Opinion ID: 2982336
Heading Depth: 2
Heading Rank: 2

Heading: The “Loan Loss” exclusion in the Bond

Text: Defendant argues that section 2(e) of the Bond precludes coverage for Plaintiff’s loss. Section 2(e) reads that “[t]his bond does not cover: (e) loss resulting directly or indirectly from the complete or partial nonpayment of, or default upon any Loan or transaction involving the Insured as a lender or borrower, or extension of credit, including the purchase, discounting or other acquisition of false or genuine accounts, invoices, notes, agreements of Evidences of Debt, whether such Loan transaction or extension was procured in good faith or through trick, artifice, fraud, or false pretenses, except when covered under Insuring Agreements (A), (E) or (G).” Section 1(m) also reads that “[a]s used in this bond: (m) Loan means all extensions of credit by the Insured and all transactions creating a creditor relationship in favor of the Insured and all transactions by which the Insured assumes an existing creditor relationship.” Defendant contends that the loss Plaintiff suffered as a result of the fraudulent wire transfer request was from the extension of credit and is therefore excluded from coverage. However, the clear meaning of section 2(e) is that Defendant will not cover a loss resulting from a customer default on a loan or extension of credit made by Plaintiff. The loss in this case did not result 9 No. 13-1752 from the nonpayment of a loan. It was a loss as a result of a fraudulent wire transfer request by someone other than the true customer. The purpose of the “loan loss” exclusion is to exclude from coverage credit risks that are within the expertise of the financial institution, while still protecting the financial institution from insurable risks. In other words, insurance companies use these provisions to exclude losses that are the result of bad loans that a financial institution should have known better than to enter into. Hudson United Bank v. Progressive Cas. Ins. Co., 284 F. Supp. 2d 249, 252 (E.D. Pa. 2003). The rationale for financial institutions relying upon their own business judgment and risk tolerance makes sense. The financial institution should bear the loss associated with credit decisions it makes from which it hopes to profit. People’s State Bank v. American Cas. Co. of Reading, Pa., 818 F. Supp 1073 (E.D. Mich. 1993), involved a dishonest bank employee who filled out loan applications in the name of unsuspecting or unknown persons, signed promissory notes using the false applicant’s name, and then directed the proceeds from the loans either to himself, the accounts of others or to make payments on fraudulent loans he had previously created. The bank made a claim under the bond, and the insurance company denied the claim on the basis of the “loan loss” exclusion, which was identical to the loan loss exclusion in this case. The district court stated that the insurance company’s argument for exclusion under the “loan loss” provision was “convoluted” because “[a] simple reading of the language of exclusion (e) makes it abundantly clear that the losses incurred by [the bank] do not fall under this term of the fidelity bond. Exclusion (e) applies to losses that arise from the ‘complete or partial nonpayment of, or default upon, any Loan or transaction involving the Insured as a lender or borrower, or extension of credit . . .’” Id. at 1077. 10 No. 13-1752 The court went on to find that the “transactions [did] not constitute loans under the definitions set forth in the bond.” Id. After reciting the bond’s definition of the term “loan,” which, exactly like the Bond at issue here, was defined as all “extensions of credit,” and the term “letter of credit,” which, exactly like the Bond at issue here, was defined as “an engagement in writing by a bank or other person made at the request of a customer,” the court held that because the loans were not made at the request of a customer, they did not constitute loans as defined by the fidelity bond and were not excepted from coverage. Id. at 1077–1078 (emphasis in original). In addition, the court held that even if the dishonest transactions were found to constitute loans, the bank’s losses nonetheless fell outside the purview of the “loan loss” provision because they did not result from “the complete or partial non-payment of, or default upon, any Loan,” as the “loan loss” provision required. Id. at 1078. Therefore, the court denied the insurance company’s motion for summary judgment based upon the “loan loss” exclusion. Similarly, the “loan loss” exclusion is inapplicable here because the risk in this case had nothing to do with the Bank making a poor credit decision, improperly valuing collateral or the risk of utilizing poor credit policies or practices. Rather, the risk at issue in this case was the risk of forgery. Plaintiff purchased and paid premiums for insurance that covered, among other things, losses resulting from forgery. The plain language of the Bond covers forgeries. (R. 12-2, Bond, at 198.) Plaintiff understood that it was not insured for losses resulting from defaulted loans or other extensions of credit when a customer failed to repay monies owed, even if the customer engaged in fraudulent conduct. In conclusion, Plaintiff did not lose $196,000 as a result of a giving out a loan or extension of credit. Plaintiff lost $196,000 because an individual forged the signature of its true customer and thereby managed to get $196,000 transferred from the true customer’s HELOC to 11 No. 13-1752 an account in South Korea which resulted in the money being stolen. The plain language of the Bond covers this type of loss and the exclusion in section 2(e) clearly does not apply.