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Universal Mortgage Corporation v. Wurttembergischeversigherung Ag

July 11, 2011


Appeal from the United States District Court for the Eastern District of Wisconsin. No. 09-CV-1142-J.P. Stadtmueller, Judge.

The opinion of the court was delivered by: Sykes, Circuit Judge.


Before POSNER, FLAUM, and SYKES,Circuit Judges.

Wurttembergische Versigherung AG ("Wurtt") is one of several investors (the "Under-writers") in a mortgage bankers blanket bond issued to Universal Mortgage Corporation. As relevant to this case, the bond insures Universal against financial loss resulting from employee misconduct. One of Universal's employees engaged in a scheme by which, for a kickback, he caused Universal to fund mortgages below its standards. Not knowing the loans were substandard, Universal sold them, warranting that they met its standards. When investors realized the loans were substandard, they forced Universal to repurchase the loans, causing Universal a significant financial loss. Universal filed a claim under the bond, asserting that this loss was directly caused by employee dishonesty. The Underwriters denied the claim and this suit followed. The district court dismissed the suit, finding that the bond did not cover Universal's loss.

We affirm. The fidelity bond at issue here employs direct-loss causation language. The bond provides coverage for losses "directly caused by" dishonest acts of employees. A financial loss resulting from contract liability to third parties is not "directly" caused by employee misconduct, even if employee misconduct is the source of the contract liability. Here, Universal's loss resulted from its contractual repurchase obligations. Although this contract liability arose as a result of an employee's misconduct, the employee misconduct did not directly cause the eventual financial loss associated with the repurchases. In addition, an exclusion in the bond specifically bars coverage for losses resulting from loan-repurchase obligations. Because Universal's loss resulted from its contractual obligation to repurchase real-estate loans, this exclusion applies.

I. Background

Universal originates mortgage loans and sells them to investors. As part of its sales contract, Universal warrants that its loans are compliant with Federal National Mortgage Corporation ("FNMC") standards, which forbid the use of down-payment-assistance programs. Universal's warranties require it to repurchase any mortgage sold that does not comply with FNMC standards.

For about a year and a half, Ray Hightower, one of Universal's employees, conspired with an outside mortgage broker to have Universal fund mortgages that did not meet the FNMC down-payment requirements. For a kickback Hightower ensured the loans were approved by Universal despite being noncompliant. Unaware of Hightower's scheme, Universal sold the noncompliant loans to investors, warranting that the loans were compliant. When certain loans went into default, the investors realized the loans did not comply with FNMC standards and exercised their contractual right to force Universal to repurchase the loans. To date, Universal has repurchased some of these loans and is obligated to repurchase others. As a result of the repurchases and outstanding obligations to repurchase, Universal will lose an estimated $4.5 million.

After learning of Hightower's misconduct and the impending financial loss, Universal filed a claim under a mortgage bankers blanket bond issued to it by a consortium of Lloyds of London underwriters that included Wurtt. In relevant part the bond states: "The Underwriters hereby undertake and agree . . . to indemnify the Assured for . . . [d]irect financial loss sustained by the Assured . . . by reason of and directly caused by . . . dishonest acts by any Employee of the Assured." In addition, the Bond states at Exclusion 18: "THIS BOND DOES NOT COVER . . . [a]ny loss resulting from the Assured having repurchased or having been required to repurchase a Real Estate Loan from an Investor . . . ."

The Underwriters denied the claim, and Universal brought this suit for breach of contract, statutory interest, and bad-faith denial of an insurance claim. Wurtt moved to dismiss, arguing that the bond did not cover Universal's loss. The district court granted the motion, holding that Universal's loss was not directly caused by Hightower's fraud but rather by Universal's contractual obligations to investors. Alternatively, the court held that Exclusion 18 barred coverage because Universal's loss resulted from its contractual obligation to repurchase mortgage loans. Accordingly, the court dismissed the claim for breach the contract. Because the statutory-interest and bad-faith claims were dependent on a breach, the court dismissed those claims as well.

II. Discussion

A bankers blanket bond, sometimes called a fidelity bond or financial institution bond, offers bundled indemnification coverages for various specific risks, typically including financial loss from forgeries, employee dishonesty, and theft. See 9A JOHN ALAN APPLEMAN & JEAN APPLEMAN,INSURANCE LAW AND PRACTICE § 5701, at 377-78 (1981 & Supp. 2010). The most common bankers blanket bond is the Standard Form No. 24, which has a well-chronicled history. See, e.g., Private Bank & Trust Co. v. Progressive Cas. Ins. Co., 409 F.3d 814, 816 (7th Cir. 2005), and sources cited below. Over the last century, nearly every term in the Form 24 bond has been developed in reaction to court interpretations of prior versions of the bond. As a result, certain terms within the bond carry nuanced and well-established meanings. Peter I. Broeman, An Overview of the Financial Institution Bond, Standard Form No. 24, 110 BANKING L.J. 439, 445 (1993).

Modern bankers blanket bonds typically limit coverage to losses "directly" caused by covered conduct. See Peter Haley, Loss and Causation, in ANNOTATED FINANCIAL INSTITUTION BOND 99 (Michael Keeley ed., 2d ed. 2004).

Although the direct-loss language was clearly adopted to limit coverage, courts today debate its precise effect. See Robert J. Duke, A Brief History of the Financial Institution Bond, in FINANCIAL INSTITUTION BONDS 5-6 (Duncan L. Clore ed., 3d ed. 2008). Two interpretive camps exist: the "proximate cause" camp and the "direct means direct" camp. Compare Scirex Corp. v. Fed. Ins. Co., 313 F.3d 841, 849-50 (3d. Cir. 2002) ("[T]he 'direct cause of a loss' does not have to be the 'sole cause' or 'immediate cause,' but need only be a proximate or substantial cause.") with Vons Cos., Inc. v. Fed. Ins. Co., 212 F.3d 489, 492-93 (9th Cir. 2000) ("We hold that 'direct' means 'direct' and that . . . Vons's policy did not provide indemnity for ...

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