Universal Mortgage Corporation v. Wurttembergische Versigherung

Filing

Filed opinion of the court by Judge Sykes. AFFIRMED. Richard A. Posner, Circuit Judge; Joel M. Flaum, Circuit Judge and Diane S. Sykes, Circuit Judge. [6321457-3] [6321457] [10-3015]

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In the

United States Court of Appeals
For the Seventh Circuit
No. 10-3015
U NIVERSAL M ORTGAGE C ORPORATION,
Plaintiff-Appellant,
v.

W ÜRTTEMBERGISCHE V ERSIGHERUNG AG,
Defendant-Appellee.
Appeal from the United States District Court
for the Eastern District of Wisconsin.
No. 09-CV-1142—J.P. Stadtmueller, Judge.

A RGUED F EBRUARY 16, 2011—D ECIDED JULY 11, 2011

Before P OSNER, F LAUM, and S YKES, Circuit Judges.
S YKES, Circuit Judge. Württembergische Versigherung
AG (“Württ”) is one of several investors (the “Underwriters”) in a mortgage bankers blanket bond issued
to Universal Mortgage Corporation. As relevant to this
case, the bond insures Universal against financial loss
resulting from employee misconduct. One of Universal’s
employees engaged in a scheme by which, for a kickback,

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he caused Universal to fund mortgages below its standards. Not knowing the loans were substandard,
Universal sold them, warranting that they met its standards. When investors realized the loans were substandard, they forced Universal to repurchase the loans,
causing Universal a significant financial loss. Universal
filed a claim under the bond, asserting that this loss
was directly caused by employee dishonesty. The Underwriters denied the claim and this suit followed. The
district court dismissed the suit, finding that the bond
did not cover Universal’s loss.
We affirm. The fidelity bond at issue here employs
direct-loss causation language. The bond provides coverage for losses “directly caused by” dishonest acts of
employees. A financial loss resulting from contract
liability to third parties is not “directly” caused by employee misconduct, even if employee misconduct is the
source of the contract liability. Here, Universal’s loss
resulted from its contractual repurchase obligations.
Although this contract liability arose as a result of an
employee’s misconduct, the employee misconduct did
not directly cause the eventual financial loss associated
with the repurchases. In addition, an exclusion in the
bond specifically bars coverage for losses resulting
from loan-repurchase obligations. Because Universal’s
loss resulted from its contractual obligation to repurchase
real-estate loans, this exclusion applies.

I. Background
Universal originates mortgage loans and sells them to
investors. As part of its sales contract, Universal warrants

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that its loans are compliant with Federal National Mortgage Corporation (“FNMC”) standards, which forbid
the use of down-payment-assistance programs. Universal’s
warranties require it to repurchase any mortgage sold
that does not comply with FNMC standards.
For about a year and a half, Ray Hightower, one of
Universal’s employees, conspired with an outside mortgage broker to have Universal fund mortgages that did
not meet the FNMC down-payment requirements. For a
kickback Hightower ensured the loans were approved
by Universal despite being noncompliant. Unaware of
Hightower’s scheme, Universal sold the noncompliant
loans to investors, warranting that the loans were compliant. When certain loans went into default, the investors
realized the loans did not comply with FNMC standards
and exercised their contractual right to force
Universal to repurchase the loans. To date, Universal
has repurchased some of these loans and is obligated to
repurchase others. As a result of the repurchases and
outstanding obligations to repurchase, Universal will
lose an estimated $4.5 million.
After learning of Hightower’s misconduct and the
impending financial loss, Universal filed a claim under
a mortgage bankers blanket bond issued to it by a consortium of Lloyds of London underwriters that included Württ. In relevant part the bond states: “The
Underwriters hereby undertake and agree . . . to
indemnify the Assured for . . . [d]irect financial loss
sustained by the Assured . . . by reason of and directly
caused by . . . dishonest acts by any Employee of the

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Assured.” In addition, the Bond states at Exclusion 18:
“THIS BOND DOES NOT COVER . . . [a]ny loss resulting from the Assured having repurchased or having
been required to repurchase a Real Estate Loan from
an Investor . . . .”
The Underwriters denied the claim, and Universal
brought this suit for breach of contract, statutory
interest, and bad-faith denial of an insurance claim.
Württ moved to dismiss, arguing that the bond did not
cover Universal’s loss. The district court granted the
motion, holding that Universal’s loss was not directly
caused by Hightower’s fraud but rather by Universal’s
contractual obligations to investors. Alternatively, the
court held that Exclusion 18 barred coverage because
Universal’s loss resulted from its contractual obligation
to repurchase mortgage loans. Accordingly, the court
dismissed the claim for breach the contract. Because
the statutory-interest and bad-faith claims were
dependent on a breach, the court dismissed those
claims as well.

II. Discussion
A bankers blanket bond, sometimes called a fidelity
bond or financial institution bond, offers bundled indemnification coverages for various specific risks, typically
including financial loss from forgeries, employee dishonesty, and theft. See 9A JOHN A LAN A PPLEMAN &
JEAN A PPLEMAN, INSURANCE L AW AND P RACTICE § 5701, at
377-78 (1981 & Supp. 2010). The most common bankers
blanket bond is the Standard Form No. 24, which has a

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well-chronicled history. See, e.g., Private Bank & Trust Co.
v. Progressive Cas. Ins. Co., 409 F.3d 814, 816 (7th Cir.
2005), and sources cited below. Over the last century,
nearly every term in the Form 24 bond has been
developed in reaction to court interpretations of prior
versions of the bond. As a result, certain terms within
the bond carry nuanced and well-established meanings.
Peter I. Broeman, An Overview of the Financial Institution
Bond, Standard Form No. 24, 110 B ANKING L.J. 439,
445 (1993).
Modern bankers blanket bonds typically limit coverage
to losses “directly” caused by covered conduct. See Peter
Haley, Loss and Causation, in A NNOTATED F INANCIAL
INSTITUTION B OND 99 (Michael Keeley ed., 2d ed. 2004).
Although the direct-loss language was clearly adopted
to limit coverage, courts today debate its precise effect. See
Robert J. Duke, A Brief History of the Financial Institution
Bond, in F INANCIAL INSTITUTION B ONDS 5-6 (Duncan L.
Clore ed., 3d ed. 2008). Two interpretive camps exist:
the “proximate cause” camp and the “direct means
direct” camp. Compare Scirex Corp. v. Fed. Ins. Co., 313 F.3d
841, 849-50 (3d. Cir. 2002) (“[T]he ‘direct cause of a loss’
does not have to be the ‘sole cause’ or ‘immediate cause,’
but need only be a proximate or substantial cause.”) with
Vons Cos., Inc. v. Fed. Ins. Co., 212 F.3d 489, 492-93 (9th Cir.
2000) (“We hold that ‘direct’ means ‘direct’ and that . . .
Vons’s policy did not provide indemnity for vicarious
liability for tortious acts of its employee.”). The primary
dispute between the two camps is over whether courts
should import tort causation principles when interpreting bankers bonds.

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We have previously sided with the direct-means-direct
camp, First State Bank of Monticello v. Ohio Cas. Ins. Co., 555
F.3d 564, 570 (7th Cir. 2009) (calling the proximatecause approach “misdirected”), as have scholars, William
T. Bogaert & Kerry Evensen, Loss and Causation Under
the Financial Institution Bond, in F INANCIAL INSTITUTION
B ONDS 596-97 (Duncan L. Clore ed., 3d ed. 2008) (“The
phrase ‘resulting directly from’ is unambiguous and its
meaning indicates a stricter standard of causation than
mere ‘proximate cause.’ Unfortunately, the courts have
been inconsistent in their enforcement of this contractual
language.”). More importantly, Wisconsin, whose law
governs this case, has placed itself in the direct-meansdirect camp. See Tri City Nat’l Bank v. Fed. Ins. Co., 2004
WI App 12, ¶¶ 14-20, 674 N.W.2d 617, 622-24 (Wis. Ct.
App. 2003).
For those in the direct-means-direct camp, a loss resulting from an insured’s liability to third parties is not
a direct loss under a fidelity bond, even if the liability
resulted from a covered act. See Bogaert & Evensen,
supra at 594 (“[T]he Bond does not provide coverage
for liability to third parties for their losses which may
otherwise result from covered conduct, such as the insured’s employees’ dishonesty.”). In Tri City the
Wisconsin Court of Appeals held that a fidelity bond
containing direct-loss language did not cover loss from
third-party tort liability, even though the liability
resulted from misconduct of the insured’s employee.
2004 WI App 12, ¶¶ 17-20, 674 N.W.2d at 623-24.
Similarly, and relying on Tri City, the Appellate Court
of Illinois has held that third-party contract liability is not

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a direct loss under a fidelity bond, even when an employee’s misconduct caused the warranty breach supporting liability. RBC Mortg. Co. v. Nat’l Union Fire Ins. Co.
of Pittsburgh, 812 N.E.2d 728, 735 (Ill. App. Ct. 2004). RBC
Mortgage is a logical extension of Tri City, and we believe
Wisconsin courts would follow its holding if presented
with the same question. As these cases show, when an
insured incurs liability to a third party—whether in
contract or tort—as a result of employee misconduct,
financial loss resulting from that liability is not “directly”
caused by the employee misconduct and therefore is
not covered by fidelity bonds containing direct-loss
language.1

1

As explained in Tri City, liability insurance, as opposed to
a fidelity bond, is meant to cover losses from third-party
liability: “ ’Insurance covers the liability of the insureds to a
third-party, while fidelity bonding covers the loss of property
owned by the insureds or held by the insureds, as a consequence
of employee dishonesty.’ ” Tri City Nat’l Bank v. Fed. Ins. Co., 2004
WI App 12, ¶ 13, 674 N.W.2d 617, 622 (Wis. Ct. App. 2003)
(quoting Aetna Cas. & Sur. Co. v. Kidder, Peabody & Co., 676
N.Y.S.2d 559, 565 (N.Y. App. Div. 1998)); see also 9A JOHN A LAN
A PPLEMAN & JEAN A PPLEMAN , I NSURANCE L AW AND P RACTICE
§ 5701, at 380 (Supp. 2010) (“Nor is a bankers’ blanket bond
a contract in the nature of liability insurance that would
indemnify the bank against liability to a third party due to the
acts of a bank employee.” (citing Tri City and RBC Mortg. Co.
v. Nat’l Union Fire Ins. Co. of Pittsburgh, 812 N.E.2d 728 (Ill. App.
Ct. 2004))); William T. Bogaert & Kerry Evensen, Loss and
Causation Under the Financial Institution Bond, in F INANCIAL
(continued...)

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The particular bond at issue in our case is a mortgage
bankers bond, a variation of a bankers blanket
bond specifically tailored to institutions that originate and resell mortgage loans. See http://www.
statesideunderwriting.com/mbb/mortgage_banker_broker_
insurance.html (last visited June 30, 2011). Because
bankers blanket bonds have changed over time, we must
closely examine the operative language in the bond to
ensure the authorities we have cited are applicable. See
First Nat’l Bank of Manitowoc v. Cincinnati Ins. Co., 485
F.3d 971, 977 (7th Cir. 2007). The bond’s relevant
insuring clause covers loss “directly caused by” employee
dishonesty, while the Standard Form No. 24 and the
bonds interpreted in Tri City and RBC Mortgage
covered loss “directly resulting from” employee dishonesty. These phrases differ slightly, but the key word in
each is “directly,” which courts have exhaustively interpreted. We see no meaningful difference between
“caused by” and “resulting from” in this context, a conclusion with which the parties appear to agree. Accordingly, consistent with Tri City and RBC Mortgage, the
bond does not cover losses sustained by Universal as
a result of third-party contract liability.
In a different twist on the argument, Universal contends
that its loss was not caused by its contractual repurchase

1

(...continued)
I NSTITUTION B ONDS 584 (Duncan L. Clore ed., 3d ed. 2008) (“The
Financial Institutional Bond is ‘indemnity’ insurance, not
‘liability’ insurance.”).

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obligations but rather by its initial funding of Hightower’s noncompliant loans. An “ ‘actual depletion of bank
funds’ ” due to employee dishonesty is a direct loss that
would be covered under the bond. First State Bank, 555
F.3d at 569 (quoting RBC Mortgage, 812 N.E.2d at 733); see
A PPLEMAN, supra § 5722, at 475 (Supp. 2010) (“ ‘[L]oss
resulting directly from’ an employee’s dishonest act,
means an actual depletion of bank funds resulting from
the employee’s act.”). In this sense Universal may
have suffered an actual, direct loss when it funded
Hightower’s noncompliant loans. See F.D.I.C. v. United
Pac. Ins. Co., 20 F.3d 1070, 1080 (10th Cir. 1994) (“In terms
of loss with respect to the making of loans, a bank
suffers a loss when funds are disbursed due to the employee’s wrongful conduct.” (citing Portland Fed. Emps.
Credit Union v. Cumis Ins. Soc’y, Inc., 894 F.2d 1101, 1105
(9th Cir. 1990))). But Universal recouped that loss in
full when it resold the noncompliant loans to investors.
The loss for which Universal seeks coverage arose later
when investors exercised their contractual resale rights.
This conclusion flows from the allegations in
Universal’s complaint, incorporating attached exhibits,
which we take as true when reviewing a motion to dismiss. FED. R. C IV. P. 10(c), 12(b)(6). The complaint itself
is unclear regarding the exact source of the loss for
which Universal seeks coverage; that is, whether the
loss resulted from Universal’s contractual repurchase
obligations or the initial loan funding. But it states that
all loans for which Universal seeks coverage were sold
to investors, and that since learning of Hightower’s
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tracts with the investors, to repurchase the loans.” Attached to the complaint is Universal’s Sworn Proof of
Loss—the document Universal submitted to the Underwriters in support of its initial claim under the bond.
The third page of the proof of loss contains a table identifying the amount of Universal’s claimed loss by loan.
Universal characterizes its loss amounts as “Repurchased
Amount” or “Pending Repurchase Amount.” Reading
the proof of loss in combination with the complaint, it is
inescapable that Universal seeks coverage for the cost
of repurchasing loans. Because its obligation to repurchase results from contract liability to the thirdparty investors, any loss associated with repurchasing
costs is not covered by the bond.
In addition, even if we assume Universal’s loss to
be covered by the bond’s insuring clause, Universal’s
claim is plainly barred by Exclusion 18, which once again
states: “THIS BOND DOES NOT COVER . . . [a]ny loss
resulting from the Assured having repurchased or
having been required to repurchase a Real Estate Loan
from an Investor . . . .” Universal does not dispute that
within the meaning of Exclusion 18, its mortgage loans
are “Real Estate Loans” and the investors forcing
Universal to repurchase them are Investors. Nevertheless,
Universal claims Exclusion 18 is inapplicable because
the real source of its loss was Hightower’s misconduct.
In Continental Corp. v. Aetna Casualty & Surety Co., 892
F.2d 540 (7th Cir. 1990), we interpreted a similar
exclusion in a fidelity bond. There, a dishonest employee
issued false title insurance to fool real-estate investors,

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who later sued his employer, a title insurance company,
based on the fraudulent policies. The insurance
company settled the cases and filed a claim under its
fidelity bond, claiming to have suffered a loss as a result
of employee dishonesty. The bond excluded “[l]oss or
expense resulting from . . . liability of the Insured under
contracts or purported contracts of insurance.” Id. at 542.
We held that this exclusion applied: “The underlying
cause of Continental’s losses is admittedly employee
dishonesty. But because the mechanism by which
that dishonesty caused loss was through fraudulent
title policies and improper title reports, the losses
are excluded from coverage by operation of [the exclusion].” Id. at 547.
Just as in Continental, although the “underlying cause”
of Universal’s loss was admittedly employee dishonesty,
the loss “result[ed] from” Universal’s contractual repurchase obligations, bringing it within the terms of Exclusion 18.
A FFIRMED.

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