Bank, as required under Insuring Agreement E of financial institution bond, had “actual physical possession” of fake guarantees from Borrower, even though Borrower rather than Bank possessed guarantees, because Borrower was Bank’s “authorized representative” within the meaning of Insuring Agreement E

by Christopher J. Graham and Joseph P. Kelly

BancInsure, Inc. v. Highland Bank, Civil No. 11-2497 (D. Minn. Dec. 4, 2012):

Borrower entered into an agreement with First Premier (a lease financing company). First Premier requested a loan from Highland Bank (Bank) to finance the purchase of the equipment to be leased in exchange for an assignment of the lease payments to Bank, and Bank agreed to lend the funds. First Premier sent various financial documents to Bank under their agreement, including certified copies of what purported to be the borrower’s guaranties. After approximately 30 months, borrower ceased making its payments. Bank learned upon investigation that the leased equipment did not actually exist, the illusory equipment was in fact pledged to multiple lenders, and the guaranty supposedly provided by one of the borrower’s principals was fake. Bank eventually charged off $2,011,618.30 due to the defaulted loan.

Bank filed a claim with BancInsure (Insurer), who wrote a Financial Institution Bond for Bank for the entire amount of the loss.

In pertinent part, Insuring Agreement E provides coverage for:

Loss resulting directly from the Insured having, in good faith, for its own account or for the account of others,

(1) acquired, sold or delivered, given value, extended credit or assumed liability on the faith of any original

(f) Corporate, partnership or personal Guarantee, [which]

(i) bears a signature of any maker, drawer, issuer, endorser, assignor, lessee, transfer agent, registrar, acceptor, surety, guarantor, or of any person signing in any other capacity which is a Forgery,

(2) guaranteed in writing or witnessed any signature upon any transfer, assignment, bill of sale, power of attorney, Guarantee, endorsement or any items listed in (1)(a) through (h) above. This includes loss resulting directly from a registered transfer agent accepting or instructions concerning transfer of securities by means of a medallion seal, stamp, or other equipment apparatus which identifies the Insured as guarantor, as used in connection with a Signature Guarantee Program, but such use or alleged use of said medallion seal, stamp, or other equipment apparatus was committed without the knowledge or consent of the Insured, and the Insured is legally liable for such loss,

(3) acquired, sold or delivered, given value, extended credit or assumed liability on the faith of any item listed in (1)(a) through (d) above which is a Counterfeit.

Actual physical possession of the items listed in (1)(a) through (i) above by the Insured, its correspondent bank or other authorized representative is a condition precedent to the Insured’s having relied on the faith of such items.

A mechanically reproduced facsimile signature is treated the same as a handwritten signature.

Insurer denied coverage, alleging that Bank did not have actual physical possession of the document, which was a condition precedent to coverage under Insuring Agreement E. Insurer then filed for a declaratory judgment of non-coverage against Bank. Bank moved for summary judgment that First Premier was its “authorized representative” within the meaning of Insuring Agreement E, and the Court resolved the issue as follows:

Issue: Was First Premier Bank’s “authorized representative” within the meaning of Insuring Agreement E so as to satisfy the “actual physical possession” requirement of the Insuring Agreement? Yes.

Bank argued that First Premier was its “authorized representative” as the loan originator under the Insuring agreement, meaning that since First Premier had the original of the guaranty, Bank’s loss would be covered under the Bond. The Court held that there are three elements to an inquiry into whether one party was another party’s agent: did the principal consent to the agency, did the agent actually act on behalf of the principal, and did the principal exercise control over the agent.

Employees of Bank testified that they considered First Premier their agent, and that Bank permitted First Premier to retain the original guaranty. It was also standard industry practice to have a lease financing company like First Premier retain original guaranties. Given these facts, the Court held that Bank consented to First Premier’s agency.

Because First Premier actually held the original guaranties, collected and remitted loan payments, paid sales and use tax, provided additional financial documentation, updated insurance, inspected collateral and acted as the primary contact with the borrower, the Court held that First Premier acted on behalf of Bank.

The Court also held that Bank exercised control over First Premier, because Bank held the funds at its discretion in the lending transaction. Bank could have refused to fund the loan if the location of the original guaranty documents was not acceptable; therefore they controlled First Premier’s actions.

Given that the three elements of the test were met, the Court held that First Premier was Bank’s authorized agent, but refused to rule on the issue of whether the loss was covered by the Bond, as that issue was not presented for summary judgment.

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