The Fidelity Law Journal

The Fidelity Law Journal

published by

The Fidelity Law Association

Volume XXII, November 2016

Editor-in-Chief Michael Keeley

Associate Editors Carla C. Crapster Robert J. Duke Adam P. Friedman Ann I. Gardiner Jeffrey S. Price John R. Riddle Daniel J. Ryan Joel Wiegert

Cite as XXII FID. L.J. ___ (2016)

THE FIDELITY LAW ASSOCIATION

Executive Committee President Robert Olausen, ISO Solutions

Immediate Past President Michael Retelle, CUMIS

Vice President Dolores Parr, Zurich Secretary Michael V. Branley, The Hartford

Treasurer Timothy Markey, CNA

Members Ann Gardiner, ABA Insurance Services, Inc. Mark Struthers, CUMIS

Advisors Emeritus Samuel J. Arena, Jr., Stradley, Ronon, Stevens & Young, LLP Armen Shahinian, Chiesa Shahinian & Giantomasi PC Robert Briganti, Belle Mead Claims Service, Inc. Michael Keeley, Strasburger & Price, LLP Harvey C. Koch, Montgomery Barnett, LLP

Advisors CharCretia V. Di Bartolo, Hinshaw & Culbertson LLP Gary J. Valeriano, Anderson McPharlin & Connors LLP

The Fidelity Law Journal is published annually. Additional copies may be purchased by writing to: The Fidelity Law Association, c/o Chiesa Shahinian & Giantomasi PC, One Boland Drive, West Orange, New Jersey 07052.

The opinions and views expressed in the articles in this Journal are solely of the authors and do not necessarily reflect the views of the Fidelity Law Association or its members, nor of the authors’ firms or companies. Publication should not be deemed an endorsement by the Fidelity Law Association or its members, or the authors’ firms or companies, of any views or positions contained herein. The articles herein are for general informational purposes only. None of the information in the articles constitutes legal advice, nor is it intended to create any attorney-client relationship between the reader and any of the authors. The reader should not act or rely upon the information in this Journal concerning the meaning, interpretation, or effect of any particular contractual language or the resolution of any particular demand, claim, or suit without seeking the advice of your own attorney. The information in this Journal does not amend, or otherwise affect, the terms, conditions or coverages of any insurance policy or bond issued by any of the authors’ companies or any other insurance company. The information in this Journal is not a representation that coverage does or does not exist for any particular claim or loss under any such policy or bond. Coverage depends upon the facts and circumstances involved in the claim or loss, all applicable policy or bond provisions, and any applicable law. Copyright © 2016 Fidelity Law Association. All rights reserved. Printed in the USA. For additional information concerning the Fidelity Law Association or the Journal, please visit our website at http://www.fidelitylaw.org. Information which is copyrighted by and proprietary to Insurance Services Office, Inc. (“ISO Material”) is included in this publication. Use of the ISO Material is limited to ISO Participating Insurers and their Authorized Representatives. Use by ISO Participating Insurers is limited to use in those jurisdictions for which the insurer has an appropriate participation with ISO. Use of the ISO Material by Authorized Representatives is limited to use solely on behalf of one or more ISO Participating Insurers.

POST HOC, ERGO PROPTER HOC: A FIFTY-STATE SURVEY OF CAUSATION IN FIDELITY BONDS

David Spielbauer Shane Mecham

I. INTRODUCTION

Post hoc, ergo propter hoc: after this, therefore resulting from it. The Latin phrase expresses the logical fallacy of concluding that one thing caused another simply because one preceded the other. For example, between 1999 and 2009 there was an 80.57% correlation between the number of letters in the winning word of the Scripps National Spelling Bee and the number of people killed by venomous spiders.1 During that same period, there was a 99.38% correlation between the number of lawyers in North Carolina and the number of suicides by hanging.2 Unless we believe that spelling bee participants are using venomous spiders to take down the competition and that practicing law in North Carolina is incredibly unpleasant,3 we must accept that correlation does not imply causation. While that fallacy might seem obvious, financial institutions routinely submit bond claims showcasing this logical fallacy. The claims simply state that insured conduct occurred and then the financial institution suffered a loss.

1 SPURIOUS CORRELATIONS, http://www.tylervigen.com/spurious- correlations (last visited May 18, 2016). 2 Id. 3 The authors have nothing but respect for the great state of North Carolina, spelling bee participants, and, for that matter, venomous spiders who, after all, are only acting on instinct.

David Spielbauer is a Senior Claims Professional with CUMIS Insurance Society, Inc. in Madison, Wisconsin. Shane Mecham is a shareholder with Levy Craig Law Firm in Kansas City, Missouri.

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The Standard form Financial Institution Bond,4 commercial crime policies, and virtually all of their progeny, protect carriers from spurious correlations by predicating coverage on causation.5 For example, each insuring agreement in the Bond requires a “loss resulting directly from” the insured conduct. Unfortunately, not all courts agree on what the phrase “loss resulting directly from” means. The majority rule and modern trend is for courts to enforce the plain language of the contract and conclude that the Bond unambiguously requires the loss to be “direct” or immediate.6 Intervening and superseding acts break the causal chain. A minority of courts, however, incorrectly interpret the Bond’s “direct loss” language to mean “proximate cause” or “but for” causation.7

This article defines the direct loss and proximate cause approaches before exploring arguments used by courts for and against each. Following this article are two tables showing the causation theory to which each state and federal circuit subscribes.8

4 Financial Institution Bond, Standard Form No. 24, 1986 [hereinafter, the Bond]. 5 Id. 6 Tooling, Mfg and Tech. Ass’n v. Hartford Fire Ins. Co., 693 F.3d 665, 674 (6th Cir. 2012); Susan Koehler Sullivan, Teresa Jones, “The Question of Causation in Loan Loss Cases,” 11 FID. L.J. 89, 90 (Oct. 2005). 7 See, e.g., Bidwell & Co. v. Nat’l Union Fire Ins. Co., No. CV-00-89- HU, 2001 WL 204843, at *9 (D. Or. Jan. 18, 2001); see also Mid-America Bank of Chaska v. American Cas. Co., 745 F. Supp. 1480, 1485 (D. Minn. 1990); Bogda M.B. Clark, Patricia Thompson & Michael A. Shafir, “Loss Resulting Directly From . . . .”: Causation Under the Financial Institution Bond and Similar Insurance Forms,” 9 FID. L.J. 25, 27 (Oct. 2003); but see BancInsure, Inc. v. Highland Bank, 779 F.3d 565, 566 (8th Cir. 2015) (“the phrase ‘resulting directly from’ in the [Bond] does suggest a stricter standard of causation than mere ‘proximate cause.’”). 8 Where possible, the authors cited specifically to fidelity cases. Where the authors were forced to rely on other insurance cases, that fact is noted in the comments. Readers would also be wise to consider whether a state has any applicable statutes or regulations.

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II. HISTORY OF CAUSATION IN THE STANDARD BOND FORM

Employee theft is a problem as old as time. In ancient Babylonia, traveling merchants could not be trusted to return with the goods they were sent to buy. So their investors would take as security a pledge of the merchant’s spouse, children, and property.9 Unfortunately, merchants occasionally enjoyed life abroad more than their families. The Code of Hammurabi circa 2250 B.C., however, states that an honest merchant, “on his oath was freed from forfeiture where his goods were pillaged through no negligence or connivance of the salesman.”10 The code also required the city and governor to indemnify a person who was robbed if the thief was not captured.11

Despite Hammurabi’s best efforts, employee theft continues to be a problem. By the late 1800s, banks and other financial institutions sought insurance against unfaithful employees. Insurers responded with various types of fidelity coverage, but the rules at the time required banks to purchase a series of bonds and policies to protect them from various breeds of dishonesty, including employee dishonesty, theft, and robbery.12 It was not until 1912 that the New York State Commissioner of Insurance, probably at the request of the Surety Association of America13 and the American Bankers Association, permitted insurers to combine various types of coverages for financial institutions into a single bond.14 In 1916, the SAA and the American Bankers Association worked together to draft their first bond, the Standard Form No. 1 Banker’s

9 J.L. Longnaker, History of Insurance Law, INS. L.J. 642, 643 (1962). 10 Id. 11 Robert A. Babcock, History of Fidelity Coverage, in COMMERCIAL BLANKET BOND ANNOTATED, Ch. 1, at 1-7 (William F. Haug ed., 1985). 12 Robin V. Weldy, History of the Bankers Blanket Bond and the Financial Institution Bond Standard From No. 24 with Comments on the Drafting Process, in SECOND SUPPLEMENT: ANNOTATED BANKERS BLANKET BOND, Ch. 1 at 3 (Harvey C. Koch ed., 1988). 13 Now known as the Surety & Fidelity Association of America. Hereinafter SAA. 14 Weldy, supra note 12, at 3-4.

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Blanket Bond, to compete with the uniform contract then offered by Lloyd’s of London.15

Originally, a “fidelity bond” was similar to a surety bond, a tripartite relationship between a principal and the surety to protect or indemnify the obligee against larceny or embezzlement committed by the principal, usually the employee.16 However, as fidelity coverage grew to encompass risks other than employee dishonesty, it became more like a contract of insurance.17 Thus, a Bankers Blanket “Bond” is not actually a bond. While frequently labeled “insurance,” it is important to understand that fidelity bonds are not liability insurance policies. Instead, they involve a two-party indemnity agreement where the insurer reimburses the insured for losses the insured actually suffered that were caused by a covered event or transaction.

Standard Form No. 1 covered “any loss,” but that language could have been misconstrued to cover both direct and indirect, or consequential, losses such as bad loans or decreases in security values.18 So when the SAA introduced Standard Form No. 2 in 1920, it clarified that the bond only covered “direct” losses. This change limited the insurer’s liability to losses sustained from the transaction itself, regardless of “subsequent or ultimate losses flowing out of changes in

15 Edward G. Gallagher, et al., A Brief History of the Financial Institution Bond, in FINANCIAL INSTITUTION BONDS 7 (2d ed. Duncan L. Clore ed., 1998); Bankers Blanket Bond, Standard Form No. 24, Master Appendix, Exhibit 10; 9A JOHN ALAN APPLEMAN & JEAN APPLEMAN, INSURANCE LAW AND PRACTICE § 5701 (2014); Peter I. Broeman, An Overview of the Financial Institution Bond, STANDARD FORM 24, 110 BANKING L.J. 439, 442-43 (1993). 16 E.B. McCahan, Jr., Surety Bonds, Fidelity Coverages and the Practicing Lawyer 209, 209 (Address presented by the Fidelity and Surety Law Committee to the First General Session of the Insurance Negligence and Compensation Law of the American Bar Association, San Francisco, CA, Aug. 7, 1962). 17 Id. 18 Towner Rating Bureau, Bankers’ Blanket Bonds: Analysis of American Forms and Lloyds H.A.N.(C) Form, at 1 (Aug. 4, 1920).

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value, solvency, or other related events.”19 At the time the competing Lloyd’s form also only covered “direct losses.”20

Later versions of the Bond further clarified this point by requiring a “loss through” a covered event or transaction, but claims for coverage for consequential losses continued to be an issue.21 The 1980 version further emphasized the direct loss requirement by insuring a bank only for loss “resulting directly from dishonest or fraudulent acts” of its employees.22 “The expressed intent of the underwriters was to refine the exact meaning of employee dishonesty under the bonds as a means of addressing judicial decisions expanding coverage beyond that originally contemplated, while ensuring that employers . . . could purchase . . . protection” against dishonest employees.23 In 1980 all insuring agreements in the Bond were specifically modified to require a loss “resulting directly from” the covered peril. That modification was a response to certain court interpretations that incorrectly applied tort concepts of causation to the bond’s contractual loss-causation requirements.24

Like most other sections of the Bond, the causation language has undergone a series of revisions over the years. The Bond is the result of negotiations and collaboration between the surety and banking industries. Courts have noted that the Bond should not necessarily be construed against carriers because it is a particularized type of insurance policy that was partly drafted by, and widely discussed within, the insured banking industry. Over the years, the parties to the Bond have carefully considered and then drafted specific language to best articulate coverage. The goal has been to more accurately define the parties’ respective expectations, with awareness of case law interpreting earlier versions of

19 Id. 20 Id. 21 Bradford R. Carver, Loss and Causation, in HANDLING FIDELITY BOND CLAIMS 363, 379 (Michael Keeley & Sean Duffy eds., 2d ed. 2005). 22 Karen Wildau, Evolving Law of Third-Party Claims Under Fidelity Bonds: When is Third Party Recovery Allowed?, 25 TORT & INS. L.J. 92, 94 (1989). 23 Id. 24 Carver, supra note 21.

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the bond.25 Nearly every provision of the Bond “has been developed in response to and tested by case law.”26

The reality is that no bank or business can insure itself against all of the risks that come with doing business. Therefore, the Bond has been drafted to allocate the various risks of loss between insurer and the financial services industries, compromising between insuring against certain risks and providing coverage at a reasonable premium. The history of the Bond’s development shows that it was not intended to constitute broad insurance against the risk of loss to the financial institution in its financial banking operations. The Bond’s precise language, including the requirement of direct causation and the standard exclusions, expresses the allocation of risks between insured and insurer.27

III. DIRECT CAUSE

Unfortunately, some courts continue to ignore the Bond’s language and apply tort concepts of causation to coverage cases. The goal in interpreting the Bond is the same as interpreting any contract. The focus of contract interpretation is to determine the parties’ intentions and give effect to those intentions.28 The parties’ intent is to be ascertained from the contract alone and not extrinsic or parol evidence.29 The words of a contract are to be given their plain, ordinary meaning.30 “The reason underlying the rule is to give stability to written agreements.”31 “The written contract is conclusively presumed to . . .

25 Bogda et al., supra note 7, at 28. 26 J. Kelly Reyher, A Brief Review of the Financial Institution Bond Standard Form No. 24 and Commercial Crime Policy, 563 PLI/Lit 57, PLI Order No. H4-5259, 61 (May 1997). 27 Id. 28 Care Ctr. of Kan. City v. Horton, 173 S.W.3d 353, 355 (Mo. App. W.D. 2005). 29 Id. 30 Id. 31 Woods of Somerset, LLC v. Developers Sur. and Indem. Co., 422 S.W.3d 330, 336 (Mo. App. E.D. 2013) (quoting J.W. Jenkins Sons Music Co. v. Johnson, 162 S.W. 308, 309 (Mo. App. 1914)).

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express the final agreement of the parties.”32 If courts did not enforce the plain meaning of contract language it “would absolutely destroy the value of all contracts and negotiable instruments.”33 The direct cause approach follows the rules of contract interpretation by giving the words in the Bond their plain, ordinary meaning.

A. Definition

The American Heritage Dictionary defines “result[ing]” as “[t]o come about as a consequence . . . . The consequence of a particular action, operation or course.”34 It defines “directly” as “[i]n a direct line or manner; straight . . . . Without anyone or anything intervening . . . . At once, instantly.”35 Combining these definitions, the plain meaning of “loss resulting directly from” is a loss that is the instant or immediate consequence of specified conduct, without any intervening event or activity.36

Losses resulting directly from are “those that flow immediately in time or space, and without any intervening cause, from the specified conduct or peril.”37 Under the “direct is direct” approach, a loss suffered after some “intervening space, time, agency, or instrumentality” from the employee’s theft is not a direct loss.38 The phrase “resulting directly from” requires “stronger, more immediate proof of causation than that provided for under tort law.”39

If an employee’s dishonesty causes losses to a third party, which then leads to litigation concluding in a judgment or settlement, the insured has not incurred a “direct loss” under a fidelity bond; the insured’s loss is “indirect” and the third party’s loss is “direct.” To find

32 Id. 33 Id. 34 THE AMERICAN HERITAGE DICTIONARY OF THE ENGLISH LANGUAGE 1539 (3d ed. 1992). 35 Id. at 527. 36 Bogda et al., supra note 7, at 28. 37 Id. at 29 38 Tooling Mfg. and Tech Ass’n v. Hartford Fire Ins. Co., 693 F.3d 665, 673 (6th Cir. 2012). 39 Bogda et al., supra note 7, at 29.

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coverage in these circumstances would be contrary to the “direct is direct” approach and would convert a direct loss policy into a third-party indemnity policy or liability policy. In the absence of a third-party- claims clause, an insured’s fidelity bond, unlike a liability policy, does not provide indemnity for vicarious liability for losses suffered by others arising from its employee’s tortious conduct.40 The Bond is not there to cover liability as in a liability policy but to cover only a direct loss, due to only a direct event and not due to proximate events.

B. Justifications for Direct Cause

Courts have relied on a number of different arguments to support their use of the direct cause approach. Initially, “Resulting directly from” is “clear and unambiguous and must be afforded its plain and ordinary meaning.”41 This approach does precisely that.

In addition, the direct is direct approach gives effect to the parties’ intent as expressed in the Bond’s language.42 The drafters amended the Bond to avoid proximate cause and invoke a direct result requirement. In Lynch Properties, Inc. v. Potomac Insurance Co., a bookkeeper misappropriated funds from a client’s personal account.43 The employer repaid the funds and sought to recover that amount from its employee dishonesty insurer. The Fifth Circuit explained that direct causation is critical to prevent employee dishonesty policies from becoming liability policies:

Employee dishonesty policies insure against the risk of property loss through employee dishonesty. Liability policies, by contrast, require an insurer to discharge an obligation of the insured to a third party for some act of the insured or its employee. Although employee dishonesty policies may cover the loss of third-party property in the possession of the insured, these policies do not serve as liability insurance to protect employers

40 RBC Mortgage Co,. 812 N.E.2d at 733. 41 Id. at 734. 42 See, e.g., FDIC v. Firemen’s Fund Ins. Co., 109 F.3d 1084, 1087 (5th Cir. 1997). 43 140 F.3d 622, 629 (5th Cir. 1998).

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against tortious acts committed against third-parties by their employees. Mere insertion of the words “legal liability” into an employee dishonesty policy does not transform the policy into a liability policy.44

By contrast, the proximate cause approach transforms an employee dishonesty policy or fidelity bond into liability insurance, which is not the coverage for which the parties had bargained.

Furthermore, direct is direct aligns the coverages with the exclusions. The Bond excludes from coverage any “indirect or consequential loss of any nature,” as well as “damages of any type for which the Insured is legally liable, except compensatory damages . . . arising directly from a loss covered under this bond.” These and several other exclusions prohibit coverage for losses “resulting directly” from factors other than the specifically enumerated covered risks. That parallel structure reinforces the drafters’ intent to narrow the scope of coverage only to those losses strongly and immediately linked to a covered act.45

C. Criticisms of Direct Cause

Claimants eager to expand the scope of the Bond beyond the coverage that was intended or for which they contracted have argued that the direct is direct approach defines a term by using the very language requiring definition. They assert that the term “direct cause” is not susceptible to a clear, definite meaning, but instead is “a nebulous and largely indeterminate concept.”46

A leading case on this point is Scirex Corp. v. Federal Insurance Co.47 Scirex clinically tested new pharmaceuticals, and this case arose out of its “Blanket Employee Dishonesty” policy. A clinical trial required nurses to observe patients for eight hours, but the nurses sent the patients home after as little as one hour. The nurses then forged observation notes. Scirex had to spend $1.2 million to replicate the

44 Id. 45 Bogda et al., supra note 7, at 28. 46 Cumberland & Erly, LLC v. Nationwide Mut. Ins. Co., 128 F. Supp. 3d 888, 895 (D. Md. 2015). 47 313 F.3d 841, 850 (3d Cir. 2002).

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studies, and it sought to recover that amount from its insurer. The insurer denied coverage because the losses were not direct. It explained that examples of direct loss would include if the nurses had forged time cards to make them eligible for overtime pay or if they had pilfered office supplies. The Third Circuit rejected the insurer’s argument because Pennsylvania law disfavored the “nebulous” concept of direct cause.48

Those critics also argue that, by prohibiting coverage for third- party claims, the direct is direct approach contradicts the plain meaning of a direct loss. “The proximate cause theory, on the other hand, recognizes that restricting ‘direct loss’ to preclude recovery for any third- party obligations would seem to conflict with the plain and ordinary meaning of a direct loss.”49 Fortunately, more and more courts are rejecting these criticisms of direct cause.

IV. PROXIMATE CAUSE

In a minority of jurisdictions, however, causation continues to be “a sometimes-misunderstood concept in the case law interpreting financial-institution bonds.”50 “Even after the 1986 revision, some courts have continued to look to proximate cause and other causation principles borrowed from tort law to decide loss-causation issues under the financial institution bond.”51

A. Definition

Perhaps part of the problem is that even Black’s Law Dictionary conflates proximate and direct cause.52 While the term is commonly used, it often defies definition.

48 Id. 49 Id. 50 First State Bank of Monticello v. Ohio Cas. Ins. Co., 555 F.3d 564, 570 (7th Cir. 2009). 51 Id. 52 Proximate Cause, BLACK’S LAW DICTIONARY (7th ed. 1999) (asserting that “proximate cause” is “also termed direct cause”).

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“Proximate cause”—in itself an unfortunate term—is merely the limitation which the courts have placed upon the actor’s responsibility for the consequences of the actor’s conduct. In a philosophical sense, the consequences of an act go forward to eternity, and the causes of an event go back to the dawn of human events, and beyond. But any attempt to impose responsibility upon such a basis would result in infinite liability for all wrongful acts, and would “set society on edge and fill the courts with endless litigation.” North v. Johnson, 58 Minn. 242, 59 N.W. 1012 (1894). As a practical matter, legal responsibility must be limited to those causes which are so closely connected with the result and of such significance that the law is justified in imposing liability. Some boundary must be set to liability for the consequences of any act, upon the basis of some social idea of justice or policy.53

The proximate cause approach co-opts tort law and permits recovery wherever the insured’s obligation to reimburse, even a third party, was reasonably foreseeable.54 The direct cause of the loss need not be the “‘sole cause’ or ‘immediate cause,’ but need only be a proximate or substantial cause.”55

Tort causation involves two elements: (1) cause-in-fact, also referred to as the “but for” or “sine qua non” test; and (2) legal cause, also referred to as “proximate cause” or the “substantial factor” test.56 Courts in Bond coverage cases often consider whether both of these elements have been satisfied because, unless an otherwise covered act is

53 W. PAGE KEETON ET AL., PROSSER AND KEETON ON TORTS § 41, at 264 (5th ed. 1984). 54 Retail Ventures, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 691 F.3d 831-32 (6th Cir. 2012); Auto Lenders Acceptance Corp. v. Gentilini Ford, Inc., 854 A.2d 378, 386 (N.J. 2004). 55 Scirex Corp. v. Fed’l Ins. Co., 313 F.3d 841, 849-50 (3d Cir. 2002) (citing Jefferson Bank v. Progressive Cas. Ins. Co., 965 F.2d 1274, 1281-82 (3d Cir. 1992). 56 John W. Hinchey, Loss and Causation, in ANNOTATED BANKERS BLANKET BOND, FIRST SUPPLEMENT 5-6 (Frank L. Skillern, Jr. ed., 1983).

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both the cause-in-fact and the legal cause of a loss, the claim will fail.57 The “legal cause” element of tort causation requires a plaintiff to prove that the defendant’s conduct was also the proximate cause of the harm suffered.58 While cause-in-fact relates to the chain of events culminating in a loss, the proximate cause concept ostensibly narrows the scope of a tortfeasor’s legal responsibility by requiring something more.59

B. Arguments Used by Advocates of the Proximate Cause Approach

Proponents of proximate cause have inertia on their side. Courts are familiar with that approach and some use it in fidelity bond cases without asking “why?” Instead, they ask “why not?”60 Those courts have contended that the “‘direct cause of a loss’ does not have to be the ‘sole cause’ or ‘immediate cause,’ but need only be a proximate or substantial cause.”61

A leading case on this point is Jefferson Bank v. Progressive Casualty Insurance Co.62 The bank sought indemnification for a loan documented by an imposter notary who did not record the mortgage. When the customer defaulted, the bank was unable to take possession of the property. The insurer argued that the loss was indirect because it was not caused by the fraudulent notary. Rather, the bank’s loss was the result of other mortgages being recorded on the same property and having priority over the bank’s interest. The Third Circuit disagreed and held that it was sufficient that the fraudulent notary was one of the substantial causes of the loss.63

57 James J. Moran, Jr. & William T. Bogaert, Loss and Causation in the Simplified Commercial Crime Forms, in FIDELITY BONDS § M, at 17 (1991). 58 DAN B. DOBBS, THE LAW OF TORTS 405 (West Group 2000). 59 Id. at 407. 60 Auto Lenders Acceptance Corp. v. Gentilini Ford, Inc., 854 A.2d 378, 387 (N.J. 2004) (stating that there was “no sound reason why a proximate cause analysis should not be employed”). 61 Scirex Corp., 313 F.3d. at 849-50. 62 965 F.2d 1274, 1281-82 (3d Cir. 1992). 63 Id.

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Advocates of proximate cause have claimed that proximate cause comports with the principle of broadly construing insurance coverage provisions.64 Note, though, that the principle of interpreting insurance policies in favor of coverage does not apply to the Bond because the Bond is jointly drafted by the banking and insurance industries.65

Another argument sometimes used to justify proximate cause is a rule borrowed from fire insurance. It is an “established rule of insurance law” that, where the peril specifically insured against sets other causes in motion which, in an unbroken sequence and connection between the act and the final loss produces the result for which recovery is sought, the insured peril is regarded as the proximate cause of the loss.66 Regardless of these three contentions, there are substantial problems with applying proximate cause in fidelity bond cases that have resulted in proximate cause becoming the minority rule.

C. Terminal Defects in the Proximate Cause Approach

Initially, proximate cause analysis simply is too broad to capture accurately the intent behind the phrase “loss resulting directly from.” A “direct loss” must be afforded its plain and ordinary meaning. “Loss proximately caused by” requires a strained reading of “direct loss,” which is a much narrower concept than “proximately caused loss.”67 In fact, applying proximate cause requires reading the word “directly” out of the Bond.68

In Vons Cos., Inc. v. Federal Insurance Co., the Ninth Circuit explained that a claimant “is covered only for direct losses to [itself] caused by its employee’s dishonesty, not for vicarious liability for losses

64 Id. 65 Edward G. Gallagher, James L. Knoll & Linda M. Bolduan, A Brief History of the Financial Institution Bond, in FINANCIAL INSTITUTION BONDS 1 (Duncan L. Clore ed., 2d 1998). 66 FDIC v. Reliance Ins. Corp., 716 F. Supp. 1001, 1004 (E.D. Ky. 1989); Mid-American Bank v. Am. Cas. Co., 754 F. Supp. 1480, 1485 (D. Minn. 1990). 67 RBC Mortg. Co. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 812 N.E.2d 728, 736-37 (Ill. Ct. App. 2004). 68 Bogda et al., supra note 7, at 28.

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suffered by others arising from its employee’s tortious conduct.”69 Vons arose out of a grocer’s employee dishonesty policy. The employee in that case participated in a Ponzi scheme by confirming fictitious transactions on the secondary food market. Vons Companies paid ten million dollars to settle two lawsuits brought by the investors in the Ponzi scheme and sought to recover that amount from its insurer. The Ninth Circuit succinctly concluded, “We hold that ‘direct’ means ‘direct.’”70

In addition, the Bond’s drafters did not intend to invoke the proximate cause standard. Proximate cause is a well-known legal principle. If the Bond’s drafters had wanted to use a proximate cause standard, they could have done so. Instead, though, the drafters revised the Bond by strengthening the direct cause language in response to courts’ invoking proximate cause analysis in prior cases. They replaced the pre-1980 language of the Bond, which stated the causation requirement in the far more general terms of insuring “loss through” a covered act, with the very specific requirement of “resulting directly from.”71

Furthermore, the purpose of proximate cause is inconsistent with the issue of insurance coverage. “[P]roximate cause . . . is not about causation at all but about the significance of the defendant’s conduct or the appropriate scope of liability, an issue that entails heavy elements of moral and policy judgment about the very particular facts of the case.”72 “Insurance-coverage cases are not concerned with the philosophical social-duty underpinnings of tort law.”73 The action sounds in contract, and the court’s task is to interpret the parties’ agreement.74 The plain language of the bond is the best evidence of that agreement.

69 212 F.3d 489, 491 (9th Cir. 2000). 70 Id. 71 Bogda et al., supra note 7, at 31. 72 DOBBS, supra note 57, at 408. 73 Id. 74 Id.

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V. RECENT CASES

Two cases handed down in 2015 illustrate that, while direct cause is increasingly the majority rule, the debate about how to interpret the Bond’s causation requirement continues between courts. BancInsure, Inc. v. Highland Bank75 involved a claim under Insuring Agreement (E) of the Bond, which covers loss “resulting directly from the Insured having . . . acquired, sold, or delivered, given value, extended credit or assumed liability on the faith of any original . . . personal guaranty . . . which bears a signature of any guarantor . . . which is a Forgery.” The bank took an assignment of industrial equipment leases personally guaranteed by owners of the leases.76 The bank would not have entered into the agreement but for the personal guarantees from the lessees to the lessors.77 It was later discovered that the business was a Ponzi scheme, and one of the personal guarantees was forged.78 The bank sought coverage for its loss under Insuring Agreement (E).

The court recognized that the “Bankers Blanket Bond is designed to protect a bank against risks of dishonesty, both external and internal, but does not insure good management nor against the risk of loss inherent in the banking operations.”79 It agreed with the Third Circuit that “the phrase resulting directly from in the Bond does suggest a stricter standard of causation than mere proximate cause.”80 The court held that the bank’s loss did not result directly from the forgery because (1) the personal guaranty was worthless to begin with and (2) the bank never obtained a legal interest in the guaranty.81 Even if the guaranty had not been forged, the guarantor did not have assets to repay the loss. “This is an issue of loss causation.”82 Moreover, while the bank took assignment of leases, it never took an assignment of the guaranty itself.

75 779 F.3d 565, 566 (8th Cir. 2015). 76 Id. at 569. 77 Id. 78 Id. 79 Id. at 568. 80 Id. at 569. 81 Id. at 572. 82 Id. at 569.

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The bank’s loss was not direct because the guaranty always ran from the lessee to the lessor.83

Meanwhile, Cumberland & Erly, LLC v. Nationwide Mutual Insurance Co.84 arose out of an employee dishonesty policy that Nationwide issued to a law firm. The law firm was the trustee of a special needs trust checking account created for the benefit of a disabled minor who made a recovery in a medical malpractice action.85 A paralegal forged an attorney’s name on checks drawn on the trust account and deposited the funds in her own name.86 She intercepted and altered the bank statements to conceal her misconduct.87 The law firm replaced the funds stolen by its paralegal and made a claim to Nationwide for its loss.88 The policy obligated Nationwide to pay for “direct loss of or damage to Business Personal Property and ‘money’ and ‘securities.’”89

Nationwide argued that the law firm did not suffer a “direct loss” because the paralegal stole trust funds, rather than the law firm’s own money.90 The law firm only suffered an indirect loss when it used its own money to repay the funds stolen from the trust account.91 The court found Nationwide’s argument “unnecessarily narrow” and held that a “‘direct loss’ is one proximately caused by an employee’s dishonest act.”92 It admitted that proximate cause is borrowed from tort law but was persuaded by the argument in Scirex Corp. that the “‘direct is direct’ approach suffers from the flaw of attempting to define a term through the

83 Id. at 572. In FDIC v. RLI Insurance Co., 784 F.3d 1104, 1109-10 (7th Cir. 2015), the Seventh Circuit noted that the Bond requires “‘a direct nexus between the forgery and the loss’” in order to trigger coverage” but expressed doubt about the worthless collateral rule, although it found that the collateral at issue did have value. 84 128 F. Supp. 3d at 890. 85 Id. 86 Id. 87 Id. 88 Id. at 891. 89 Id. at 892. 90 Id. at 895. 91 Id. 92 Id.

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very language requiring definition.”93 The court found that the “term ‘direct cause’ is not susceptible to a clear, definite meaning, but instead is ‘a nebulous and largely indeterminate concept.’”94 It also expressed concern with an interpretation that did not cover third-party obligations “renders the policy meaningless.”95

Even though a few courts continue to cling to the familiar concept of proximate cause, it is apparent that the direct cause approach embodies the intent of the insurance and banking industries who have been negotiating the Bond’s coverage since the early 1900s.

VI. CONCLUSION Correlation is not enough. Coverage requires causation. Consequently, claimants and carriers consistently contest causation, including how the concept is defined. The SAA, fidelity carriers, and others have championed the direct is direct approach to causation by revising the standard bond form and advocating that approach in courts across the country. Courts have not yet reached a uniform conclusion on how to apply causation in fidelity cases, but there has been progress. Even though a few courts continue to cling to the familiar concept of proximate cause, it is apparent that the direct cause approach embodies the intent of the insurance and banking industries, which have been negotiating the Bond’s coverage since the early 1900s. While some courts continue to cling to proximate cause, an increasing majority require direct causation.

93 Id. 94 Id. 95 Id. at 896.

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STATE CAUSATION CASES COMMENTS Alabama Direct N & L Enterps., LLC Explaining that “the v. Lioce Props., LLP, intention of the 51 So.3d 273, 279 parties is to be (Ala. 2010). derived from the provisions of the contract itself . . . .” Alaska Direct State Farm Fire and Joining the Cas. Co. v. Bongen, “majority rule” that 925 P.2d 1042, 1045 the intention of the (Alaska 1996). parties as to the coverage of property insurance is determined by the words used in the policy. Arizona Direct Farmers Ins. Co. of Explaining that auto Ariz. v. Till, 825 P.2d policy language 954, 955 (Ariz. App. requiring causation Div. 1 1991). did not equate to proximate cause.

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Arkansas Proximate Pine Bluff Nat’l Bank Holding that v. St. Paul Mercury proximate cause Ins. Co., 346 F. Supp. was sufficient 2d 1020, 1032 (E.D. because the bond Ark. 2004). did not require a sole cause. California Direct Valley Comm. Bank v. Upholding insurer’s Progressive Cas. Ins. right to contract Co., 854 F. Supp. 2d around California 697, 709 (N.D. Cal. Insurance Code § 2012). 530, which adopts the proximate cause standard. Colorado Direct Abady v. Certain Writing that “direct Underwriters at financial loss” refers Lloyd’s London only to immediate Subscribing to Mortg. loss of the insured’s Bankers Bond-No. property through the MBB-06-0009, 317 dishonesty of its P.3d 1248, 1253 own employees. (Colo. App. Div. III 2012). Connecticut Direct Finkel v. St. Paul Fire Using contract, & Marine Ins. Co., rather than tort, No. principles to 3:00CV1194(AHN), determine causation. 2002 WL 1359672, at *3 (D. Conn. Jun. 6, 2002). Delaware Direct Mass. Mut. Life Ins. Noting that “direct Co. v. Certain means direct” is the Underwriters at majority rule across Lloyd’s of London, the country. C.A. No. 4791-VCL, 2010 WL 2929552, at *17 (Del. App. July 23, 2010).

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Florida Direct Prudential Prop. & Observing that Cas. Ins. Co. v. “Florida law has Swindal, 622 So.2d long followed the 467, 470 (Fla. 1993). general rule that tort law principles do not control judicial construction of insurance contracts.” Georgia Direct Citizens Bank & Trust Finding that “loss Co. v. St. Paul resulting directly Mercury Ins. Co., from” is not 2007 WL 4973847, at ambiguous. *4 (S.D. Ga. Sept. 14, 2007). Hawaii Direct Royal Hawaiian Sales Enforcing “direct Co. v. Home Ins. Co. loss” language in of Hawaii, 27 Haw. auto collision 333, 335 (1923). policy. Idaho Proximate Burgess Farms v. Requiring proximate New Hampshire Ins. cause for property Group, 702 P.2d 869, insurance coverage. 874 (Idaho App. 1985). Illinois Direct RBC Mortg. Co. v. Concluding that Nat’l Union Fire Ins. “the proximate Co. of Pittsburgh, 812 cause analysis is N.E.2d 728, 736 (Ill. simply too broad to App. 1st Dist. 2004). capture accurately the intent behind the phrase ‘loss resulting directly from.’”

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Indiana Proximate Nationwide Mut. Ins. Defining “loss Co. v. Neville, 434 resulting directly” N.E.2d 585, 588 (Ind. language in App. 1st Dist. 1982). accidental death policy as proximate cause and approving use of tort jury instruction. Iowa Direct City of Burlington v. Finding no direct Western Sur. Co., 599 loss when insured N.W.2d 469 (Iowa city chose to replace 1999). locks on school buildings after master key disappeared in order to avoid potential third-party liability claim by school district. Kansas Direct Steil v. Humana Holding in ERISA Kansas City, Inc., 124 case that “the court F. Supp. 2d 660, 664 cannot rewrite the (D. Kan. 2000). agreement importing an intent wholly unexpressed when it was executed.” Kentucky Proximate Fed. Deposit Ins. Equating direct Corp. v. Reliance Ins. cause with Corp., 716 F. Supp. proximate cause. 1001, 1004 (E.D. Ky. 1989). Louisiana Proximate First Nat’l Bank of Adopting proximate Louisville v. Lustig, cause standard. 961 F.2d 1162, 1167- 68 (5th Cir. 1992).

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Maine Proximate Hutchins v. Ford, 19 Using proximate A. 832, 834 (Me. cause language to 1890). discuss the “real” cause of loss under marine policy. Maryland Proximate Cumberland & Erly, Writing that a LLC v. Nationwide “‘direct loss’ is one Mut. Ins. Co., 128 F. proximately caused Supp. 3d 888, 895 (D. by an employee’s Maryland 2015). dishonest act.” Massachusetts Direct Atlas Metals Prods. Fearing that Co. Inc. v. proximate cause Lumbermens Mut. would turn fidelity Cas. Co., 829 N.E.2d bonds into liability 257, 262 (Mass. App. policies. 2005). Michigan Proximate Phillip R. Seaver Title Rejecting insurer’s Co., Inc. v. Great Am. argument that an Ins. Co., No 08-cv- employee stealing 11004, 2008 WL funds from a 4427582, at *3-4 customer trust (E.D. Mich. Sept. 30, account was merely 2008). a third-party liability. Minnesota Direct Alerus Financial N.A. Requiring direct v. St. Paul Mercury cause in forgery Insurance Co., Case case. But see Mid- No. 27-CV-09-3344 America Bank v. (Minn. Dist. Ct. for American Cas. Co., Hennepin County 745 F. Supp. 1480, June 28, 2010). 1485 (D. Minn. 1990) (applying proximate cause standard)

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Mississippi Direct U.S. Fid. & Guar. Co. Enforcing the v. Planters Bank & unambiguous Trust Co., No. language of Form 492CV240SD, 1995 24. WL 1945556, at *1 (N.D. Miss. Feb. 10, 1995). Missouri Direct Empire Bank v. Concluding no Fidelity & Dep. Co., coverage because 828 F. Supp. 675, 677 bank’s conduct, (W.D. Mo. 1993). rather than forgeries, was direct cause of loss. Montana Proximate Frontline Processing Adopting proximate Corp. v. Am. Econ. cause standard. Ins. Co., 149 P.3d 906, 908 (Mont. 2006). Nebraska Direct Omaha Bank for Holding that Coop. v. Aetna Cas. banker’s blanket & Sur. Co., 301 bond does not insure N.W.2d 564 (Neb. against 1981). consequences of insured’s own torts. Nevada Proximate Fourth St. Place v. Applying proximate Travelers Indem. Co., cause doctrine to 270 P.3d 1235, 1243 property insurance (Nev. 2011). coverage analysis. New Hampshire Direct Turtle v. N.H. Med. Noting that, Malpractice Joint “Contractual Underwriting Ass’n, language is 992 A.2d 624, 636 construed according (N.H. 2010). to its common meaning.”

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New Jersey Proximate Auto Lenders In a case of first Acceptance Corp. v. impression, the Gentilini Ford, Inc., court relied on what 854 A.2d 378, 387 it identified as the (N.J. 2004). approach taken by “the majority of federal courts.” New Mexico Direct Gonzalez v. Allstate Noting in under- Ins. Co., 921 P.2d insured motorist 944, 946 (N.M. case that “the 1996). language in the particular insurance policy is critical.” New York Direct Americredit Fin. Providing that “a Servs., Inc. v. Oxford contract should be Mgmt. Servs., 627 F. interpreted so as not Supp. 2d 85, 99 to render its terms (E.D.N.Y. 2008). nonsensical.” North Carolina Direct State Capital Ins. Co. Stating that v. Nationwide Mut. “homeowners Ins. Co., 350 S.E.2d policies provide 66, 73 (N.C. 1986). coverage for injuries so long as a non- excluded cause is either the sole or concurrent cause of the injury giving rise to liability.” North Dakota Direct NDCC § 26.1-32-03 “An insurer may contract out of the efficient proximate cause doctrine.” Ohio Proximate First Defiance Fin. Court relied on Corp. v. Progressive language in Cas. Ins. Co., 688 F. brokerage services Supp. 2d 703, 708 exclusion to (N.D. Ohio 2010). interpret “direct loss.”

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Oklahoma Direct Duensing v. State Recognizing that Farm Fire and Cas. policy language can Co., 131 P.3d 127, avoid the 134 (Okla. Civ. App. application of the Div. 1 2005). proximate cause doctrine. Oregon Proximate Bidwell & Co. v. Applying proximate Nat’l Union Fire Ins. cause standard. Co., No. CV-00-89- HU, 2001 WL 204843, at *9 (D. Or. Jan. 18, 2001). Pennsylvania Proximate Jefferson Bank v. Using proximate Progressive Cas. Ins. cause despite Co., 965 F.2d 1274, writing that “the 1281 (3d Cir. 1992). phrase ‘resulting directly from’ in the [bond] does suggest a stricter standard of causation that mere ‘proximate cause.’” Rhode Island Direct Textron, Inc. v. Aetna Requiring insured to Cas. and Sur. Co., show one direct 754 A.2d 742, 755 covered cause. (R.I. 2000). South Carolina Proximate Stevenson v. Conn. Interpreting Gen. Life Ins. Co., causation language 218 S.E.2d 427, 430 in accident (S.C. 1975). insurance policy as requiring proximate cause. South Dakota Direct SDCL § 58-11-39; Enforcing anti- Swenson v. State proximate cause Farm Fire & Cas. provision of Co., 891 F. Supp. 2d homeowner’s 1101, 1109 (D.S.D. insurance policy. 2012).

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Tennessee Direct K.W. Bancshares, Inc. Finding that bank’s v. Syndicates of loss was not due to Underwriters at the fact that a Lloyds, 965 F. Supp. document offered to 1047 (W.D. Tenn. induce the giving of 1997). a loan was forged, but that the statements therein were not factually true. Texas Direct Lynch Props., Inc. v. Recognizing that Potomac Ins. Co., 962 fidelity coverage is F. Supp. 956, 964 meant to insure (N.D. Tex. 1996), “against immediate aff’d, 140 F.3d 622 harm from (5th Cir. 1998). employee dishonesty.” Utah Direct Direct Mortg. Corp. Surveying cases and v. Nat’l Union Fire finding “direct Ins. Co. of Pittsburgh, means direct” PA, 625 F. Supp. approach more 1171, 1176 (D. Utah persuasive. 2008). Vermont Direct Patrick v. St. Paul Quoting cases Fire & Marine Ins., holding that “direct No. Civ. 1:99CV314, means direct.” 2001 WL 828251, at *3 (D. Vermont Feb. 15, 2001). Virginia Direct Piedmont Fed. Sav. & Denying coverage Loan Ass’n v. because loss was Hartford Accident & “hypothetical.” Indem. Co., 307 F.2d 310, 314 (4th Cir. 1962).

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Washington Proximate Hanson PLC v. Nat’l Approving Union Fire Ins. Co. of proximate cause Pittsburgh, Pa., 794 jury instruction. P.2d 66, 73 (Wash App. Div. 1 1990). West Virginia Direct Commercial Bank of Invoking direct loss Bluefield v. St. Paul causation analysis. Fire & Marine Ins. Co., 336 S.E.2d 552, 556 (W. Va. 1985). Wisconsin Direct Tri City Nat’l Bank v. Explaining that Fed. Ins. Co., 674 “direct” is not N.W.2d 617, 624 synonymous with (Wisc. App. 2003). “proximate.” Wyoming Proximate Bankers Life Co. v. Finding life Nelson, 108 P.2d 584, insurance coverage 588 (Wyo. 1940). where injury was proximate cause of death and there were no intervening forces. Puerto Rico Direct Oriental Fin. Group, Requiring claimant Inc. v. Fed. Ins. Co., to prove that loss Inc., 598 F. Supp. 2d resulted solely or 199, 208 (D.P.R. directly from 2008). employee’s dishonest acts.

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CIRCUIT CAUSATION CASES COMMENTS

1st Circuit Direct Summit Packaging Sys., Stating that “it is a Inc. v. Kenyon & Kenyon, basic principle of 273 F.3d 9, 12 (1st Cir. contract law that 2001). constructions that render contract terms meaningless should be avoided.” 2nd Circuit Proximate FDIC v. Nat’l Union Fire The court applied Ins. Co. of Pittsburgh, proximate cause to PA, 205 F.3d 66, 76 (2d policy language Cir. 2000). covering “loss resulting directly from” employee dishonesty. 3rd Circuit Proximate Scirex Corp. v. Fed. Ins. Adopting Co., 313 F.3d 841, 850 proximate cause (3d Cir. 2002). standard.

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4th Circuit Direct Piedmont Fed. Sav. & Holding no forgery Loan Ass’n v. Hartford coverage for loan Accident & Indem. Co., losses that savings 307 F.2d 310, 314 (4th and loan would Cir. 1962). have incurred even if the loan documents had not been forged because the “relation of the forgery to the loss is, at most, oblique.” 5th Circuit Proximate First Nat’l Bank of The court applied Louisville v. Lustig, 961 proximate cause to F.2d 1162, 1167 (5th Cir. policy covering 1992). “loss resulting directly from” employee dishonesty. 6th Circuit Direct Tooling, Mfg and Tech. Collecting cases Ass’n v. Hartford Fire from other Ins. Co., 693 F.3d 665, jurisdictions and 674 (6th Cir. 2012). finding that “at least a simple majority of courts that have considered the issue favor a ‘direct is direct’ . . . approach.” 7th Circuit Direct First State Bank of Applying contract, Monticello v. Ohio Cas. rather than tort, Ins. Co., 555 F.3d 564, principles to the 571 (7th Cir. 2009). bond.

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8th Circuit Direct BancInsure, Inc. v. The court denied Highland Bank, 779 F.3d coverage even 565, 571 (8th Cir. 2015). though the bank would not have entered into the collateral assignments but for the forgeries. 9th Circuit Direct Vons Co., Inc. v. Fed. Ins. The court Co., 212 F.3d 489, 492 succinctly wrote, (9th Cir. 2000). “‘direct’ means ‘direct.’” 10th Circuit Direct FDIC v. United Pacific Stating that “loss Ins. Co., 20 F.3d 1070, directly resulting 1080 (10th Cir. 1994). from” indicates a direct loss or the actual depletion of bank funds caused by the employee’s dishonest acts. 11th Circuit Direct Beach Community Bank Rejecting tort v. St. Paul Mercury Ins. principles but Co., 635 F.3d 1190, 1195 finding coverage (11th Cir. 2011). where the bank would not have made the loan in the absence of the fraud.