partner in the firm of E. R. Burt & Co., who acted as the official auditors for Midland, informed Pensec that he would not provide the bank with a "clean" letter of audit and that he would have to take exception to certain of the ship loan files because of a lack of documentation. Pensec thereupon brought this problem to the attention of Walter Jones, Midland's general counsel. Jones, greatly disturbed at this news, immediately sent Marvin Gladstone, an associate in his law firm, over to the Bank to investigate the situation and determine whether the ship loan files were as lacking in documentation as Perry had reported and to attempt to discern exactly what was missing. A meeting was scheduled in Jones' office for the following day to discuss the dilemma. Jones then called Peter Moraites requesting he attend the meeting and further instructing him to bring whatever documentation he may have had respecting any of the ship loans. Present at the January 13th meeting were Perry, Pensec, Moraites, Jones, Gladstone and Donald Salmon, a member of Midland's Board of Directors. From this day forward, Walter Jones assumed the responsibility of administering the ship loans and was given the authority to do whatever was necessary to reduce the outstanding loans.
At the January 13th meeting, it was decided to send Gladstone to London in an effort to obtain whatever was necessary from the K & M Group to straighten out their ship loan files. While in London, Gladstone made some renewal loans, obtained irrevocable undertakings to mortgage as collateral
and also executed a paydown agreement, which outlined a schedule of payments to which K & M was bound to adhere. Gladstone, in effect, arranged a restructuring of loans to the K & M Group, which placed Midland in a much sounder position. Following this series of events Perry issued Midland a clean audit report and the merger went through.
On February 16, 1968 both the New Jersey Department of Banking and the Federal Deposit Insurance Corporation made an official examination of Midland. On May 31, 1968, when the State Banking Authority's report was transmitted to Midland, Roger F. Wagner, the Chief Examiner for the State, requested that a special meeting of the Board be held in his office to discuss the report. Walter Jones was present at the meeting along with Midland's Board of Directors. While criticizing generally, Midland's ship loan program and advising the Board that $719,000 of the loans were "adversely classified" and another $2,205,000 were "especially noted" the Banking Department as of July 1968 still did not classify any of the loans as a loss. In fact, as of July 1968, neither the Bank, the F.D.I.C. nor the New Jersey Department of Banking seriously doubted the ultimate collectability of the ship loans. By way of resolution in February 1968, the Board of Directors refused to grant any new ship loans and under Jones' direction they were pursuing a steady course to liquidate the outstanding loans.
By October 1968, however, it became apparent that K & M would not be able to fulfill the paydown agreement as the loans began to fall into arrears. At this time, the New Jersey Department of Banking and the F.D.I.C. were conducting a special examination of Midland which was limited principally to ship loans and letters of credit made to three specific borrowing groups, which included the K & M, Bacalakis and Markogianis groups. On December 23, 1968 Chief Examiner Wagner advised the Bank that despite their continued efforts to achieve the best solution to a very difficult problem, it would be necessary for the Bank to either charge off these loans or to specifically set up a reserve in the amount of $1,700,000 to offset possible ship loan losses, prior to December 31, 1968. In compliance with this request, the Board of Directors, by resolution dated December 26, 1968, charged off $695,121.35 as loan losses and established a reserve of $1,000,000.
With the charging-off of these loans came the realization that Midland stood the risk of incurring a substantial loss on the ship loans. As a result, the Board of Directors, for the first time, became suspicious of the validity of these loans in general and in January 1969 retained the law firm of Riker, Danzig, Scherer and Brown to investigate the matter. The Bank, in the Spring of 1969, also retained the accounting firm of Pogash & Co. to assist in the investigation.
Upon the completion of an initial review of the ship loan files, Peter Berkley, a member of the Riker firm, met with representatives of the defendant on March 20, 1969 to discuss the ship loans. The next day he sent a follow-up letter to F & D, which stated in pertinent part:
"We notified you at that time that the Bank has discovered a loss or losses under your Banker's Blanket Bond # 53 60 496 D, resulting from fraudulent or dishonest acts of officers and/or employees, and/or attorneys for the Bank, and loss of property in connection with a series of ship loans, letter of credit transactions, and related loan transactions entered into by the Bank and certain shipping interests. Notification of the discovery of such loss is provided to you in accordance with the provisions of Section 3 of the Bond."
Over one month later, by letter dated April 23, 1969, F & D forwarded Proof of Loss forms to Mr. Berkley. The letter written by Charles J. Herman, a claims attorney for the defendant, stated in pertinent part:
". . . We understand that the matters referred to in your letter are under continuing investigation by the Bank and that upon completion of such investigation, the Bank intends to file detailed Proofs of Loss."