Fidelity Bond Pays Third-Party Verdict In Fee-Advance Scam.

A Minnesota federal court recently ruled a fidelity bond responsible to pay damages to a third-party where an employee used the principal bank to complete a fraudulent transfer.  In Avon State Bank v. BancInsure, Inc., CIV. 12-2557 RHK/LIB (D. Minn. Jan. 10, 2014) (case pending appeal to the Eight Circuit), Avon State Bank made a claim on its fidelity bond and liability policy after a verdict against it for fraud by an employee who solicited funds paid to in “fee-advance” scam.  The scammers purported to have a $9 million dollar estate, the “Gildon estate,” which needed help with taxes and fees to be transferred to the U.S.  The scammers promised “investors” would be paid handsomely for their assistance.

In 2007, an Avon employee, Eric Carlson, issued a loan and contributed $60,000 of his own money to a customer who was neck-deep in the scam.  The customer had repeatedly sent money overseas, but the scammers repeatedly claimed additional hurdles prevented release of the customer’s money.  Carlson began to express serious doubts about the customer’s “investment opportunity.”  Despite these concerns, he recruited two additional customers as “investors” to put up nearly $500,000 – supposedly the last tax hurdle – so the $9 million would be released and the parties would be paid their substantial profits.  Carlson led the “investors” to believe the bank was investing the money, and asked them to make the checks payable to the bank.  Carlson, against bank rules then, wired the money to a Hong Kong bank account.  As with every other “foreign riches” email, none of the investors, including Carlson, ever received the promised return.

The investors then sued Avon.  BancInsure agreed to defend Avon under the errors and omissions endorsement to directors’ and officers’ liability policy (“policy”) under a reservation of rights.  In January 2012, a jury returned a verdict for the plaintiff-investors, finding Carlson, acting within the scope of his employment, fraudulently misrepresented the investments and breached his duty to disclose material information.  Avon and the investors settled while the appeal was pending.  Avon then sought indemnification from BancInsure.

BancInsure refused, stating the judgment was not covered because the policy excluded liability for fraudulent acts, and it requested Avon reimburse its defense costs.  Avon then asserted the judgment and defense costs were covered under the Policy and a fidelity bond Avon purchased from BancInsure.  Avon commenced this action for declaratory judgment and breach of contract under the Bond and Policy.

U.S. District Judge Richard Kyle ruled the fidelity bond covered the verdict and defense costs, but the D&O policy did not.  The court found that although the policy would be the most logical source of coverage, it specifically excluded Carlson’s fraudulent acts.  Avon contended Carlson and Avon were separate insureds, so the fraud exclusion only applied if Avon itself acted fraudulently.  The court rejected that, reasoning the bank could only act through its employees, so any claim based on fraudulent actions of employees necessarily implies the bank’s culpability.  Because the jury found Carlson acted within the scope of his employment, his fraud was the bank’s fraud, and the exclusion precluded coverage under the policy.

Judge Kyle found the bond provided limited coverage for third-party property lost through bank employee fraud if Avon “held” the property.  BancInsure argued the bank did not “hold” the investors property because it merely acted as a conduit for the investors’ money.  The court rejected this argument reasoning Carlson solicited the investments in the course of his employment, Avon held the money in its accounts, and it wired the money.  This, the court reasoned, established Avon possessed and controlled the investors’ funds.  Thus, BancInsure was required to pay the entire settlement and defense costs.

This case is significant for its treatment of fidelity bond liability to third-parties.  The holding arguably expands the scope of fidelity bonds beyond thefts and frauds by its employees of assets it holds – such as safety deposit boxes, account funds, etc.  We will monitor this case on appeal and other decisions impacting liability insurance policies and fidelity bonds.  If you have any questions about this, or any other matter, please give us a call.