No Rescission Based on Application Signer’s Fraud; Fraudster’s Knowledge Cannot Be Imputed to Bank

Applying Louisiana law, the United States District Court for the Western District of Louisiana has held that an insurer cannot rescind a fidelity bond issued to a bank because it could not prove as a matter of law that the bank intended to deceive the insurer. Everest Nat’l Ins. Co. v. Tri-State Bancshares, Inc., No. 5:15-cv-1491 (W.D. La. Aug. 2, 2016). Even though the officer who signed the bond application admittedly perpetrated the fraud, the court held that the officer’s intent to deceive could not be imputed to the bank.

In 2014, a Louisiana bank learned that its vice president of operations had embezzled almost $1.8 million from the bank by manipulating the bank’s internal controls to disguise imbalances in the bank’s ledgers. After receiving the bank’s proof of loss, the insurer filed a declaratory judgment action to rescind the bond. The insurer argued that the vice president and the bank’s president, both of whom signed the application, made material misrepresentations about the bank’s internal controls and had knowledge of facts that could give rise to a loss covered by the fidelity bond.

The court held that the insurer could not rescind the fidelity bond based on material misrepresentations by the bank’s vice president because his knowledge could not be imputed to the bank. Under Louisiana law, an insurer must prove that an insured’s material misrepresentations were made with an intent to deceive. The bank did not dispute that the vice president made material misrepresentations or that he personally intended to deceive the insurer. However, the bank contended that the vice president’s knowledge could not be imputed to it under the “adverse interest” exception. The court agreed, holding that an agent’s knowledge is not imputed to his principal if an agent is acting adversely to his principal and solely for his own benefit. The court reasoned that the vice president acted adversely to the bank by embezzling funds and made the misrepresentations for his sole benefit, namely, to prevent his fraud from being discovered. The court rejected the insurer’s argument that it was protected by the “innocent third party” doctrine, which shields a third party who deals with the principal in good faith from the adverse interest exception. The court held that insurers are excepted from the innocent third party doctrine and the bank purchased insurance expressly to protect against employee theft.

The insurer also argued that it was entitled to rescind because the bank’s president also signed the application. The court held that disputed issues of material fact prevented summary judgment as to the president’s knowledge about the design of the bank’s internal controls and intent to deceive the insurer.

Wiley Executive Summary

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