National Bank of Andover v. Kbs

• Decision Date: 05 March 2010
• Docket Number: No. 95,548.,95,548.
• Parties: NATIONAL BANK OF ANDOVER, Appellee/Cross-appellant, v. KANSAS BANKERS SURETY COMPANY, Appellant/Cross-appellee. Kansas Bankers Surety Company, Appellant/Cross-appellee, v. National Bank of Andover, Appellee/Cross-appellant.
• Court: Kansas Supreme Court

225 P.3d 707

NATIONAL BANK OF ANDOVER, Appellee/Cross-appellant, v. KANSAS BANKERS SURETY COMPANY, Appellant/Cross-appellee.

Kansas Bankers Surety Company, Appellant/Cross-appellee, v. National Bank of Andover, Appellee/Cross-appellant.

No. 95,548.

Supreme Court of Kansas.

March 5, 2010.

Ann L. Hoover, of Topeka, argued the cause and was on the briefs for appellant/cross-appellee.

Richard C. Hite, of Hite, Fanning & Honeyman L.L.P., of Wichita, argued the cause and was on the briefs for appellee/cross-appellant.

Stanley R. Parker and Deanne Watts Hay, of Parker & Hay, LLP, of Topeka, were on the brief for amicus curiae The Surety & Fidelity Association of America.

The opinion of the court was delivered by NUSS, J.:

This appeal arises out of an employee's unauthorized honoring of insufficient funds checks, which resulted in a loss to her employer, National Bank of Andover (bank). The bank had obtained a Financial Institution Crime Bond, which its issuer, Kansas Bankers Surety Company (KBS), then sought to rescind via a declaratory judgment action. The bank filed a separate suit and alleged breach of contract by KBS.

The cases were consolidated and tried to a jury. KBS obtained a verdict in its favor, but the trial court granted the bank's motion for a new trial. On retrial, the bank obtained a verdict in its favor. KBS appealed, and the bank cross-appealed. The Court of Appeals panel reversed and remanded for a third trial. This court granted the petition and cross-petition for review. Our jurisdiction is under K.S.A. 20-3018(b) and K.S.A. 60-2101(b).

We have reorganized the issues on appeal, which, along with our holdings, are as follows:

THE BANK'S ISSUES:

1. Did the Court of Appeals panel err in holding that an insurer may rescind a financial institution crime bond whose terms expressly allow rescission for an insured's conduct which is less serious than fraudulent misrepresentation? No.

2. Did the panel err in holding that the phrase "does your bank require" contained in the bond application refers not only to standards of performance but also to actual performance? No.

3. Did the panel err in reversing the trial court's grant of judgment to the bank on KBS's claim that the bank gave an untrue answer to Question 1 of the bond application? No.

4. Did the panel err in holding that employee Steward's transactions can be characterized as bank loans? No.

5. Did KBS show prejudice resulting from the trial court's order in limine and evidentiary rulings? Yes.

6. Did the panel err in reversing and remanding for a third trial? No.

KBS'S ISSUES ON CROSS-APPEAL:

7. Did the panel err in failing to reinstate KBS's favorable jury verdict in the first trial? No.

8. Did the panel err in failing to rule as a matter of law that no coverage exists under Insuring Agreement (A) of the bond? No.

9. Did the panel err in failing to reverse the trial judge's grant of judgment as a matter of law against KBS regarding Question 2 of the bond application? Yes.

Accordingly, we affirm in part and reverse in part the Court of Appeals, reverse the district court, and remand for a third trial.

FACTS

For years National Bank of Andover had been covered by annual renewals of a Financial Institution Crime Bond through Kansas Bankers Surety Company. On January 11, 2002, the bank submitted its annual application and renewal form for the bond to KBS. The application was filled out by Jo Ann Wallace, the bank's cashier; reviewed by Lane Kvasnicka, the bank's senior vice-president; and signed by Dennis Bush, the bank's president and CEO.

The application provides that it becomes part of the bond upon issuance. The application also addresses an insured's representations to KBS and the grounds for KBS's rescission of the bond:

"THE INSURED REPRESENTS THAT THE INFORMATION FURNISHED IN THIS APPLICATION IS COMPLETE, TRUE AND CORRECT. ANY MISREPRESENTATION, OMISSION, CONCEALMENT OR ANY INCORRECT STATEMENT OF A MATERIAL FACT, IN THIS APPLICATION OR OTHERWISE, SHALL BE GROUNDS FOR THE RESCISSION OF ANY BOND ISSUED OR RENEWED IN RELIANCE UPON SUCH INFORMATION."

Among other things, the application required bank president Bush to answer the following three questions:

"Does EVERYONE employed by the bank know and understand the POLICY AND PROCEDURES as approved by the Board of Directors for their job or department? [Hereinafter referred to as Question 1.]

"Do you have a planned program requiring segregation of duties so that no single transaction can be fully controlled by one person? [Question 2.]

"The correspondent account, suspense account, or transit account is used most often by dishonest employees. Does your bank require that all correspondent accounts, suspense accounts, and transit accounts be balanced regularly and balanced by a second person at least monthly? [Question 3.]"

Bush answered yes to each question. After KBS received the application, it issued the bond on March 15, 2002. One week later, a bank employee discovered suspicious checks in the desk of employee Paula Steward.

Steward was the head accounting clerk at the bank beginning in 1998. From 1999 through the beginning of 2002, Steward paid insufficient funds checks drawn on the accounts of three of the bank's customers: William Spillman, Dr. John Brooks, and Brooks' business, Meadowbrook Farms, Inc. Steward did not charge the paid amounts against the customers' accounts. Rather, she made false entries in the bank records to hide the payments. She paid each of the checks despite the "no pay" instructions given to her by the bank's officers and hid the checks in her desk drawer.

Steward later explained she paid these checks because she was having problems keeping up with her job, things got out of control, and she panicked. She also believed these customers when they told her they would repay the bank for the overdrafts.

On March 27, the bank notified KBS of the problem. The next day, the bank's outside accounting firm, Kennedy and Coe, LLC, began an investigation of the bank's losses. Kennedy and Coe confirmed that Steward had paid insufficient funds checks without charging the three customer accounts even though bank officers had instructed her to return such checks unpaid. The bank's net loss was calculated at nearly $900,000 after customer Spillman refunded the bank for his insufficient funds checks. Kennedy and Coe eventually wrote to inform the bank of "an absence of segregation of duties in regard to return item handling, transit functions and the reconciliations and balancing of both internal general ledger accounts and due from correspondent accounts."

The bank ultimately submitted its sworn proof of loss statement to KBS seeking coverage for the losses on the three accounts. Within a week, KBS vice president Paul Bures began his investigation. He interviewed bank employees and reviewed documents, including the bank's Compliance Policies and Procedures Manual. The Internal Control Policy contained there stated that, among other things, its cashier "shall perform or supervise in the performance of the following" functions:

"5. Reconcile and prove to the general ledger daily:

a. All deposit accounts....

....

"7. Reconcile and prove to the general ledger monthly:

a. All correspondent bank accounts."

The job description for Steward's position, head accounting clerk, provides that she reports to the cashier; her purpose is to "assist the Cashier with daily operations and to supervise the bookkeeping department to insure completion of daily operations." Her "duties and responsibilities" include "balancing of General Ledger Accounts" and "Balancing of Correspondent Accounts." Steward confirmed through her testimony that her job included the balancing of the correspondent and general ledger accounts.

Through Bures' investigation, he discovered that Steward was the only bank employee who had been taught to balance the correspondent accounts. He also discovered that before discovery of the losses, correspondent accounts had not been balanced regularly or by a second person on a monthly basis.

KBS president Donald Towle eventually wrote a letter to the bank declaring the bond rescinded ab initio because of the bank's false answer to Question 3 on the renewal application. Consequently, Towle returned to the bank its bond premium. Towle later officially amended the basis for KBS's rescission to include the bank's false answers to Questions 1, 2, and 3 on the renewal application.

That same day, KBS filed a declaratory judgment action in Shawnee County District Court. It claimed, among other things, that because the bond was issued in reliance upon the bank's misstatements in its renewal application, KBS "has no contractual obligation to [the bank] under the bond, and the bond is void ab initio." The following day, the bank filed a breach of contract action against KBS in Butler County District Court. Consistent with KBS's declaratory judgment action, its defenses included a contention that the contract was void ab initio because it was obtained by fraud. The Shawnee County case was transferred to Butler County, and these cases were consolidated.

Both parties moved for summary judgment and for orders in limine. After argument, the trial court denied both summary judgment motions but sustained the bank's motion in limine. It excluded from the trial, among other things, evidence of the failure of the bank's employees to follow the bank's policies relating to their job descriptions and duties. The court found this evidence irrelevant in the declaratory judgment action and reasoned that this evidence would improperly interject issues of comparative fault into a contract action.

The consolidated cases were tried to a jury, which returned a verdict in favor of KBS. The bank filed motions for a new trial and for judgment notwithstanding the verdict. The trial court sustained the motion for a new trial for three reasons. First, the court found that KBS had violated the orders...