Federal Ins. Co. v. Hpsc, Inc.

• Decision Date: 15 March 2007
• Docket Number: No. 06-1050.,06-1050.
• Citation: 480 F.3d 26
• Parties: FEDERAL INSURANCE CO., Plaintiff, Appellant, v. HPSC, INC., Defendant, Appellee.
• Court: U.S. Court of Appeals — First Circuit

480 F.3d 26

FEDERAL INSURANCE CO., Plaintiff, Appellant, v. HPSC, INC., Defendant, Appellee.

No. 06-1050.

United States Court of Appeals, First Circuit.

Heard December 4, 2006.

Decided March 15, 2007.

Bradford R. Carver, with whom CharCretia, V. DiBartolo, Stephen R. Swofford and Hinshaw & Culbertson LLP were on brief, for appellant.

Jillian B. Hirsch, with whom William Shields and Day, Berry & Howard LLP were on brief, for appellee.

Before TORRUELLA and LIPEZ, Circuit Judges, and SMITH,^* District Judge.

TORRUELLA, Circuit Judge.

This case arises from a failed attempt by defendant-appellee HPSC, Inc. ("HPSC") to recover an embezzlement loss under an executive protection insurance policy issued by plaintiff-appellant Federal Insurance Co. ("Federal"). Federal brought this declaratory judgment action against HPSC seeking rescission of the policy based on a misrepresentation made by HPSC in its 2001 insurance renewal application. HPSC counterclaimed, seeking recovery under the policy and damages for unfair and deceptive trade practices. Judgment was entered in favor of HPSC on all claims. Federal appeals, claiming that the district court admitted irrelevant and prejudicial evidence on the materiality of HPSC's misrepresentation and that it is entitled to judgment as a matter of law on all claims. After carefully reviewing the record, we affirm.

I. Relevant Facts

On May 28, 2002, HPSC reported to its long-time insurer, Federal, that an officer of its asset-based lending subsidiary American Commercial Finance Corp. ("ACFC"), Kevin Morrison, had embezzled $4.7 million over the previous five years. HPSC submitted proof of loss to Federal on July 9, 2002, pursuant to its Executive Protection Policy, which provided for $1,000,000 of employee theft coverage, subject to a $25,000 deductible. With its claim, HPSC included an investigative report by PricewaterhouseCoopers (the "PwC report") indicating that the theft occurred due to Morrison's unsegregated control over account activities. The PwC report stated that Morrison "exercised sole control over the factoring [of accounts receivable] business at ACFC and had full authority to disburse funds, collect payments, reconcile accounts and report financial performance." As a result, "ACFC had insufficient segregation of duties in the factoring operation."

The investigation of HPSC's claim was assigned to Federal claims examiner Anna MacKay. Upon reading the PwC report, MacKay concluded that Morrison both reconciled bank statements and signed checks on the same ACFC accounts, which contradicted information provided by HPSC on its April 13, 2001 renewal application. Specifically, HPSC had answered "no" to Question 12 of the application, "Do the employees who reconcile the monthly bank statements also either: a. sign checks? b. handle deposits? or c. have access to check signing machines or signature plates?" MacKay related her findings up the ladder to her superiors at Federal, who proceeded on the same assumptions as MacKay. MacKay also engaged outside coverage counsel, who reviewed HPSC's file and issued an opinion letter.

Meanwhile, HPSC remained in contact with Federal regarding the status of its claim. Finally, on September 13, 2002, HPSC issued an ultimatum to Federal: If Federal did not pay the claim, HPSC would file suit by September 20, 2002.

II. Relevant Proceedings

Without further investigation, Federal responded to HPSC's ultimatum by filing a diversity suit seeking rescission of the policy for fraud and misrepresentation. HPSC counterclaimed for recovery under the policy and for damages under Mass. Gen. Laws ch. 93A for unfair and deceptive trade practices based on Federal's delay in investigating and paying the claim.

Two weeks after the initial case management conference, HPSC informed Federal that MacKay had misread the PwC report.¹ In fact, it was not Morrison, but his subordinate, Sylvia Maguire, who reconciled the bank statements on ACFC's fifteen operating accounts. Maguire did not sign checks or handle deposits, and ACFC had no check signing machine or signature plate. All transactions on these fifteen accounts were accomplished through wire transfers. The only account for which Morrison both reconciled statements and signed checks was an imprest petty cash account, which was capped at $10,000 and could only be replenished each month after HPSC reviewed ACFC's disbursements.

Federal then shifted its theory of the case, relying on Morrison's authority over all sixteen of the ACFC accounts. Federal also contended that Morrison's authority over wire transfers was the equivalent of signing checks for the purposes of Question 12 on the renewal application.

Both sides filed cross motions for summary judgment. The district court denied both motions, concluding that HPSC's response to Question 12 was truthful as to the fifteen operating accounts, given that the question did not ask about an employee's unexercised authority or about wire transfer authority. The district court found that the only misrepresentation made by HPSC involved Morrison's control over the petty cash account,² but that given the relatively small size of that account compared to the fifteen operating accounts, the materiality of the misrepresentation was a question of fact for the jury. The district judge noted, however, that if he "were the factfinder, [he] would most likely agree that the misrepresentation ... [was] a material one."

Prior to trial, Federal moved in limine to exclude any evidence regarding Federal's past underwriting practices on the basis that such evidence was irrelevant to the materiality of HPSC's misrepresentation. The district court denied the motions.

At trial, Federal's underwriter, Yalonda Mason, testified that had she known the truth about Morrison's unsegregated duties, she still would have written the policy, but with a larger deductible or higher premium because of the increased risk. Federal also called a risk management expert, Dean P. Felton, who testified that the lack of segregation between reconciliation and check-writing duties increased the risk of loss from theft. Felton further indicated that if HPSC's answer to Question 12 had been truthful, he would have either increased the deductible, increased the premium, or excluded the checking account from coverage.

HPSC's expert, Michael Bracken, testified that in his opinion the imprest petty cash account "did not present a materially elevated risk of loss to HPSC or [Federal]." Bracken also concluded that had HPSC answered "yes" to Question 12, it would have made no difference in Federal's decision to underwrite HPSC's policy. He explained that he had reviewed HPSC's past applications to Federal, and that Federal had not followed up on any of HPSC's past "no" answers or even questioned its "yes" answer to Question 12 in 1995. Bracken claimed that this question was important and that, as an underwriter, he would have investigated an affirmative answer.

At the conclusion of the evidence, Federal moved for a directed verdict under Rule 50(a), but the district court denied the motion. The district court instructed the jury that Federal was not obligated to pay HPSC's claim if HPSC's misrepresentation was material, meaning that if Federal had known the truth, it would have declined to issue the policy or charged a higher rate or premium in light of the increased risk. The jury found in favor of HPSC, concluding that its misrepresentation was not material.

The district court then held a bench trial on the chapter 93A claim. At the close of HPSC's case, Federal filed a motion for judgment as a matter of law, which the district court denied. After Federal presented its case, the court found that Federal's initial determination regarding HPSC's misrepresentation was made in good faith, but that Federal had violated two statutory duties under Mass. Gen. Laws ch. 176D, § 3(9): Federal's decision to seek rescission without inquiring into the facts or giving HPSC a chance to respond breached its duty under subsection (d) to conduct a reasonable investigation before rejecting a claim, and its failure to make a reasonable settlement offer upon learning of its mistaken conclusion regarding Morrison's reconciliation and check-writing duties on the fifteen operating accounts violated its duty under subsection (f) to "effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear." The court concluded that the two statutory violations constituted unfair business practices within the meaning of chapter 93A, and that Federal's conduct after learning of its flawed assumptions was a breach of its duty of good faith, which merited doubling the damages incurred thereafter.

III. Discussion

On appeal, Federal argues that it is entitled to judgment as a matter of law on the rescission claim because HPSC's misrepresentation objectively increased the risk of loss, or alternatively to a new trial because the district court admitted irrelevant and prejudicial evidence on the materiality issue. Federal also contends that it is entitled to judgment as a matter of law on the unfair trade practices claim because it had a reasonable, plausible basis for denying HPSC's claim, even after it learned of its original mistaken conclusion.

A. Preservation of the Issues

As a preliminary matter, HPSC asserts that Federal failed to preserve any issues on appeal because it did not renew its Rule 50(a) motion and it did not make any evidentiary objections at trial.

1. Judgment as a Matter of Law

It is now settled that an appellate court "cannot review the denial of a Rule 50(a) motion based on the sufficiency of the evidence when the party appealing the verdict failed to renew its sufficiency challenge in the district court pursuant to Rule 50(b)." Vázquez-Valentín v. Santiago-Díaz, 459 F.3d 144, 148 (1st Cir.2006) (citing Unitherm Food Sys., Inc. v. Swift-Eckrich, Inc., 546 U.S....