Insurance Co. of North America v. Gibralco, Inc., 86-6078

• Decision Date: 23 May 1988
• Docket Number: No. 86-6078,86-6078
• Citation: 847 F.2d 530
• Parties: INSURANCE COMPANY OF NORTH AMERICA, Plaintiff-Counter-Defendant-Appellant, v. GIBRALCO, INC., Defendant, and Trustee for the Liquidation of Gibralco, Inc., Defendant-Counter-Claimant- Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 530

847 F.2d 530

INSURANCE COMPANY OF NORTH AMERICAPlaintiff-Counter-Defendant-Appellant, v.GIBRALCO, INC., Defendant and Trustee for the Liquidation of Gibralco, Inc.Defendant-Counter-Claimant- Appellee.

No. 86-6078.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Jan. 5, 1988.

Decided May 23, 1988.

William P. Gemmill, Los Angeles, Cal., for plaintiff-counter-defendant-appellant.

Gregory Houle, Los Angeles, Cal., for defendant-counter-claimant-appellee.

Appeal from the United States District Court for the Central District of California.

Before CANBY and WIGGINS, Circuit Judges, and LOVELL, ^*District Judge.

CANBY, Circuit Judge:

This case involves the interpretation of an exclusionary clause limiting recovery for trading losses under an insurance policy purchased by a municipal bond brokerage firm.Insurance Company of North America ("INA") appeals the district court's judgment awarding $3,313,667.66 ¹ to the Trustee for the broker Gibralco, Inc.² INA contends that the district court misinterpreted the pertinent provisions of the Bond.We affirm.

BACKGROUND

On November 12, 1980, INA issued a Broker's Blanket Bond to Gibralco, Inc.Among other forms of coverage, the Bond provided Gibralco with $2 million of insurance for losses sustained as a result of employee dishonesty ³ and forgery.⁴The Bond excluded coverage for any trading losses that Gibralco might sustain; ⁵ trading losses were the subject of a separate clause providing coverage limited to $100,000.Although an exception to the trading loss exclusion seemed to permit coverage of trading losses resulting from employee dishonesty, ⁶ the exception did not explicitly set forth the availability of coverage for such losses.⁷

Steven R. Grayson, a sales representative at Gibralco, maintained two trading accounts at the firm without the knowledge of his employer: the "S.R. Grayson" and "Michael Scott" accounts.Between 1979 and 1981, Grayson persuaded several Gibralco customers to let him exchange their municipal bonds for higher-yielding investments.Grayson subsequently sold the customer bonds through the S.R. Grayson account.Grayson used the proceeds from the sales to gamble, and to purchase a few high-yield bonds for his customers to lull them.In addition, Grayson ordered $150,000 of Rancho California water district bonds through the Michael Scott account.When Gibralco demanded that "Michael Scott" take delivery of and pay for the bonds, Grayson obtained physical possession of the Rancho California bonds, with the understanding that he would deliver them to the purchaser.Grayson did not return with either the bonds or the payment due Gibralco.

Gibralco subsequently presented INA with a claim for the losses it sustained as a result of Grayson's fraudulent activities.INA determined that Gibralco's Grayson-related losses were not recoverable as losses for employee dishonesty, because they fell within the trading loss exclusion of the Bond.INA therefore paid Gibralco only $100,000, the limit of Gibralco's separate trading loss coverage.Soon thereafter, Gibralco was unable to maintain minimum capital requirements as a result of the customer claims against it.To avoid suspension of Gibralco's trading operations, INA agreed to settle or defend the customer claims against Gibralco up to $2 million.At that time, INA reserved its right to obtain a declaratory judgment on the applicability of the Bond's trading loss exclusion to Gibralco's claims.

In August 1982, INA filed this claim for declaratory relief in federal district court.Gibralco filed a counter-claim, seeking a declaratory judgment that its losses were covered under either the employee dishonesty or the forgery provisions of the Bond.Gibralco also asserted a claim for insurer bad faith.The district court entered judgment for Gibralco's Trustee.INA now appeals.

DISCUSSION

1.The Definition of "Trading Loss"

The first issue on appeal is whether the district court was correct in ruling that Gibralco's Grayson-related losses were recoverable as losses from employee dishonesty up to the full $2 million value of the Bond.The district court's interpretation of the Bond presents a mixed question of law and fact that we review de novo.Hanson v. Prudential Ins. Co. of America, 783 F.2d 762, 764(9th Cir.1985).INA essentially argues that if Grayson engaged in trading at any point in furtherance of his schemes, the Bond's trading loss exclusion precludes coverage of Gibralco's losses.The Trustee concedes that Grayson engaged in trading, but contends that Gibralco's losses resulted not from the trades, but from Grayson's dishonesty or his forgery, both of which were covered under the Bond.

Trading losses are generally understood to be market losses sustained by firms as a result of ill-advised, unauthorized, or simply unlucky trading decisions made in the purchasing, selling, or trading of securities.In Research Equity Fund v. Insurance Co. of N. America, 602 F.2d 200(9th Cir.1979), cert. denied, 445 U.S. 945, 100 S.Ct. 1344, 63 L.Ed.2d 780(1980), for example, an investment firm sustained trading losses as a result of an employee's portfolio management decisions.Id. at 202.While the employee had been bribed to make unprofitable trading recommendations, the firm's losses were a direct result of the trades that the employee ordered in the ordinary course of the firm's business.Similarly, in Bass v. American Ins. Co., 493 F.2d 590, 591(9th Cir.1974), a municipal bond firm sustained trading losses when an employee made misrepresentations in selling bonds to customers, and advised his employer to invest in worthless ventures in which the employee had a personal stake.The court found that the insured's losses were not recoverable because of the trading loss exclusion of its Broker's Blanket Bond.Both cases involved classic trading losses sustained in the course of regular trading activities.⁸

In this case, Gibralco's losses were not caused by Grayson's trades, but by his dishonesty.Grayson stole both the Rancho California bearer bonds and the proceeds of the customer bonds.The fact that Grayson disguised the theft of the customer bonds as a sale does not make it any less a theft.Research Equity, 602 F.2d at 204.Moreover, Gibralco did not suffer losses at the time that Grayson traded the bonds.The actual losses occurred later: when Grayson wrongfully retained the sales proceeds of the customers' bonds or when the rightful owners claimed their bonds, and when Grayson stole the Rancho California bearer bonds.Indeed, Gibralco would have suffered losses as a result of Grayson's activities whether or not the stolen bonds or proceeds were ultimately traded.

We do not agree with INA that the trading loss exclusion precludes coverage if a trade occurs anywhere in the chain of events resulting in a loss to the insured.The broad applicability of the trading loss exclusion urged by INA would eviscerate the employee dishonesty coverage provisions of the Bond in every case where a trade might occur in the course of an employee's dishonest scheme.We have no doubt that in requiring brokers' bonds to provide coverage against losses from employee dishonesty, ⁹ the SEC intended such bonds to cover the kind of dishonest and fraudulent activity in which Grayson engaged.The district court correctly found INA liable under the Bond for Gibralco's Grayson-related losses.

2.The Ambiguity of the Trading Loss Exclusion

INA next argues that the district court incorrectly held the trading loss exclusion of the Bond to be ambiguous.At oral argument, INA's counsel conceded that the Bond could have been clearer, but explained that broad language was used in the Bond because the same insurance contract was used for many types of brokerage policies.While INA may well have its reasons for using a form contract, such a practice invites interpretive problems in applying unspecific or general terms to particular cases.In view of the inclusionary language found in the exception to the trading loss exclusion, seesupra note 6, and INA's failure to provide more precise exclusionary language in the explanatory clause of that exception, seesupra note 7, we conclude that the Bond was ambiguous with respect to losses involving both trading and employee dishonesty.

It is well established California law that any ambiguities or uncertainties in insurance contracts are construed against the insurer.Hanson, 783 F.2d at 764.Exclusionary clauses must also be construed narrowly against the insurer.Continental Cas. Co. v. Richmond, 763 F.2d 1076, 1079(9th Cir.1985).If two or more interpretations are reasonable, we must adopt the interpretation that favors coverage.Hanson, 783 F.2d at 764;Reserve Ins. Co. v. Pisciotta, 30 Cal.3d 800, 808, 640 P.2d 764, 768, 180 Cal.Rptr. 628, 632(1982)(en banc).The district court correctly required INA to cover Gibralco's Grayson-related losses, given the ambiguity of the Bond's trading loss exclusion.

3.Gibralco's Reasonable Expectations

INA further argues that the district court incorrectly considered Gibralco's expectations of coverage under the Bond.We disagree.Regardless of any ambiguity in the contract, the trial judge...