Coverage often turns on the meaning of a single word or phrase in an insurance policy. The definition of “counterfeit” in financial institution bonds can be especially tricky. On June 12, 2017, the court in Harvard Sav. Bank v. Sec. Nat’l Ins. Co., No. 15-CV-11674, 2017 WL 2560900, at *1 (N.D. Ill. June 12, 2017) addressed the definition of “counterfeit” in the financial institution bond issued by Security National Insurance Company to Harvard Savings Bank. As the ruling illustrates, terminology that may appear to be insignificant can often make all the difference between millions of dollars in recovery versus no coverage being available.

Harvard Savings Bank was the victim of a large Ponzi scheme, whereby the fraudsters created fake loan documents that purported to be for loans issued by the fraudster’s company (First Farmers) and guaranteed by the USDA’s Business and Industry Guaranteed Loan Program. Though the USDA’s Business and Industry loan program is a true federal loan program, the loan documents created by First Farmers were entirely fake—documents evidencing loans that were never made, to borrowers that did not exist. The fraudsters simply made up the names of the borrowing companies and their respective managing members, and then signed the loan documents themselves as the lender and the borrowers. The fraudsters also forged the signatures of the Georgia and Florida state directors of the USDA on the Loan Note Guarantees and Assignment Guarantee Agreements.

The fraudsters then sold “Guaranteed Portions of the USDA B&I Loans” to Pennant Management (an investment advisor) for $179 million. Harvard Savings Bank, a client of Pennant, purchased approximately $18 million of the “loans.” When the fraud was discovered, Harvard Savings made a claim under its financial institution bond issued by Security National Insurance Company, which covered, among other things, “counterfeit” securities. Security National moved for summary judgment, in part by arguing that as a matter of law the fake loans cannot be “counterfeit” because no authentic, original loans existed.

As with any insurance contract dispute, the court began with the bond’s definition of “counterfeit”: “an imitation which is intended to deceive and to be taken as an Original.” The court then distinguished the two cases relied on by Security National. The court stated that Capitol Bank of Chicago v. Fid. & Cas. Co. of New York, 414 F.2d 986 (7th Cir. 1969) was not controlling, because the definition of “counterfeit” used by the Seventh Circuit in that case differed from the definition in the bond. The court also concluded that North Shore Bank, FSB v. Progressive Cas. Ins. Co., 674 F.3d 884 (7th Cir. 2012) was not controlling, as the definition of “counterfeit” in the bond in that case was again materially different (“a Written imitation of an actual, valid Original which is intended to deceive and to be taken as the Original.”).

Because the definition of “counterfeit” in the Savings National bond required only an imitation of “an Original,” the court denied the insurer’s motion for summary judgment. The court explained that “no party has presented any valid Business and Industry Guaranteed Loans for the Court to determine whether the fake loan packages could ‘be taken as an Original,’ ” and then stated that Harvard Savings Bank “should submit copies of valid USDA-guaranteed Business and Industry Loans, so the Court can make the determination of whether the fake loans created by First Farmers qualify as ‘Counterfeit.’ ”

Thus, the court held that under the definition of “counterfeit” in the bond, coverage depended not upon whether the fake loan documents were an imitation of actual, existing loan documents to the borrowers in question (which did not exist), but rather on whether the fake loan documents were an imitation of real USDA-guaranteed Business and Industry Loans made to real borrowers. The court also rejected the insurer’s effort to shift responsibility for the loss to the victim, noting that “[w]hen applying the definition of counterfeit, the judicial inquiry should focus on how closely the fake documents look to valid documents, not the actions taken, or not taken, by the victim of the fraud.” The court counseled that “blaming the victim” is “not the best rationale for courts to use when determining the quality of an imitation.”

The court also addressed coverage for “Forgery or alteration of, on, or in any Negotiable Instrument” under the bond. Savings National argued that there was no coverage under that insuring agreement because the forgery of the USDA officials’ signatures was only on the guarantees, and not on the promissory notes themselves. The court disagreed, holding that all of the loan documents executed at the same time must be viewed collectively as a single “loan package,” and that coverage existed because each loan package contained a forgery of a USDA official’s signature.

The Harvard Savings Bank case serves as a reminder of the importance of closely scrutinizing the definitions and coverages in each insurance policy. Experienced coverage counsel can help navigate coverage issues and help ensure that (1) insureds understand the scope of the coverage they are purchasing on the front end and (2) insurers live up to the terms of the agreement on the back end.