The opinion of the court was delivered by: SAROKIN
This is an action by an insurer, Fidelity & Deposit Company of Maryland ("F& D"), for rescission of a banker's blanket bond alleging fraud by the insured, Hudson United Bank ("the Bank"), in procuring the bond. The Bank counterclaimed for recovery of certain losses allegedly compensable under the policy's employee dishonesty provision and other provisions. F&D moved, pursuant to Fed.R.Civ.P. 42(b), to bifurcate the claim for rescission. The motion was granted, and trial was held on the rescission claim only. The cause was tried by the Court without a jury.
The plaintiff, F&D, is a corporation organized and existing under the laws of the State of Maryland with principal offices in that state. During all pertinent times, F&D was in the business of writing various lines of insurance, including fidelity insurance for financial institutions. Defendant Bank was a commercial banking institution incorporated in New Jersey with principal offices therein. Jurisdiction is premised upon 28 U.S.C.A. § 1332(a). As this is a diversity action involving a claim for rescission of an insurance contract delivered and performed in New Jersey, the substantive law of that state is applicable. Erie Railroad v. Tompkins, 304 U.S. 64, 58 S. Ct. 817, 82 L. Ed. 1188 (1938).
On or about February 4, 1974, the Bank hired Robert Lee Potter as a senior loan officer in its commercial loan department; he was subsequently appointed Vice-President of the Bank in September of that year. On or about July 24, 1975, on Potter's recommendation to the board of directors, the Bank made loans eventually totaling $ 700,000 to companies owned and controlled by one Thomas Mullens. In early 1976, said loans defaulted, and the Bank became aware of the losses resulting therefrom.
During January of 1976, Joseph L. Robertson was appointed President of the Bank. Upon assuming his duties, Robertson conducted an examination of certain documents at the Bank, including those relating to the Mullens' loans. As the result of his examination, Robertson found: (1) that there had been improper cashing of corporate checks contrary to standard banking practices; (2) that Potter had given his approval to the cashing of corporate checks for the Mullens' companies; (3) that there were inconsistencies between the presentations made by Potter to the board of directors regarding the Mullens' loans and the documentation supporting same contained in the loan files; (4) that the loans which were recommended by Potter and approved by the board of directors should not have been granted based upon the documentation contained in the file; (5) that certain of the financial statements submitted in connection with said loans had been incorrectly totalled; (6) that the financial statements contained pencilled changes; and (7) that said statements had been prepared by a fictitious, non-existent accounting firm.
As the result of his investigation, Robertson reported to the board of directors of the Bank on February 10, 1976 that the Mullens' loans were apparently worthless, and that Mullens was in the custody of federal authorities. On February 19, 1976, Robertson wrote to the Federal Deposit Insurance Corporation ("F.D.I.C.") outlining what he had discovered as the result of his investigation ("the F.D.I.C. letter" See Appendix). Copies of the letter were forwarded to the Department of Banking of the State of New Jersey, the Federal Bureau of Investigation, the Hudson County Prosecutor's office, the United States Attorney's office and Scarborough and Company (Hudson's insurance broker and agent for Employers Mutual Liability Insurance Company of Wisconsin ("Employers")). On February 27, 1976, the Bank issued a letter to shareholders describing what had occurred respecting the Mullens' loans.
During this time period, the Bank was insured under a fidelity bond issued by Employers. The policy was a "claims made" policy that insured against specific losses resulting from acts occurring at any time, provided that such losses were discovered during the policy period. In late 1975 and early 1976, the Bank considered obtaining coverage elsewhere and solicited four insurance companies. The Bank forwarded an application for insurance to plaintiff F&D on or about January 27, 1976.
In March 1976, prior to the issuance of its bond, F&D was advised that the Bank had sustained certain losses and as a result, "possible pending fraud" claims existed. On March 12, 1976, F&D requested further information respecting the possible pending fraud losses by letter directed to the Bank. No response to that letter, either oral or written, was ever received by F&D from the bank. The Court finds that neither the F.D.I.C. letter nor the letter of February 27, 1976, from the Bank to its stockholders was submitted to F&D.
On March 19, 1976, Employers advised the Bank that it would not renew the existing coverage. Prior thereto, Hartford Insurance had advised the Bank that it would not provide coverage. Therefore, the Bank ordered the bond from F&D, which bond was issued on March 21, 1976.
As of the date of the issuance of the policy, the Bank had not advised F&D of the nature and extent of the Mullens' losses, the discrepancies between the loan files and the recommendations made by Potter, the issuance or content of the F.D.I.C. letter or the existence of an investigation by counsel for Employers regarding the Mullens' losses in order to determine whether or not the Bank had a compensable claim under the existing policy with Employers.
Robertson, as bank president, believed that it was important that all of the aforesaid information be forwarded to F&D as part of its application disclosure. He instructed that the information be transmitted and was under the impression that it had been so provided. He testified it was of particular importance that F&D receive a copy of the F.D.I.C. letter which contained a summary of all that had transpired respecting the Mullens' losses.
Harold J. Fitzgerald, in charge of underwriting the fidelity bonds for F&D, testified that had he received the F.D.I.C. letter, F&D would not have written the coverage and issued the bond. The Court finds that if F&D had received the F.D.I.C. letter or otherwise been informed of the information respecting the Mullens' loans, F&D would not have provided the coverage represented by the bond issued on March 21, 1976. The Bank offered no proof to the contrary.
Commencing in July 1976, the Bank advised F&D of its claims under the subject bond. In early 1977, F&D became aware of the fact that dual and identical claims had been filed against it and Employers. The bond was cancelled by F&D effective April 9, 1977. After investigation and consultation with counsel, F& D determined to rescind its bond with the Bank on the ground that the Bank had discovered evidence of employee dishonesty prior to March 21, 1976, the effective date of the bond, and failed to disclose same to F&D. Notice of rescission was forwarded to the Bank by F&D on January 31, 1978.
In summary, prior to March 21, 1976, the Court finds that the Bank had knowledge of the following:
1. The facts as set forth in the F.D.I.C. letter including the fact that Mullens had defrauded the Bank in connection with certain loans;
2. That corporate checks of Executive Investments, a Mullens' company, were being cashed and approved by Potter whose explanation for cashing said checks was unsatisfactory;
3. That the structure of the loans to Executive Investments was improper;
4. That there were inconsistencies between Potter's recommendation to the board of directors regarding the loans and the documentation allegedly supporting said loans as contained in the relevant files;
5. That the accounting statements upon which the Mullens' loans were predicated were fictitious and the accountant non-existent;
6. That said financial statements contained pencilled changes;
7. That Employers, which had refused to renew its bond, had been advised of the Mullens' losses by the Bank and had received a copy of the F.D.I.C. letter; and
8. That, based upon his testimony, Mr. Robertson, as President of the Bank, would not have granted the Mullens' loans and would have disclosed to F&D the knowledge the Bank possessed at that time concerning said loans.
The applicant for a fidelity bond is under a duty to make full disclosure of all facts upon which the bonding company might reasonably rely in evaluating the risks to be insured. The insured should "advise the insurer of such matters that (it) knows (or has reason to believe) might influence the insurer in (accepting) or declining the risk, (particularly) where such facts are not of record and are not discoverable therefrom by the insurer. See Gallagher v. New England Mut(ual) Life Ins(urance) Co. of Boston, 19 N.J. 14 (114 A.2d 857) (1955); (and) Weir v. City Title Ins(urance) Co., 125 N.J.Super. 23 (308 A.2d 357) (App.Div.1973)." Pioneer National Title Insurance v. Lucas, 155 N.J.Super. 332, 338, 382 A.2d 933, 936 (App.Div.1978), aff'd 78 N.J. 320, 394 A.2d 360 (1978). Accord, Apolskis v. Concord Life Insurance, 445 F.2d 31, 35 (7th Cir. 1971), Stipcich v. Metropolitan Life Insurance Co., 277 U.S. 311, 316-317, 48 S. Ct. 512, 513-514, 72 L. Ed. 895 (1928); Metropolitan Life Insurance Co. v. Chambers, 142 N.J.Eq. 440, 443, 60 A.2d 244 (Ch.1948), See, Jewish Center of Sussex v. Whale, 165 N.J.Super. 84, 397 A.2d 712 (Ch.1978). Therefore, assuming that the Bank did not know or believe that employee dishonesty was involved in any of the losses which were discovered prior to the issuance of the bond by F&D, nonetheless, it was under a duty to advise F&D of all of the information known to it prior to March 21, 1976, (the date upon which the bond was issued) which reasonably related to the risks to be covered. The failure to disclose such information is not excused by an honest belief that the losses or potential losses within the knowledge of the Bank did not involve a risk which would be covered by the bond, if issued. In this matter information was specifically requested (March 12, 1976 letter to F&D) and was material to the insurer in deciding whether to insure the risk (testimony of Harold J. Fitzgerald). A fact is material if the knowledge or ignorance of it would naturally and reasonably influence the judgment of the insurer in determining whether to undertake the risk, or in estimating its degree or character, or in fixing the rate of the premium. Kozlowski v. The Pavonia Fire Insurance Company, 116 N.J.L. 194, 198, 183 A. 154 (E. & A.1936), Gallagher v. New England Mutual Life Ins. Co., supra. See, Urback v. Metropolitan Life Ins. Co., 127 N.J.L. 585, 23 A.2d 568 (E. & A.1942). The failure to provide information where there is a duty to disclose is equivalent to an affirmative misrepresentation. Jewish Center of Sussex v. Whale, supra, 165 N.J.Super. at 89, 397 A.2d 712; Costello v. Porzelt, 116 N.J.Super. 380, 383, 282 A.2d 432 (Ch.1971).
The circumstances which came to the attention of the Bank at or about the time it submitted its bond application and continued until the effective date of the bond presented serious symptoms which were not then susceptible of any final diagnosis. It was too early to rule out the possibility of employee dishonesty, and as the facts subsequently developed, the losses were due in part to such employee dishonesty.
In the face of such losses, coupled with the fact that the Bank had commenced rather than concluded its investigation, F&D was entitled to be made aware of said circumstances so that it could make its own determination whether it wished to issue the bond and insure the risks incident thereto, without further investigation and information.
The Bank should have exercised the same caution in regard to its prospective carrier as it did to its existing carrier. Although acting under the honest belief that the losses were not covered by its existing bond, it nonetheless advised Employers of the circumstances. Through that very same means and even utilizing the identical document, the Court finds that Fidelity should have been so advised.