Peoples Bank & Trust Co. of Madison County v. Aetna Cas. & Sur. Co., 95-6250

• Decision Date: 19 May 1997
• Docket Number: No. 95-6250,95-6250
• Citation: 113 F.3d 629
• Parties: PEOPLES BANK & TRUST COMPANY OF MADISON COUNTY, Plaintiff-Appellant, v. The AETNA CASUALTY & SURETY COMPANY and the Ohio Casualty Insurance Company, Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 629

113 F.3d 629

PEOPLES BANK & TRUST COMPANY OF MADISON COUNTY, Plaintiff-Appellant, v. The AETNA CASUALTY & SURETY COMPANY and the Ohio Casualty

Insurance Company, Defendants-Appellees.

No. 95-6250.

United States Court of Appeals, Sixth Circuit.

Argued Oct. 3, 1996.

Decided May 19, 1997.

William M. Lear, Jr., J. Mel Camenisch, Jr., William L. Montague (briefed), Stoll, Keenon & Park, Lexington, KY, James T. Gilbert (argued), Coy, Gilbert & Gilbert, Richmond, KY, for Peoples Bank & Trust Company of Madison County.

Steven C. Martin (argued and briefed), McCaslin, Imbus & McCaslin, Cincinnati, OH, for The Aetna Casualty & Surety Company.

George B. Hocker (argued and briefed), Clark, Ward & Cave, Lexington, KY, for the Ohio Casualty Insurance Company.

Before: KRUPANSKY, BOGGS, and SILER, Circuit Judges.

OPINION

BOGGS, Circuit Judge.

Several officers and directors of Peoples Bank & Trust Co. of Madison County ("Peoples") cheated two bank customers in a business transaction. The customers sued the bank and its employees for fraud, and ultimately obtained a large settlement. Peoples then sued to recover that loss from its insurers, Aetna Casualty & Surety Company and Ohio Casualty Insurance Co. ("OCIC"), issuers of Bankers Blanket Bonds held by Peoples. ¹ Peoples appeals the district court's order of summary judgment for defendants. Because we agree with the district court that the officers and directors did not show the requisite "manifest intent" to cause a loss to Peoples, we affirm.

I

We begin the tale in medias res, in 1985, when Lawrence C. and Shirley A. Noble filed suit against Peoples and four of its officers and directors in Madison County, Kentucky, Circuit Court, alleging fraud and breach of fiduciary duty. The Nobles sought unspecified compensatory damages based, in part, on the loss of expectations, damage to reputation and credit, and severe emotional distress. They also sought punitive damages based on their allegation that "the actions of Defendants ... were deliberate, intentional, wanton, oppressive, and in reckless disregard of [the Nobles'] rights."

The Nobles' grievance against Peoples dated to 1979. At that time, they operated a filling station in Madison County, Kentucky, but aspired to some new business. They confided their ambitions to their banker, Robert E. Harris, executive vice president of Peoples. At one point, they considered adding a "Convenient store" to their service station, at a cost of about $15,000. Harris discouraged them from that modest and straightforward investment.

At about the same time the Nobles were expressing to Harris their eagerness to get into a new business, two of Harris's colleagues on the board of directors of Peoples told him of their desire to rid themselves of a business, and offered Harris a finder's fee for rounding up a buyer.

The enterprise in question was the Iron Gate Restaurant and Lounge, in Richmond, Kentucky, not far up the road from Berea, Kentucky, home of Peoples. The co-directors, Hershel Jones and Roger M. Oliver, Esq. (who was also the bank's counsel), each owned a one-third interest in the restaurant.

Harris urged the Nobles to buy the Iron Gate (according to the allegations in their lawsuit), saying the restaurant was doing "fantastic" and would be an ideal investment for the pair. The asking price was $210,000, he said, but the restaurant could be had for just $185,000.

To these temptations the Nobles succumbed. They did not have $185,000, but asked Peoples to loan them the sum. Harris presented the request to his boss, Marion Dempsey, the president and C.E.O. of Peoples, and agreed to split the finder's fee with Dempsey if the deal closed. The reason for splitting the commission with Dempsey is not stated; perhaps it was to secure his collusion in making the loan without submitting it to the bank's loan committee. Whatever the personal inducements, Dempsey and Harris decided that the credit risk on such a loan was too great for Peoples, and that the bank could make the loan only if the Small Business Administration were willing to guarantee ninety percent of it.

Harris and Oliver then prepared an SBA loan guarantee application for the Nobles and their newly-formed company, Noble Enterprises, Inc. Oliver, though himself a seller, also acted as Peoples's counsel, and rendered opinions in connection with the application.

As an essential step in obtaining the guarantee, Harris executed an SBA Settlement Sheet on behalf of Peoples certifying that "neither the Lender nor its officers, agents, affiliates or attorneys, have or will charge or receive, directly or indirectly, any bonus, fee, commission, or other payment or benefit.... Lender and Borrower hereby certify that no [such] fees have been or will be paid, directly or indirectly.... It is understood that all fees not approved by SBA are prohibited." Harris was not deterred by the legend on the Settlement Sheet clearly citing the statutory prohibitions against making false statements for the purpose of influencing in any way the action of the SBA, and warning of the possible penalties for so doing: a fine of not more than $5,000, or imprisonment for not more than two years, or both. See 18 U.S.C. § 1001 and 15 U.S.C. § 645. The concealment carried out by Harris also led to the frustration of SBA regulations against agency participation in a loan to finance the purchase of property in which the lender or an "associated person"--including the lender's officers and directors--is the seller, unless the SBA first makes a written determination that the purchase from the lender or associate is in the best interests of the small business concern. 13 C.F.R. §§ 120.1, 120.5(a)(1).

The fraudulently prepared and certified application passed muster at the SBA, which issued the desired guarantee. In August 1979, the Iron Gate sale closed. Jones and Oliver each pocketed some $60,000 for their shares of the business. Harris and Dempsey split a $5,800 finder's fee. The Nobles were in business.

But not for long. Within a year, their complaint averred, the Nobles "discovered that they had been induced by the aforesaid representations to purchase Iron Gate Restaurant at an extremely inflated price and that the restaurant was of little value and was not then and never had been a profitable business." By then, they had already stopped making payments on the Peoples loan. They filed for bankruptcy in 1981 and were discharged of their debts.

Shortly after completing the loan, Peoples had sold the guaranteed ninety-percent portion in the secondary market. When the Nobles defaulted, the then-assignee made demand on the SBA under the guarantee. The SBA honored the guarantee, to the tune of $171,604 in principal and interest.

There matters rested until April 1982, when the SBA, having received allegations from sources not revealed in the record, notified Peoples that it suspected "irregularities" in the application. After further investigation confirmed the false statements on the guarantee forms, the SBA demanded reimbursement by Peoples.

The chairman of the board of Peoples--who was, by all indications, unconnected with the transaction--retained counsel to investigate, confirmed the malfeasance of Dempsey, Harris, and Oliver, fired them, and notified appropriate banking regulators and the United States Attorney.

The bank also promptly notified its then-insurer, OCIC, of the discovery of what it believed was an insurable loss under the Bankers Blanket Bond issued by OCIC on January 1, 1981. ² Peoples submitted to OCIC a Proof of Loss under the fidelity bond, providing a detailed description of the dishonest and fraudulent acts of its employees and directors, and claiming a total of $200,607. ³ In February 1983, OCIC and Peoples negotiated a compromise settlement whereby OCIC paid Peoples $50,000, and Peoples released and discharged OCIC from "any and all claims, demands, actions or causes of actions, accrued, or to accrue, by reason of, or in any manner growing out of" the defaults of Dempsey, Harris, and Oliver.

Peoples replaced the OCIC Bankers Blanket Bond with one issued by Aetna, effective May 1, 1984. The Aetna bond had a higher liability limit and deductible than the OCIC bond, but was an otherwise identical Standard Form 24 policy.

II

For four years, meanwhile, the Nobles, even as they benefitted from the "fresh start" granted by the Bankruptcy Code, continued to nurture their grievance. Thus, we come around to where we began, with the filing of their lawsuit against Peoples in May 1985.

Upon receiving the Nobles' summons and complaint, Peoples promptly notified OCIC by letter, stated its position that the OCIC Bankers Blanket Bond covered the event, and invited OCIC to exercise its right under the bond to conduct the defense. OCIC responded by asserting its belief that "the release taken in February 24, 1983 is solid and discharges us from any further claims on this particular action." Further, OCIC asserted that the discovery of any loss that might flow from the lawsuit occurred at the time of the filing of the suit, after the coverage period of the OCIC bond ended.

Similarly, Peoples promptly notified Aetna of the Noble lawsuit, stated that it believed the Aetna bond covered any loss that might result, and invited Aetna to exercise its right under the bond to defend against the action. Aetna denied coverage on the grounds that discovery of the potential claim by a third party occurred when the SBA notified Peoples of the irregularities it had found in 1982, a date outside the period of coverage.

The record tells us little of the eight-year state court saga of Noble v. Peoples Bank & Trust Co. For present purposes, it is only important to know that Peoples's insurers declined to participate in the defense, and that in late 1993, on the eve of trial, Peoples settled the suit for $350,000.

Peoples promptly presented Proofs of Loss to both OCIC and Aetna, claiming...