On March 3, 2015, the Eighth Circuit Court of Appeals released its decision in BancInsure, Inc. v. Highland Bank. The decision provides guidance with respect to (i) what constitutes a “direct loss” under the Securities Coverage of the Financial Institution Bond; and (ii) the nature of the reliance required for an insured to demonstrate that it has “extended credit … on the faith of” a forged guarantee.
In 2005, First Premier Capital (FPC), an equipment lease finance company, entered into a Master Lease Agreement with Equipment Acquisition Resources (EA). Player and Malone, who were spouses, each owned 50 per cent of EA. The Master Lease Agreement provided that FPC would lease EA pieces of equipment, as described in individual lease agreements. Player and Malone provided FPC with personal guarantees of EA’s indebtedness. FPC and EA ultimately entered into approximately 20 separate lease agreements under the Master Lease Agreement.
To finance its equipment purchases, FPC entered into Collateral Assignment agreements with several banks, whereby it assigned EA’s lease payment streams to those banks in exchange for up-front funds. In 2006 and 2007, Highland Bank obtained assignments of payments due from EA to FPC under three such lease agreements, in exchange for advancing almost $4 million to FPC. FPC also expressly assigned its ownership interest in the leased equipment to Highland Bank, and warranted that “[t]he Lease and any accompanying guarantees … are genuine and enforceable in accordance with their terms.” FPC purchased the leased equipment at the direction of EA, usually from a distributor named Machine Tools Direct (MTD). MTD delivered the equipment directly to EA.
Before entering into the Collateral Assignment agreements and funding FPC’s equipment purchases, Highland Bank:
- reviewed copies of the Master Lease Agreement and individual lease documents, as well as the personal guarantees of Player and Malone; and,
- obtained a joint personal financial statement of Player and Malone, in which they reported total assets of $63 million (including their shares in EA, which Player and Malone valued at $47 million); a negative after-tax net worth of $4.5 million; and $38 million in contingent liabilities (primarily guarantees of EA debts).
However, Highland Bank did not inspect the purchased equipment, and had no direct contact with EA, Player or Malone.
The lease payments were kept current until September 2009. At that time, EA ceased making lease payments and filed for bankruptcy. The bankruptcy proceedings revealed that EA had essentially been run as a Ponzi scheme. EA had colluded with MTD in order to inflate the purchase prices of some of the equipment; other equipment simply never existed. EA had used some of the proceeds from the lenders’ purchases of equipment to make EA’s lease payments, thereby keeping the Ponzi scheme running. Other proceeds were used to fund distributions to EA’s shareholders, and to pay for EA’s principals’ gambling and other personal expenses.
In December 2009, Highland Bank concluded that the unpaid lease payments under the Collateral Assignment agreements were uncollectible and wrote off over $2 million in losses. In July 2010, Highland Bank was advised that Malone’s signature on the guarantee was likely forged. Malone subsequently swore an affidavit of forgery to this effect.
The Securities Coverage Claim
Highland Bank asserted a claim under the Securities Coverage of its Financial Institution Bond, which indemnified it for:
Loss resulting directly from the Insured having … acquired, sold or delivered, given value, extended credit or assumed liability on the faith of any original … personal Guarantee … which bears a signature of any … guarantor … which is a Forgery.
Highland Bank asserted that Malone’s Guarantee Agreement was a “personal Guarantee” within the scope of the coverage, and that Malone’s signature had been forged. Highland Bank argued that it would not have entered into the Collateral Assignment agreements with FPC, had Player and Malone not personally guaranteed EA’s obligations under the Master Lease Agreement. As a consequence of the forgery of Malone’s signature, Highland Bank sustained a loss.
The District Court below held that Highland Bank had failed to demonstrate a direct loss. Highland Bank never obtained a legal interest in Malone’s guarantee, through assignment or other transfer; at all times, Malone’s guarantee was in favour of FPC only. Consequently, Highland Bank could not demonstrate reliance on the guarantee in extending credit. Further, and in any event, the Malone guarantee was worthless when Highland Bank extended credit, because Highland Bank’s own credit assessment showed that Malone and Player had a substantial negative tangible net worth and contingent liabilities of over $38 million.
The Eighth Circuit Court of Appeals affirmed the District Court’s decision. The Court of Appeals first observed that the test for causation under the Securities Coverage (i.e., Loss resulting directly from…”) suggested a stricter standard than proximate causation. (There is, incidentally, support for this more stringent test in Canadian insurance law as well.) The Court also noted that there was authority supporting the District Court’s conclusion that a “loan loss is not directly caused by reliance on forgeries in documents constituting or referencing collateral when the collateral is worthless at the time of the loan.”
However, the primary focus of the Court of Appeals’ decision was on Highland Bank’s inability to demonstrate reliance on Malone’s guarantee when it entered into the Collateral Assignment agreements with FPC in 2006 and 2007. As Highland Bank did not obtain any legal interest in Malone’s guarantee, it could not demonstrate such reliance:
It was FPC that obtained the personal guarantees of Player and Malone. Although Highland Bank examined copies of the guarantees before entering into Collateral Assignment agreements with FPC, Highland Bank relied on FPC’s due diligence and warranties, taking an assignment of FPC’s rights to the lease payments, and an assignment of FPC’s interest in the leased equipment as collateral, but not an assignment of FPC’s right to enforce the personal guarantees. … In these circumstances, we agree with the district court that the guarantees were worthless at least to the Bank. Therefore, Highland Bank failed to show the “direct relation between the injury asserted and the injurious conduct alleged” [emphasis in original]
As a result, the reliance requirement of the Securities Coverage was not made out.
Much like the Eleventh Circuit’s recent Bank of Brewton decision (which we discussed in our February 10 post), Highland Bank demonstrates the careful factual and legal analysis that must be performed in applying the Securities Coverage. As a factual matter, Highland Bank may indeed have “relied” on the personal guarantees in deciding whether to advance funds to FPC, in the sense that the existence of the guarantees may have factored into the bank’s decision. However, that “reliance” did not meet the requirements of the Securities Coverage in this case. The Court’s analysis suggests that the result might have been different, if (i) Highland Bank had obtained a proper assignment of Malone’s guarantee; and (ii) the guarantee would have had some real value, but for the forgery of Malone’s signature.
BancInsure, Inc. v. Highland Bank, 2015 WL 871806 (8th Cir.)