In a March 17, 2017 opinion, a Minnesota federal court rejected a financial institution bond carrier’s attempt to rescind the bond it issued to a credit union despite the credit union’s manager making a false statement in the bond application that she had no knowledge of any act which might give rise to a claim, after she had embezzled $3 million. See National Credit Union Administration Board v. CUMIS Insurance Society, Inc., No. 16-139, 2017 WL 1047256 (D. Minn. Mar. 17, 2017). The court refused to attribute the embezzler’s misrepresentation to her employer because, in embezzling the credit union’s money, she was working solely for her own benefit.

The insurer, CUMIS Insurance Society (“CUMIS”) issued a bond to St. Francis Campus Credit Union based on an application signed by one of the credit union’s managers, Margurite Cofell. The application warranted, among other things, that no officer or employee had knowledge of any act which might give rise to a claim which would be covered under the bond.

The credit union later discovered that Cofell had embezzled over $3 million from it, and sought coverage for the loss under the CUMIS bond. The next month, the National Credit Union Administration Board placed the credit union into receivership, in large part because of the embezzlement. CUMIS denied the claim, refunded the premium, and notified the credit union, through counsel, that it would seek to rescind the bond. At some point, the letter to counsel and the check became separated, and the credit union cashed it pursuant to receivership procedures.

The receiver sued CUMIS seeking a declaratory judgment that the bond covered the embezzlement loss. CUMIS moved for summary judgment, contending, first, that it rightly rescinded the bond under a Minnesota statute because the manager’s false answers in the application increased CUMIS’s risk of loss and, second, that the Board agreed to the rescission by cashing the premium refund check.

The court denied CUMIS’s motion on both grounds. In addressing whether CUMIS could rescind the bond under the Minnesota statute (a relatively common limitation on policy rescission requiring a misrepresentation to increase risk of loss), the court considered only whether Cofell’s misrepresentation could be attributed to the credit union. The court ruled that it could not. Noting the general rule that a principal is bound by an agent’s authorized actions and the agent’s knowledge during those actions, the court held that Cofell’s false statements fell within the “adverse interest exception” to the general rule (i.e., the manager did not disclose her theft in the application because the theft was for her benefit and the credit union’s detriment). The court explained, “because Cofell’s only misrepresentation was about the fraud itself—as opposed to misrepresentation tangentially related to the fraud, such as the existence of internal controls—the misrepresentation is not imputed to the Plaintiff.”

The court also rejected CUMIS’s argument that it had established as a matter of law that the receiver had accepted the rescission after receiving the denial letter and cashing the premium refund check. The court noted Minnesota authority that merely cashing the premium check does not itself establish an agreement to rescind and that there were disputed facts about whether the receiver had sufficient knowledge of CUMIS’s basis for rescission when the check was cashed.

As this case highlights, financial institutions and other industries that rely on similar fidelity bonds risk rescission when application answers are not truthful. Carriers carefully scrutinize the policyholder’s application when a claim is made. The institution should exercise reasonable due diligence to determine accurate information for all of its answers. Where rogue employees act for their own interests as the credit union manager did in this case, the policyholder may ultimately avoid rescission, but care in the application process is the best way to avoid rescission litigation. Experienced coverage counsel can facilitate the application process.