The Continental Corporation v. The Aetna Casualty & Surety Company

Citations: 892 F.2d 540; 1989 WL 156192Docket: 88-3165

Court: Court of Appeals for the Seventh Circuit; March 14, 1990; Federal Appellate Court

SummaryOriginalCytator Case TreatmentAnalysis

EnglishEspañolSimplified EnglishEspañol Fácil

The appeal involves a legal dispute between Continental Corporation and Aetna Casualty and Surety Company regarding the interpretation of a fidelity bond following losses incurred by Continental due to the fraudulent actions of a former employee, Michael Maciejewski, at its subsidiary, American Title Insurance. The district court had ruled that the fidelity bond's exclusion of losses from insurance contracts did not pertain to Maciejewski's dishonest acts, leading to a summary judgment in favor of Continental and significant damages awarded for settling claims arising from a racketeering conspiracy lawsuit filed by competitor Safeco Title Insurance Company.

Maciejewski engaged in fraudulent activities by issuing deceptive title insurance commitments that concealed prior mortgages, allowing properties to be traded without proper disclosure. After resigning from American, he continued similar fraudulent practices at Safeco. These actions resulted in a surge of claims against American, costing approximately $3.2 million in settlements. Safeco's lawsuit accused American of complicit actions in Maciejewski's fraud, alleging knowledge of his wrongdoing and active participation to mitigate losses, thereby asserting liability under the theory of respondeat superior and as a co-conspirator in racketeering. The appellate court ultimately reversed the district court's decision.

Continental sought indemnification from Aetna for a $3.2 million settlement of customer claims linked to fraudulent title policies prepared by Maciejewski, along with related attorneys' fees and litigation expenses. The fidelity bond in question, the 'Form 25 Insurance Companies Blanket Bond,' stipulates indemnification for losses resulting from dishonest acts of an employee, defined as those compensated and directed by the insured. A crucial exclusion (j) in the bond specifies that it does not cover losses from insurance-related liabilities, except for certain conditions related to unearned premiums or fraudulent claims adjustments. Aetna denied indemnification, arguing that the losses stemmed from fraudulent insurance contracts, thus falling under this exclusion. The district court denied Aetna's summary judgment motion, indicating that the bond covered the matter, leading Continental to seek summary judgment, which the court granted regarding liability and set a damages trial. Aetna's attempt to depose Continental's former vice president regarding exclusion (j) was quashed by the court, which found it irrelevant to the damages trial. After the damages trial, the court ordered Aetna to indemnify Continental for the settlement and attorneys' fees, including those related to the Safeco litigation, concluding that Aetna had an obligation to defend Continental in that case.

On October 6, 1987, Continental settled the Safeco litigation for $1.85 million and sought reimbursement from Aetna under the indemnification clause of a fidelity bond. Aetna filed a Rule 16 motion to compel Continental to amend its complaint to include new Safeco-related claims, but the court denied this request. Aetna also sought summary judgment, arguing that the bond did not cover losses from the Safeco settlement, but this motion was also denied as the court had previously ruled on the coverage of Safeco-related matters. Following a two-day damages trial, the court confirmed that allegations in Safeco's complaint exposed American to liability due to Maciejewski's dishonest actions, leading to an award of all Safeco-related losses to Continental, including the settlement and attorneys' fees.

On appeal, Aetna contested the district court's findings on two grounds: first, that the losses from Maciejewski's fraudulent activities were covered under the fidelity bond despite exclusion (j), and second, that Aetna was liable for indemnifying Continental's losses related to the Safeco settlement. Aetna argued it was not liable as a matter of law and thus entitled to summary judgment. The review of the summary judgment was to be conducted de novo, with the burden on the moving party to show the absence of any genuine issues of material fact. Under Wisconsin law, the interpretation of insurance policy language is generally a legal question, subject to independent review on appeal, and only becomes an issue of fact in cases of ambiguity requiring extrinsic evidence for interpretation.

In interpreting an insurance policy, courts apply the common and ordinary meaning of its terms. Ambiguous exclusions are construed against the drafter (the insurance company) and in favor of coverage. However, when language is clear, it is enforced as written without strict construction principles. The court's initial task is to determine whether exclusion (j) is ambiguous; if it is unambiguous, it can be interpreted as a matter of law. Ambiguity exists when terms can reasonably be interpreted in multiple ways. Aetna argues that exclusion (j) is unambiguous and that the district court erred in not enforcing it based on its plain meaning. Alternatively, Aetna contends that if the exclusion was deemed ambiguous, extrinsic evidence should have been considered to ascertain the intended meaning, such as deposition testimony from a co-author of the clause. The district court found the fidelity bond's terms ambiguous regarding coverage for losses from fraudulent insurance policies issued by a dishonest employee. It acknowledged that exclusion (j) exempts losses from insurance contracts and improper inspections but concluded that it did not apply to dishonest employee actions, thus allowing for coverage of Continental's losses.

The district court's interpretation of exclusion (j) is contested, with the argument that it explicitly excludes coverage for Continental's losses. Exclusion (j) states that losses resulting from (a) liabilities under insurance contracts or (b) liabilities due to inspections, title searches, or reports (whether conducted properly or not) are not covered. Although the district court recognized that Continental's losses stemmed from insurance contracts, it limited the exclusion to only those contracts that were honestly issued. This interpretation was deemed incorrect since Maciejewski's title insurance contracts were issued dishonestly, leading the court to erroneously apply comprehensive coverage for employee dishonesty to these losses.

The critique emphasizes that exclusion (j) does not distinguish between honestly and dishonestly procured insurance contracts, unlike other exclusions in the policy that clearly limit their effects in cases of employee dishonesty. The court's reliance on the 1938 Paddleford decision, which interpreted a similar exclusion as applicable only to honest trading losses, is viewed as a misguided modification of the clear language of exclusion (j). The Paddleford case involved a brokerage that was insured against employee dishonesty but excluded losses from trading activities, which the court interpreted narrowly in light of the business's nature. The argument posits that such a restrictive interpretation undermines the bond's protective purpose and is inconsistent with the intentions of the parties involved.

The reasoning established in Paddleford has faced significant criticism from the Third Circuit in Roth v. Maryland Cas. Co., which addressed an exclusionary clause in a fidelity bond mirroring that of Paddleford. The Third Circuit found Paddleford's distinction between honest and dishonest trading to misinterpret the insurance contract's plain meaning, stating that the policy did not intend to cover losses from honest trading, such as those resulting from mistakes or negligence. Consequently, excluding such losses was unnecessary. The court rejected the notion that ambiguous contract language should favor the insured, asserting that the clear intent of the parties was to exclude losses from trading that would otherwise fall under dishonest coverage. Furthermore, the court disagreed with Paddleford's assertion that the exclusion would nullify the coverage sought by the insured, clarifying that the bond still provided protection against theft and related losses, and that coverage for trading losses could be purchased at a higher premium.

In light of fifty years of developments in fidelity insurance, a reevaluation of Paddleford is warranted, particularly since the current case involves two large insurance companies capable of negotiating and understanding the terms of a fidelity bond. Notably, one drafter of the exclusion was a former vice president of the insured, suggesting that the standard rule of construing terms against the drafter may not apply here. The rationale behind exclusion (j) was aimed at enabling fidelity carriers to resume bonding in the title insurance sector, which had become increasingly risky. 

Ultimately, although Paddleford could be distinguished on various grounds, the reasoning behind it is deemed fundamentally flawed. The current opinion overrules Paddleford, aligning with the Third Circuit's analysis in Roth. The interpretation of exclusion (j) as applicable solely to honest insurance contracts is criticized for rendering the exclusion meaningless, as losses from honest acts are not covered by the bond. Thus, exclusion (j) should not limit coverage that does not exist, contradicting both the plain language of the contract and logical reasoning.

Paddleford's viability is questioned in light of recent Wisconsin court rulings emphasizing the enforcement of exclusion clauses in insurance policies to limit coverage. The Wisconsin Supreme Court has established that exclusions are integral to insurance policies, deserving equal enforcement alongside insuring clauses (D'Angelo v. Cornell Paperboard Products Co.). Exclusions are intended to modify and limit coverage, explicitly notifying insured parties about the limitations on their coverage (Bulen v. West Bend Mut. Ins. Co.). 

Continental's argument, which suggests that excluding all losses from insurance contracts renders the bond ineffective despite premium payments, is rejected. The relevant exclusion does not cover all losses but specifically allows for two exceptions: losses linked to unearned premiums upon policy cancellation and dishonest employee actions involving fictitious claims. The bond also covers losses from employee forgery and theft.

Continental's alternative arguments are dismissed. The district court had previously found the policy terms ambiguous, which led to a construction against the insurer. Continental's claim that its losses were solely due to dishonesty, and thus should trigger coverage, is deemed unconvincing. It argues that because dishonesty and fraudulent insurance contracts both contributed to the loss, coverage should apply; however, this reasoning lacks sufficient support. Lastly, Continental posits that the losses stemmed from tort liability related to Maciejewski's actions rather than contractual liability, arguing this distinction exempts the losses from exclusion.

Continental's arguments regarding its contract liability in relation to employee dishonesty are unconvincing. The court affirms that the losses stem from insurance contracts, as the district court found, and attempts to redefine these losses as incidental or tort derivatives are merely semantic maneuvers that misinterpret the insurance policy's clear language. Any tort claims are linked to misrepresentations in the insurance contracts and title reports, which fall under exclusion (j). Despite acknowledging that employee dishonesty caused the losses, the mechanism of that dishonesty involved fraudulent title policies and reports, leading to an exclusion from coverage by exclusion (j). Aetna's counsel emphasized that exclusion (j) distinguishes between fidelity and title insurance risks, attributing specific losses from employee dishonesty to the fidelity carrier while assigning title insurance risks to the title carrier. The court finds no justification to distort the policy’s unambiguous language regarding risk allocation.

As a result, the court reverses the district court’s summary judgment and damages awarded to Continental for these losses and instructs that summary judgment be granted to Aetna. 

Regarding the Safeco Settlement, Aetna contends that the district court incorrectly ruled that it was obligated to reimburse Continental for settlement costs related to the Safeco litigation. The record suggests that the district court did not adequately address whether these losses were covered by the fidelity bond. During the damages trial for fraudulent contract claims, the court awarded Continental attorneys’ fees that included expenses related to the Safeco litigation. However, after the settlement, the court denied new pleadings on the Safeco-related reimbursement request and summarily dismissed Aetna's summary judgment motion, concluding that the bond covered all associated losses without thorough consideration.

The interpretation of the indemnification provision in the fidelity bond determines whether the Safeco settlement expenses are considered covered losses. For Aetna to be liable for indemnification, Safeco must have sought recovery for a covered loss, as established in relevant case law. The fidelity bond specifies coverage for losses directly resulting from the dishonest or fraudulent acts of an employee, defined as those compensated and controlled by the Insured at their offices. Coverage for a loss involving a terminated employee applies only if the dishonest act occurred within sixty days post-termination and would have been covered had employment not ceased. Absent these conditions, dishonest acts of former employees are not covered under the bond.

Aetna contended that the district court incorrectly denied its summary judgment motion regarding the Safeco-related losses, asserting that these losses fell outside the bond's coverage. The court agreed, noting that Safeco's alleged injuries occurred after Maciejewski's employment with American had ended, thus failing to meet the bond's requirement that losses "result directly from" Maciejewski's conduct as an American employee. The district court's "but for" analysis was criticized as flawed; it suggested that Maciejewski’s dishonest acts while employed at American led to Safeco's lawsuit. However, the fraudulent activities central to Safeco's claims were conducted after Maciejewski left American, and there was no evidence linking losses directly to his employment at American. The bond explicitly did not cover losses from former employees' actions occurring months after termination. Consequently, the court reversed the district court's award of indemnification to Continental for Safeco's litigation expenses and instructed that summary judgment be entered in favor of Aetna regarding liability. The opinion, which overruled a previous decision, was circulated to all active judges, with none opting for a rehearing en banc.