Boston Mut. Life Ins. v. Fireman's Fund Ins.

• Decision Date: 22 July 1985
• Docket Number: Civ. A. No. 82-1786-K.
• Citation: 613 F. Supp. 1090
• Parties: BOSTON MUTUAL LIFE INSURANCE COMPANY, Plaintiff, v. FIREMAN'S FUND INSURANCE COMPANY, Defendant.
• Court: U.S. District Court — District of Massachusetts

613 F. Supp. 1090

BOSTON MUTUAL LIFE INSURANCE COMPANY, Plaintiff, v. FIREMAN'S FUND INSURANCE COMPANY, Defendant.

Civ. A. No. 82-1786-K.

United States District Court, D. Massachusetts.

July 22, 1985.

Alan Spiro, Will J. Bangs, Wm. Gerald McElroy, Jr., Choate, Hall & Stewart, Boston, Mass., for plaintiff.

Allen N. David, Paul R. Devin, Peabody & Arnold, Boston, Mass., for defendant.

Opinion

KEETON, District Judge.

Plaintiff, Boston Mutual Life Insurance Company ("Boston Mutual"), filed suit against Fireman's Fund Insurance Company ("Fireman's Fund") to recover on a Fidelity Name Schedule Bond for losses resulting from dishonest acts of Alexander M. Thompson, doing business as Alex Thompson Insurance Service ("Thompson"). This action is before the court under diversity jurisdiction. See 28 U.S.C. § 1332 (1982). The evidence was presented in a five day non-jury trial. On the basis of the findings and conclusions recited in this Opinion, judgment will be entered for the defendant because of plaintiff's failure to give notice as required by paragraph 6 of the bond.

I.

Boston Mutual is an insurer on various life, accident, and sickness group insurance policies for public employees in the State of Maryland. These group insurance policies are managed by a third-party administrator, who acts as a contact between the primary insurer, Boston Mutual, and the insured employees, their union, and the payroll centers that remit premiums. In October 1976 Boston Mutual entered into an agreement with Thompson providing that he was to serve as the third-party administrator for the Maryland group insurance policies. During 1977 and 1978, Boston Mutual discovered that Thompson had misappropriated some of its premiums from the group insurance policies. Thompson agreed to return the money, and he signed a $120,000 note payable to Boston Mutual and eventually gave Boston Mutual a mortgage on his home. In light of Thompson's agreement to return the money, Boston Mutual decided not to terminate his service as third-party administrator.

On November 10, 1978, Boston Mutual purchased a Fidelity Name Schedule Bond from Fireman's Fund. The bond covered Boston Mutual against losses resulting from larceny, embezzlement, and misappropriation or any other fraudulent or dishonest acts committed by its employees, including third-party administrators. Between 1978 and 1981, Thompson allegedly misappropriated almost $500,000 in premiums from Boston Mutual. Boston Mutual notified Fireman's Fund of these acts on March 30, 1981, and seeks to recover all of the misappropriated funds. Fireman's Fund contends that, under the terms of the policy, Boston Mutual is not entitled to recover the alleged losses.

II.

The relevant provisions of the bond follow:

THIS BOND IS SUBJECT TO THE FOLLOWING CONDITIONS:

. . . . .

WHAT EMPLOYEES ARE COVERED— WHEN COVERAGE EFFECTIVE

2. This bond shall be effective as of the 10th day of November, 1978. Employees named in the attached schedule are covered on and after the effective date....

. . . . .

TERMINATION OF COVERAGE

5. The coverage on any employee shall terminate when the employment terminates; ... or the Insured becomes aware of any act of the employee which is or could be made the basis of a claim under this bond....

. . . . .

TIME LIMIT FOR DISCOVERING AND REPORTING LOSS AND BRINGING SUIT

6. Compliance by the Insured with the following limitations shall be a condition precedent to recovery hereunder: That as soon as reasonably possible and in any event within fifteen days after discovery by the Insured of any act or circumstance indicating a probable claim hereunder, written notice thereof be given to the Underwriter ...; that within ninety days after such discovery, itemized sworn statement of claim be filed with the Underwriter....

Exhibit 111, at 1-3.

The principal legal issues in dispute in this case center on differing interpretations advanced by the parties as to the meaning and effect of a phrase in paragraph 5, "Termination of Coverage,"

the Insured becomes aware of any act of the employee which is or could be made the basis of a claim under this bond,

and a phrase in paragraph 6, "Time Limit for Discovery and Reporting Loss and Bringing Suit,"

discovery by the Insured of any act or circumstance indicating a probable claim hereunder.

The decision in this case turns upon the application of the notice requirement prescribed in paragraph 6. Because of the relevance of both similarities and differences between paragraph 6 and paragraph 5, this Opinion examines both provisions.

Defendant contends that, in determining whether Boston Mutual became "aware" of enough to terminate coverage before all the losses claimed had occurred (paragraph 5), or made "discovery" of enough to bar recovery for noncompliance with the requirement of written notice (paragraph 6), the court should apply a standard that is, to some extent, objective rather than purely a state-of-mind standard. Thus, a central issue before the court may be stated in this way: Under applicable law, will "aware" as used in paragraph 5 and "discovery" as used in paragraph 6 be held to refer only to states of mind, or may the plaintiff be held to be "aware" and to have made a "discovery" because, by some objective standard of judgment, plaintiff should have been "aware" and "should have discovered" some relevant fact or circumstance?

The defense argument for an objective standard is not merely an argument that negligence in failing to discover loss earlier terminated coverage and invoked the notice requirement. That is, the choice among standards is not simply a choice between one objective standard — the negligence standard — and one subjective standard — the state of mind of knowledge of Thompson's fraud. In this, as in other contexts, many objective standards might be suggested, ranging from slight negligence to a form of extreme fault that is sometimes described as ignoring the obvious — failing even to recognize what would be perceived by all but the most foolish persons. Similarly, many different state-of-mind standards might be suggested — ranging from knowledge that Thompson had committed fraudulent acts that had caused probable loss within the coverage of the bond to "awareness" or "discovery" of some defined act or circumstance, without "awareness" or "discovery" of its significance. How should the court determine which among these many possibilities is the standard to be applied under the law applicable to this case?

The answer cannot be found by comparing the number of decisions applying subjective standards with the number applying objective standards for defining the duration of coverage or determining when written notice must be given. Neither party has called attention to any applicable precedent explicitly purporting to override the manifested intent of the parties in relation to the contractual provisions at issue here. Thus, no basis for rights at variance with contract provisions having been shown to apply, the contract between the parties is to be construed and enforced in accordance with the manifested intent of the parties. As to each of the two clauses at issue here, "it is a contract provision we are interpreting, and meaning is to be extracted in the usual commonsense ways." Morin v. Massachusetts Blue Cross, Inc., 365 Mass. 379, 387, 311 N.E.2d 914, 919 (1974).

Parts III and IV of this Opinion examine the two clauses at issue from the perspective of a commonsense interpretation. Parts V and VI of the Opinion consider contentions for a different interpretation and authorities cited in support of and in opposition to those contentions. Parts VII, VIII, and IX apply the conclusions of law to the facts of this case.

III.

The "Termination of Coverage" clause of the bond states that the duration of the period of coverage shall extend from November 10, 1978 until plaintiff "becomes aware of any act of the employee Thompson which is or could be made the basis of a claim under this bond." A commonsense construction of the phrase "becomes aware" is that it refers to a state of mind. This interpretation is consistent with ordinary usage.

Applying a state-of-mind standard to any claim of vicarious liability — that is, liability of one person or entity for the conduct of another — may present a number of special problems. One troublesome problem — whether one responsible person must be found to have both the requisite state of mind as to the existence of the bond and as to the fraudulent acts of Thompson — is considered in Part VIII. A related but less troublesome point, not in dispute in this case, is that the standard of being "aware" applicable to Boston Mutual in this case is satisfied if it is proved that a person in authority for Boston Mutual (that is, a person having authority and acting within the scope of that authority), was "aware." Cf. Guthrie v. J.J. Newberry Co., 297 Mass. 245, 249, 8 N.E.2d 774, 776 (1937) (using the idiom of "imputing" to defendant corporation its restaurant manager's knowledge of plaintiff's contention that she had been made ill by eating food purchased in its restaurant). Thus, one relevant inquiry is whether some person in authority for Boston Mutual, at a time preceding occurrence of part or all of the loss claimed, became "aware."

As with any other state-of-mind standard, we must answer the question, "aware of what," before we have defined the standard for determining the issue at hand. The answer provided by clause 5 of the bond is, "of any act of the employee Thompson which is or could be made the basis of a claim under this bond." Does this clause mean that awareness need extend only to the act itself, so the standard is satisfied without a finding of awareness that the act has significance, or even potential significance, in relation to a claim under the bond? Or must the awareness extend as well to the fact that the act "is ... the basis of a claim," or at least to a...