Direct Mortg. Corp. v. National Union Fire Ins., Case No. 2:06-CV-534-TC.

• Decision Date: 08 August 2008
• Docket Number: Case No. 2:06-CV-534-TC.
• Parties: DIRECT MORTGAGE CORPORATION, Plaintiff, v. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA, Defendant.
• Court: U.S. District Court — District of Utah

625 F.Supp.2d 1171

DIRECT MORTGAGE CORPORATION, Plaintiff, v. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA, Defendant.

Case No. 2:06-CV-534-TC.

United States District Court, D. Utah, Central Division.

August 8, 2008.

Daniel K. Brough, Bennett Tueller Johnson & Deere PC, Salt Lake City, UT, for Plaintiff.

Curtis J. Drake, Peter H. Donaldson, Scott A. DuBois, Snell & Wilmer, David N. Wolf, Utah Attorney General's Office, Salt Lake City, UT, for Defendant.

ORDER AND MEMORANDUM DECISION

TENA CAMPBELL, Chief Judge.

This case arises out of Plaintiff Direct Mortgage Corporation's ("Direct Mortgage") claim for coverage under a fidelity bond issued by Defendant National Union Fire Insurance Company of Pittsburgh, PA ("National Union"). Direct Mortgage seeks coverage for its liability to third party financial institutions that unknowingly purchased fraudulently-obtained mortgages from Direct Mortgage and then demanded that Direct Mortgage buy back the mortgages under warranty clauses in the purchase agreements. Direct Mortgage settled with those entities and submitted a claim to National Union. National Union denied the claim on the basis that Direct Mortgage did not suffer a direct loss under the fidelity bond.

The parties have filed cross-motions for partial summary judgment¹ on the coverage issue.² Because the court finds that the fidelity bond's unambiguous language does not cover the indirect, consequential loss suffered by Direct Mortgage, National Union is entitled to partial summary judgment on that issue.

A. Factual Background³

Direct Mortgage is a wholesale lending company that generates revenue by originating mortgages through its broker network and selling those loans in the secondary market. National Union issued Direct Mortgage a Financial Institution Bond which contains various types of coverage,⁴ including protection against the risk of employee dishonesty (the "Fidelity Bond").⁵

Direct Mortgage filed its claim with National Union after it discovered that its employee, Lloyd Rutherford,⁶ falsified various documents necessary to close the loans. For example, Mr. Rutherford purportedly changed the value of the appraisals, altered the square footage of the property, falsified income verifications, and, in some cases, replaced the property description to which the loan pertained with a different property description. Direct Mortgage then sold the loans to its customers—including CitiMortgage, Countrywide Home Loans, GMAC Mortgage, and Washington Mutual—which, upon discovery of the fraud, demanded (based on Direct Mortgage's repurchase obligations in the sales agreements) that Direct Mortgage buy back the fraudulently-obtained loans.

Direct Mortgage settled with its customers. Then Direct Mortgage filed a claim with National Union for loss based on its settlement obligations. National Union contends that Direct Mortgage's claim does not fall within the type of loss covered by the Fidelity Bond.

B. The Fidelity Bond

The relevant portion of the Financial Institution Bond is titled the "Amended Fidelity Agreement." The language, located in Rider # 8 of the bond, creates the "fidelity bond" in dispute here. According to Rider # 8, National Union agreed to provide coverage to Direct Mortgage for:

(A) Loss resulting from dishonest or fraudulent acts committed by an Employee acting alone or in collusion with others. Such dishonest or fraudulent acts must be committed by the Employee with the manifest intent:

(a) to cause the Insured to sustain such loss, and

(b) to obtain financial benefit for the Employee or another person or entity.

As used throughout this Insuring Agreement, financial benefit does not include any employee benefits earned in the normal course of employment, including: salaries, commissions, fees, bonuses, promotions, awards, profit sharing or pensions.

(Financial Institution Bond No. 690-71-28, Fidelity Insuring Agreement ["Fidelity Bond"], attached as Ex. A to Def.'s Mem. Supp. Mot. Summ. J.) The bond contains the following relevant exclusions:

This bond does not cover: ...

(l) damages of any type for which the Insured is legally liable, except compensatory damages, but not multiples thereof, arising directly from a loss covered under this bond; ...

(n) indirect or consequential loss of any nature....

(Fidelity Bond Exclusions 2(l) & 2(n).)

C. Coverage Under the Fidelity Bond

According to the Fidelity Bond language, Direct Mortgage, in order to prevail on its claim of coverage, must present sufficient evidence that Mr. Rutherford was an employee who committed dishonest or fraudulent acts, with a manifest intent to harm Direct Mortgage and to benefit himself or others, that resulted in a loss covered under the Fidelity Bond. Because the court finds that Mr. Rutherford's actions did not result in a loss covered under the Fidelity Bond,⁷ Direct Mortgage is not entitled to coverage.

1. Split Among Jurisdictions (Proximate Cause v. "Direct Means Direct")

No Utah law exists on the question of recovery under fidelity bonds. "In deciding an issue that the Utah Supreme Court has not addressed, we must look to lower state court decisions, decisions of other states, federal decisions, and other available resources in deciding how the Utah Supreme Court would decide the issue." FDIC v. Oldenburg, 34 F.3d 1529, 1539 (10th Cir.1994) (internal citation and quotation marks omitted).

Direct Mortgage and National Union present two competing interpretations of "loss" under the Fidelity Bond. Their positions reflect a split in jurisdictions on the issue of what constitutes a direct loss under a fidelity bond.

Direct Mortgage advocates application of the "proximate cause" standard to determine whether the loss directly resulted from Mr. Rutherford's actions. See, e.g., Scirex Corp. v. Federal Ins. Co., 313 F.3d 841, 848-50 (3d Cir.2002) (adopting proximate cause test; applying Pennsylvania law); Resolution Trust Corp. v. Fidelity & Deposit Co. of Maryland, 205 F.3d 615, 655 (3d Cir.2000) (same; applying New Jersey law); Jefferson Bank v. Progressive Cas. Ins. Co., 965 F.2d 1274, 1282 (3d Cir.1992) (same; applying Pennsylvania law); First Nat'l Bank of Louisville v. Lustig, 961 F.2d 1162, 1167-68 (5th Cir. 1992) (same; applying Louisiana law); Auto Lenders Acceptance Corp. v. Gentilini Ford, Inc., 181 N.J. 245, 854 A.2d 378 (2004) (same). These courts have essentially equated "direct loss" with a loss proximately caused by the dishonest employee's acts. An Illinois court described the proximate cause standard as requiring a finding that the employee's conduct was "a substantial contributing factor to the harm suffered." RBC Mortgage Co. v. National Union Fire Ins. Co. of Pittsburgh, 349 Ill.App.3d 706, 285 Ill.Dec. 908, 812 N.E.2d 728, 736 (2004). The courts adopting the "proximate cause" standard have borrowed from tort law and other insurance contexts. See, e.g., Jefferson Bank, 965 F.2d at 1280-81. In Utah, proximate cause is "that cause which, in the natural and continuous sequence[ ] (unbroken by an efficient intervening cause), produces the injury and without which the result would not have occurred. It is the efficient cause—the one that necessarily sets in operation the factors that accomplish the injury." Thurston v. Workers Comp. Fund of Utah, 83 P.3d 391, 395 (Utah Ct.App.2003) (internal quotation marks and citation omitted).

National Union advocates a narrower reading, sometimes referred to as the "direct means direct" approach. See, e.g., Vons Cos., Inc. v. Federal Ins. Co., 212 F.3d 489 (9th Cir.2000) (interpreting California law, the court rejected proximate cause test); Patrick Schaumburg Autos. v. Hanover Ins. Co., 452 F.Supp.2d 857 (N.D.Ill.2006) (same); RBC Mortgage Co. v. National Union Fire Ins. Co. of Pittsburgh, 349 Ill.App.3d 706, 285 Ill.Dec. 908, 812 N.E.2d 728, 736-37 (2004) (same); Travelers Ins. Cos. v. P.C. Quote, Inc., 211 Ill.App.3d 719, 156 Ill.Dec. 138, 570 N.E.2d 614, 621 (Ill.App.Ct.1991) (same); Aetna Cas. & Surety Co. v. Kidder, Peabody & Co., Inc., 246 A.D.2d 202, 676 N.Y.S.2d 559 (1998) (same); Tri City Nat'l Bank v. Federal Ins. Co., 268 Wis.2d 785, 674 N.W.2d 617 (2003) (same). The "direct means direct" approach requires a court to focus on whether the employer suffered actual depletion of funds as a direct (immediate) result of the employee's conduct.

2. Cases Adopting "Direct Means Direct" Approach are More Persuasive.

The court finds that the Utah Supreme Court would most likely adopt the "direct means direct" approach because cases advocating that approach are better reasoned and more consistent with the traditional nature of fidelity bonds and the language of the Fidelity Bond at issue. See Nielsen v. O'Reilly, 848 P.2d 664, 666 (Utah 1992) (noting the purpose and nature of policy is relevant to interpretation of insurance contract). For example, adopting the proximate cause approach would effectively ignore the term "direct" in the Fidelity Bond because a direct loss is narrower than a proximately caused loss. See, e.g., RBC Mortgage, 285 Ill.Dec. 908, 812 N.E.2d at 736 ("[T]he phrase `resulting directly from' suggests a stricter standard of causation than mere proximate cause, and requires more than a substantial cause, since the words imply that the loss must flow `immediately,' either in time or space, from the fraud."); Aetna Cas. & Sur., 246 A.D.2d at 210, 676 N.Y.S.2d 559 ("The logical extension of [the proximate cause argument], that settlement with a third-party under [facts showing that employee broker engaged in insider trading], would create the potential for almost any loss, not initially direct to the insureds, to become a direct loss, a subterfuge that would render the exclusion in this case [which was identical to Exclusion 2(l) here] clearly meaningless."); Tri City Nat'l Bank, 674 N.W.2d at 625 (noting that fidelity bond is not a liability insurance policy and to adopt the proximate cause standard would...