A Wisconsin federal court recently held that forged USDA loan guarantees did not trigger coverage under a bankers blanket bond held by Wisconsin-based Citizens Bank, resulting in a $15 million loss to the bank. Atlantic Specialty Insurance Co. issued the bankers blanket bond to provide coverage for losses stemming from certified securities or corporate, partnership or personal guarantees that were fraudulent, but the court determined that the bond did not cover counterfeit government-backed guarantees.

In 2013, Citizens invested $15 million in a pool of loans purportedly backed by USDA guarantees under the USDA’s Business & Industry guaranteed loan program. The loans were purportedly made to a variety of businesses, including a distribution center, an energy company, and several hotels. The loans, however, had been originated in the name of fictitious borrowers with fictitious collateral. The USDA guarantees on the loans were forged by the originating lender as well, and Citizens discovered that the USDA had no record of the loans at all.

After learning of the forgery, Citizens filed a claim under its financial institution bond—also known as a bankers blanket bond. Citizens sought coverage under the provisions of the bond that covered losses stemming from forgery and alteration of certificated securities or corporate, partnership, or personal guarantees. Atlantic denied the claim, however, and Citizens filed suit in Wisconsin federal court to recover its $15 million in losses on the forged loans.

In the litigation, Atlantic maintained that the bond did not cover losses for counterfeit government-backed guarantees, arguing that the forged USDA guarantees did not fall under the definition of certificated securities or corporate, partnership, or personal guarantees. Citizens Bank, in turn, argued that the forged USDA guarantee agreements qualified as a certificated security because they met the class, obligation, medium, and issuance elements laid out by the terms of the bond. Citizens Bank also argued that the USDA acts as a quasi-corporation, triggering coverage under the bond for “corporate, partnership, or personal” guarantees.

The court, noting that neither party contemplated losses related to government-issued guarantees, sided with Atlantic. Specifically, the court found that the self-identified guarantees were not covered as a certified security, since the bond separately defined “certificated securities” and “guarantees.” The fraudulent USDA guarantees also were not covered as corporate, partnership, or personal guarantees, the court found, since the USDA is a government agency and not a corporation.

This decision illustrates a potentially costly oversight in insurance coverage for commercial lenders dealing in government-backed loans. In addition to implicating USDA guaranteed loans, other government-backed loans, such as loans backed by the U.S. Small Business Administration, could potentially be excluded from coverage with terms similar to Citizen’s bankers blanket bond. Commercial lenders should review the terms of their insurance coverage for potential gaps in coverage related to government-backed guarantees that may not fit within otherwise broad coverage.