Leucadia, Inc. v. Reliance Ins. Co.

• Decision Date: 18 January 1989
• Docket Number: D,No. 1333,1333
• Citation: 864 F.2d 964
• Parties: LEUCADIA, INC., Plaintiff-Appellant, v. RELIANCE INSURANCE COMPANY, Defendant-Third-Party Plaintiff-Appellee, v. Edward H. HELMKE, Third-Party Defendant. ocket 88-7197.
• Court: U.S. Court of Appeals — Second Circuit

Page 964

864 F.2d 964

LEUCADIA, INC., Plaintiff-Appellant, v. RELIANCE INSURANCE COMPANY, Defendant-Third-Party Plaintiff-Appellee, v. Edward H. HELMKE, Third-Party Defendant.

No. 1333, Docket 88-7197.

United States Court of Appeals, Second Circuit.

Argued June 3, 1988.

Decided Dec. 22, 1988.

As Amended on Denial of Rehearing Jan. 18, 1989.

Raymond Fitzgerald, New York City (Butler, Fitzgerald & Potter, New York City, Andrew W. Sidman, David J. McCarthy, of counsel), for plaintiff-appellant.

Philip Schlau, New York City (Newman Schlau Fitch & Burns, P.C., New York City, Abraham S. Altheim, Jan Kevin Myers, of counsel), for defendant-third-party plaintiff-appellee.

Perry S. Reich, Lindenhurst, N.Y. (Schapiro and Reich, Lindenhurst, N.Y., Steven M. Schapiro, of counsel), for third-party defendant.

Before LUMBARD, MINER, Circuit Judges, and CONNER, District Judge. ^*

LUMBARD, Circuit Judge:

Leucadia, Inc. appeals from a judgment of the Southern District entered on February 5, 1988, Daronco, J., pursuant to a jury verdict in favor of Reliance Insurance Company and third-party defendant Edward H. Helmke. Leucadia, which is in the business of factoring and investing, brought this action to recover $10 million pursuant to two fidelity bonds issued to it by Reliance, because of losses totaling over $15 million, allegedly sustained as a result of the dishonest and fraudulent acts of its employee Helmke while he was head of Leucadia's mortgage loan department. Reliance impleaded Helmke as third-party defendant for indemnification. Jurisdiction is based on diversity of citizenship, as Leucadia is a New York corporation, and Reliance is a Pennsylvania company. The parties agree that New York law applies.

Leucadia makes two principal claims. First, it asserts that the district court erroneously instructed the jury that Reliance was liable only for those fraudulent and dishonest acts committed during the period the bonds were in force, namely from May 1, 1976 to October 25, 1977. Leucadia alleges that the second bond covered all losses sustained while the bond was effective, regardless of when the acts that caused the losses had been committed. Leucadia also asserts that it was error for the judge to rule that any evidence of alleged misconduct occurring prior to the effective date of the first bond could be considered by the jury only to show intent to commit similar acts within the coverage period.

Second, Leucadia claims that the district court erred in instructing the jury that Leucadia was required to prove that Helmke had acted dishonestly by clear and convincing evidence. It alleges that, because the fidelity bonds covered both fraud and dishonesty, the court should have charged that there were different burdens of proof for fraud and dishonesty. Only a preponderance of the evidence is necessary to prove acts of dishonesty under New York law.

We hold that the district court correctly limited the coverage of the bonds to acts committed within their duration and that therefore it was proper to admit evidence of prior alleged misconduct only for the purpose of showing Helmke's intent. On Leucadia's second claim, we find that, because the fidelity bonds insured against either a "dishonest or fraudulent act," under New York law the court should have instructed the jury to employ separate evidentiary standards for proving fraud and for proving dishonesty. Judge Daronco correctly charged the jury that, in order to find that Leucadia's losses had resulted from fraudulent acts, it must find that the evidence of fraud was clear and convincing. However, he should also have instructed the jury that, in deciding whether any of Leucadia's losses had resulted from Helmke's dishonest acts, they would only have had to find that this was established by a preponderance of the evidence.

Although it was error for the court to charge the jury that there was a higher standard for dishonesty, our review of the evidence convinces us that no reasonable jury could have found that Leucadia had failed to establish Helmke's dishonesty by a preponderance of the evidence. In view of the evidence, the court's error was therefore harmless.

In May 1976, Leucadia purchased a fidelity bond (the May bond) under which Reliance agreed to indemnify it for up to $2 million in losses resulting from dishonest or fraudulent acts of an employee committed from May 1, 1976 through the bond period. On December 1, 1976, Leucadia cancelled the May bond and replaced it with a second fidelity bond (the December bond) to cover similar losses, this time up to $5 million, sustained from December 1, 1976 through its cancellation in October 26, 1977. The December bond provided continuing coverage for losses that would have been recoverable under the May bond but which were only sustained and discovered during the December bond's term.

Both fidelity bonds stipulated that for a loss to be covered, it must have been the "direct result" of a "dishonest or fraudulent act" of an employee or agent. As defined in a rider to both bonds, a "dishonest or fraudulent act" means:

only dishonest or fraudulent acts committed by [an] Employee with the manifest intent:

(a) to cause the Insured to sustain [a] loss; and

(b) to obtain financial benefit for the Employee or for any other person or organization intended by the Employee to receive such benefit....

In October 1978, Leucadia discovered that it had suffered losses allegedly within the coverage of the fidelity bonds. It believed that Helmke had fraudulently and dishonestly loaned millions of dollars of Leucadia's money to three borrowers, Isaac Silverman, Wayne Duddlesten and Morris Suson, and it demanded that Reliance pay it $10 million pursuant to the fidelity bonds. Reliance refused and Leucadia brought suit.

The evidence adduced at the four-week trial which concluded on January 29, 1988 showed the following. Helmke began his employment with James Talcott, Inc., Leucadia's predecessor in interest, on March 25, 1963 as assistant in-house counsel in the legal department. On March 1, 1965, he became an assistant secretary in the company's mortgage loan department where his duties were to process and supervise loans. In August 1967, he was promoted to assistant vice president of the mortgage loan department, in which he processed and supervised loans. On April 15, 1972, Helmke was promoted to vice president and manager of the mortgage loan department, where he remained until his termination on September 1, 1977.

As manager of the five-man mortgage loan department, which was engaged in making speculative investments involving real estate, investment trusts, and second and third mortgage loans, Helmke was responsible for overseeing all the accounts, for insuring that Leucadia received sufficient collateral on new loans and for protecting existing collateral on loans that were in default. In this position, Helmke reported directly to the president.

Prior to February 1, 1977, Helmke had the power to advance up to $350,000 in new investments. To effect a loan, someone in the mortgage loan department (usually Helmke) had to fill out and initial an advance card reflecting the amount of the loan. The card was then forwarded to the cashier's department, from which the money was paid out. After February 1977, Helmke's authority was reduced to $1,000 and he was additionally required to obtain the approval of Leucadia's senior credit committee, which based its decisions largely on internal memos, quarterly status reports, monthly statements of delinquent accounts, and computer credit worthiness analyses that Helmke provided.

In mid-October 1977, two weeks after his termination on September 1, 1977, Helmke became director and president of a company controlled by Silverman's son-in-law, Marvin Shafron, who had assisted Silverman during the period when Helmke, as head of the department, had loaned Silverman money.

The facts concerning Helmke's dealings with the three borrowers, Silverman, Duddlesten and Suson, are as follows:

The Silverman Transactions

Isaac Silverman, a client of Leucadia's since the 1960s, used most of his borrowed funds to operate the Grand White Realty Corporation, a New York company he owned. Grand White owned seven properties in New York on which Leucadia had second and third mortgages as security for its loans. Silverman also gave Leucadia a personal guaranty on the loans. The Grand White loan, the subject of a "consolidation extension agreement" in 1970, was scheduled to be repaid in August 1973, one year into Helmke's tenure as head of the mortgage loan department. By then the debt was in default for over $6 million.

In the summer of 1973, Helmke entered into a second consolidation and extension agreement with Silverman which postponed repayment to January 1975. At about the same time, Helmke caused Leucadia to foreclose upon one of the seven properties securing the Grand White loans and reduced the outstanding debt accordingly.

Later in 1973, Helmke returned one of Silverman's personal guaranties. At trial he explained that this guaranty meant nothing to Leucadia because its policy was never to collect personal guaranties and, in any event, it had other Silverman guaranties on file; the return of this one guaranty, he said, was necessary in order to negotiate certain terms of a loan agreement with Silverman.

From 1972 to 1976, as a result of a decline in the real estate market, the properties that collateralized the Grand White loan became less marketable. In a status report to his superiors in 1976, Helmke stated that the net appraised total value of the collateral was $10,984,828 (arrived at after deducting the amount of the prior mortgages to cover the Leucadia mortgage), in contrast to its 1972 appraised value of $21,200,000.

Leucadia claims that in this report Helmke overrepresented the value of one of the properties by $1,350,000 to $2,000,000. Helmke cited its appraised value at...