On November 16, 2016, the U.S. District Court for the Eastern District of Wisconsin released its decision in Citizens Bank Holding Inc. v. Atlantic Specialty Insurance Co. The Court held that forged business loan guarantees purportedly issued by the U.S. Department of Agriculture (USDA) did not qualify for indemnity under Insuring Agreements D or E of a Financial Institution Bond. The decision is notable in that it reaffirms the interpretive principle that the Bond is not to be interpreted contra proferentem, as it is a product of negotiation between the banking and fidelity insurance industries.

The Facts

Citizens Bank maintained an investment advisory agreement with Pennant Management, Inc. (“Pennant”), a company engaged in acquiring USDA-guaranteed loans on behalf of community banks. Pursuant to this agreement, Citizens Bank began purchasing shares in loan pools administered by Pennant.

In 2013, Pennant entered into a master repurchase agreement with First Farmers Financial LLC (“First Farmers”), a company approved by the USDA as an eligible lender for certain USDA loans. Under the terms of the master repurchase agreement, Pennant, on behalf of its clients, agreed to purchase from First Farmers guaranteed portions of USDA loans and supporting agreements, documents, and instruments, including USDA-issued Assignment Guarantee Agreements (AGAs).

Beginning in 2013, Pennant purchased, on behalf of Citizens Bank, 25 USDA-guaranteed loans purportedly originated by First Farmers. Citizens Bank’s investment in the loan pool totaled $15 million. For each loan, Citizens Bank’s custodian received an original USDA AGA that contained an original ink signature purporting to be that of a USDA state director.

In 2014, Pennant discovered that the First Farmers loans were fictitious and that the signatures on the AGAs were forged. The identified borrowers and collateral were fictitious and the CPA who allegedly audited First Farmers did not exist. First Farmers refused Pennant’s request to repurchase the loans it purportedly originated, and the USDA refused Pennant’s demand to honor the AGAs, reasoning that it had not guaranteed any valid loans. As a result, Citizens Bank lost its investment.

The Coverage

Citizens Bank pursued a claim under Insuring Agreements D (Forgery) and E (Securities) of its Bond, and ultimately moved for summary judgment against its insurer, Atlantic. Before the District Court, Citizens Bank contended that certain provisions of the Bond had to be interpreted contra proferentem. The District Court reviewed the principles for interpreting Financial Institution Bonds and rejected Citizens Bank’s contention, applying the principle, recognized since at least Sharp v. FSLIC in 1988, that the contra proferentem rule “generally does not apply where the policy in question is a standard Bankers Blanket Bond, drafted by representatives from both the banking and insurance industries.”

The Court then considered coverage under Insuring Agreement E(1), which indemnified for:

Loss resulting directly from the Insured having, in good faith, for its own account or for the account of others: … acquired, sold, delivered, or given value, extended credit or assumed liability, on the faith of any original Written document that is a:

(a) Certificated Security … [or]

(g) corporate, partnership or personal Guarantee …

which … bears a handwritten signature of any … guarantor … that is a Forgery.

Citizens Bank asserted that the forged AGAs qualified as certificated securities, or as corporate or personal guarantees. Atlantic took the view that the AGAs did not fall within either category of documents.

The Court first determined that the AGAs were not certificated securities. The Bond defined a “Certificated Security” as:

a share, participation or other interest in property of, or an enterprise of, the issuer or an obligation of the issuer, which is:

(a) represented by an instrument issued in bearer or registered form;

(b) of a type commonly dealt in on securities exchanges or markets or commonly recognized in any area in which it is issued or dealt in as a medium for investment; and

(c) either one of a class or series or by its terms divisible into a class or series of shares.

Citizens Bank contended that an AGA “is a ‘class’ of obligation ‘issued by the USDA’ in ‘registered’ form and ‘commonly recognized’ as a ‘medium of investment’ in the secondary market for USDA guaranteed loans.” Atlantic responded that the Bond defined guarantees and certificated securities separately, and that the documents in issue were self-identified as guarantees. Further, an AGA was not a share, nor was it divisible into shares.

The Court held that a reasonable insured would not expect the AGAs to qualify as certificated securities under the Bond, observing that, while one could try to classify an AGA as a certificated security by separating each of the terms used in defining the document, “such terms must be viewed in context of the Bond as a whole and not in isolation.” As the AGAs were labeled as guarantees, and fit within the definition of “guarantee” used in the Bond, it was not reasonable to accept that the parties intended such documents to also qualify as certificated securities.

The Court then considered whether the AGAs were “corporate, partnership or personal” guarantees. Citizens Bank contended that they represented (i) corporate guarantees, because the USDA acts in a corporate capacity in providing loan guarantees; and (ii) personal guarantees, because the USDA, as a political body, is an artificial “person” akin to a corporation or partnership. The Court rejected these arguments, holding that the USDA is a government agency and not a corporation. As the types of guarantees in Insuring Agreement E(1)(g) expressly included only corporate, partnership or personal guarantees, accepting Citizens Bank’s definition would be “unreasonable as it would render those expressly included terms superfluous.” As a result, the AGAs did not fall within Insuring Agreement E(1).

The Court then considered coverage under Insuring Agreement D, which indemnified for, inter alia, loss resulting directly from forgery of, on, or in any Letter of Credit. “Letter of Credit” was defined as:

an engagement in writing by a bank or other person made at the request of a customer that the bank or other person will honor drafts or other demands for payment upon compliance with the conditions specified in the Letter of Credit.

Citizens Bank contended that the USDA acted as a “bank” by facilitating the transmission of funds to lenders and borrowers, and also argued that the USDA was an “other person”, on the basis that that term encompassed human beings, corporations and partnerships.

The Court held that the AGAs were not letters of credit:

The Court finds that a reasonable insured in Citizens Bank’s position would not expect the [AGAs] to qualify as letters of credit under the terms of the Bond. For one, the [AGAs] are labeled as guarantees and clearly fit within the definition of a guarantee as used in the Bond and for which coverage is provided under Insuring Agreement E. That other instruments, for example certificates of deposit, may qualify for coverage under multiple insuring agreements does not mean that a document expressly labeled as a guarantee — a term defined in the Bond — should be treated as an instrument with an entirely different definition.

Even if the Court were to ignore this unambiguous label, it would nevertheless find that a USDA [AGA] does not satisfy the definition of a letter of credit. … the USDA is neither a “bank” nor an “other person.” [emphasis added]

Conclusion

Citizens Bank is notable for three reasons. First, the holdings by the Court regarding Insuring Agreements D and E(1) will undoubtedly be of interest to fidelity professionals dealing with claims involving government-issued guarantees. Second, the Court expressly reaffirmed the principle that Financial Institution Bonds are not to be interpreted contra proferentem, as they are effectively products of joint authorship.

Third, the Court took a robust approach to interpreting the Bond, exemplified by its observation that:

This failure of the contracting parties to consider government guarantees explains why Citizens Bank has pressed a highly creative interpretative stratagem, urging a microscopic focus on the dictionary or statutory definitions of individual words. … Such an approach, however, runs contrary to the general rule that interpretation must take into account the whole of the contract.

Citizens Bank militates against an interpretive approach which seeks to generate coverage by “stitching together” definitions of individual words and phrases to try to fit the circumstances of a loss within coverage, and in favour of an approach whereby courts give effect to the wording of the Bond, read as a whole. The latter approach is consistent with the interpretive methodology used by U.S. courts generally, and is expressly mandated by the Supreme Court of Canada as the “primary interpretative approach” to be taken in our country.

Citizens Bank Holding Inc. v. Atlantic Specialty Insurance Co., 15-CV-782 (E.D. Wis. November 16, 2016) [Note: this decision does not appear to be accessible online; please contact us if you would like a copy.]