On certification to the Superior Court, Appellate Division.
For reversal and remandment -- Chief Justice Hughes, and Justices Pashman, Clifford, Schreiber and Handler. For affirmance -- Justice Sullivan. The opinion of the court was delivered by Pashman, J. Sullivan, J. (dissenting).
This appeal requires the Court to determine whether the fidelity provisions of a Banker's Blanket Bond issued to the plaintiff Bank provide coverage for the losses caused by the conduct of one of its employees under the rather unusual circumstances of this case. If coverage is found to exist, we must next determine whether the filing of the claim herein was timely under the limitation period specified in the bond.
National Newark and Essex Bank, now named Midlantic National Bank (hereinafter the Bank), seeks indemnification from the American National Insurance Company (Insurer) for losses resulting from the improper actions of a Vice-President and Branch Manager of the Bank, William C. Bowers, with respect to his handling of large collateralized loans. It is undisputed that the Banker's Blanket Bond was in effect at all times pertinent to the events of this case. The fidelity provision of the Bond (coverage A) committed the Insurer to indemnify the Bank for:
Loss through any dishonest or fraudulent act of any of the Employees, committed anywhere and whether committed alone or in collusion with others, including loss, through any such act of any of the Employees of Property held by the Insured for any purpose or in any capacity and whether so held gratuitously or not and whether or not the Insured is liable therefor.
Section 4 of the Bond, on timeliness of claims, provided that:
At the earliest practicable moment after discovery of any loss hereunder the Insured shall give the Underwriter written notice thereof and shall also within six months after such discovery furnish to the Underwriter affirmative proof of loss with full particulars. Legal proceedings for recovery of any loss hereunder shall not be brought prior to the expiration of sixty days after such proof of loss is filed with the Underwriter nor after the expiration of twenty-four months from the discovery of such loss, except that any action or proceeding to recover hereunder on account of any judgment against the Insured in any suit mentioned in General Agreement D or to recover attorneys' fees paid in any such suit, shall be begun within
twenty-four months from the date upon which the judgment in such suit shall become final. If any limitation embodied in this bond is prohibited by any law controlling the construction hereof, such limitation shall be deemed to be amended so as to be equal to the minimum period of limitation permitted by such law.*fn1
The limit of liability under the Bond was $4,000,000.
William C. Bowers' banking career began in 1948 with a bank which merged with National Newark and Essex Bank in 1950. He steadily worked up through the ranks until becoming Branch Manager of the Watsessing office in January 1965. Bowers was introduced to a Bank customer named Charles D. Erb, Jr. in 1965 by the outgoing branch manager, who indicated that the Bank considered the Erb family's longstanding account to be an excellent one. Erb's collateral loan account dated back to 1961, and from 1965 to January 1969 the outstanding balance remained relatively constant. During this period he traded stocks and often exchanged stocks held in his account for other stocks.
In early 1969 Erb became a partner of Baerwald & De Boer, a registered brokerage firm in New York City. He called upon Bowers to lend him increasing amounts of capital, obtaining six loans between January 16 and August 1, 1969.
Under the Bank's internal regulations, Bowers was authorized to grant unsecured loans of up to $25,000 and secured loans of up to $50,000 without obtaining the approval of the head office. He could also increase any loan whose outstanding balance was already more than $50,000 to $75,000. For all other loans he was required to secure the approval of a superior by submitting a report form to the central office of the Bank. Bowers testified that he was familiar with these rules and regulations and that he followed them.
All of the above loans were also subject to margin requirements. The bank's own guidelines set a 70% maximum margin for "non-purpose" loans.*fn2 Moreover, branch managers were required to complete Federal Reserve Form U-1, titled "Statement of Purpose of the Proceeds of a Stock-Secured Extension of Credit by a Bank." This form requires a statement of the amount of the loan, the collateral pledged to secure the loan, the market value and source of valuation of that collateral, and the purpose for which the proceeds of the loan are to be used by the borrower. The Bank's signing officer must affirm his familiarity with the provisions of Regulation U and that he has accepted the customer's statement of purpose in good faith.*fn3
Branch managers were required to margin all secured loans on a monthly basis to ensure that the market value of the securities held as collateral was sufficient to maintain the required margin on the outstanding loan. Where the market value had fallen to the point where the Bank's margin requirements were not met, branch managers were directed
to request additional collateral from the borrowers. They were also responsible for monitoring the checking accounts of borrowers to enforce the Bank's requirement that a 20% compensating balance corresponding to the outstanding loan be maintained at all times. Lending officers were expected to keep collateral for loans in the Bank's possession. A customer was not to sell a pledged security until the branch manager determined whether the collateral offered in replacement was satisfactory. If so, he would arrange for sale of the security by a brokerage house, taking a check at the time of delivery and reducing the amount of the loan until the customer delivered new collateral to the Bank. At that time a new note would be signed and a new Regulation U form completed.
In the first eight months of 1969 Bowers granted Erb six loans in the following amounts: $40,000 on January 16, $15,000 on February 20, $30,000 on March 24, $62,000 on May 16, $80,000 on June 4, and $93,000 on August 1. Every one of these loans was preceded by an overdraft in Erb's checking account, and the amount of the loan subsequently approved was usually close to the amount overdrawn. Bowers completed the Federal Reserve U-1 forms for each of these loans. Despite his knowledge that each loan was for purposes of covering an overdraft, he usually wrote a brief statement indicating a business use for the funds. Bowers claimed that these overdrafts had been created for business purposes. He never investigated the purposes of these loans.
Bowers adamantly maintained that he had approval for all of his loans of over $50,000. Yet, Erb's credit file, which should have included an approval form for each of these loans, contained only one form relating to the loans in question -- the June 4 loan of $80,000. That form was signed by Richard F. Monks, the Vice-President in charge of collateral loans. However, Monks testified that he approved the loan on the representation that the stated collateral of $448,774 was in the Bank. In fact, there was only $225,456
on hand and the loan balance was $303,900. Bowers testified that he margined Erb's account by including securities due to arrive from Baerwald & De Boer among the collateral. Franz Arzt, who audited Bowers' branch in early 1970, testified that the usual practice was only to value securities in the Bank's possession.
The August 2 loan of $93,000 was directly contrary to instruction by Monks, who had indicated that after the June 4 loan all future loans to Erb would be strictly on "an offering basis." Bowers listed $570,000 collateral on the U-1 form, when the actual collateral on hand was $377,280. On August 21 and 29 he released securities to Erb worth nearly $330,000, leaving $41,644 as collateral for a loan balance of $396,989. Bowers was promised securities worth $125,000 to replace the collateral released. However, until mid-December, when Erb's father pledged additional securities worth $170,000, the level of collateral remained constant. On December 30 and January 14, 1970 Bowers complied with Erb's request for the release of securities in the account, leaving $180,062 to secure the loan totalling $396,989.
On May 14, 1969 Bowers granted a loan of $125,000 to one Bertram A. Knight, a customer of Erb's brokerage firm, taking 100,000 shares of Academic Systems & Management Corp. stock as collateral. Despite a restrictive legend across the face of the stock indicating that it was marketable under only limited circumstances, Bowers never checked for himself to verify that the stock was selling for $5 a share, as represented by Erb. He did have Erb sign a limited guarantee for the note. Bower's testimony that he had obtained prior approval for this loan was contradicted by other witnesses. The interest on the Knight loan was in default after July and the stock was trading at $1 a share in October. The note was called in January 1970.
Erb's partner at Baerwald & De Boer, Thomas Oswald, completed the firms financial statements to the New York Stock Exchange. When Erb professed to be unsure of the amount of collateral securing his loans at the Bank, a three-way
conference call with Bowers was arranged to obtain the figures necessary for Oswald's November 1969 report. Bowers represented that the total loan was $396,989 with collateral of $632,500. The actual collateral on hand at that time was no more than $50,000.
In January 1970 Mr. C. Richard Carlson, then Vice-President and Senior Mortgage Officer of the Bank, was given overall responsibility for the supervision of collateral loans. His first action was to assign Franz Arzt to investigate and review outstanding loans in all branches of over $100,000 to determine whether they were sufficiently collateralized. Arzt soon discovered the collateral shortage in the Erb account, the undermargining of loans approved by Bowers, the large overdrafts and the constant violation of the 20% compensating balance rule. On his second visit in January he learned that Bowers had been making loans in excess of his authority. After review within the bank the Erb loan was recalled on January 27, 1970, by a letter of Bowers at the instruction of his supervisors. A conference was held on February 6, 1970, with Arzt, Carlson, Bowers and Erb participating, at which time it became clear that Erb would be unable to meet his obligations. Carlson thereupon telephoned Erb's father and advised him of the Bank's intention to liquidate the collateral. The senior Erb told Carlson not ...