Downey Savings & Loan Assn. v. Ohio Casualty Ins. Co.

• Decision Date: 26 February 1987
• Citation: 234 Cal.Rptr. 835,189 Cal.App.3d 1072
• Court: California Court of Appeals Court of Appeals
• Parties: DOWNEY SAVINGS AND LOAN ASSOCIATION, Plaintiff, Appellant and Cross- Respondent, v. The OHIO CASUALTY INSURANCE COMPANY, Defendant, Respondent and Cross-Appellant. B009549.

Page 835

234 Cal.Rptr. 835

189 Cal.App.3d 1072

DOWNEY SAVINGS AND LOAN ASSOCIATION, Plaintiff, Appellant and Cross- Respondent, v. The OHIO CASUALTY INSURANCE COMPANY, Defendant, Respondent and Cross-Appellant.

B009549.

Court of Appeal, Second District, Division 3, California.

Feb. 26, 1987.

Review Denied May 27, 1987.

George C. Montgomery, Bruce M. Thornton, Montgomery, Gascou, Gemmill & Thornton and Robert E. Jones, Los Angeles, for defendant, respondent and cross-appellant.

Saphier and Rein and Michael S. Saphier, Los Angeles, for plaintiff, appellant and cross-respondent.

KENNARD, ^* Associate Justice.

Plaintiff Downey Savings and Loan Association (hereafter Downey) brought a bad faith action against defendant Ohio Casualty Insurance Company (hereafter Ohio) for denial of benefits under a fidelity bond issued by Ohio. A jury awarded Downey $152,983.43 in compensatory damages and $5,000,000 in punitive damages. Downey appeals from that portion of the judgment denying it attorney's fees, while Ohio cross-appeals from the judgment against it. Reversed as to Downey's appeal.

FACTS

Viewing the evidence in the light most favorable to Downey, as we must (Leff v. Gunter (1983) 33 Cal.3d 508, 511, 189 Cal.Rptr. 377, 658 P.2d 740; Moore v. American United Life Ins. Co. (1984) 150 Cal.App.3d 610, 616, fn. 2, 197 Cal.Rptr. 878), the facts are as follows:

A. Facts Relating to Downey's Claim Based on Employee Dishonesty

On February 1, 1973, Ohio issued a "Savings and Loan Blanket Bond" to Downey. The bond provided coverage for losses caused by the dishonest act of any of Downey's employees, up to a maximum of $3,000,000. The bond also promised to indemnify Downey for court costs and attorney's fees incurred by Downey in defending any lawsuit brought by a third party arising out of the dishonest acts of Downey's employees.

In late 1974, Steven Jones and Ronald Noday concocted a scheme whereby checks with insufficient funds would be used to buy certificates of deposit, which would then be pledged as security for loans from third-party lenders. The bad checks would be provided by Noday or his associates, Arthur Madison and William Beverly Smart. Having heard from his brother-in-law that Dennis McGrew, manager of Downey's branch in Rolling Hills, might be interested in making "some extra money," Jones invited McGrew to Noday's house in Palos Verdes on October 31, 1974. After a six-hour meeting, McGrew agreed to participate.

On December 11, 1974, McGrew wrote to the Bank of America in Sacramento that Madison and Noday were valued clients of Downey's and could place large certificates of deposit, up to a total of $1 million, with the Bank of America. Though McGrew's signature was on the letter, it had been drafted by Madison. Also, neither Noday nor Madison had an account with Downey.

On December 31, 1974, Noday obtained a check for $100,000 from Madison to open an account at Downey's Rolling Hills branch office in the name of Laurence A. Smith, Jr. There were insufficient funds to cover the check, a fact known to McGrew. Three days later, Noday opened another account at Downey's Rolling Hills branch, this time in his name, with a check for $220,000 drawn on a bank in the Bahamas, whose president was a friend of Noday's. This too was a bad check, and McGrew knew this.

In early January 1975, Noday and his associates applied to American Funding for a loan to CTR Leasing Company, which was controlled by Smart, pledging the $100,000 Smith account at Downey's as collateral. In response to a telephone call from an American Funding employee, McGrew verified the existence of the $100,000 certificate of deposit, even though he already knew the check had been dishonored because it was drawn on a closed account. The American Funding employee also made an appointment to see McGrew later that day to have him sign an assignment of the account. McGrew specifically mentioned to his assistant, Linda Johnson, that he had to sign an assignment that afternoon. As part of the plan worked out with Noday and Jones, however, McGrew left for lunch at 3:00 p.m., before the arrival of the American Funding employee. When the latter arrived at the bank and found that McGrew was not there, she became upset, saying she had an appointment with him. Assistant Manager Linda Johnson signed the assignment. Later McGrew told Jones everything had worked out as planned and since he did not sign the assignment he would not be directly connected with it.

Upon McGrew's return to the bank later in the day, Johnson showed him a copy of the assignment she had signed. The document stated there were no liens, holds or encumbrances on the Smith account, and certified that the account was fully insured. McGrew knew this information to be false, but he did not notify American Funding or anyone at Downey's thereof. Relying on the signed assignment, American Funding issued Smart a cashier's check for $100,000 in the late afternoon of January 8, 1975. The check was cashed the next day.

In late January 1975, Noday tried to obtain a second loan from American Funding by pledging his $220,000 account at Downey's as collateral. The Chief Executive Officer at American Funding, A. Gordon Elder, became suspicious when he noticed that the assignment executed by Downey did not contain the name of the assignee. He paid a visit to Richard Bond, Vice-President at Downey's main office in Downey, and asked if it was Downey's practice to leave the name of the assignee blank. When Bond replied it was not, Elder showed him the assignment of the $220,000 account. Elder also showed Bond the assignment of the $100,000 account and asked about its validity, adding he had already made a loan on the $100,000 but not on the $220,000 account. When Bond discovered a zero balance on the $100,000 account, he told Elder he would have to do some further checking and would telephone him later, but that the $220,000 assignment was not valid and would not be honored by Downey.

Unable to collect on the $100,000 loan to the company controlled by Smart, American Funding sued Downey. Downey requested Ohio to pay its attorney's fees in defending the American Funding lawsuit, but Ohio refused to do so, claiming no liability under the fidelity bond it had issued to Downey.

B. Facts Relating to Ohio's Bad Faith

John H. Rehm, Jr., Assistant Vice-President at Ohio and its Superintendent of the Bond Claims Department at Ohio, supervised all of Ohio's bond claims on a nationwide basis. He also wrote Section 18 of Ohio's claims manual setting forth the standards for the handling of bond claims. Those standards were consistent with the standards of the insurance industry, and included the following: (1) upon receipt of notice of any occurrence, the underwriter was to immediately refer the matter to the claims department; (2) if review by the claims department indicated the possibility of a claim, an adjuster was to be assigned immediately and an investigation commenced forthwith, requiring contact with the insured within 24 hours after an adjuster's assignment, and prompt contact with the allegedly dishonest employee.

On January 31, 1975, within 48 hours after the meeting between Downey's Bond and American Funding's Elder, Downey notified Ohio of the circumstances surrounding the $100,000 and $220,000 transactions. A second notice to Ohio was given on February 3, 1975. Ohio, however, took no action and did not refer the matter to its claims department, even though it knew of Downey's belief that an "inside man" was involved.

On February 28, 1975, Downey's Bond wrote a letter to Judith Nye, the insurance agent for Ohio, mentioning McGrew's representation to the American Funding employee that he would sign the assignment of the $100,000 account, even though McGrew had learned the previous day that the $100,000 check used to open the account at Downey had been dishonored. It was not until May 19, 1975 that Ohio's claims department received the February 28, 1975 letter. Robert Shafer, manager of Ohio's claims department, sent a copy of the letter to Rehm with the notation, "questioning possible fraud or embezzlement." Shafer also sent Rehm a letter from Nye stating that McGrew was no longer employed by Downey. Shafer assigned the matter to adjuster Robert Jones for investigation.

On May 23, 1975, Rehm wrote Shafer a memorandum in which he acknowledged the possibility of employee dishonesty but warned Shafer not to waive any defenses under the bond. Rehm then assigned a claim number to the matter, and established a reserve, that is, an estimate of the value of the claim. No attempt was made to interview any of the persons involved in the transaction. Ohio's first contact with Downey was by letter dated May 29, 1975, stating that Ohio did not receive notice of the transaction until May 19, 1975. Rehm admitted in court that Ohio was given notice on January 31 and February 3, 1975, but that Ohio used the May 19, 1975 date to set up its defense of late notice under the bond. Rehm also said he knew the letter contained false information, but that he did nothing to correct it.

A copy of Ohio's May 29, 1975 letter to Downey was sent to Judith Nye. She immediately called Shafer, telling him the May 19, 1975 date was incorrect since she had personally notified Ohio in late January and early February 1975 of the incident. Shafer told Nye, "Don't worry about it. It is just a form letter. It goes to everybody."

In late July 1975, Ohio conducted a 20-minute interview with Richard Bond. A memorandum of the interview was written on August 27, 1975, and a copy was sent to Rehm. Rehm testified that after reading the results of the investigation, he suspected McGrew's involvement in both the $100,000 and $220,000 transactions, but he never instructed anyone at Ohio to interview McGrew, even though he realized such an interview was necessary to complete Ohio's investigation. On September 5, 1975, Rehm wrote a...