Home Sav. and Loan v. Aetna Cas. and Sur. Co.

• Decision Date: 06 August 1991
• Docket Number: No. 890101-CA,890101-CA
• Citation: 817 P.2d 341
• Parties: HOME SAVINGS AND LOAN, a Utah corporation, Plaintiff and Appellee, v. The AETNA CASUALTY AND SURETY COMPANY, Defendant and Appellant.
• Court: Utah Court of Appeals

Page 341

817 P.2d 341

HOME SAVINGS AND LOAN, a Utah corporation, Plaintiff and Appellee, v. The AETNA CASUALTY AND SURETY COMPANY, Defendant and Appellant.

No. 890101-CA.

Court of Appeals of Utah.

Aug. 6, 1991.

Lynn S. Davies (argued) and Russell C. Fericks, Richards, Brandt, Miller & Nelson, Salt Lake City, for defendant and appellant.

Gary R. Howe, P. Bryan Fishburn (argued) and Scott A. Call, Callister, Duncan & Nebeker, Salt Lake City, for plaintiff and appellee.

Before BENCH, BILLINGS and GREENWOOD, JJ.

OPINION

GREENWOOD, Judge:

Aetna Casualty and Surety Company appeals the trial court's ruling that a loss incurred by Home Savings and Loan was covered by a fidelity bond issued to Home by Aetna. Home made a total of forty-two second mortgage loans to individuals (AFCO investors) who had been referred to Home by Grant Affleck. The loan proceeds were invested in AFCO, which was controlled by Affleck. Following the financial demise of Affleck and AFCO, the AFCO investors brought suit against Home because of its involvement with AFCO. Home lost the lawsuit and was ordered to return the second mortgage notes and trust deeds to the AFCO investors, foregoing, as a result, any further collection on the loans. Home thereby incurred a significant loss which it claims was covered by Aetna's fidelity bond. Aetna denied coverage and Home brought this suit. Following a jury trial, the trial court ruled that Home's loss was covered by the Aetna bond. We affirm.

FACTS

During 1981, Affleck arranged for several lending institutions to issue second-mortgage loans to people who were interested in investing in AFCO. AFCO sought this financing because it was experiencing critical cash flow problems and lending institutions would not lend to AFCO directly.

In November of 1981, Affleck arranged for Home to grant second-mortgage loans to potential AFCO investors. Affleck delivered the investors' loan applications to Home and indicated that the applicants had been rejected by other lending institutions because those institutions had reached their lending caps. Bill Cox, vice president of Home's mortgage department, asked Larry Glad, the loan solicitor who brought Affleck to Home, to contact all of the applicants to see if they were still interested in obtaining a loan and to verify that the information contained in the applications was correct. Two days later, Glad reported that all of the applicants were still interested. Glad then began to process the loan applications. Home claims that Glad altered loan applications to increase the income, credit, and home equity of the AFCO investors so that they would qualify for larger loans. Home also claims that while processing the loan applications Glad caused unauthorized persons to sign some of the loan documents.

Affleck pressured Home personnel to approve the loans quickly. One of Affleck's employees was even "loaned" to Home in order to expedite the approval process. Home claims to have given Glad and Elaine Reese, a loan closer for Home, specific instructions to make sure that one of them was present at every loan closing. Glad, however, gave the loan documents to Affleck and Affleck closed the loans himself without any Home employee being present.

One of the closing documents was a notice of the borrower's right to rescind the loan at any time within three days of the closing. Reese, on Glad's instruction, backdated the rescission notices and other closing documents in order to expedite the disbursement of the loans. The backdating was intended to create the illusion that the borrowers' right to rescind had expired on or before the day the loan was actually closed. Home was thereby able to disburse the loan proceeds on the same day as the closing.

In mid-December 1981, Home learned that Glad had engaged in dishonest and fraudulent acts unrelated to the AFCO investor loans. Included in these acts was Glad's receipt of a kickback on a loan made directly to AFCO, a loan that AFCO eventually repaid. Glad was promptly terminated effective December 29, 1981. Following Glad's departure, Home closed several more second mortgage loans to AFCO investors.

On January 28, 1982, AFCO issued a check to Home, to be applied toward the first monthly payments due on the AFCO investor loans. Although it was contrary to Home's usual policy to accept third-party repayments of its loans, AFCO and its investors had apparently made this arrangement. However, when Home attempted to cash the check, it was returned due to insufficient funds in AFCO's account.

On February 26, 1982, Affleck sent a letter to Home requesting additional time to bring the second mortgage loans current. He informed Home that there were potential problems with the loans because the loan documents had been backdated in order to eliminate the right of the AFCO investors to rescind the loans. He also informed Home that he had closed the loans personally without any Home employee being present. Affleck requested the extension in order to avoid "any direct legal action from individuals that have taken out the above referenced 2nd mortgage loans."

On March 8, 1982, AFCO filed for bankruptcy. At Home's board of directors' meeting held on March 17, 1982, Home's legal counsel indicated to the board that Home's position was sound despite AFCO's bankruptcy because of the "documentation of the loans."

In April 1982, approximately three hundred plaintiffs filed a complaint in the United States Bankruptcy Court against Affleck, AFCO, and numerous other defendants, including Home and sixteen other lending institutions that had made similar second mortgage loans to AFCO investors. The complaint, designated as Alcorn, et al. v. Grant Affleck, et al., was served upon Home on April 13, 1982. The complaint listed numerous irregularities in the loans and sought an order declaring the notes and second mortgage trust deeds void, and an order barring the financial institutions involved from demanding repayment of loans made to the AFCO investors. ¹

The Federal Home Loan Bank Board conducted an examination of Home which indicated that as of June 4, 1982, Home was already scheduling the second mortgage loans as being at risk. The examiner concluded that "[t]hese loans represent a potential for losses and/or large legal expenses to the institution." After discussing the Alcorn lawsuit then pending in bankruptcy court, the examiner made the following observation in its report: "[Home's] Management expects that there will be further attempts to frustrate the foreclosures [of the second mortgage trust deeds] by challenging the validity of the documentation and underwriting."

In May 1982, an Aetna insurance agent approached Home with the proposition that Home replace its savings and loan blanket bond, issued by Fidelity and Deposit Company of Maryland (F & D), and due to expire June 21, 1982, with an Aetna bond. Home completed an Aetna application form that asked, among other things, whether Home had sustained any insurable losses within the past five years. Home truthfully responded that it had sustained no such losses over the $5000 deductible amount. On July 14, 1982, the sale of the Aetna bond to Home was completed. The bond was a Standard Form 22 bond, identical in form and language to the F & D bond it replaced. It provided for coverage in a principal amount of up to $1,135,000 for a period of three years from June 21, 1982, to June 20, 1985. ² Home and Aetna subsequently agreed to extend the coverage period through August 20, 1986.

The bankruptcy court abstained from hearing the Alcorn complaint as part of the AFCO bankruptcy. It therefore dismissed the Alcorn complaint on July 2, 1982. The complaint was refiled, in essentially the same form, in federal district court on the same day as Abbott, et al. v. Shaffer, et al. The action was then severed into several different lawsuits each naming a particular financial institution as defendant. The lawsuit relating to Home involved thirty-six loans and was styled as Armitage v. Home Savings and Loan.

On December 9, 1982, counsel for Home sent a letter to Aetna giving formal notice of the claims being made by the AFCO borrowers in the Armitage case. In the notice letter, Home's counsel indicated that discovery in the Armitage case had uncovered the likelihood of dishonesty of Home employees in processing the AFCO investor loans, creating the likelihood that if Home lost the case, such loss would fall within the bond's fidelity loss coverage. Aetna then began monitoring the case.

On September 30, 1983, Aetna elected to not assume defense of the Armitage litigation. Aetna gave three reasons for this decision. First, Aetna claimed its bond would not cover losses sustained during the coverage period of the F & D bond it replaced, except to the extent that such losses exceeded the F & D coverage amount. ³ Second, Aetna concluded that the borrowers' claims in the various complaints were attributed to acts of Home employees that were committed "at the direction of and for the benefit of Home Savings." Such acts did not fall within the bond's definition of employee dishonesty and, therefore, even if proven, would not fall within the fidelity coverage of the bond. Third, Aetna stated, "it appears that many of the claims may have been discovered prior to 6-21-82, the date on which this bond was issued."

Nearly a year later, on August 14, 1984, the Armitage jury returned special verdicts against Home. Judgment in the case was entered on February 24, 1986. Pursuant to the judgment, Home was barred from foreclosing on the second mortgage trust deeds and from seeking any recovery of its loans to the AFCO investors. Home's Aetna bond was still in effect at that time.

Home sought indemnification under the Aetna bond for the Armitage loss, claiming that the loss was the direct result of the dishonesty of its former employee, Larry Glad, and was, therefore, covered by the Aetna bond. Aetna responded...