Investors in failed lender have no right to recover investment loss under lender’s bond’s Dishonesty Insuring Clause even after lender’s bankruptcy trustee’s assignment of rights under that bond to investors; investors’ loss is not “direct loss” under bond’s terms

By Christopher J. Graham and Joseph P. Kelly

Abady v. Certain Underwriters At Lloyd’s of London, Col. Court of Appeals No. 11CA1870, (3rd Div. October 11, 2012):

Commercial Capital, Inc. (CCI) provided short-term financing for commercial construction developers that could not secure credit from traditional lenders. CCI raised capital by borrowing from investors. It guaranteed investors that it had a $5 million bond securing them against loss of principal and also annual rates of return of between 18% and 25%. CCI’s owner also personally guaranteed payment of CCI’s debt to the investors. CCI defaulted, the owner refused to honor his guaranty, and CCI filed bankruptcy. The investors received relief from the automatic bankruptcy stay, and the bankruptcy trustee assigned them CCI’s rights under CCI’s Mortgage Bankers Bond, underwritten by Lloyd’s.

The investors sued in Colorado state court, alleging various claims against CCI and two claims against Lloyd’s: one as assignee of the bond and the other to garnish Lloyd’s bond as CCI’s judgment creditor. Both claims were based on the bond’s “Dishonesty Insuring Clause” under which Lloyd’s agreed, subject to the bond’s terms, conditions, and exceptions to pay:

Direct financial loss sustained by the Assured at any time and discovered by the Assured during the Bond Period by reason of and directly caused by [a] Theft of Money, Securities and other Property by any Employee of the Assured, whether committed alone or in collusion with others, or [b] any other dishonest acts by any Employee of the Assured, whether committed alone or in collusion with others, committed by said Employees with the manifest intent to obtain Improper Personal Financial Gain for said Employee, or for any other person or entity intended by the Employee to receive such Improper Personal Financial Gain.

Lloyd’s moved for summary judgment, and the trial court held: (1) the bond is a fidelity bond and not a surety bond; (2) the bond terms were unambiguous; (3) the plain language of the bond protects only CCI; (4) the bankruptcy trustee’s assignment of CCI’s rights to investors did not convert the investors’ third-party claims into first-party insurance claims; and, therefore, (5) investors’ claims were not recoverable under the bond. The investors appealed.

Issue #1: Can the investors collect under the Bond for damages that CCI could not itself collect? No.

“An assignee has no greater rights than his or her assignor. Pierce v. Ackerman, 488 P.2d 1118, 1120 (Colo. App. 1971) (not published pursuant to C.A.R. 35(f)). Therefore, investors’ third-party claims — to the amounts, plus interest, that they invested in CCI — have not become first-party losses merely because investors now stand in CCI’s shoes as first-party claimants. Rather, investors may only recover those losses that CCI could have recovered for itself.”

Issue #2: Are the losses asserted by the investors recoverable as “direct losses” under the terms of the Bond? No.

As “direct financial loss” is not defined in the Bond, the court looks to the plain and ordinary meaning of the term. The Court adopted Black’s definition of “direct” as “free from extraneous influence; [or] immediate.” The court noted that: “A liability policy protects the insured against claims brought by third parties who have been injured by the insured’s conduct. . . . In contrasting liability insurance with a fidelity bond, it is helpful to note that in the liability context, the insured’s loss is indirect; it is a third party who directly suffers the loss. City of Burlington v. Western Sur. Co., 599 N.W.2d 469, 472 (Iowa 1999)(emphasis added) (citing 1 Eric Mills Holmes & Mark S. Rhodes, Holmes’s Appleman on Insurance § 3.3, at 349 (2d ed. 1996)); see also Qwest Communications Int’l, Inc. v. QBE Corporate Ltd., 829 F. Supp. 2d 1037, 1040 (D. Colo. 2011) (“Commercial crime policies are not intended to be liability policies.”).”

The court chose not to follow bond cases holding that “direct financial loss” included losses from an insured’s liability to third parties, including F.D.I.C. v. United Pacific Ins. Co., 20 F.3d 1070, 1079 (10th Cir. 1994), Continental Savings Ass’n v. U.S. Fidelity & Guarantee Co., 762 F.2d 1239, 1243 (5th Cir. 1985), and RBC Dain Rauscher Inc. v. F.D.I.C., 370 F. Supp. 2d 886, 890 (D. Minn. 2005). The court also distinguished Massachusetts Mutual Life Insurance Co. v. Certain Underwriters at Lloyd’s of London, 2010 WL 2929552 (Del. Ch. No. 4791-VCL, July 23, 2010)(unpublished opinion), which denied a bonding company’s motion to dismiss an insured mutual fund’s complaint alleging coverage under the fidelity insuring agreement for indemnity and defense costs arising from mutual fund investor claims. The investors’ claims in that case were premised on allegations that the mutual funds deposited funds with the notorious Bernie Madoff to manage as an investment advisor (which qualified as an Employee under the bond), the funds remained property of the mutual funds while possessed by Madoff, and the funds were misappropriated by Madoff for his own benefit.

Given the meaning of “direct” and that CCI bought a fidelity bond, not a liability policy, the Court held that “direct financial loss” unambiguously refers to the immediate loss of CCI’s property, not harm to investors. The investors therefore could not recover the losses under the Bond.

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