Federal Deposit Insurance v. Insurance Co. of North America

United States Court of Appeals

For the First Circuit

Nos. 96-1556
96-1557

FEDERAL DEPOSIT INSURANCE CORPORATION
as RECEIVER FOR THE BANK FOR SAVINGS,

Plaintiff, Appellant,

v.

INSURANCE COMPANY OF NORTH AMERICA,

Defendant, Appellee/Third-Party Plaintiff, Appellant,

v.

PAUL J. BONAIUTO and DOLORES DiCOLOGERO,

Third-Party Defendants, Appellees.

APPEALS FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Robert E. Keeton, U.S. District Judge]

Before

Selya, Circuit Judge,

Cyr, Circuit Judge,

and Lynch, Circuit Judge.

Eugene J. Comey, with whom Robert D. Luskin, Comey Boyd &

Luskin, Ann S. DuRoss, Assistant General Counsel, Federal Deposit

Insurance Corporation, Thomas L. Hindes, Counsel, E. Whitney

Drake, Special Counsel, and Leslie Ann Conover, Senior Attorney,

were on brief for FDIC.
Gerald W. Motejunas, with whom Marie Cheung-Truslow and

Lecomte, Emanuelson, Motejunas & Doyle were on brief for

Insurance Company of North America.

February 3, 1997

LYNCH, Circuit Judge. In 1977 the Massachusetts
LYNCH, Circuit Judge.

legislature enacted a statute, Mass. Gen. Laws ch. 175,

112, which provided that, for certain types of liability

insurance, the Commonwealth would adopt a "notice prejudice"

rule. This new statutory rule departed from the traditional

common law rule which had strictly enforced notice provisions

in insurance policies, allowing forfeiture of coverage where

notice to an insurer of a claim was late. The Supreme

Judicial Court of Massachusetts subsequently extended, by

common law, and then limited the extension of, the notice

prejudice rule for liability insurance policies. At issue

here is whether the notice due under a fidelity bond was

late. If so, does the state common law notice prejudice

rule, under which an insurer must show prejudice in order to

be excused from coverage by the insured's late notice, extend

to the Financial Institution Bond at issue.

The import here is whether a suit by the Federal

Deposit Insurance Corporation ("FDIC"), as receiver for the

failed Bank for Savings, may proceed against the Bank's

insurer, the Insurance Company of North America ("INA"), for

coverage of losses due to certain dishonest acts committed by

a Bank officer and by a lawyer retained by the Bank. The

loss to the Bank from these activities is asserted to be $10

million. The FDIC, as receiver for the Bank, seeks

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reimbursement for these losses to the full amount covered by

the Financial Institution Bond issued by INA, $4 million.

I.

The Bank gave INA notice of potential loss under

the Bond on January 16, 1990. The insurer declined to pay,

and the Bank brought suit. The district court, interpreting

the Bond provisions on a motion for summary judgment, held

that the Bank's notice was late because it had not been filed

within 30 days of discovery of loss as required by the

policy. FDIC v. Insurance Co. of N. Am., 928 F. Supp. 54,

62-63 (D. Mass. 1996). The court granted summary judgment

for the defendant. Id. The Bank appeals, disputing the

district court's analysis of the date of discovery and

claiming that its notice was timely. The Bank further

asserts that, even if its notice was late, the district court

erred in failing to apply the notice prejudice rule to the

Bond.1

Our review of a grant of summary judgment is de

novo. Wood v. Clemons, 89 F.3d 922, 927 (1st Cir. 1996). We

hold that the district court was plainly correct in holding

that the notice was late, but we do so on different grounds

1. The parties have agreed that Massachusetts law applies.
The FDIC here sues as the receiver of a Massachusetts bank,
and we discern no conflict between state law and federal
statutory provisions or significant federal policies.
O'Melveny & Myers v. FDIC, 114 S. Ct. 2048, 2055 (1994);

Wallis v. Pan Am. Petroleum Corp., 384 U.S. 63, 68 (1966).

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than the district court. We also hold that the notice

prejudice rule does not apply in this instance.2

II.

The facts of the employee misconduct underlying the

Bank's losses are taken from the Bank's Bond claim and

accepted as true for present purposes. From 1987 to 1989,

Dolores DiCologero, an Assistant Vice President of the Bank

and the manager of the mortgage department, and Paul

Bonaiuto, an attorney retained to represent the Bank in

mortgage closings, conspired with a condominium development

group, the Rostoff Group, to make hundreds of mortgage loans

using inflated appraisals and purchase prices in violation of

Bank regulations and the law.

The Bank made loans on condominium projects

developed by the Rostoff Group until February 1989. Although

internal regulations forbade the Bank from participating in

more than one-third of the units in a particular development,

the Bank exceeded these limits as to Rostoff Group

properties. In addition, despite regulations prohibiting the

financing of more than 80% of the purchase price of a

property, the Bank made loans to purchasers for the full

2. INA originally brought a third-party claim in this action
against the dishonest Bank employees who caused the claimed
losses. The district court dismissed INA's claim as moot
because it held that, under the Bond, INA had no liability.
INA appeals that dismissal. As we affirm the district
court's finding that INA has no liability, INA's appeal on
this issue is moot.

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value of condominiums in Rostoff Group properties. Bonaiuto

prepared closing documents overstating the purchase price of

the condominiums and falsely indicating that the purchasers

had equity in the property. The loan documentation reflected

nonexistent down payments. In fact, the "down payments" took

the form of discounts on the purchase price. DiCologero

expedited approval of the mortgages without any investigation

of the creditworthiness of the applicants, many of whom were

not creditworthy for the loans given. The aggregate face

value of the loans was approximately $30 million, and many

culminated in default.

Other DiCologero family members also participated

in the scheme, to their profit. The overstated values of the

condominiums were supported by appraisals prepared by

DiCologero's son. He earned more than $33,000 for his work;

DiCologero's daughter received $4,550 from the Rostoff Group

for secretarial work. DiCologero's husband received $12,000

in referral fees for directing potential purchasers to the

Rostoff Group and purchased a condominium himself without

paying a deposit, although the Bank records falsely reflected

that he had done so. Other aspects of this tale of avarice

and corruption need not be detailed. The Bank was declared

insolvent on March 20, 1992, and the FDIC was appointed

receiver. The FDIC asserts that these events helped bring

down the Bank.

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In March 1989, the Bank received a letter from

counsel for Erna Hooton, a former bookkeeper of the Rostoff

Group and a mortgagee on six Rostoff Group units. Ms. Hooton

had defaulted on the loans, and the Bank had begun

foreclosure proceedings. The letter said that the Bank had

misrepresented in the loan documents that Ms. Hooton had made

down payments on the properties. The letter also said that

Ms. Hooton's financial position should have led the Bank to

refuse financing. The letter claimed that Bonaiuto, as

closing counsel on the Hooton loans, was aware of the false

documentation. The Bank investigated these charges;

representatives of the Bank met with Steven Rostoff, a

principal of the Rostoff Group, on March 21, 1989. Rostoff

said that the down payment for some loans, including Ms.

Hooton's, had taken the form of a discounted purchase price.

He denied that anyone associated with the Bank was aware of

this. DiCologero also denied knowledge of any

irregularities. The Bank responded to the Hooton letter by

denying the allegations. Because Ms. Hooton did not pursue

the matter, neither did the Bank.

Then, in August 1989, Herbert and Deanna Bello, two

defaulting borrowers on six Rostoff Group units, sued the

Bank for damages and asserted counterclaims in a foreclosure

action brought by the Bank. The Bellos asserted, as had Ms.

Hooton, that Bonaiuto was aware that they had not made the

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down payments reflected in the closing documents. They also

alleged that when they told Steven Rostoff that they had

previously been unable to obtain financing, he replied that

they would "not have to worry about financing" because he had

made a "deal" with the Bank. The Bank, the Bellos said,

never asked for financial information from them. The Bellos

further alleged that, at one closing, they had pointed out to

Bonaiuto that the closing documents stated an inflated

purchase price and an inflated down payment. Bonaiuto

referred them to Rostoff, who said this was "what the Bank

wanted." In the foreclosure action, the Bellos' counterclaim

specifically alleged that the Bank knowingly permitted

Rostoff's misrepresentations.

Another couple who had purchased Rostoff Group

properties, Edward and Dorothy Giamette, filed suit on

September 22, 1989 against the Bank and the Rostoff

principals. Again the complaint alleged that down payments

were falsely represented on the closing documents, that

Steven Rostoff told the plaintiffs that the Bank knew the

figures were false, that the appraisals, which were done by

DiCologero's son, were for more than the fair market value of

the properties, and that this scheme had been repeated with

at least eight other purchasers who had bought a total of

forty-five condominiums. Earlier, on September 11, 1989, Mr.

Giamette had made similar allegations in a counterclaim in

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the Bank's foreclosure action against him. None of these

claims, however, prompted the Bank to notify INA of possible

losses due to alleged employee misconduct. What eventually

did lead the Bank to submit a notice of claim was a

conversation in October 1989 between DiCologero and a Vice

President of the Bank during which DiCologero remarked that

her husband had purchased a condominium from the Rostoff

Group without making a down payment. The Vice President

reported DiCologero's remark to the Bank's President, who met

with the Bank's Audit Committee on November 6, 1989. Outside

legal counsel from Gaston & Snow were present at the meeting.

The Committee discussed "the possibility of 100% loans, the

unknown extent of these loans, employee involvement and legal

ramifications." Gaston & Snow was asked to prepare a

preliminary analysis which was submitted on November 15,

1989. Gaston & Snow then investigated and reported back to

the Bank on December 18, 1989. The report recommended, among

other measures, that the Bank refer the matter to federal

authorities, notify INA, and dismiss DiCologero. On December

27, 1989, the Bank filed a Report of Apparent Crime with the

FDIC, advising that it had learned of suspected violations of

federal law on December 18, 1989. The Bank also notified the

FBI and the U.S. Attorney's Office. DiCologero, Bonaiuto,

and the development group were later convicted on federal

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bank fraud and conspiracy charges. United States v. Rostoff,

53 F.3d 398 (1st Cir. 1995).

On January 16, 1990, the Bank gave INA notice of a

potential loss arising from employee misconduct. The Bank

enclosed copies of the complaints in the Giamettes' state and

federal lawsuits with its letter of notice.

III.

As is customary in the banking industry, the Bank

had obtained a Financial Institution Bond, Standard Form No.

24, from INA. The Bond period originally ran from January 1,

1988 to April 1, 1989, and was later extended by agreement to

April 1, 1990. Insured losses include those resulting from

employee dishonesty and fraud.3 For present purposes, we

assume that the actions of DiCologero and Bonaiuto caused the

Bank to sustain losses of the type covered by the "INSURING

AGREEMENTS FIDELITY" section of the Bond.4

3. Other types of losses covered under other portions of the
Bond are not pertinent here.

4. That provision reads:

INSURING AGREEMENTS
FIDELITY

Loss resulting directly from dishonest or
fraudulent acts committed by an Employee
acting alone or in collusion with others.
Such dishonest or fraudulent acts must be
committed by the Employee with the
manifest intent:

(a) to cause the Insured to sustain
such loss, and

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The obligation of the insurer to indemnify the

insured for covered losses is explicitly made:

subject to the Declarations, Insuring
Agreements, General Agreements,
Conditions and Limitations and other
terms [of the Bond].

The "CONDITIONS AND LIMITATIONS" section of the

Bond contains, among other clauses, the "DISCOVERY" clause.

Under that clause, the Bond applies to "loss discovered by

the Insured during the Bond Period." The clause then defines

"Discovery" in two ways:

Discovery occurs when the Insured first
becomes aware of facts which would cause
a reasonable person to assume that a loss
of the type covered by this bond has been
or will be incurred, regardless of when
the act or acts causing or contributing
to such loss occurred, even though the
exact amount or details of the loss may
not then be known.

(b) to obtain financial benefit for the
Employee or another person or
entity.

However, if some or all of the Insured's
loss results directly or indirectly from
Loans, that portion of the loss is not
covered unless the Employee was in
collusion with one or more parties to the
transactions and has received, in
connection therewith, a financial benefit
with a value of at least $2,500.

As used throughout this Insuring
Agreement, financial benefit does not
include any employee benefits earned in
the normal course of employment,
including: salaries, commissions, fees,
bonuses, promotions, awards, profit
sharing or pensions.

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Discovery also occurs when the Insured
receives notice of an actual or potential
claim in which it is alleged that the
Insured is liable to a third party under
circumstances which, if true, would
constitute a loss under this bond.

The "CONDITIONS AND LIMITATIONS" section of the

Bond also contains pertinent notice provisions which state in

relevant part:

NOTICE/PROOF - LEGAL PROCEEDINGS
AGAINST UNDERWRITER

a) At the earliest practicable moment,
not to exceed 30 days, after discovery of
loss, the Insured shall give the
Underwriter notice thereof.

Construing the Bond's first definition of

discovery, the district court found that, at the latest, the

Bank had discovered the loss by November 15, 1989. The court

thus determined that the Bank was required to give notice to

INA no later than December 15, 1989 and that the January 16,

1990 notice was therefore untimely. The district court

concluded that, "[i]f notice to INA was untimely, the Bank is

precluded from recovery, regardless of whether INA can prove

any actual prejudice as a result of the delay. J.I. Corp. v.

Federal Ins. Co., 920 F.2d 118, 120 (1st Cir. 1990)

(interpreting Johnson Controls v. Bowes, 409 N.E.2d 185

(Mass. 1980))." Insurance Co. of N. Am., 928 F. Supp. at 59.

The district court then granted INA's motion for summary

judgment.

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We agree that discovery was earlier than the Bank

posits. Although the district court relied on the Bond's

first definition of discovery to reach this conclusion, it is

most clearly reached under the second definition. See Levy

v. FDIC, 7 F.3d 1054, 1056 (1st Cir. 1993). Under the second

definition, discovery occurs "when the Insured receives

notice of an actual or potential claim in which it is alleged

that the Insured is liable to a third party under

circumstances which, if true, would constitute a loss under

this bond." The lawsuits and counterclaims brought by the

Bellos and the Giamettes plainly constituted actual claims.

The complaints alleged knowing acts of dishonesty or fraud by

Bank employees.5 Any harm caused by these alleged acts would

qualify as loss under the Bond.6

5. We reject the Bank's argument that the complaints only
alleged that the Bank itself defrauded the Bellos and
Giamettes and thus could not constitute discovery of loss.
The complaints and counterclaims all specifically allege that
DiCologero and/or Bonaiuto acted in a dishonest and
fraudulent manner under circumstances which, if true, would
have created a loss under the Bond. Moreover, when the Bank
finally provided INA with notice, it cited the allegations
contained in the Giamette complaints as the source of its
discovery of loss.

6. Though it is largely irrelevant for our purposes, we will
assume that the other elements of "loss" are present --
namely that, with regard to the portion of the loss resulting
from loans, the employee(s), DiCologero and/or Bonaiuto, were
in collusion with one or more parties to the transactions and
received a financial benefit with a value of at least $2,500
from principals involved in the transactions. The Bank
conceded in its notice letter to INA that, with regard to the
loans alleged in the Giamette complaints, it appeared that
DiCologero's family members received financial benefits of at

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The Bank weakly argues that these complaints "did

not rise to the level of allegations of deceit and

misrepresentation on the part of Bank employees seeking to

obtain improper financial benefits but rather were nothing

more than the litigation tactics of defaulting borrowers who

were confronting foreclosure proceedings." That argument

misses the point. The Bond requires notice to the insurer

upon a claim of employee dishonesty and does not allow the

insured to wait until the claim is proved. Further, General

Agreement F of the Bond independently required the Bank to

provide INA -- within thirty days -- with all pleadings and

pertinent papers in any legal proceeding brought to determine

the insured's liability for any loss.

The Bank also asserts that third-party claims do

not trigger discovery under the second definition of

discovery unless those claims are reasonable. Whether or not

Massachusetts adopts such a reasonableness standard,7 the

claims here met any such requirement and triggered the notice

least $2,500.

7. But cf. Clore & Keeley, "Discovery of Loss," in Financial

Institution Bonds 89, 113 (Duncan L. Clore ed., 1995) ("As

long as a third party's claim would constitute a covered loss
under the bond if proven to be true, it matters not whether
the allegations are perceived as true. Instead, the
allegations can be completely false. The point is, once the
allegations are made, the insurer has the right to know about
them and to conduct whatever investigation it may deem
appropriate.").

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requirement by, at the latest, mid-September 1989. By that

time, the Bank had been informed that at least ten persons

claimed to have purchased more than fifty condominiums from

the Rostoff Group without any down payment or with a lower

down payment than the Bank's loan documentation reflected.

The Bank was charged with knowing that the figures in the

loan documentation were false. The Bank's attorney was

alleged to be complicit in the falsehoods. The son of the

Bank's mortgage department manager purportedly had been paid

for false appraisals. A principal of the Rostoff Group had

confirmed that this had happened. The similarity of all the

allegations is telling. If a "smell test" was in order, the

smell was rank indeed. Accordingly, the notice given by the

Bank on January 16, 1990 was untimely.

IV.

More difficult is the question of whether the

Massachusetts courts would apply the common law "notice

prejudice" rule to Financial Institution Bonds of this sort.

This is a question of law. See J.I. Corp. v. Federal Ins.

Co., 920 F.2d 118, 119 (1st Cir. 1990).

A.

The two primary cases from the Supreme Judicial

Court on the notice prejudice rule are Johnson Controls, Inc.

v. Bowes, 409 N.E.2d 185 (1980), which creates a common law

notice prejudice rule for liability policies, and Chas. T.

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Main, Inc. v. Fireman's Fund Insurance Co., 551 N.E.2d 28

(Mass. 1990), which limits the rule in the context of

liability policies. The Massachusetts law of notice

prejudice has been previously visited by the decisions of

this court in J.I. Corp., supra; National Union Fire

Insurance Co. v. Talcott, 931 F.2d 166 (1st Cir. 1991); and

Liberty Mutual Insurance Company v. Gibbs, 773 F.2d 15 (1st

Cir. 1985). For various reasons, in all three of these cases

this court declined to apply the notice prejudice rule.

The Bank urges us to analyze the issue in terms of

whether the admittedly different policy language in the

Financial Institution Bond is closer to an "occurrence"

liability policy or a "claims made and reported" liability

insurance policy. There is, however, a logically prior

question and one which it is prudent to ask under our

obligation to apply state substantive law (in the absence

here of any conflict with or a threat to federal policies).

See Atherton v. FDIC, No. 95-928, 1997 WL 9781 (U.S. Jan. 14,

1997); Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938); see

also infra n.1. We must apply the law of Massachusetts as

given by its state legislature and state court decisions.

And in that lies the difficulty of the Bank's position.

The Supreme Judicial Court has never applied the

notice prejudice rule to a Financial Institution Bond. Such

fidelity bonds, as discussed later, are different in kind

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from liability insurance policies. In creating a common law

notice prejudice rule, the Johnson Controls court did so in

the context of liability policies. The statutory progenitor

to Johnson Controls concerned automobile liability policies.8

The refinement and limitation of the notice prejudice rule in

Chas. T. Main was also in the context of liability policies.

And the usual posture in which the court has applied the rule

has been in liability policies. See, e.g., Darcy v. Hartford

Ins. Co., 554 N.E.2d 28 (Mass. 1990). No court has yet

extended the Massachusetts notice prejudice rule to fidelity

policies such as this Bond. See, e.g., J.I. Corp., 920 F.2d

at 118; Boston Mut. Life Ins. Co. v. Fireman's Fund Ins. Co.,

613 F. Supp. 1090 (D. Mass. 1985).

When guidance is sought from Massachusetts caselaw

concerning fidelity policies, that law, admittedly not of

recent vintage, does not require our application of the

notice prejudice rule here. The background law of

Massachusetts, which we believe is not overruled by Johnson

Controls, was that conditions and limitations in such

8. In Goodman v. American Casualty Co., 643 N.E.2d 432, 434

(Mass. 1994), the court applied the usual notice prejudice
rule for automobile liability coverage to uninsured motorist
coverage, finding no meaningful distinction between the two.
Accord MacInnis v. Aetna Life and Cas. Co., 526 N.E.2d 1255

(Mass. 1988).

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policies are construed as written.9 In Gilmour v. Standard

Surety and Casualty Co., 197 N.E. 673 (Mass. 1935), the court

was concerned with a bond for acts of dishonesty. "The

contract of suretyship made by the defendant provided

indemnity to the plaintiffs in the event they sustained loss

through dishonest conduct on the part of the agency." Id. at

673. The bond had the following condition and limitation:

"That loss be discovered during the continuance of the

suretyship or within six (6) months after its termination,

and notice delivered to the Surety at its Home Office within

ten (10) days after such discovery." Id. at 673. The court

held that "[t]he giving of such notice was made a condition

precedent to recovery on the bond." Id. at 675. The court

noted that it was concerned not with "the question of the

circumstances under which at common law an obligation is

imposed on the obligee in a fidelity bond to give the surety

notice," but rather with the question of the timing of the

notice given. Id. at 674. The question was whether the

9. The requirement of timely notice is a condition of this
Bond and so is a condition of coverage under the parties'
agreement. In a bond of this type, the Insured agrees to
comply with the bond's "CONDITIONS AND LIMITATIONS" governing
the procedure for presenting and proving the Insured's claim
in exchange for the indemnity promised by the Underwriter.
Woods, "Conditions Precedent to Recovery: Presentation of the
Insured's Claim," in Financial Institution Bonds 285, 285

(Duncan L. Clore ed., 1995). "A condition, unlike an
agreement or a covenant, makes the Bond's indemnity
contingent upon the Insured's performance of the condition."

Id. (emphasis added).

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plaintiffs had complied with the ten day notice period in

order to be able to recover on the bond. The notice was

apparently given during the bond year, but the court still

considered the dispositive question to be whether the notice

was given within the ten day period. Id. at 674. (The court

concluded that it had). No case has said that Gilmour has

been overruled.

In Liberty Mutual Insurance Co. v. Gibbs, 773 F.2d

15 (1st Cir. 1985), this court held that, Johnson Controls

notwithstanding, the contract of insurance there must be

enforced according to its terms and that the notice prejudice

rule did not apply. At issue was a contract of reinsurance.

The contract's notice clause required notice to be given "as

soon as possible." Id. at 18. Our court thought important

three things. First, the parties involved were not lay

policyholders who required protection. Id. Second, the case

involved two insurance companies, experienced businesses,

that had bargained at arm's length. Id. Third, the

Massachusetts insurance statute, as is true here,10

distinguished between the contracts at issue (reinsurance)

and liability policies. Id.

In Cheschi v. Boston Edison Co., 654 N.E.2d 48, 53

(Mass. App. Ct. 1995), Chief Judge Warner of the Appeals

10. See Mass. Gen. Laws ch. 175, 107 (distinguishing

between surety bonds and insurance contracts).

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Court of Massachusetts rejected application of the notice

prejudice rule to an indemnity contract, distinguishing

Johnson Controls. The court adopted and expanded upon this

court's reasoning in Liberty Mutual, doubting that the notice

prejudice rule would apply to types of insurance other than

liability insurance when the insureds were not laypersons and

when the parties to the contract were two sophisticated

business concerns. 654 N.E.2d at 53. The court held that it

would apply traditional contract principles to the language

of the indemnity clause, saying: "Rules addressing the

special circumstances of certain insurance policies should

not be applied in these circumstances." Id. at 53-54.

Because it found language in the policy equivalent to making

prompt notice a condition, the court held that the lack of

prompt notice relieved the insurer of its obligation to

reimburse the insured. Id. at 54.

Guided by these principles, we analyze

Massachusetts law. Cheschi cautions against automatic

application of notice prejudice rules designed for one type

of insurance to other insuring arrangements.11 654 N.E.2d at

53-54. The Bond here is a Financial Institution Bond,

11. In J.I. Corp., this court, based on the analysis of the

language in a fidelity policy, declined to apply the notice
prejudice rule to that policy. While dicta in J.I. Corp.

suggests that the operative distinction is not the type of
insuring arrangement involved, 920 F.2d at 120, the panel did
not have the benefit of Cheschi.

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Standard Form No. 24, as revised in 1986. It is the most

recent form in a long line of Financial Institution Bond

forms utilized by members of the Surety Association of

America. See generally Knoll & Bolduan, "A Brief History of

the Financial Institution Bond," in Financial Institution

Bonds (1995), supra, at 1. Such bonds are basically fidelity

bonds, written specifically for financial institutions,

including commercial and savings banks, savings and loan

associations, credit unions, stockbrokers, finance companies,

and insurance companies. I Fitzgerald et al., Principles of

Suretyship 67 (1st ed. 1991).

Fidelity bonds are a sort of "honesty insurance,"

insuring against employee dishonesty. See Weldy, "History of

the Bankers Blanket Bond and the Financial Institution Bond

with Comments on the Drafting Process," in Financial

Institution Bonds 1, 1 (1989); Knoll & Bolduan, supra, at 1.

The capacity of one who ensures the fidelity of another's

employee has been described as part insurer and part surety,

with liability in either capacity being primary and direct.

1 Russ & Segalla, Couch on Insurance 3d 1:16 (1995). Early

Massachusetts cases about the Blanket Bankers Bond, the

predecessor to the Financial Insurance Bond, use both the

language of surety and the language of insurance. See, e.g.,

Fitchburg Sav. Bank v. Massachusetts Bonding & Ins. Co., 174

N.E. 324, 328 (Mass. 1931).

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It is said that "[i]n most cases and for most

purposes, . . . [fidelity bonds] are recognized to be a form

of insurance that are subject to the rules applicable to

insurance contracts generally." 1 Couch on Insurance 3d,

supra, 1:16 (citing law from various states). Nonetheless,

scholars have noted that, while fidelity bonds have, over

time, become more like insurance contracts,12 a fidelity bond

is still not liability insurance:

Although often referred to as insurance,
it is not liability insurance, but rather
a two-party indemnity agreement through
which the insurer reimburses the insured
for losses actually suffered in
accordance with the contract provisions.

Weldy, supra, at 2; see also Knoll & Bolduan, supra, at 5.

It is significant that the Bond possesses some

characteristics of surety arrangements which distinguish them

from liability policies. "The nature of the risk assumed by

the party in the role of 'insurer' is a major distinction

between insurance and the arrangements of guaranty and

surety. . . . [T]he risk can be characterized in terms of the

12. The transformation from treatment as a surety bond to
treatment as an insurance contract was prompted by a
broadening in the scope of coverage of fidelity bonds.
"[F]idelity coverage came to encompass not only traditional
employee dishonesty, but other related risks, and became more
like a contract of insurance, using the terms 'underwriter'
and 'insured' instead of 'surety' and 'obligee.'" Knoll &
Bolduan, supra, at 5. Here, the only insuring clause at

issue is the one covering "traditional employee dishonesty."
But it is also true that INA is described in the Bond as an
"underwriter" providing insurance.

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degree to which the contingency is within the control of one

of the parties. In the classic instance of insurance, the

risk is controlled only by chance or nature. In guaranty and

surety arrangements, the risk tends to be wholly or partially

in the control of one of the three parties [promisor,

creditor, or debtor]." 1 Couch on Insurance 3d, supra,

1:18. There is also a difference in the liability of a

classic insurer and that of surety/guarantor. An insurer,

upon the occurrence of the contingency, must bear the

ultimate loss, while a surety is entitled to indemnity in

case the surety is compelled to perform.

It is also significant, as was true in Liberty

Mutual, 773 F.2d at 18, that the Massachusetts legislature

has made distinctions in this area. The Massachusetts

legislature has decided that, for most regulatory purposes,

surety bonds are not insurance contracts. See Mass. Gen.

Laws ch. 175, 107. In Williams v. Ashland Engineering Co.,

45 F.3d 588, 592 (1st Cir.), cert. denied, 116 S. Ct. 51

(1995), this court found that "surety bonds are not insurance

contracts, and are thus not subject to the Commonwealth's

insurance laws." See also General Elec. Co. v. Lexington

Contracting Corp., 292 N.E.2d 874, 876 (Mass. 1973). That

expression of public policy undercuts any automatic

application of the insurance notice prejudice rule to surety

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bonds, and thus to Financial Institution Bonds to the extent

that they partake of the characteristics of surety bonds.

These distinctions confirm our reluctance to extend

the state notice prejudice rule for liability insurance to

Financial Institution Bonds. The material technical and

substantive differences between a Financial Institution Bond

and liability insurance make it difficult to apply easily the

common law notice prejudice rule, developed as it was in the

liability insurance context, to the insuring arrangement

here.

In Cheschi, as in Liberty Mutual, the court

considered the fact that the insuring arrangements (not

liability policies) did not involve layperson consumers.

Rather, they involved sophisticated businesses. Accordingly,

there was little reason to depart from the usual rule of

holding the parties to their bargain. In Johnson Controls,

the Supreme Judicial Court had stated that one reason for

applying the notice prejudice rule in that case was that the

insurance policy was:

not a negotiated agreement; rather its
conditions are by and large dictated by
the insurance company to the insured.
The only aspect of the contract over
which the insured can 'bargain' is the
monetary amount of the coverage.

409 N.E.2d at 187 (quoting Brakeman v. Potomac Ins. Co., 371

A.2d 193, 196 (Pa. 1977)).

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23

Here, in contrast, the Bond is an agreement whose

basic terms are negotiated between two industries. Over the

years, the banking industry and the fidelity bond companies

have negotiated various standard forms of the Financial

Institution Bonds. See generally Knoll & Bolduan, supra;

Weldy, supra. As one commentator has noted, "the fidelity

bond is an arms-length, negotiated contract between

sophisticated business entities, the standard form for which

was drafted by the joint efforts of the Surety Association of

America and the American Bankers Association." Koch, supra,

at vii. For example, at the request of the American Bankers

Association, the 1986 Bond added coverage for Uncertificated

Securities, and adopted the UCC definitions of these

financial instruments. Knoll & Bolduan, supra, at 25; see

also Calcasieu-Marine Nat'l Bank v. American Employers' Ins.

Co., 533 F.2d 290, 295 n.6 (5th Cir.) (bankers bond being

construed was drafted as a joint effort by the American

Bankers Association and the American Surety Association),

cert. denied, 429 U.S. 922 (1976).

The Bank brings up the doctrine of contra

proferentum arguing that "[a]mbiguities are resolved against

the insurer, who drafted the policy, and in favor of the

insured." GRE Ins. Group v. Metropolitan Boston Hous.

Partnership, Inc., 61 F.3d 79, 81 (1st Cir. 1995). This

doctrine provides the Bank no refuge. The presumption

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against the insurer is not applied where the policy language

results from the bargaining between sophisticated commercial

parties of similar bargaining power. Falmouth Nat'l Bank v.

Ticor Title Ins. Co., 920 F.2d 1058, 1062 (1st Cir.

1990)(applying Massachusetts law).13

Thus, to the extent the notice prejudice rule is

supported by the policy of protecting consumers who

effectively have little or no bargaining leverage, that

policy provides no basis here to extend the notice prejudice

rule.

B.

Finally, the Bank draws support for its position

from a Tenth Circuit decision, FDIC v. Oldenburg, 34 F.3d

1529 (10th Cir. 1994), cert. denied, 116 S. Ct. 171 (1995)

and district court decisions from other jurisdictions. The

court in Oldenburg predicted that Utah law would require a

Financial Institution Bond company to show prejudice in order

to avoid coverage where the bank gave late notice. Id. at

1546. The court held that the notice prejudice rule applied

in light of: (1) the failure of the policy to expressly make

notice within a specific time a condition precedent to

recovery; (2) the Utah rule that provisions excluding

13. The Fifth Circuit has also rejected the application of
the doctrine of contra proferentum to Financial Institution

Bonds. Sharp v. FSLIC, 858 F.2d 1042, 1046 (5th Cir. 1988);

Calcasieu-Marine Natl Bank, 533 F.2d at 295 n.6.

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coverage are strictly construed against the insurer; and (3)

a Utah statute, enacted after the Bond period, which

expressed a public policy that the notice prejudice rule be

applied to all insurance policies. Id. at 1545-46. Whatever

the requirements of Utah or other law, Massachusetts law

governs this issue, and Massachusetts has, until the Supreme

Judicial Court or the state legislature decides otherwise,

framed its public policy choices differently.

We hold that the notice prejudice rule does not

apply.

Affirmed.

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