Banks rely on Financial Institution Bonds (sometimes referred to as “bankers blanket bonds”) to protect them against risks such as employee misconduct, forged or altered securities, and counterfeit currency. But, a recent Eighth Circuit Court of Appeals decision, BancInsure, Inc. v. Highland Bank, No. 13-3324, March 3, 2015, illustrates that the coverage provided by Financial Institution Bonds may not be as broad as expected.
Highland Bank purchased the assignment of payments under certain equipment leases. The leases were supported by personal guarantees from the principals of a company involved in the underlying lease arrangements. Unfortunately, it turned out that the underlying lease arrangements were part of a Ponzi scheme, and the signatures on the personal guarantees were forged. Highland Bank received only a small fraction of the amount owed to it under the lease assignments.
Highland Bank sought coverage under its Financial Institution Bond, issued by BancInsure. A Financial Institution Bond is intended to protect a bank against risks of dishonesty, but is not intended to protect the bank from making bad business decisions. Thus, a typical Financial Institution Bond does not provide coverage for nonpayment on loans or other transactions unless the loss falls within the scope of certain specified coverage. The relevant specified coverage is under “Insuring Agreement E,” which provides coverage for “loss resulting directly from the insured having” undertaken a transaction “on the faith of any original instrument…which proves to bear a forged signature….” Highland Bank had reviewed the personal guarantees, and would not have bought the rights to the lease payments if the guarantees had not been included. Thus, Highland argued, the loss “resulted directly from” the forged personal guarantees and it should be afforded coverage under its Bond.
In BancInsure, the Eighth Circuit rejected this argument, on the basis that Minnesota law requires that even if the forged guarantees were a “but-for” cause of the loss, they must also be a “proximate cause” of the loss, i.e., a substantial factor in bringing about the resulting harm. The BancInsure court looked to a Minnesota case, Alerus Fin. N.A. v. St. Paul Mercury Ins. Co., No. A11-680, 2012 WL 254484 (Minn. Ct. App. Jan. 30, 2012), which held that there is no coverage under Insuring Agreement E for losses resulting from forged documents if the insured would have sustained the same loss had the documents been genuine. Applying Alerus, the Eighth Circuit held that Highland Bank must lose because the forged guarantees were worthless when Highland Bank entered into the transaction; in other words, Highland’s loss was not caused by the lack of authenticity of the guarantees, but by the fact that the entire underlying lease arrangements were bogus. The Eighth Circuit emphasized that Highland Bank did not itself take an assignment of the right to enforce the guarantees, which meant that from Highland’s perspective, the guarantees had never provided any protection.
BancInsure v. Highland Bank is a useful reminder that the scope of coverage under Financial Institution Bonds may not be as broad as expected. It is important to periodically review your coverage, and ensure that the transactions being entered into do not create risk that exceeds the scope of coverage.