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RBC Mortgage Co. v. National Union Fire Insurance Co. of Pittsburgh

June 30, 2004


[6] Appeal from the Circuit Court of Cook County. Honorable Lester D. Foreman, Judge Presiding.

[7] The opinion of the court was delivered by: Justice Hartman

[8]  Plaintiffs, RBC Mortgage Company (RBC) (formerly Prism Mortgage Company) and First City Financial Corporation (First City) appeal from the circuit court's section 2-615 dismissal of their action for indemnity under a financial institution bond issued by defendant, National Union Fire Insurance Company of Pittsburgh (National Union). On review, RBC and First City (sometimes collectively RBC) contend that the court erred in finding that the bond does not afford coverage to RBC for payments made to a third party under a settlement agreement.

[9]  First City is a wholly owned subsidiary of RBC, a mortgage banking company. From March 1, 1999 to December 3, 1999, First City employed Brandon Earl as a loan officer in its Utah branch. There, Earl prepared loan packages for potential home mortgage borrowers, which consisted of various financial documents used to evaluate creditworthiness. Earl originated a fraudulent loan package for himself in the amount of $450,000 and put in the name of his wife, Andrea Earl. In an effort to conceal his own loan, Earl compiled fraudulent packages for other borrowers. The packages contained fabricated documents necessary to close the loan, including counterfeit credit reports, falsified appraisals and forged income verifications. To facilitate the scheme, Earl paid off the various providers of the tainted documents. Earl collectively submitted the packages for sale from First City, as a broker, to Evergreen Moneysource Mortgage Company (EMMC), which funded the loans and ultimately sold them to third party investors.

[10]   Under the brokerage agreement between EMMC and First City, EMMC retained sole discretion to approve and fund the loans, relying on the packages submitted by First City. Once the loans were funded and closed they became the property of EMMC, which paid First City a brokerage fee in return. EMMC assumed the risk of any losses associated with interest rate fluctuations, loan servicing, and change in the market value of the property. A warranty provision in the brokerage agreement guranteed that the loan packages submitted by First City would not contain any untrue statements and, if breached, First City was obligated to indemnify EMMC for any resultant losses.

[11]   In early December of 1999, First City's Utah branch manager, Sue Bitterman, uncovered Earl's self-funded loan. Bitterman then initiated an audit of all loan packages originated by Earl. By the end of January of 2000, First City confirmed the fraud, however, Earl's loan for $450,000 already had been funded and sold to third party investors. First City immediately notified EMMC of the fraud and, on January 13, 2000, EMMC requested that First City confirm its obligation to bear the risk of the warranted, but fraudulent loans. Days later, First City informed National Union that it would seek coverage under the bond, should it incur losses as a result of the fraud.

[12]   The insuring agreement between First City and National Union was in the form of a financial institution bond or fidelity bond, in effect from March 1, 1999 to March 1, 2002.*fn1 Under "Insuring Agreement A" entitled "Fidelity," National Union promised to indemnify RBC for:

[13]   "(A) Loss resulting directly from dishonest or fraudulent acts committed by an [e]mployee acting alone or in collusion with others.

[14]   Such dishonest conduct or fraudulent acts must be committed by the [e]mployee with the manifest intent:

[15]   (a) to cause the Insured to sustain such loss; and

[16]   (b) to obtain financial benefit for the [e]mployee or another person or entity."*fn2

[17]   The policy does not provide a definition for "loss resulting directly from," and excludes from coverage generally "indirect or consequential loss of any nature." The agreement permitted National Union to "elect" whether to provide a defense for RBC in the event of a claim against it.

[18]   On March 17, 2000, EMMC commenced an action against First City,*fn3 requesting (1) damages for losses incurred in reliance on the fraudulent loan packages, and (2) that First City buy back the defective loan packages. On April 14, 2000, First City notified National Union of the suit; however, National Union declined to provide a defense or commit to coverage.

[19]   Over 14 months later, on June 20, 2001, RBC sent a proof of loss to National Union on behalf of First City and RBC, as First City's guarantor. The parties reached an "agreement in principle" to settle the suit. On October 10, 2001, EMMC and First City finalized a settlement agreement, wherein RBC agreed to pay to EMMC $175,000 for losses already incurred, and to indemnify EMMC for any future losses traceable to the fraud. RBC also promised to compensate directly one of EMMC's investors, Conseco Finance Corporation, for related losses not yet incurred. RBC provided National Union with drafts of the settlement agreement, supplementing its proof of loss previously tendered. In a letter to RBC dated November 28, 2001, National Union denied the claim, asserting that RBC's losses did not result "directly" from the fraud.

[20]   On May 31, 2002, RBC filed a four-count complaint against National Union, alleging claims for declaratory judgment, breach of contract, attorney's fees and costs, and prejudgment interest. On August 23, 2001, National Union moved to dismiss RBC's claims pursuant to 735 ILCS 5/2-615 (West 2000) (section 2-615). On October 21, 2002, following oral argument, the circuit court granted the motion with prejudice, finding that (1) "[t]he language of the bond is not ambiguous," (2) "[n]either Insuring Agreement A nor E affords coverage because the loss was not a loss resulting directly from the covered risk," and (3) "'[d]irect loss,' as used in the bond, is not properly construed by analogy to proximate cause." The court commented that "courts throughout the land take surprisingly, a very, very narrow approach to fidelity bonds with regard to this issue of direct loss. *** [T]o suffer a direct loss[,] ...

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