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First National Bank of Decatur v. Insurance Co.

March 16, 1970


Swygert, Chief Judge, Hastings, Senior Circuit Judge, and Cummings, Circuit Judge.

Author: Hastings

HASTINGS, Senior Circuit Judge.

Plaintiff First National Bank of Decatur, Illinois (Decatur) brought this diversity action in the district court against defendant Insurance Company of North America (INA) seeking recovery under a Bankers' Blanket Bond issued by defendant. Decatur asserts that a loss it suffered as the result of an alleged check kiting scheme is covered by the bond issued by INA. On the basis of evidence presented during a bench trial and an agreed stipulation of facts, written briefs and oral argument, the trial court entered judgment adverse to INA in the amount of $88,442.64. INA appeals. We affirm.

The losses on which this suit are based arose out of the hectic and unsuccessful scramble of a failing corporation to save itself from financial ruin. Community Industries, Limited (Community) began as the local business of a small religious sect*fn1 in the early 1930's in Sullivan, Illinois during the "Great Depression." It grew until, in 1964, it had assets of approximately $3,800,000.00 and about 400 employees. Community suffered severe losses in the recession of 1957-1958. Business improved after that for a time, but in 1963 the corporation again suffered substantial losses due to "much more severe" competition and uninsured fire losses. It managed to continue with the aid of capital invested by many of its factory workers who mortgaged "what they could." But apparently its position continued to deteriorate, particularly from January through March, 1966. On April 22, 1966, Community filed proceedings for an arrangement under Chapter XI of the federal Bankruptcy Act and has since been dissolved.

For several years prior to 1966, Community had maintained a checking account with Decatur. This account was used mainly for payroll deposits and the drawing of payroll checks. During this same period, Community maintained a checking account at the National Bank of Mattoon, Illinois (Mattoon). This was its general account used for payment of its accounts. Community also maintained a checking account in the State Bank of Arthur, Illinois (Arthur). This account was relatively inactive until late in 1965. Early in 1966, Community opened a checking account in the First City National Bank of New York (First City). The purpose of this account was to speed the flow of funds from Sam Levitt in New York, Community's major customer, to Community in Illinois.

Levitt came to Community's attention in June, 1965, through James Talcott, Inc., (Talcott) a nationwide private commercial banking company which had been financing Community's receivables. An agreement was negotiated between Levitt and Community whereby approximately 80% of Community's production would go to Levitt. Levitt then began advancing funds on an informal and unsecured basis to get Community into production. Community would telephone Levitt and advise him of its current production run and of the amount of money required. Levitt would then deposit funds in Community's First City account. Community would draw checks on its account with First City and deposit them in its Arthur account. It would then draw checks on its Arthur account and deposit them in its Mattoon account. Finally, it would draw checks on its Mattoon account and deposit them in its Decatur account. The cash flow between these accounts increased 50% from January to February, 1966 and further increased until March 18, 1966, when the banks stopped paying Community's checks.

All three Illinois banks had been allowing Community to draw checks against uncollected deposits. On or about March 18, 1966, Decatur discovered for the first time, through a telephone call to Mattoon, that the checks on Mattoon which Community had been depositing in Decatur were not covered by funds in Mattoon when such deposits were made, but were covered only after being presented for payment at Mattoon. It appears that for some time it had been a daily practice for Mattoon to notify Community of the amount needed to cover all of Community's checks presented for payment, including those received from Decatur. Community would then send a courier to Mattoon with a list of those checks to be paid and funds to cover them. Other of such checks would be returned unpaid.

Upon learing this, Decatur stopped paying Community's checks drawn on it and returned them unpaid. It closed Community's account on March 26, 1966. At about the same time, Community's accounts at Mattoon and Arthur were seized by those banks. Upon final adjustment of Community's accounts at these three banks, each showed a negative balance as follows: Arthur -- $97,720.00; Mattoon -- $117,779.93; and Decatur -- $106,068.53. The total amount was $321,568.46.

Through various adjustments with Community and after settling its claim in the Chapter XI arrangement proceeding, Decatur was left with a loss of $74,730.70. This amount plus Decatur's reasonable attorneys' fees in the Chapter XI proceeding plus interest make up the amount of the judgment rendered in its behalf in the instant action against its insurer INA.

Decatur maintains that the loss it suffered due to Community's activities is covered by Bankers' Blanket Bond, Form No. 24, issued to it by INA and in effect at all times relevant herein. Specifically, coverage is claimed under coverage (B) of the bond, which reads, in applicable part, as follows:


(B) Any loss of Property through robbery, burglary, common-law or statutory larceny, theft, false pretenses, hold-up, misplacement, mysterious unexplainable disappearance, damage thereto or destruction thereof, whether effected with or without violence or with or without negligence on the part of any of the Employees, and any loss of subscription, conversion, redemption or deposit privileges through the misplacement or loss of Property, while the Property is (or is supposed to be) lodged or deposited within any offices or premises located anywhere, except in any of the Insured's offices hereinafter excluded or in the mail or with a carrier for hire, other than an armored motor vehicle company, for the purpose of transportation. * * * (Emphasis added.)

The trial court concluded "Insuring Clause B of the Bond is applicable in the instant case, for the reason that the facts shown * * * constitute false pretenses under the law of Illinois." The court relied on a number of Eighth Circuit cases holding that check kiting ...

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