There is not an abundance of case law on the nature and scope of a bank’s “financial institution bond.” Indeed, in the recent case of Bank of Brewton v. The Travelers Companies, Inc., the U.S. Court of Appeals for the Eleventh Circuit indicated that there did not appear to be “any precedent precisely on point” when it was called upon to review the extent of coverage of a financial institution bond. More specifically, the Eleventh Circuit addressed the issue of whether, under Alabama law, a bank’s financial institution bond covered a “duly authorized stock certificate” that was procured under false pretenses and was used as collateral for a bank loan. In ruling that the bond did not cover the bank’s monetary loss stemming from the stock certificate, the Eleventh Circuit emphasized that its ruling hinged on the bond’s definition of a “counterfeit” document.
Before looking at the court’s decision in more detail, an essential background question comes to mind. What exactly is a financial institution bond? As characterized by the Eleventh Circuit, a financial institution bond is “a type of fidelity bond that is designed to insure financial institutions against fraudulent or unfaithful dealings by employees and certain outside parties which could damage the institution.”
The case involved Bank of Brewton, a small, privately held bank in Alabama that was covered by a financial institution bond issued by the Travelers Companies, Inc. Among other things, the bond covered Bank of Brewton from a “loss resulting directly from the [bank] having, in good faith, …extended credit…on the faith of [a certificated security], which is a Counterfeit.” In turn, the financial institution bond from Travelers defined “Counterfeit” as “an imitation which is intended to deceive and to be taken as an original.”
Under the facts of the case, the Bank of Brewton made and renewed a number of loans with a “long-time” customer, Jackson Hines. On some occasions, Hines pledged stock certificates as collateral for these loans. In December 2009, in keeping with an agreement between Hines and Bank of Brewton, the bank consolidated all its outstanding loans with Hines into one major loan of approximately $1.5 million. However, in April 2010, Bank of Brewton discovered that one of the underlying stock certificates, representing 180 shares of stock in a company, was “void and of no effect” and had been “procured under false pretenses.”
Although Bank of Brewton initially sought to have Hines replace the stock certificate with another form of collateral, that option quickly evaporated because Hines defaulted on the consolidated loans and filed for bankruptcy. When the bank filed a claim to recover its loss under the financial institution bond with Travelers, Travelers took the stance that the bank’s loss was not covered by the bond but investigated the claim “for the next several years.” Ultimately, Bank of Brewton filed a breach-of-contract lawsuit against Travelers, alleging that Travelers refused to pay under the financial institution bond even though the bank “had sustained a covered loss based on a forged or counterfeit stock certificate.”
The federal trial court determined that Bank of Brewton could not recover its loss under the financial institution bond for either of the two stock certificates (Certificate No. 2 and Certificate No. 11) at issue in the case. On appeal to the Eleventh Circuit, the bank contended that the trial court had erred in finding that Certificate No. 11 was not a counterfeit under the terms of the financial institution bond. As depicted by the Eleventh Circuit, “Boiled down, the Bank’s argument appears to be quite simple: the Bond defines a ‘counterfeit’ as ‘an imitation which is intended to deceive and to be taken as an original’; and Hines, with the requisite intent, gave the Bank a valueless stock certificate that appeared for all intents and purposes to be a valuable stock certificate.”
In reviewing the scant case law from other federal circuits, the Eleventh Circuit distinguished between counterfeit documents that deceive by misrepresenting authenticity and those that deceive by misrepresenting value. The federal appellate court found that although Certificate No. 11 had been fraudulently procured and was valueless, it was authentic. In the court’s view, the financial institution bond did not cover losses “resulting from every document tainted by fraud.” Instead, the bond provided coverage “for a subset of deception-based losses—those stemming from documents that imitate an original.” The real problem, the Eleventh Circuit stressed, resided in the fact that because Certificate No. 11 was “obtained under false pretenses, it had no value.” Consequently, the Eleventh Circuit upheld the trial court’s ruling that Bank of Brewton’s loss was not covered by its financial institution bond.
