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CMN Secures $3 Million D&O Victory

First National Bank of Ely’s (Nevada) loan officer embezzled over $4.2 million from T-bill accounts for over a decade.  Following the employee’s plea agreement to federal charges, Progressive paid over $1.5 million of $1.675 million in employee fraud benefits under its financial institution bond.  But as part of its complaint against Progressive, the Bank demanded the balance of bond benefits, plus the full $3 million limit under a separate directors and officers’ liability policy.

On a motion to dismiss, the District Court agreed with the Firm’s arguments and rejected the Bank’s various D&O coverage theories, dismissed all contract and tort counts seeking D&O benefits, all tort counts seeking the $127,000 in remaining bond benefits, and all punitive damages claims.

Moreover, after also securing the dismissal of ABA Insurance Services Inc. (Progressive’s third-party claim administrator) from all counts, the Bank’s $3 million action was reduced to a one count breach of contract claim for $127,000 in remaining disputed bond benefits, with secondary claim-handling allegations.

Just as significant to the case at issue, however, the District Court’s ruling in First National Bank of Ely v. Progressive Casualty Insurance Company confirmed a critical point for carriers defending against separate bond and D&O claims for the same employee fraud loss.

That is: an employee’s criminal fraud – while a potential basis for employee dishonesty coverage under a bond – may exclude any claimed D&O coverage.

The facts of the case are not altogether unfamiliar to banks or their carriers.

After discovering its loan officer’s embezzlement, First National Bank of Ely quickly reimbursed customers, and turned to Progressive for coverage.  And after offering various indemnity theories, the Bank settled on one: the Bank maintained its President (and shareholder) was entitled to D&O indemnity for alleged claims made against him by other shareholders.  For his part, the President (presumably to help make the case for D&O indemnity coverage) readily admitted he was negligent in failing to prevent the loan officer’s embezzlement which, the Bank then argued, entitled him to D&O coverage.

On behalf of Progressive, the Firm argued the President’s conduct and negligence admission was immaterial.

The President’s negligence was not the source of the Bank’s loss.  Rather the source of the Bank’s loss inescapably was the loan officer’s embezzlement. And since the D&O Policy’s Fraud/Violation of Law Exclusion barred all Loss involving a “fraudulent, dishonest or criminal act by the Insured” [with Insured defined as “any Employee”], Progressive argued the loan officer’s admitted conviction and sentence barred all claimed D&O coverage.

The District Court agreed with the Firm’s position, and also rejected the Bank’s argument that the Policy’s “severability” clause (notwithstanding the loan officer’s fraud) created separate coverage for the Bank’s President. Though certain jurisdictions (including California) had construed severability clauses as creating separate D&O coverage for individual employees, the District Court agreed with the Firm’s argument that Progressive’s specific severability clause was more limited in scope and the clause did not affect the Policy’s unqualified exclusion of fraud losses.

The District Court also agreed that the Bank could not sustain common law tort claims of fraud and negligence.

In each count, the Bank claimed Progressive’s separate bond and D&O denial letters misrepresented coverage.  But as the Firm argued and the Court agreed, not only had Progressive accurately recited both the bond and D&O Policy (which the Bank had a legal duty to read), but the Bank did not plead it detrimentally relied on any supposed misrepresentation or that any such misrepresentation caused the Bank damages.  Nor could plead these essential elements since the Bank – far from relying or acting on these alleged coverage misrepresentations – refuted those same alleged misrepresentations by filing suit.

And finally, the District Court rejected the Bank’s arguments that Progressive had waived, was estopped from asserting, or otherwise failed to preserve its coverage arguments.  Again, the Court adopted the Firm’s position, ruling that Progressive’s reservation of rights included in its coverage letters together with the coverage arguments asserted in the litigation were more than adequate to preserve its coverage position.

Altogether then, with the favorable ruling dismissing $3 million of the Bank’s claim combined with a denial of the Bank’s petition to amend the complaint, the claimed contractual exposure was reduced $127,000.  And following the ruling, the case was resolved.

A copy of the District Court’s opinion can be found at First National Bank of Ely v. Progressive Casualty Insurance Company, No.: 3:11-cv-00859, *1, ___ F. Supp. 2d ___ (D. Nev. Nov. 27, 2012), a copy of which is attached below.  CMN attorneys Michael B. Galibois and Julie F. Wall handled the case.

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