The opinion of the court was delivered by: Irenas, Senior District Judge
Appellants appeal from two Orders for Judgment issued on October 21, 2005, and March 29, 2006, by the United States Bankruptcy Court for the District of New Jersey (Wizmur, J.), granting Appellee's request to rescind an insurance contract and dismissing Appellants' counterclaims.*fn1 (TA at pp. 120 and 224). For the reasons set forth below, this Court affirms the Bankruptcy Court's orders.
Tri-State Armored Services, Inc. ("Tri-State") was an armored car company in the business of servicing ATMs owned by financial institutions. Tri-State was incorporated on or about September 15, 1997, after purchasing all assets from its predecessor, Executive Cash. The shareholders of Tri-State were Barry Chesla, William A. Mottin, and Daniel C. Feuker.*fn2
Mottin was the manager, the operational head, and the decision maker at Tri-State, and Feuker ran the armored cars of the operation. They both stationed in Tri-State's administrative headquarters in Hammonton, New Jersey. Chesla was the CEO, stationed in Ligonier, Pennsylvania. He did not participate in Tri-State's daily operations. He resigned his position some time in 1998, and redeemed all of his Tri-State stock. Chesla owned the Ligonier facilities and remained Tri-State's landlord.
When Tri-State terminated operation on March 1, 2001, its customer claims ($54.6 million) exceeded the funds recovered by the trustee ($21.9 million) by $32.7 million. Of this shortfall, approximately $12.4 million of losses are attributable to: (1) the conversion of customer funds by Mottin, Feuker, Nicholas Basile, and Joseph Fernandez; (2) miscellaneous incidents of theft and losses; and (3) misappropriations by Chesla. Over $19 million of losses are unexplained.
Within a month of its formation, Tri-State began to make unauthorized "borrowing" from its wire account and cash vault to pay operating expenses. Most customers wired money into Tri-State's wire account or had cash delivered to the Tri-State's cash vault. Several customers provided funds by check, which should have been deposited into the wire account; instead, the checks were often deposited into Tri-State's operating accounts.
The diversion of funds from Tri-State's wire account and cash vault occurred at the direction of Mottin and Feuker. The funds were primarily used for Tri-State's operating expenses. Tri-State designated these funds as "due to vault" or "change" on its books. Some funds were returned to the vault and to the wire account over the course of Tri-State's operation. The customers had no knowledge of such "borrowing." Approximately $8.4 million of customer funds were transferred from the Tri-State cash vault and wire account and utilized for Tri-State operating expenses. In addition, approximately $315,000 was kept for personal use by Tri-State's employees, including $75,000 to Feuker. Mottin claims that he always intended to pay back the "borrowing" from anticipated future profits, and thought of each borrowing as "an interest-free loan."
During the summer of 2000, Tri-State came under IRS investigation. On or about August 31, 2000, Mottin resigned as president of Tri-State, although he remained an employee, with no adjustment in salary. In September 2000, other key employees, including Michael Ricchi and David DeFebbo, Tri-State's director of security, resigned. After Mottin's resignation, Nicholas Basile and Joseph Fernandez took over.
Basile was hired by Mottin in the summer of 1999. He was in his early 30s and had no experience with ATM operations prior to his employment with Tri-State. In September 2000, he became president of Tri-State because he "drew the short straw" following Mottin's resignation. As the president, Basile had limited knowledge about the company, and consulted with Mottin daily regarding most company-related decisions. From time to time, he also consulted with Fernandez. Fernandez became general manager of the company after Basile became president. Both Basile and Fernandez took at least one check from the Tri-State wire account, which consisted entirely of customer funds, on or about February 21, 2001. They each pled guilty to federal charges in connection with the conversion of customer funds.
In February 2001, Mottin, Basile, and Fernandez realized that Tri-State would not be able to repay the missing funds it "borrowed" from its customers. At that point, they decided to cease operation.
In addition to conversion by Tri-State's employees, the company experienced many incidents of theft and loss. David DeFebbo testified that Tri-State frequently reported daily cash shortages of over $100. Such shortages were common and very difficult to trace because they were not only attributable to employee theft, but also to a lack of control in the cash room, machine failure, human error and accounting mistakes. When a shortage occurred, Tri-State would report that the daily balance was accurate even though the money wasn't there.
Each time a customer made a claim, Tri-State paid the customer by taking money from another customer and turning it over to the claimant. According to the accountant's report submitted to the trustee, approximately $421,000 can be identified as missing ATM customer funds attributable to various incidents.
The third source of loss for Tri-State is Chesla's misappropriations. While Tri-State was still operating, a federal investigation ensued against Chesla. Federal agents raided Chesla's office at the Ligonier facility in May 2000. The raid was publicized in newspapers, particularly in western Pennsylvania. At the time, Chesla was no longer associated with Tri-State except as the landlord of the Ligonier facility. On September 18, 2001, Chesla pled guilty to charges of money laundering and tax evasion.
B. Tri-State's Insurance Coverage
Tri-State's customers require it to secure comprehensive employee dishonesty, crime and disappearance insurance. On or about September 10, 1997, Mottin completed an armored car operator's proposal form for Lloyds of London on behalf of Tri-State, and forwarded it to Marshall & Sterling ("M&S"), the insurance agent for Executive Cash. Lloyds declined to offer coverage for Tri-State.
Ron Bray, the armored car specialist at M&S, then submitted Tri-State's application to Great American, noting that Lloyds of London had declined to offer coverage because a loss was currently under investigation. Sean Missal, the Great American underwriter who reviewed Tri-State's application, knew that Executive Cash's insurance coverage was not renewed by Lloyds.
On or about September 18, 1997, Missal hired AMSEC International, Inc. ("AMSEC"), a security firm, to perform a security survey of Tri-State's facility at Hammonton. A security survey report issued by AMSEC recommended numerous improvements in Tri-State's security systems and procedures. The report was forwarded to Missal with a note that a follow-up inspection within 90-120 days was recommended.
A Tri-State application for insurance coverage was submitted to Great American on October 7, 1997. Mottin signed the application. On October 10, 1997, Great American offered coverage to Tri-State, contingent on the submission of a revised armored car application, a written agreement from Tri-State that it would comply with the recommendations listed in the AMSEC report within 60 days, and a written recitation from Tri-State of the five-year loss history of Executive Cash, including a description of any open claims.
Great American issued a comprehensive employee dishonesty, crime and disappearance insurance policy to Tri-State on October 20, 1997. On December 9, 1997, Tri-State requested additional vault coverage, which Great American approved. By then, at least $80,000 had been removed from the vault by Tri-State for use in its operating account.
The Great American policy was renewed in October 1998 using a renewal insurance application that was nearly identical to the prior year's application. The 1998 insurance application was signed by Mottin on October 13, 1998. In response to questions (the "loss history questions") regarding "[a]ll claims or occurrences that may give rise to claims for the prior five years", Mottin responded "N/A." Under "Please provide descriptions of all losses in excess of $5,000, including corrective action," Tri-State gave no response. Great American conducted no follow-up investigation and renewed the policy.
Prior to the October 1999 renewal process, at Mottin's request, Great American directed AMSEC to conduct a security survey of the Tri-State Ligonier facility. Herbert R. Cunningham, the AMSEC employee who conducted the survey, wrote to Missal on September 14, 1999, that there were five areas of "significant concerns," including access control, alarm coverage, liability storage, liability staging and accountability.
Tri-State filed a renewal application again for 1999. In connection with the underwriting process for the 1999 policy, Missal prepared a Risk Analysis and Summary Form, or "CURE sheet", which is an overview of the account for underwriting and pricing purposes. The 1999 CURE sheet is the only one Great American produced in connection with Tri-State's renewal policies, and the only negative note on the CURE sheet was the absence of random credit checks of employees. Tri-State's answers to the loss history questions on the renewal application remained the same as in 1998.
On June 22, 2000, an AMSEC employee faxed to Great American underwriters Missal and Scheckton an article from the Pittsburgh Post-Gazette dated June 10, 2000, regarding the raid on Chesla in Ligonier Township. The article reported that Chesla was under investigation by the FBI and the IRS for "pilfering millions of dollars meant for automatic teller machines" and "for allegedly stealing money from the company starting in 1996." In response to the article, Missal and Scheckton requested that Bray inquire about the facts alleged in the article. When contacted, Mottin assured Bray that the investigation involved only Chesla, and did not involve Tri-State or any of Tri-State's customers. Bray communicated that message back to Missal and Scheckton. Great American did no further investigation.
Basile submitted the renewal application for October 2000 as the president, and no claims or losses were reported. Great American again renewed the policy. Following the renewal of coverage, Tri-State, M&S, and Great American made no further contact until February 26, 2001, when Basile called Bray to advise him that Tri-State was ceasing operation, and that there may be a significant shortfall in customer cash. In turn, Bray reported the news to Great American, which immediately retained AMSEC to investigate the prospective loss.
Tri-State contracted directly with Appellants Diebold, Inc. ("Diebold") and NCR Corporation ("NCR"), who in turn contracted with financial institutions to service their ATMs. Appellants American Express Travel Related Services Company, Inc. ("American Express") and Palm Desert National Bank ("Palm Desert") were customers whose ATMs Tri-State directly serviced. Diebold, NCR, and American Express were designated as "loss payees."*fn3
Tri-State was the named insured on the policy issued by Great American in 1997, and renewed each year through 2000.*fn4 In paragraph 12 of Section A, General Conditions, of the "Crime General Provisions" provides:
12. Ownership of Property; Interests Covered: The property covered under this insurance is limited to "customer's" property:
(b) for which you are legally liable.
However, this insurance is for your benefit only. It provides no rights or benefits to any other person or organization.
The "Joint Loss Payable" endorsement to the Great American policy, naming Diebold and NCR as "loss payees", provides:
You agree that any loss payable under the Coverage Form indicated above shall be paid jointly to you and the Loss Payee, as their interests may appear, designated below: Diebold, Inc.
C. No rights or benefits are bestowed on the Loss Payee other than payment of loss as set forth herein.
As stated, the policy was explicitly for the benefit of Tri-State only. The loss payees were only afforded the right to be paid jointly with Tri-State for any covered losses sustained by Tri-State under the policy. (TA at p.231). The Bankruptcy Court found no evidence that Great American actually knew, prior to the issuance of the insurance policies and loss payee endorsements each year, that employee theft of customer funds had occurred at Tri-State.
D. Bankruptcy Court Opinion
Tri-State filed a Chapter 7 petition on March 2, 2001. Great American filed an adversary proceeding on June 4, 2001, seeking a declaratory judgment that Tri-State's Comprehensive Employee Dishonesty, Crime and Disappearance Insurance policies should be rescinded and that the Tri-State ...