Court Opinion

ID: 8908595
Source: CourtListenerOpinion
Date Created: 2022-11-27 02:17:26.546783+00
Date Added: 2024-06-11T17:08:22.475630
License: Public Domain

K. K. HALL, Circuit Judge:
C. Douglas Wilson & Co. (Wilson), a mortgage broker, sustained losses in excess of $1,250,000 as a result of the mishandling of certain HUD/FHA loans by an employee, and filed a declaratory action in district court against its three defendant insurance carriers to fix their respective liabilities. On motion for nonsuit at the close of plaintiff’s evidence, the district court dismissed *1277St. Paul Fire and Marine Insurance Company (St. Paul) as a party. At the close of all the evidence, the jury returned a verdict for plaintiff against both the Insurance Company of North America (INA) and Hartford Accident and Indemnity Company (Hartford). The district court then granted a motion for judgment n. o. v. We affirm.
To resolve the question of liability in this ease we must focus attention upon the date of March 25, 1973, the dishonesty of J. L. Barksdale, then a vice president of Wilson, and the manner in which Wilson reacted to the discovery of Barksdale’s dishonesty.
St. Paul was the fidelity bond insurer prior to March 25,1973. INA and Hartford were the insurers after that date.1 The St. Paul policy provided coverage only for losses discovered during the policy period.2 The INA and Hartford policies expressly excluded coverage for losses resulting from the dishonest acts of any employee which occurred after the employer had knowledge of the employee’s dishonesty.3 The district court ruled, as a matter of law, that St. Paul was not liable because Wilson discovered its losses after the St. Paul policy had expired, and that INA and Hartford were not liable because Wilson knew of the dishonesty of its vice-president before the effective date of their policies.
The facts may be stated briefly. Wilson is a wholly-owned subsidiary of NCNB Corporation. The genesis of this lawsuit is found in various loan practices of J. L. Barksdale, then vice-president of Wilson in charge of all multi-family construction loans insured by the Secretary of HUD through FHA. On March 16, 1973, Robert Shaw, NCNB’s credit review officer, discovered during a routine audit that Barksdale was advancing construction monies to contractors before getting prior approval from HUD, which prior approval was one condition to participation in the HUD/FHA program. Shaw confronted Barksdale, who candidly admitted this practice; he also admitted that he falsely certified the dates and amounts of advances on standard HUD forms, to make those dates and amounts conform to the actual dates and amounts approved by HUD. Barksdale justified this practice by saying that “ . . . all construction lenders in FHA projects were handling. these [pre-advances and false certifications] on this basis and . . . FHA, or HUD, was aware of this practice. . . ”
Shaw, concerned about the situation, wrote a detailed memo to Wilson officials on March 18,1973. A meeting was held the following day to discuss the situation, but no action was taken against Barksdale, al*1278though the practice of making pre-advances “came to a screeching halt.” Wilson did not notify St. Paul, who was then the insurer on a fidelity bond, of Barksdale’s actions, nor did it notify INA or Hartford, who six days later were to become the insurers. Various Wilson officials testified at trial that, at the time, they considered Barks-dale’s actions to be bad business practice and poor judgment, but did not consider them dishonest or illegal. Significantly, Wilson argued vigorously both at trial and on appeal that no losses were occasioned by Barksdale’s practice of making pre-advances.4
During the week of April 23,1973, Wilson discovered that Barksdale had failed on several occasions to secure letters of credit which Wilson was obligated to hold in lieu of cash escrows required by FHA for its approval of permanent loan insurance for completed housing projects. As in the case of the pre-advances, Wilson discovered that Barksdale had falsely certified on FHA forms that he had in fact secured these letters of credit. Wilson considered these acts, which had the effect of exposing Wilson to substantial losses, dishonest and illegal, and immediately fired Barksdale and notified St. Paul, INA and Hartford of a potential claim. Wilson eventually suffered over $1,250,000 in losses due to Barksdale’s failure to secure the letters of credit, and this action was filed in district court to determine which if any of the three insurers were liable for the losses.

The INA and Hartford Policies

Both the INA and Hartford policies provided that coverage was deemed terminated or cancelled as to any employee as soon' as the Insured had knowledge that the employee had committed fraudulent or dishonest acts. Wilson admits, “with the benefit of hindsight,” that Barksdale’s false certification to HUD of the dates and amounts of pre-advances was a dishonest act, but insists that at the time it reasonably considered this to be merely poor judgment and bad business practice. INA and Hartford argue that Barksdale’s false certification of the pre-advances was dishonesty as a matter of law, and that Wilson had knowledge of this employee dishonesty before March 25, 1973, when the INA and Hartford fidelity bonds became effective. This would mean that, as to Barksdale, coverage under the bonds never went into effect.
Wilson’s argument hinges upon the distinction it attempts to make between Barksdale’s false certification of pre-advances and his false certification concerning the letters of credit; the former; it urges, is “technical only,” while the latter poses a much higher risk of loss exposure to Wilson. The district court found, and we agree, that this is a distinction without a difference. In both instances Barksdale certified false information on a HUD or FHA form, which form stated that criminal penalties attached for such false certifications,5 for the purpose of influencing HUD or FHA actions. The smaller potential for loss exposure to Wilson does not render one violation “technical.”
Wilson vigorously attempts to factually distinguish the authority cited by the district court, but we are persuaded by the reasoning in City Loan and Savings Co. v. Employers’ Liability Assurance Corp., Ltd., 249 F.Supp. 633, 656 (N.D.Ohio 1964) (citations omitted).
‘Dishonesty’, as used in a fidelity bond, is to be interpreted according to its usual and ordinary meaning. To constitute dis*1279honesty, the conduct need not amount to a crime and need only involve bad faith or a want of integrity or untrustworthiness or a disposition to lie or cheat or a faithlessness to a trust. To constitute dishonesty, there need not be an intent to profit or to cause a monetary loss to the employer.
Since we conclude that Barksdale’s false certification of pre-advances constitutes dishonesty as a matter of law and that Wilson had knowledge of it before the inception of the INA and Hartford policies, and since Wilson concedes that it did not notify INA and Hartford of Barksdale’s dishonesty, we sustain the conclusion of the district court that under the terms of their respective policies INA and Hartford cannot be held liable for Wilson’s losses. See footnote 3, supra.6

The St. Paul Policy

Wilson, INA and Hartford join in arguing that the district court erred in dismissing St. Paul from the case at the close of plaintiff’s evidence. All of that evidence indicated that Wilson’s losses were occasioned solely by Barksdale’s failure to secure the letters of credit7 and that this failure was not discovered until the week of April 23,1973. The St. Paul policy provided coverage only for losses discovered during the policy period; the policy expired on March 25, 1973.
Defendants INA and Hartford were prepared to offer the testimony of J. L. Barksdale that Wilson had discovered the missing letters of credit, and thus its loss, before March 25, 1973. However, they did not file a cross-claim against St. Paul. The district court held that, even given the relaxed burden of proof in a declaratory action, it was the plaintiff’s burden — not INA’s or Hartford’s — to establish St. Paul’s liability. See 6A Moore’s Federal Practice U 57.31, at 266-71 (2d ed. 1974). Wilson presented no evidence upon which St. Paul could be held liable. INA and Hartford, who did not file a cross-claim against St. Paul and thus did not assume the role of plaintiff as against St. Paul, should not be heard to complain.

Conclusion

We find Wilson’s argument that the district court failed to consider the materiality of Wilson’s non-disclosure to the insurers to be refuted both by the language in the court’s opinion and by the evidence. The fact of an employee’s known dishonesty cannot be non-material where the insurer is underwriting a fidelity bond. Graham v. Aetna Insurance Co., 243 S.C. 108, 132 S.E.2d 273 (1963), relied upon by Wilson, is inapposite.
We agree with the district court’s analysis of the law of waiver and estoppel and with his conclusion that these defenses are unavailing where, as here, the effect would be to add to or extend policy coverage and, in any event, the defenses have no support in the evidence.
In light of our holding that neither INA nor Hartford may be held liable for Wilson’s loss because of Wilson’s non-disclosure of employee dishonesty, we need not consider the additional issue raised by Hartford *1280of whether it may not be held liable because its coverage is written on a “loss sustained” basis rather than on a “loss discovered” basis.
The unfortunate position in which Wilson finds itself was occasioned in part by sheer bad luck in timing as to the change in insurers and in part by the poor judgment of its own officers. However, mindful of Justice Holmes’ admonition, we cannot use this hard case as a vehicle to make bad law. Each issue raised in this appeal is analyzed at length in the district court’s opinion, and we affirm on the basis of that opinion.

AFFIRMED.

. The St. Paul policy provided $1,000,000 coverage with $500 deductible. The INA policy provided $8,000,000 coverage with $50,000 deductible. Wilson purchased the Hartford policy, which provided $50,000 coverage with $1,000 deductible, to fill this gap in the INA coverage.

. The St. Paul policy contained the following:
ENDORSEMENT OR RIDER No. 3
******
“RIGHTS AFTER TERMINATION OR CANCELLATION”
“Section 17. At any time prior to the termination or cancellation of this bond as an entirety, whether by the Insured or the Company the Insured may give to the Company notice that it desires under this bond an additional period of twelve months within which to discover loss sustained by the Insured pri- or to the effective date of such termination or cancellation and shall pay an additional premium therefor. Upon receipt of such notice the Company shall give its written consent thereto; . .

. The INA policy provided:
TERMINATION OR CANCELLATION
******
Section 10.
******
This bond shall be deemed terminated or can-celled as to any Employee — (a) as soon as the Insured shall learn of any dishonest or fraudulent act on the part of such Employee, . .
The Hartford policy provided:
PRIOR FRAUD, DISHONESTY OR CANCELLATION
SECTION 6. The coverage of this Bond shall not apply to any Employee from and after the time that the Insured or any partner or officer thereof not in collusion with such Employee shall have knowledge or information that such Employee has committed any fraudulent or dishonest act in the service of the Insured or otherwise, .

. Had Wilson anticipated that losses might result from the pre-advances, it could have elected a twelve-month extension of the St. Paul policy then in effect. See footnote 2, supra.

. The forms contained the following language:
U.S. Criminal Code, Section 1010, Title 18, U.S.C., “Federal Housing Administration Transactions”, provides in part:
“Whoever, for the purpose of . influencing in any way the action of such Administration . . . makes, passes, utters, or publishes any statement, knowing the same to be false, . . . shall be fined not more than $5,000 or imprisoned not more than-two years, or both.”

. The dissent notes that all of Barksdale’s acts concerning the letters of credit occurred before Wilson’s discovery of his dishonesty, and from this argues that we are giving the termination clauses retroactive effect by holding that INA and Hartford have no liability for losses resulting from these prior acts. See pp. 1290-1291 infra. We agree that in the usual situation, where the same insurer is on the risk throughout the entire time period at issue, coverage for losses resulting from acts occurring before the employer’s discovery of employee dishonesty would not be affected by subsequent operation of the termination clause. But here, the dissent would have INA and Hartford assume liability for losses resulting from acts committed before the inception of their respective policies by an employee who was never within the coverage of the policies. This is an untenable result.
Had Wilson elected to extend its coverage under the St. Paul policy, its option as a matter of right, see note 2 supra, St. Paul would have been liable for the after-discovered losses.

. Upon questioning at oral argument, Wilson’s counsel continued to insist that it sustained no losses as a result of the pre-advances, and that there was no causal relationship between the pre-advances and the ultimate losses.