Federal Deposit Insurance ex rel. Integra Bank, N.A. v. Fidelity & Deposit Co.

Citations: 64 F. Supp. 3d 1225; 2014 U.S. Dist. LEXIS 166808Docket: No. 3:11-cv-00019-RLY-WGH

Court: District Court, S.D. Indiana; December 1, 2014; Federal District Court

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The Federal Deposit Insurance Corporation (FDIC), as receiver for Integra Bank, N.A., is pursuing recovery under a financial institution bond from Fidelity and Deposit Company of Maryland (F.D.) for losses incurred due to a Ponzi scheme orchestrated by Louis Pearlman. Integra Bank purchased the bond covering losses from July 1, 2007, to July 1, 2010. F.D. argues that the FDIC's claim is time-barred and that the FDIC cannot demonstrate coverage under Insuring Agreements A and E. The court denied F.D.'s motion for summary judgment. 

The case details how Pearlman, along with Integra's Executive Vice President Stuart Harrington, secured approximately $29 million in loans through falsified financial documents. Following defaults on these loans, which resulted in nearly $23 million in losses for Integra, the bank initiated legal action against Pearlman and Trans Continental Airlines (TCA) in December 2006. Integra's complaint highlighted the fraudulent nature of Pearlman's dealings, and by January 2007, the bank sought a temporary restraining order against him for fraud.

Pearlman was indicted in June 2007 for falsifying documents, including those signed by a deceased individual, Harry Milner. Integra's Chief Financial Officer became aware of these forgeries by September 2007, and by March 2008, Integra received Pearlman’s plea agreement. Subsequently, Integra discovered a stock certificate, purportedly signed by Milner, that had been pledged as collateral. Integra notified F.D. of the loss on April 30, 2008, and submitted a proof of loss on August 6, 2008. F.D. denied coverage on November 20, 2008, citing that the stock certificate was not in Integra's possession when the loan was issued and that Harrington was not an employee at the time the losses occurred.

Integra and F.D. established a tolling agreement on February 18, 2010, to suspend the statute of limitations for filing a lawsuit, provided it had not already expired. Integra filed a notice of loss under Insuring Agreement A on June 29, 2010, followed by a supplemental proof of loss on December 2, 2010, which F.D. denied. Upon the expiration of the tolling agreement in February 2011, Integra initiated legal action for breach of contract and declaratory judgment regarding policy coverage. Subsequently, in July 2011, Integra failed, and the FDIC was appointed as receiver. The case has advanced to the summary judgment phase after extensive discovery disputes.

F.D. seeks summary judgment claiming the FDIC's assertions are time-barred and that the FDIC cannot demonstrate coverage under Insuring Agreements A or E. The FDIC contends that its claims are timely and that factual issues regarding coverage exist that prevent summary judgment. 

F.D. argues that the FDIC's claims are time-barred based on the Bond's stipulation that legal proceedings must commence within 24 months of discovering a loss. Discovery is defined as when a titled officer or risk manager first becomes aware of facts suggesting a loss covered by the bond. The FDIC counters that this two-year limitation is unenforceable under Indiana law and asserts it discovered its losses within that timeframe.

The FDIC cites Indiana case law, including Indiana Reg’l Council of Carpenters Pension Trust Fund v. Fidelity Deposit Co. of Maryland, which invalidated a similar two-year provision, ruling it in conflict with Indiana's ten-year statute of limitations for breach of contract. The court references precedents indicating that contractual limitations shortening the statutory period are void, reinforcing that the two-year provision in question may not be enforceable.

Hack did not resolve whether the ten-year statute of limitations applies, indicating that the Supreme Court of Indiana should address this issue, which remains unresolved, leaving district courts to make determinations. In National City Mortgage Co. v. D.D. Mortgage Solutions, the court concluded that when there is no conflict between the bond's limitation period and the law, the bond prevails. The court reaffirms this stance, noting that cases cited in Indiana Regional pertain to specific statutes of limitations, unlike the bond in question. Hack’s reliance on Indiana Code Annotated, 39-1713 (1933), which specifically barred foreign insurance companies from enforcing shorter limitation periods, distinguishes it from the current case. The FDIC seeks to extend the reasoning of prior cases to include a general ten-year statute for breach of contract, but the court refuses to do so, upholding the enforceability of the bond's two-year limitation period.

The court then addresses the dispute over when losses were discovered, with F.D. arguing that Integra identified the losses in 2007, while the FDIC contends that the necessary facts for discovery were not available until February 18, 2008. The parties also disagree on whether the discovery of one type of claim impacts the discovery of others. The bond defines discovery as occurring when the insured is aware of facts indicating a covered loss. F.D. interprets this broadly, claiming knowledge of any loss triggers discovery. However, the court finds this interpretation overly expansive, reasoning that each loss is typically discovered at different times. It concludes that losses under different sections of the bond are distinct, involving separate loans and amounts, and thus can be discovered at different times.

The court examines the timing of Integra's discovery of its claims, referencing a two-part discovery standard from the Third Circuit that includes both subjective knowledge of the insured and the objective conclusions a reasonable person could draw from that knowledge. The threshold for discovery is low, meaning the insured does not need to know the specific details of the loss. 

Section E of the Insuring Agreement pertains to losses from the Insured’s good faith transactions involving original certificated securities. F.D. claims the coverage is barred due to Integra’s discovery of the loss by September 2007, when Martin Zorn learned of Pearlman’s indictment related to the use of forged documents. However, the FDIC argues that Zorn was not aware that the stock certificate was forged until March 18, 2008, when outside counsel identified the forgery. F.D. claims that knowledge of any forgery constitutes discovery, citing two cases. In Diebold Inc. v. Continental Cas. Co., the court found that the mere awareness of disappearing money sufficed for discovery, despite the absence of knowledge regarding wrongdoing. However, the court distinguishes Diebold’s circumstances, indicating that knowledge of forgery alone is insufficient for a bondable loss unless it pertains to a specific type of document. 

In FDIC v. Cincinnati Ins. Cos., the court concluded that discovery related to the nature of the underlying facts rather than the mere existence of a forgery. The court here finds that there is insufficient evidence to conclude as a matter of law that a reasonable person would have recognized a bondable loss prior to the discovery of the forged stock certificate, resulting in a material fact issue that precludes summary judgment on this claim.

Section A of the Bond addresses losses from employee fraud or dishonesty, requiring proof of collusion if the loss stems from loans. F.D. contends that the FDIC's evidence of collusion also indicates that Integra discovered the loss before February 18, 2008.

F.D. presents evidence indicating that Integra Bank discovered its Coverage A claim over two years before the lawsuit was filed. Key points include: 

1. **Knowledge of Dishonesty**: In November 2000, Mike Vea learned of Harrington's failure to report total exposure on Pearlman loans. However, Vea's testimony did not confirm dishonesty, suggesting potential negligence instead. The court found insufficient evidence of discovery of dishonesty or collusion.

2. **Interoffice Memorandum**: An October 2006 memorandum questioned the adequacy of collateral for Pearlman loans. The court interpreted this as indicating attorney negligence rather than employee dishonesty, and noted that Integra Bank's leaders believed in the financial stability of Transcontinental. Therefore, this memorandum did not establish discovery of dishonesty.

3. **Payments to Harrington**: On December 19, 2007, Integra learned of payments Harrington received from Pearlman, dated between February 2005 and December 2006. The FDIC argued these payments indicated collusion; however, the court reasoned that a reasonable juror could view these as compensation for services rendered post-employment, not evidence of prior collusion.

The court concluded that even when considering all evidence collectively, it points more towards Harrington's poor performance and subsequent employment with Pearlman rather than dishonesty. Therefore, there remains a material fact issue regarding the timing of discovery under Section A. 

Regarding coverage under Insuring Agreement A, F.D. contends that the FDIC cannot demonstrate that Harrington colluded with Pearlman, a requirement for coverage. The agreement stipulates that coverage is contingent upon proving that losses resulted from fraudulent acts committed by the employee with intent to cause loss, and that the employee was colluding with others. 

The FDIC's claims for collusion include: Harrington receiving payments from Pearlman while employed at Integra; working for Pearlman post-termination; Pearlman's comment about a 'wink wink' understanding; and Harrington invoking his Fifth Amendment right when questioned. However, the court's analysis suggests that these points may not sufficiently establish collusion as required for coverage.

F.D. contests the FDIC's claim of collusion, arguing that the FDIC's evidence is speculative and based on self-serving statements. F.D. cites various cases, notably KnowledgeAZ, Inc. v. Jim Walters Resources, Inc., where summary judgment was granted due to a lack of evidence supporting collusion, specifically dismissing an affidavit based on hearsay and speculation. In contrast, the court finds that the FDIC provides sufficient circumstantial evidence for a reasonable juror to infer collusion between Harrington and Pearlman, establishing a material issue of fact regarding coverage under Insuring Agreement A.

Regarding coverage under Insuring Agreement E, the FDIC claims a loss due to a forged stock certificate provided by Pearlman to Integra, asserting this falls under the policy's coverage for losses resulting directly from forgery. F.D. counters that Integra did not incur a loss directly linked to the forgery, arguing that the policy distinguishes between risks of authentication (forgery) and the credit risk from worthless collateral. The language of Insuring Agreement E, which covers losses directly resulting from forgery, has been interpreted to exclude tort causation concepts in favor of a more straightforward causation standard. F.D. references several cases for support, while the FDIC cites relevant case law from the Seventh Circuit and the Northern District of Illinois that reinforces its position.

A loss is not deemed to result directly from forgery if the loss would have occurred regardless of the forgery, as established in cases like Diebold Inc. v. Continental Cas. Co. and FDIC v. Cincinnati Ins. Co. There is no binding precedent interpreting the relevant provision, although the FDIC argues that First Nat. Bank of Manitowoc v. Cincinnati Ins. Co. serves as binding authority. This case suggests that the existence of forged documents directly impacted the decision to extend credit, thereby causing loss. The Eleventh Circuit emphasizes assessing the value of collateral at the time it was given, asserting that losses directly resulting from fraudulent acts are unaffected by subsequent events, like economic downturns, that could limit recovery. In this instance, the court identifies two material issues of fact: whether the stock certificate as collateral was worthless and whether Integra Bank relied on the forged certificate for the loan. Conflicting testimonies from Pearlman regarding TCA's assets and the subsequent bankruptcy auction proceeds create questions that must be resolved by a jury. The court denies F.D.'s motion for summary judgment, also noting that Harrington's Fifth Amendment claim does not categorically create a question of fact.

Seventh Circuit precedent allows for an adverse inference in civil cases when a party fails to testify, but this silence alone cannot establish guilt. The court must evaluate silence alongside other evidence. In a relevant case, the Northern District of Illinois differentiated between losses from forged documents that describe or value collateral—excluded from coverage under Agreement E—and forged documents that are collateral itself, which are covered. The court found cases ignoring this distinction unpersuasive. Additionally, RLI Insurance expressed doubts regarding the validity of the worthless collateral doctrine in the Seventh Circuit. F.D. argued that testimony based on Rule 2004 examinations was inadmissible, but the court disagreed, noting Pearlman's deposition was admissible since F.D. had the chance to examine him. Furthermore, a Minnesota court ruled that certain forged stock certificates were worthless but did not consider the specific testimony available in the current case, indicating a material fact issue.