USCA1 Opinion
United States Court of Appeals
For the First Circuit
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Nos. 96-1556
96-1557
FEDERAL DEPOSIT INSURANCE CORPORATION
as RECEIVER FOR THE BANK FOR SAVINGS,
Plaintiff, Appellant,
v.
INSURANCE COMPANY OF NORTH AMERICA,
Defendant, Appellee/Third-Party Plaintiff, Appellant,
v.
PAUL J. BONAIUTO and DOLORES DiCOLOGERO,
Third-Party Defendants, Appellees.
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APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Robert E. Keeton, U.S. District Judge]
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Before
Selya, Circuit Judge,
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Cyr, Circuit Judge,
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and Lynch, Circuit Judge.
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Eugene J. Comey, with whom Robert D. Luskin, Comey Boyd &
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Luskin, Ann S. DuRoss, Assistant General Counsel, Federal Deposit
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Insurance Corporation, Thomas L. Hindes, Counsel, E. Whitney
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Drake, Special Counsel, and Leslie Ann Conover, Senior Attorney,
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were on brief for FDIC.
Gerald W. Motejunas, with whom Marie Cheung-Truslow and
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Lecomte, Emanuelson, Motejunas & Doyle were on brief for
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Insurance Company of North America.
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February 3, 1997
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LYNCH, Circuit Judge. In 1977 the Massachusetts
LYNCH, Circuit Judge.
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legislature enacted a statute, Mass. Gen. Laws ch. 175,
112, which provided that, for certain types of liability
insurance, the Commonwealth would adopt a "notice prejudice"
rule. This new statutory rule departed from the traditional
common law rule which had strictly enforced notice provisions
in insurance policies, allowing forfeiture of coverage where
notice to an insurer of a claim was late. The Supreme
Judicial Court of Massachusetts subsequently extended, by
common law, and then limited the extension of, the notice
prejudice rule for liability insurance policies. At issue
here is whether the notice due under a fidelity bond was
late. If so, does the state common law notice prejudice
rule, under which an insurer must show prejudice in order to
be excused from coverage by the insured's late notice, extend
to the Financial Institution Bond at issue.
The import here is whether a suit by the Federal
Deposit Insurance Corporation ("FDIC"), as receiver for the
failed Bank for Savings, may proceed against the Bank's
insurer, the Insurance Company of North America ("INA"), for
coverage of losses due to certain dishonest acts committed by
a Bank officer and by a lawyer retained by the Bank. The
loss to the Bank from these activities is asserted to be $10
million. The FDIC, as receiver for the Bank, seeks
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reimbursement for these losses to the full amount covered by
the Financial Institution Bond issued by INA, $4 million.
I.
The Bank gave INA notice of potential loss under
the Bond on January 16, 1990. The insurer declined to pay,
and the Bank brought suit. The district court, interpreting
the Bond provisions on a motion for summary judgment, held
that the Bank's notice was late because it had not been filed
within 30 days of discovery of loss as required by the
policy. FDIC v. Insurance Co. of N. Am., 928 F. Supp. 54,
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62-63 (D. Mass. 1996). The court granted summary judgment
for the defendant. Id. The Bank appeals, disputing the
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district court's analysis of the date of discovery and
claiming that its notice was timely. The Bank further
asserts that, even if its notice was late, the district court
erred in failing to apply the notice prejudice rule to the
Bond.1
Our review of a grant of summary judgment is de
__
novo. Wood v. Clemons, 89 F.3d 922, 927 (1st Cir. 1996). We
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hold that the district court was plainly correct in holding
that the notice was late, but we do so on different grounds
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1. The parties have agreed that Massachusetts law applies.
The FDIC here sues as the receiver of a Massachusetts bank,
and we discern no conflict between state law and federal
statutory provisions or significant federal policies.
O'Melveny & Myers v. FDIC, 114 S. Ct. 2048, 2055 (1994);
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Wallis v. Pan Am. Petroleum Corp., 384 U.S. 63, 68 (1966).
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than the district court. We also hold that the notice
prejudice rule does not apply in this instance.2
II.
The facts of the employee misconduct underlying the
Bank's losses are taken from the Bank's Bond claim and
accepted as true for present purposes. From 1987 to 1989,
Dolores DiCologero, an Assistant Vice President of the Bank
and the manager of the mortgage department, and Paul
Bonaiuto, an attorney retained to represent the Bank in
mortgage closings, conspired with a condominium development
group, the Rostoff Group, to make hundreds of mortgage loans
using inflated appraisals and purchase prices in violation of
Bank regulations and the law.
The Bank made loans on condominium projects
developed by the Rostoff Group until February 1989. Although
internal regulations forbade the Bank from participating in
more than one-third of the units in a particular development,
the Bank exceeded these limits as to Rostoff Group
properties. In addition, despite regulations prohibiting the
financing of more than 80% of the purchase price of a
property, the Bank made loans to purchasers for the full
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2. INA originally brought a third-party claim in this action
against the dishonest Bank employees who caused the claimed
losses. The district court dismissed INA's claim as moot
because it held that, under the Bond, INA had no liability.
INA appeals that dismissal. As we affirm the district
court's finding that INA has no liability, INA's appeal on
this issue is moot.
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value of condominiums in Rostoff Group properties. Bonaiuto
prepared closing documents overstating the purchase price of
the condominiums and falsely indicating that the purchasers
had equity in the property. The loan documentation reflected
nonexistent down payments. In fact, the "down payments" took
the form of discounts on the purchase price. DiCologero
expedited approval of the mortgages without any investigation
of the creditworthiness of the applicants, many of whom were
not creditworthy for the loans given. The aggregate face
value of the loans was approximately $30 million, and many
culminated in default.
Other DiCologero family members also participated
in the scheme, to their profit. The overstated values of the
condominiums were supported by appraisals prepared by
DiCologero's son. He earned more than $33,000 for his work;
DiCologero's daughter received $4,550 from the Rostoff Group
for secretarial work. DiCologero's husband received $12,000
in referral fees for directing potential purchasers to the
Rostoff Group and purchased a condominium himself without
paying a deposit, although the Bank records falsely reflected
that he had done so. Other aspects of this tale of avarice
and corruption need not be detailed. The Bank was declared
insolvent on March 20, 1992, and the FDIC was appointed
receiver. The FDIC asserts that these events helped bring
down the Bank.
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In March 1989, the Bank received a letter from
counsel for Erna Hooton, a former bookkeeper of the Rostoff
Group and a mortgagee on six Rostoff Group units. Ms. Hooton
had defaulted on the loans, and the Bank had begun
foreclosure proceedings. The letter said that the Bank had
misrepresented in the loan documents that Ms. Hooton had made
down payments on the properties. The letter also said that
Ms. Hooton's financial position should have led the Bank to
refuse financing. The letter claimed that Bonaiuto, as
closing counsel on the Hooton loans, was aware of the false
documentation. The Bank investigated these charges;
representatives of the Bank met with Steven Rostoff, a
principal of the Rostoff Group, on March 21, 1989. Rostoff
said that the down payment for some loans, including Ms.
Hooton's, had taken the form of a discounted purchase price.
He denied that anyone associated with the Bank was aware of
this. DiCologero also denied knowledge of any
irregularities. The Bank responded to the Hooton letter by
denying the allegations. Because Ms. Hooton did not pursue
the matter, neither did the Bank.
Then, in August 1989, Herbert and Deanna Bello, two
defaulting borrowers on six Rostoff Group units, sued the
Bank for damages and asserted counterclaims in a foreclosure
action brought by the Bank. The Bellos asserted, as had Ms.
Hooton, that Bonaiuto was aware that they had not made the
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down payments reflected in the closing documents. They also
alleged that when they told Steven Rostoff that they had
previously been unable to obtain financing, he replied that
they would "not have to worry about financing" because he had
made a "deal" with the Bank. The Bank, the Bellos said,
never asked for financial information from them. The Bellos
further alleged that, at one closing, they had pointed out to
Bonaiuto that the closing documents stated an inflated
purchase price and an inflated down payment. Bonaiuto
referred them to Rostoff, who said this was "what the Bank
wanted." In the foreclosure action, the Bellos' counterclaim
specifically alleged that the Bank knowingly permitted
Rostoff's misrepresentations.
Another couple who had purchased Rostoff Group
properties, Edward and Dorothy Giamette, filed suit on
September 22, 1989 against the Bank and the Rostoff
principals. Again the complaint alleged that down payments
were falsely represented on the closing documents, that
Steven Rostoff told the plaintiffs that the Bank knew the
figures were false, that the appraisals, which were done by
DiCologero's son, were for more than the fair market value of
the properties, and that this scheme had been repeated with
at least eight other purchasers who had bought a total of
forty-five condominiums. Earlier, on September 11, 1989, Mr.
Giamette had made similar allegations in a counterclaim in
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the Bank's foreclosure action against him. None of these
claims, however, prompted the Bank to notify INA of possible
losses due to alleged employee misconduct. What eventually
did lead the Bank to submit a notice of claim was a
conversation in October 1989 between DiCologero and a Vice
President of the Bank during which DiCologero remarked that
her husband had purchased a condominium from the Rostoff
Group without making a down payment. The Vice President
reported DiCologero's remark to the Bank's President, who met
with the Bank's Audit Committee on November 6, 1989. Outside
legal counsel from Gaston & Snow were present at the meeting.
The Committee discussed "the possibility of 100% loans, the
unknown extent of these loans, employee involvement and legal
ramifications." Gaston & Snow was asked to prepare a
preliminary analysis which was submitted on November 15,
1989. Gaston & Snow then investigated and reported back to
the Bank on December 18, 1989. The report recommended, among
other measures, that the Bank refer the matter to federal
authorities, notify INA, and dismiss DiCologero. On December
27, 1989, the Bank filed a Report of Apparent Crime with the
FDIC, advising that it had learned of suspected violations of
federal law on December 18, 1989. The Bank also notified the
FBI and the U.S. Attorney's Office. DiCologero, Bonaiuto,
and the development group were later convicted on federal
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bank fraud and conspiracy charges. United States v. Rostoff,
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53 F.3d 398 (1st Cir. 1995).
On January 16, 1990, the Bank gave INA notice of a
potential loss arising from employee misconduct. The Bank
enclosed copies of the complaints in the Giamettes' state and
federal lawsuits with its letter of notice.
III.
As is customary in the banking industry, the Bank
had obtained a Financial Institution Bond, Standard Form No.
24, from INA. The Bond period originally ran from January 1,
1988 to April 1, 1989, and was later extended by agreement to
April 1, 1990. Insured losses include those resulting from
employee dishonesty and fraud.3 For present purposes, we
assume that the actions of DiCologero and Bonaiuto caused the
Bank to sustain losses of the type covered by the "INSURING
AGREEMENTS FIDELITY" section of the Bond.4
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3. Other types of losses covered under other portions of the
Bond are not pertinent here.
4. That provision reads:
INSURING AGREEMENTS
FIDELITY
Loss resulting directly from dishonest or
fraudulent acts committed by an Employee
acting alone or in collusion with others.
Such dishonest or fraudulent acts must be
committed by the Employee with the
manifest intent:
(a) to cause the Insured to sustain
such loss, and
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The obligation of the insurer to indemnify the
insured for covered losses is explicitly made:
subject to the Declarations, Insuring
Agreements, General Agreements,
Conditions and Limitations and other
terms [of the Bond].
The "CONDITIONS AND LIMITATIONS" section of the
Bond contains, among other clauses, the "DISCOVERY" clause.
Under that clause, the Bond applies to "loss discovered by
the Insured during the Bond Period." The clause then defines
"Discovery" in two ways:
Discovery occurs when the Insured first
becomes aware of facts which would cause
a reasonable person to assume that a loss
of the type covered by this bond has been
or will be incurred, regardless of when
the act or acts causing or contributing
to such loss occurred, even though the
exact amount or details of the loss may
not then be known.
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(b) to obtain financial benefit for the
Employee or another person or
entity.
However, if some or all of the Insured's
loss results directly or indirectly from
Loans, that portion of the loss is not
covered unless the Employee was in
collusion with one or more parties to the
transactions and has received, in
connection therewith, a financial benefit
with a value of at least $2,500.
As used throughout this Insuring
Agreement, financial benefit does not
include any employee benefits earned in
the normal course of employment,
including: salaries, commissions, fees,
bonuses, promotions, awards, profit
sharing or pensions.
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Discovery also occurs when the Insured
receives notice of an actual or potential
claim in which it is alleged that the
Insured is liable to a third party under
circumstances which, if true, would
constitute a loss under this bond.
The "CONDITIONS AND LIMITATIONS" section of the
Bond also contains pertinent notice provisions which state in
relevant part:
NOTICE/PROOF - LEGAL PROCEEDINGS
AGAINST UNDERWRITER
a) At the earliest practicable moment,
not to exceed 30 days, after discovery of
loss, the Insured shall give the
Underwriter notice thereof.
Construing the Bond's first definition of
discovery, the district court found that, at the latest, the
Bank had discovered the loss by November 15, 1989. The court
thus determined that the Bank was required to give notice to
INA no later than December 15, 1989 and that the January 16,
1990 notice was therefore untimely. The district court
concluded that, "[i]f notice to INA was untimely, the Bank is
precluded from recovery, regardless of whether INA can prove
any actual prejudice as a result of the delay. J.I. Corp. v.
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Federal Ins. Co., 920 F.2d 118, 120 (1st Cir. 1990)
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(interpreting Johnson Controls v. Bowes, 409 N.E.2d 185
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(Mass. 1980))." Insurance Co. of N. Am., 928 F. Supp. at 59.
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The district court then granted INA's motion for summary
judgment.
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We agree that discovery was earlier than the Bank
posits. Although the district court relied on the Bond's
first definition of discovery to reach this conclusion, it is
most clearly reached under the second definition. See Levy
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v. FDIC, 7 F.3d 1054, 1056 (1st Cir. 1993). Under the second
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definition, discovery occurs "when the Insured receives
notice of an actual or potential claim in which it is alleged
that the Insured is liable to a third party under
circumstances which, if true, would constitute a loss under
this bond." The lawsuits and counterclaims brought by the
Bellos and the Giamettes plainly constituted actual claims.
The complaints alleged knowing acts of dishonesty or fraud by
Bank employees.5 Any harm caused by these alleged acts would
qualify as loss under the Bond.6
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5. We reject the Bank's argument that the complaints only
alleged that the Bank itself defrauded the Bellos and
Giamettes and thus could not constitute discovery of loss.
The complaints and counterclaims all specifically allege that
DiCologero and/or Bonaiuto acted in a dishonest and
fraudulent manner under circumstances which, if true, would
have created a loss under the Bond. Moreover, when the Bank
finally provided INA with notice, it cited the allegations
contained in the Giamette complaints as the source of its
discovery of loss.
6. Though it is largely irrelevant for our purposes, we will
assume that the other elements of "loss" are present --
namely that, with regard to the portion of the loss resulting
from loans, the employee(s), DiCologero and/or Bonaiuto, were
in collusion with one or more parties to the transactions and
received a financial benefit with a value of at least $2,500
from principals involved in the transactions. The Bank
conceded in its notice letter to INA that, with regard to the
loans alleged in the Giamette complaints, it appeared that
DiCologero's family members received financial benefits of at
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The Bank weakly argues that these complaints "did
not rise to the level of allegations of deceit and
misrepresentation on the part of Bank employees seeking to
obtain improper financial benefits but rather were nothing
more than the litigation tactics of defaulting borrowers who
were confronting foreclosure proceedings." That argument
misses the point. The Bond requires notice to the insurer
upon a claim of employee dishonesty and does not allow the
insured to wait until the claim is proved. Further, General
Agreement F of the Bond independently required the Bank to
provide INA -- within thirty days -- with all pleadings and
pertinent papers in any legal proceeding brought to determine
the insured's liability for any loss.
The Bank also asserts that third-party claims do
not trigger discovery under the second definition of
discovery unless those claims are reasonable. Whether or not
Massachusetts adopts such a reasonableness standard,7 the
claims here met any such requirement and triggered the notice
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least $2,500.
7. But cf. Clore & Keeley, "Discovery of Loss," in Financial
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Institution Bonds 89, 113 (Duncan L. Clore ed., 1995) ("As
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long as a third party's claim would constitute a covered loss
under the bond if proven to be true, it matters not whether
the allegations are perceived as true. Instead, the
allegations can be completely false. The point is, once the
allegations are made, the insurer has the right to know about
them and to conduct whatever investigation it may deem
appropriate.").
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requirement by, at the latest, mid-September 1989. By that
time, the Bank had been informed that at least ten persons
claimed to have purchased more than fifty condominiums from
the Rostoff Group without any down payment or with a lower
down payment than the Bank's loan documentation reflected.
The Bank was charged with knowing that the figures in the
loan documentation were false. The Bank's attorney was
alleged to be complicit in the falsehoods. The son of the
Bank's mortgage department manager purportedly had been paid
for false appraisals. A principal of the Rostoff Group had
confirmed that this had happened. The similarity of all the
allegations is telling. If a "smell test" was in order, the
smell was rank indeed. Accordingly, the notice given by the
Bank on January 16, 1990 was untimely.
IV.
More difficult is the question of whether the
Massachusetts courts would apply the common law "notice
prejudice" rule to Financial Institution Bonds of this sort.
This is a question of law. See J.I. Corp. v. Federal Ins.
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Co., 920 F.2d 118, 119 (1st Cir. 1990).
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A.
The two primary cases from the Supreme Judicial
Court on the notice prejudice rule are Johnson Controls, Inc.
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v. Bowes, 409 N.E.2d 185 (1980), which creates a common law
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notice prejudice rule for liability policies, and Chas. T.
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Main, Inc. v. Fireman's Fund Insurance Co., 551 N.E.2d 28
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(Mass. 1990), which limits the rule in the context of
liability policies. The Massachusetts law of notice
prejudice has been previously visited by the decisions of
this court in J.I. Corp., supra; National Union Fire
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Insurance Co. v. Talcott, 931 F.2d 166 (1st Cir. 1991); and
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Liberty Mutual Insurance Company v. Gibbs, 773 F.2d 15 (1st
_________________________________ _____
Cir. 1985). For various reasons, in all three of these cases
this court declined to apply the notice prejudice rule.
The Bank urges us to analyze the issue in terms of
whether the admittedly different policy language in the
Financial Institution Bond is closer to an "occurrence"
liability policy or a "claims made and reported" liability
insurance policy. There is, however, a logically prior
question and one which it is prudent to ask under our
obligation to apply state substantive law (in the absence
here of any conflict with or a threat to federal policies).
See Atherton v. FDIC, No. 95-928, 1997 WL 9781 (U.S. Jan. 14,
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1997); Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938); see
______________ ________ ___
also infra n.1. We must apply the law of Massachusetts as
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given by its state legislature and state court decisions.
And in that lies the difficulty of the Bank's position.
The Supreme Judicial Court has never applied the
notice prejudice rule to a Financial Institution Bond. Such
fidelity bonds, as discussed later, are different in kind
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from liability insurance policies. In creating a common law
notice prejudice rule, the Johnson Controls court did so in
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the context of liability policies. The statutory progenitor
to Johnson Controls concerned automobile liability policies.8
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The refinement and limitation of the notice prejudice rule in
Chas. T. Main was also in the context of liability policies.
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And the usual posture in which the court has applied the rule
has been in liability policies. See, e.g., Darcy v. Hartford
___ ____ _____ ________
Ins. Co., 554 N.E.2d 28 (Mass. 1990). No court has yet
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extended the Massachusetts notice prejudice rule to fidelity
policies such as this Bond. See, e.g., J.I. Corp., 920 F.2d
___ ____ __________
at 118; Boston Mut. Life Ins. Co. v. Fireman's Fund Ins. Co.,
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613 F. Supp. 1090 (D. Mass. 1985).
When guidance is sought from Massachusetts caselaw
concerning fidelity policies, that law, admittedly not of
recent vintage, does not require our application of the
notice prejudice rule here. The background law of
Massachusetts, which we believe is not overruled by Johnson
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Controls, was that conditions and limitations in such
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8. In Goodman v. American Casualty Co., 643 N.E.2d 432, 434
_______ _____________________
(Mass. 1994), the court applied the usual notice prejudice
rule for automobile liability coverage to uninsured motorist
coverage, finding no meaningful distinction between the two.
Accord MacInnis v. Aetna Life and Cas. Co., 526 N.E.2d 1255
______ ________ ________________________
(Mass. 1988).
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policies are construed as written.9 In Gilmour v. Standard
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Surety and Casualty Co., 197 N.E. 673 (Mass. 1935), the court
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was concerned with a bond for acts of dishonesty. "The
contract of suretyship made by the defendant provided
indemnity to the plaintiffs in the event they sustained loss
through dishonest conduct on the part of the agency." Id. at
___
673. The bond had the following condition and limitation:
"That loss be discovered during the continuance of the
suretyship or within six (6) months after its termination,
and notice delivered to the Surety at its Home Office within
ten (10) days after such discovery." Id. at 673. The court
___
held that "[t]he giving of such notice was made a condition
precedent to recovery on the bond." Id. at 675. The court
___
noted that it was concerned not with "the question of the
circumstances under which at common law an obligation is
imposed on the obligee in a fidelity bond to give the surety
notice," but rather with the question of the timing of the
notice given. Id. at 674. The question was whether the
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9. The requirement of timely notice is a condition of this
Bond and so is a condition of coverage under the parties'
agreement. In a bond of this type, the Insured agrees to
comply with the bond's "CONDITIONS AND LIMITATIONS" governing
the procedure for presenting and proving the Insured's claim
in exchange for the indemnity promised by the Underwriter.
Woods, "Conditions Precedent to Recovery: Presentation of the
Insured's Claim," in Financial Institution Bonds 285, 285
__ ____________________________
(Duncan L. Clore ed., 1995). "A condition, unlike an
agreement or a covenant, makes the Bond's indemnity
contingent upon the Insured's performance of the condition."
____________________________________________________________
Id. (emphasis added).
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plaintiffs had complied with the ten day notice period in
order to be able to recover on the bond. The notice was
apparently given during the bond year, but the court still
considered the dispositive question to be whether the notice
was given within the ten day period. Id. at 674. (The court
___
concluded that it had). No case has said that Gilmour has
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been overruled.
In Liberty Mutual Insurance Co. v. Gibbs, 773 F.2d
_____________________________ _____
15 (1st Cir. 1985), this court held that, Johnson Controls
________________
notwithstanding, the contract of insurance there must be
enforced according to its terms and that the notice prejudice
rule did not apply. At issue was a contract of reinsurance.
The contract's notice clause required notice to be given "as
soon as possible." Id. at 18. Our court thought important
___
three things. First, the parties involved were not lay
policyholders who required protection. Id. Second, the case
___
involved two insurance companies, experienced businesses,
that had bargained at arm's length. Id. Third, the
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Massachusetts insurance statute, as is true here,10
distinguished between the contracts at issue (reinsurance)
and liability policies. Id.
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In Cheschi v. Boston Edison Co., 654 N.E.2d 48, 53
_______ _________________
(Mass. App. Ct. 1995), Chief Judge Warner of the Appeals
____________________
10. See Mass. Gen. Laws ch. 175, 107 (distinguishing
___
between surety bonds and insurance contracts).
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Court of Massachusetts rejected application of the notice
prejudice rule to an indemnity contract, distinguishing
Johnson Controls. The court adopted and expanded upon this
________________
court's reasoning in Liberty Mutual, doubting that the notice
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prejudice rule would apply to types of insurance other than
liability insurance when the insureds were not laypersons and
when the parties to the contract were two sophisticated
business concerns. 654 N.E.2d at 53. The court held that it
would apply traditional contract principles to the language
of the indemnity clause, saying: "Rules addressing the
special circumstances of certain insurance policies should
not be applied in these circumstances." Id. at 53-54.
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Because it found language in the policy equivalent to making
prompt notice a condition, the court held that the lack of
prompt notice relieved the insurer of its obligation to
reimburse the insured. Id. at 54.
___
Guided by these principles, we analyze
Massachusetts law. Cheschi cautions against automatic
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application of notice prejudice rules designed for one type
of insurance to other insuring arrangements.11 654 N.E.2d at
53-54. The Bond here is a Financial Institution Bond,
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11. In J.I. Corp., this court, based on the analysis of the
__________
language in a fidelity policy, declined to apply the notice
prejudice rule to that policy. While dicta in J.I. Corp.
_____ ___________
suggests that the operative distinction is not the type of
insuring arrangement involved, 920 F.2d at 120, the panel did
not have the benefit of Cheschi.
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Standard Form No. 24, as revised in 1986. It is the most
recent form in a long line of Financial Institution Bond
forms utilized by members of the Surety Association of
America. See generally Knoll & Bolduan, "A Brief History of
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the Financial Institution Bond," in Financial Institution
__ ______________________
Bonds (1995), supra, at 1. Such bonds are basically fidelity
_____ _____
bonds, written specifically for financial institutions,
including commercial and savings banks, savings and loan
associations, credit unions, stockbrokers, finance companies,
and insurance companies. I Fitzgerald et al., Principles of
_____________
Suretyship 67 (1st ed. 1991).
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Fidelity bonds are a sort of "honesty insurance,"
insuring against employee dishonesty. See Weldy, "History of
___
the Bankers Blanket Bond and the Financial Institution Bond
with Comments on the Drafting Process," in Financial
__ _________
Institution Bonds 1, 1 (1989); Knoll & Bolduan, supra, at 1.
_________________ _____
The capacity of one who ensures the fidelity of another's
employee has been described as part insurer and part surety,
with liability in either capacity being primary and direct.
1 Russ & Segalla, Couch on Insurance 3d 1:16 (1995). Early
_____________________
Massachusetts cases about the Blanket Bankers Bond, the
predecessor to the Financial Insurance Bond, use both the
language of surety and the language of insurance. See, e.g.,
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Fitchburg Sav. Bank v. Massachusetts Bonding & Ins. Co., 174
___________________ _________________________________
N.E. 324, 328 (Mass. 1931).
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It is said that "[i]n most cases and for most
purposes, . . . [fidelity bonds] are recognized to be a form
of insurance that are subject to the rules applicable to
insurance contracts generally." 1 Couch on Insurance 3d,
______________________
supra, 1:16 (citing law from various states). Nonetheless,
_____
scholars have noted that, while fidelity bonds have, over
time, become more like insurance contracts,12 a fidelity bond
is still not liability insurance:
Although often referred to as insurance,
it is not liability insurance, but rather
a two-party indemnity agreement through
which the insurer reimburses the insured
for losses actually suffered in
accordance with the contract provisions.
Weldy, supra, at 2; see also Knoll & Bolduan, supra, at 5.
_____ ___ ____ _____
It is significant that the Bond possesses some
characteristics of surety arrangements which distinguish them
from liability policies. "The nature of the risk assumed by
the party in the role of 'insurer' is a major distinction
between insurance and the arrangements of guaranty and
surety. . . . [T]he risk can be characterized in terms of the
____________________
12. The transformation from treatment as a surety bond to
treatment as an insurance contract was prompted by a
broadening in the scope of coverage of fidelity bonds.
"[F]idelity coverage came to encompass not only traditional
employee dishonesty, but other related risks, and became more
like a contract of insurance, using the terms 'underwriter'
and 'insured' instead of 'surety' and 'obligee.'" Knoll &
Bolduan, supra, at 5. Here, the only insuring clause at
_____
issue is the one covering "traditional employee dishonesty."
But it is also true that INA is described in the Bond as an
"underwriter" providing insurance.
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degree to which the contingency is within the control of one
of the parties. In the classic instance of insurance, the
risk is controlled only by chance or nature. In guaranty and
surety arrangements, the risk tends to be wholly or partially
in the control of one of the three parties [promisor,
creditor, or debtor]." 1 Couch on Insurance 3d, supra,
______________________ _____
1:18. There is also a difference in the liability of a
classic insurer and that of surety/guarantor. An insurer,
upon the occurrence of the contingency, must bear the
ultimate loss, while a surety is entitled to indemnity in
case the surety is compelled to perform.
It is also significant, as was true in Liberty
_______
Mutual, 773 F.2d at 18, that the Massachusetts legislature
______
has made distinctions in this area. The Massachusetts
legislature has decided that, for most regulatory purposes,
surety bonds are not insurance contracts. See Mass. Gen.
___
Laws ch. 175, 107. In Williams v. Ashland Engineering Co.,
________ _______________________
45 F.3d 588, 592 (1st Cir.), cert. denied, 116 S. Ct. 51
_____ ______
(1995), this court found that "surety bonds are not insurance
contracts, and are thus not subject to the Commonwealth's
insurance laws." See also General Elec. Co. v. Lexington
___ ____ __________________ _________
Contracting Corp., 292 N.E.2d 874, 876 (Mass. 1973). That
_________________
expression of public policy undercuts any automatic
application of the insurance notice prejudice rule to surety
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bonds, and thus to Financial Institution Bonds to the extent
that they partake of the characteristics of surety bonds.
These distinctions confirm our reluctance to extend
the state notice prejudice rule for liability insurance to
Financial Institution Bonds. The material technical and
substantive differences between a Financial Institution Bond
and liability insurance make it difficult to apply easily the
common law notice prejudice rule, developed as it was in the
liability insurance context, to the insuring arrangement
here.
In Cheschi, as in Liberty Mutual, the court
_______ _______________
considered the fact that the insuring arrangements (not
liability policies) did not involve layperson consumers.
Rather, they involved sophisticated businesses. Accordingly,
there was little reason to depart from the usual rule of
holding the parties to their bargain. In Johnson Controls,
________________
the Supreme Judicial Court had stated that one reason for
applying the notice prejudice rule in that case was that the
insurance policy was:
not a negotiated agreement; rather its
conditions are by and large dictated by
the insurance company to the insured.
The only aspect of the contract over
which the insured can 'bargain' is the
monetary amount of the coverage.
409 N.E.2d at 187 (quoting Brakeman v. Potomac Ins. Co., 371
________ ________________
A.2d 193, 196 (Pa. 1977)).
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23
Here, in contrast, the Bond is an agreement whose
basic terms are negotiated between two industries. Over the
years, the banking industry and the fidelity bond companies
have negotiated various standard forms of the Financial
Institution Bonds. See generally Knoll & Bolduan, supra;
___ _________ _____
Weldy, supra. As one commentator has noted, "the fidelity
_____
bond is an arms-length, negotiated contract between
sophisticated business entities, the standard form for which
was drafted by the joint efforts of the Surety Association of
America and the American Bankers Association." Koch, supra,
_____
at vii. For example, at the request of the American Bankers
Association, the 1986 Bond added coverage for Uncertificated
Securities, and adopted the UCC definitions of these
financial instruments. Knoll & Bolduan, supra, at 25; see
_____ ___
also Calcasieu-Marine Nat'l Bank v. American Employers' Ins.
____ ___________________________ ________________________
Co., 533 F.2d 290, 295 n.6 (5th Cir.) (bankers bond being
___
construed was drafted as a joint effort by the American
Bankers Association and the American Surety Association),
cert. denied, 429 U.S. 922 (1976).
_____ ______
The Bank brings up the doctrine of contra
______
proferentum arguing that "[a]mbiguities are resolved against
___________
the insurer, who drafted the policy, and in favor of the
insured." GRE Ins. Group v. Metropolitan Boston Hous.
________________ ___________________________
Partnership, Inc., 61 F.3d 79, 81 (1st Cir. 1995). This
__________________
doctrine provides the Bank no refuge. The presumption
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24
against the insurer is not applied where the policy language
results from the bargaining between sophisticated commercial
parties of similar bargaining power. Falmouth Nat'l Bank v.
___________________
Ticor Title Ins. Co., 920 F.2d 1058, 1062 (1st Cir.
_______________________
1990)(applying Massachusetts law).13
Thus, to the extent the notice prejudice rule is
supported by the policy of protecting consumers who
effectively have little or no bargaining leverage, that
policy provides no basis here to extend the notice prejudice
rule.
B.
Finally, the Bank draws support for its position
from a Tenth Circuit decision, FDIC v. Oldenburg, 34 F.3d
____ _________
1529 (10th Cir. 1994), cert. denied, 116 S. Ct. 171 (1995)
_____ ______
and district court decisions from other jurisdictions. The
court in Oldenburg predicted that Utah law would require a
_________
Financial Institution Bond company to show prejudice in order
to avoid coverage where the bank gave late notice. Id. at
___
1546. The court held that the notice prejudice rule applied
in light of: (1) the failure of the policy to expressly make
notice within a specific time a condition precedent to
recovery; (2) the Utah rule that provisions excluding
____________________
13. The Fifth Circuit has also rejected the application of
the doctrine of contra proferentum to Financial Institution
______ ___________
Bonds. Sharp v. FSLIC, 858 F.2d 1042, 1046 (5th Cir. 1988);
_____ _____
Calcasieu-Marine Natl Bank, 533 F.2d at 295 n.6.
__________________________
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25
coverage are strictly construed against the insurer; and (3)
a Utah statute, enacted after the Bond period, which
expressed a public policy that the notice prejudice rule be
applied to all insurance policies. Id. at 1545-46. Whatever
___
the requirements of Utah or other law, Massachusetts law
governs this issue, and Massachusetts has, until the Supreme
Judicial Court or the state legislature decides otherwise,
framed its public policy choices differently.
We hold that the notice prejudice rule does not
apply.
Affirmed.
_________
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