employing a strict objective standard, a negligent assured which is defrauded will almost always run afoul of the timely notice requirement since discovery will occur the moment the loss occurs. A bank that believes the release of escrow documents is entirely proper can hardly be expected to immediately notify its insurer that it has suffered a loss. Thus, what a reasonably competent escrow agent would have concluded from the facts which led to the erroneous release of the originally escrowed documents is not the proper test for determining when the loss was discovered. To hold otherwise would completely vitiate the uncontested finding of the trial court that the parties intended the bonding agreement to cover losses incurred when the Bank negligently accepts as true, false representations. 39 Thus, when the notice provision is considered in the context of the whole bonding agreement, as it must under Arkansas law, See Great American Indemnity Co. v. Saltzman, 213 F.2d 743, 746 (8th Cir.), Cert. denied,348 U.S. 862, 75 S.Ct. 85, 99 L.Ed. 679 (1954), And Shepherd v. Mutual Life Insurance Co., 63 F.2d at 579, it is clear that the discovery provision should be construed to avoid frustrating the object of the bonding agreement and intent of the parties. Construction of the discovery provision must be consistent with the terms of the insuring agreement. See American Surety Co. v. Pauly, 170 U.S. at 144, 18 S.Ct. 552; Habaz v. Employers' Fire Insurance Co., 243 F.2d 784, 786 (8th Cir. 1957); Smith v. Mutual Life Insurance Co., 188 Ark. 1111, 69 S.W.2d 874, 876 (1934); Aetna Life Insurance Co. v. Spencer, 182 Ark. 496, 32 S.W.2d 310, 312 (1930). An insuring agreement should not be construed to provide coverage for a defined loss and then simultaneously construed to defeat coverage because of the operative circumstances surrounding the same loss. 40 Thus, we conclude that although the Bank may have been grossly negligent in releasing the escrowed documents, the subsequent facts must be such that a reasonable recipient of the June 18 letter would have known from the information communicated in the letter that the release of the documents was obtained by Daugherty's false pretenses. A facile understanding of the definition of discovery under a fidelity bond has been stated to be: 41 An oversimplification of the definition is that when the insured learns the facts constituting the alleged dishonesty his prior suspicions, if any, are converted to knowledge which he cannot ignore and which constitutes discovery. 42 Alfalfa Electric Cooperative, Inc. v. Travelers Indemnity Co., 376 F.Supp. at 906. 43 Thus, the test of discovery under the present bonding agreement, which insured the Bank against the negligent release of escrow documents based on false misrepresentations, must relate to a reasonable person's subsequent awareness of facts which would convert his negligent appreciation of the facts into actual knowledge of the alleged dishonesty. 44 We find the information contained in the June 18 letter would not have led a reasonable person to reject the Bank's prior conclusions about the escrow arrangement. Indeed, the letter is for the most part consistent with the Bank's view of the escrow arrangement. The third paragraph of the letter unambiguously states that the Bank was required to release the documents relating to the San Antonio and Arkansas property when Proceeds of at least $80,000 were paid to (the Bank) by Mr. Daugherty. (Emphasis added.) This interpretation of the escrow agreement and addendum precisely coincides with the Bank's understanding. Furthermore, Mrs. Perkins' apparent unawareness of the $80,000 promissory note resulting from the G. C. Daugherty Properties Tanzana transaction readily accounts for her belief that the Bank had not received the proceeds required prior to releasing the originally escrowed documents. 45 The major inconsistency between Mrs. Perkins' position and the Bank's results from Mrs. Perkins' belief that proceeds meant cash. While it is true that cash received from the sale of property constitutes proceeds, it is equally true that proceeds are not limited to cash. See Phelps v. Harris, 101 U.S. 370, 380, 25 L.Ed. 855 (1879). Indeed, the addendum, which was signed by Mrs. Perkins, explicitly provides that first lien real estate notes may be accepted by the Bank as proceeds of the sale of the San Antonio property. The trial court found the addendum was invalid. Nevertheless, as discussed in connection with losses covered by the bonding agreement, the Bank's negligence in releasing the escrow documents and in relying on the addendum cannot preclude the Bank's recovery. 46 Additional knowledge that the January 15 installment had not been paid and Mrs. Perkins' inquiries in regard thereto also fail to demonstrate any more than a possible breach of contract by Daugherty. 7 If this is so, it hardly implicates the Bank. It is well settled that an escrow agent is not liable for another person's breach of the contract which is subject to the escrow agreement. Cf. Fulk v. Gay, 216 Ark. 462, 226 S.W.2d 69, 74 (1950), And Ford v. Moody, 169 Ark. 649, 276 S.W. 595, 597 (1925) (failure of grantee to perform conditions of contract did not give rise to escrow agent liability). Furthermore, although the alleged inconsistencies between Daugherty's view of the escrow arrangement and the view apparently held by Mrs. Perkins might have led to further inquiries by the Bank, as previously noted the Bank had no duty under the insuring agreement to diligently seek out the facts. 47 Thus, we conclude that the letter and facts known by the Bank were not sufficiently inconsistent with the Bank's view of the escrow arrangement to result in discovery of the loss through false pretenses. We therefore conclude that the Bank discovered the loss when served with the complaint in this case sometime between August 13 and August 16, 1975. Accordingly, the notice of loss given to Fidelity was timely. 48 The decision of the district court is affirmed in part and reversed in part and the cause remanded with directions that the Bank be awarded judgment under the bonding agreement.