First Nat. Bank of Louisville v. Lustig

• Decision Date: 30 September 1996
• Docket Number: No. 94-30619,94-30619
• Citation: 96 F.3d 1554
• Parties: , 45 Fed. R. Evid. Serv. 813 FIRST NATIONAL BANK OF LOUISVILLE, Plaintiff-Appellee, Cross-Appellant, v. Loretta LUSTIG, et al., Defendants, Aetna Casualty and Surety Co., and Federal Insurance Co., Defendants-Appellants, Cross-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 1554

96 F.3d 1554

36 Fed.R.Serv.3d 307, 45 Fed. R. Evid. Serv. 813

FIRST NATIONAL BANK OF LOUISVILLE, Plaintiff-Appellee, Cross-Appellant, v. Loretta LUSTIG, et al., Defendants Aetna Casualty and Surety Co., and Federal Insurance Co. Defendants-Appellants, Cross-Appellees.

No. 94-30619.

United States Court of Appeals Fifth Circuit.

Sept. 30, 1996.

Matt J. Farley, Barbara Malik Weller, Deutsch, Kerrigan & Stiles, New Orleans, LA, Thomas G. Hungar, Larry L. Simms, Rebecca Anne Womeldorf, John J. Swenson, Gibson, Dunn & Crutcher, Washington, DC, for defendants-appellants.

John M. Newman, Jr., Richard I. Weder, Jr., Jeffrey S. Sutton, Jones, Day, Reavis & Pogue, Cleveland, OH, Barry W. Ashe, Stone, Pigman, New Orleans, LA, Patrick M. Ardis, Mary L. Wolff, Douglas A. Black, Wolff & Ardis, Memphis, TN, William S. Boyd, III, Gulfport, MS, William E. Brown, Covington, LA, for plaintiff-appellee.

Appeals from the United States District Court for the Eastern District of Louisiana.

Before BARKSDALE, DeMOSS and PARKER, Circuit Judges.

DeMOSS, Circuit Judge:

We are again faced with questions surrounding the First National Bank of Louisville's suit against Aetna Casualty and Surety Company and Federal Insurance Company (the "Sureties") to recover under a Banker's Blanket Bond for damages arising out of the dishonest or fraudulent activities of a former bank loan officer. On our first visit, we (1) reversed the district court's summary judgment order because we found that genuine issues of material fact existed as to whether the bank officer intended to injure the bank and benefit himself so as to trigger liability for the Sureties under the bond coverage provisions; and (2) held that the district court erred in using a restrictive definition of dishonest or fraudulent conduct when instructing the jury on the Sureties' termination of coverage defense. First Nat. Bk. of Louisville v. Lustig, 961 F.2d 1162 (5th Cir.1992) (Lustig I ).

On remand from Lustig I, a bifurcated jury trial resulted in awards for First National Bank of Louisville ^BL on the bond coverage issues and for FNBL on its bad faith denial of coverage claim. The Sureties again appeal to this Court contending (1) that insufficient evidence exists to support a favorable verdict on FNBL's bad faith claims for denial of coverage; (2) that the district court erred in awarding attorney's fees and costs to FNBL for its bad faith claims under Kentucky law; (3) that the district court erred in denying the Sureties' motion for sanctions and their related fraud-on-the-court claims; (4) that the district court erred in permitting FNBL to allocate the sale proceeds of its loan collateral to interest as opposed to applying the proceeds to FNBL's stated loss; (5) that the district court made various evidentiary errors which prejudiced the Sureties' defense of this case; and (6) that the special interrogatories submitted by the district court confused and misled the jury. ¹

Finding that the district court erred in denying the Sureties' Motion for Judgment as a Matter of Law on FNBL's bad faith claims, we reverse the judgment of the district court awarding consequential damages to FNBL. We also reverse the district court's award of $5.85 million in attorney's fees for the bad faith claims. On the remaining issues, we affirm the district court's decision to permit FNBL to allocate the sales of loan collateral against unpaid interest on the loans at issue. After reviewing the record, we also hold that FNBL, its attorneys, and the United States Attorney, did not engage in a fraud on the court and, therefore, we affirm the district court's decision to deny sanctions on these grounds. We further find no abuse of discretion in the district court's evidentiary rulings regarding the admission of the bank officer's plea agreement, the admission of testimony concerning the circumstances surrounding the plea, and the admission of testimony of FNBL witnesses on its policy coverage claim. Finally, we find no abuse of discretion concerning the district court's submission of the special interrogatories to the jury.

I.

This dispute arises from over $20 million in losses sustained by FNBL due to the dishonest or fraudulent activities of an overzealous loan officer, Kevin DeWitt. DeWitt was the loan officer for the eight failed real estate projects at issue. DeWitt joined FNBL's management training program after he graduated from college in 1983. FNBL trained DeWitt and then assigned him to the Construction Loan Division where he prepared credit approval applications and administered the closing and payout of large commercial real estate loans. DeWitt presented these eight construction loans to FNBL's loan committee for approval at various times between 1984 and 1986. The individual loan amounts ranged from $1.9 million to $10.9 million.

The Sureties had issued FNBL a standard Banker's Blanket Bond to cover acts of employee fraud and dishonesty resulting in losses to FNBL. In 1986, FNBL filed a $20 million claim under this policy for losses suffered in connection with DeWitt's eight failed real estate financing projects. To recover under the bond, FNBL had to show that it suffered a "loss resulting directly from dishonest or fraudulent acts of an Employee...." (Emphasis added.)

Section (A) of the Insuring Agreement further defines the scope of the bond coverage:

Dishonest or fraudulent as used in this Insuring Agreement shall mean only dishonest or fraudulent acts committed by such Employee with the manifest intent

(a) to cause the Insured to sustain such 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, other than salaries, commissions, fees, bonuses, promotions, awards, profit sharing, pensions or other employee benefits earned in the normal course of employment.

(Emphasis added.)

The Insuring Agreement also contains a termination or cancellation of coverage provision which would effectively end coverage when FNBL learns of related fraudulent acts committed by DeWitt. This provision states:

This bond shall be deemed terminated or canceled as to any Employee or any partner, officer or employee of any Processor--(a) as soon as any Insured, or any director or officer not in collusion with such person, shall learn of any dishonest or fraudulent act committed by such person at any time against the Insured or any other person or entity, without prejudice to the loss of any Property then in transit in the custody of such person....

Termination of the bond as to any Insured terminates liability for any loss sustained by such insured which is discovered after the effective date of such termination.

The Sureties presented evidence that FNBL learned that DeWitt had made misrepresentations during his training program and had acted beyond the scope of his authority well before he made some of the failed loans. While DeWitt was in the training program, his supervisors discovered that he was changing numbers in his credit analysis to make them balance, a technique referred to as "plugging." The parties dispute whether plugging is considered a dishonest practice.

In June 1985, a loan reviewer discovered deficiencies in one of DeWitt's loans. After meeting with DeWitt, the reviewer informed FNBL officials that DeWitt had distorted the credit history of a guarantor and did not write the loan to a borrower included in the original documentation. FNBL also knew that DeWitt had closed two of the failed loans at issue "outside of approval" by not following FNBL's established procedures for loan approval. Furthermore, in 1985, an FNBL official discovered that DeWitt lied about whether the "Odyssey Two" loans had been approved by the Executive Loan Committee. DeWitt was not formally disciplined by the bank for these acts. Instead, notwithstanding these questionable practices, DeWitt was recommended for a bonus, promoted, and praised for his "extraordinary" results. The Sureties contend that FNBL's knowledge of DeWitt's dishonest loan practices triggered the bond's termination clause and, as a result, ended FNBL's coverage under the bond.

DeWitt resigned in March 1986 to accept a position at a Baltimore, Maryland bank. Nine days after his resignation, DeWitt received $40,000 from Loretta Lustig through three checks, two checks for $5,000 and another for $30,000. A fourth check for $10,000 was voided. Lustig was either an individual or corporate borrower or guarantor on at least four of the failed real estate loans. Soon after DeWitt left FNBL, testimony revealed that he became a business partner of Lustig. Evidence also showed that DeWitt received approximately 200 shares of Global Development Corporation, a company owned by Lustig. These shares had an estimated value of $788,000. DeWitt never admitted that he received $40,000 from Lustig or that he received stock from one of her companies. DeWitt only admitted that he received a $10,000 loan from Lustig.

Soon after DeWitt left FNBL, serious problems with his loans emerged. In late March, FNBL called DeWitt back to Louisville to meet with bank officials in connection with an investigation of the credit information that he supplied about certain loans. At this meeting, DeWitt admitted to fabricating credit references and later issued a handwritten statement explaining that he falsified information to make good loans and receive recognition at FNBL. The statement further explained that DeWitt did not seek personal gain from customers by submitting these loans. FNBL notified the government of its findings and launched an investigation.

On April 2, 1986, FNBL notified the Sureties of a possible claim under the bond. However, no formal investigation by FNBL or by the Sureties could begin until fifteen months after the notification was sent due to an ongoing FBI investigation. The Sureties determined that certain defenses to coverage were...