In a decision important to insurers, the Eleventh Circuit recently determined that the definition of “counterfeit” does not include authentic documents that are fraudulently procured, despite the bond holder’s argument that the stock certificate appeared to be valuable and thus a counterfeit. Insurance companies should be aware that there is a distinction between types of fraud. Specifically, losses covered under the definition of counterfeit, including documents misrepresenting authenticity, versus losses outside the bounds of coverage, based on a document misrepresenting value.
In its Feb. 9, 2015 decision, the Eleventh Circuit unanimously held that a stock certificate which was obtained under false pretenses was not a covered loss under a bond’s definition of “counterfeit.” The court reasoned that a counterfeit document was different than a fraudulently procured document, and upheld the U.S. District Court for the Southern District of Alabama’s grant of summary judgment in favor of the insurance company.
The facts are as follows: Travelers Company Inc. (“Travelers”) issued a financial institution bond (“Bond”) to the Bank of Brewton (“Bank”) in Escambia County, Alabama. The Bond covered losses that were a result of the Bank’s good faith reliance on counterfeit securities. “Counterfeit” was defined as “an imitation which is intended to deceive and to be taken as an original.”
Jackson Hines, a long-standing customer of the Bank, had taken out a loan and pledged among other assets, 180 shares of stock in The Securance Group (“TSG”). The stock certificate representing these shares, Certificate No. 2, was merely a copy of the original. The original stock Certificate No.2 had been used as collateral for a loan at another bank.
In 2009, the Bank discovered that Certificate No. 2 was a copy of the original and confronted Hines, who replied that he gave the Bank a copy since he had lost the original and set out to obtain a replacement certificate from TSG.
Hines told TSG that he lost Certificate No. 2 and needed a replacement. He represented that he had not encumbered Certificate No. 2 other than with the Bank. In response, TSG gave Hines Certificate No. 11, representing the same 180 shares lost in Certificate No. 2. Just like Certificate No. 2, Certificate No. 11 was numbered, dated, and signed by the appropriate officer. Hines then delivered the certificate to the Bank.
In December 2009, the Bank consolidated all of Hines’ loans into one, and issued him an additional loan to compensate for costs of the consolidation. These loans were secured in part by Certificate No. 11.
In April 2010, the Bank discovered that Hines had issued the original stock Certificate No. 2 to another bank back in 2007. The Bank asked Hines to replace the collateral, but he instead defaulted on his loans and filed for bankruptcy.
The Bank sued Travelers for breach of contract, arguing that the Bond covered the losses sustained from Hines’ default. Travelers filed a motion for summary judgment, contending that the loss was not covered because the loss was not a direct result of the Bank’s good faith reliance on the counterfeit Certificate No. 2.
Travelers stated that the Bank knew as early as April 2009 that Certificate No. 2 was a copy and that the loss at issue was a result of the December 2009 loans. The Bank responded that either Certificate No. 2 or Certificate No. 11 would qualify as a counterfeit under the policy and that any loss as a result of its good faith reliance on the certificates would qualify as a covered loss under the Bond. Travelers replied that Certificate No. 11 was not a counterfeit and therefore the Bank could not recover based on a claim under Certificate No. 11. The Bank countered that Certificate No. 11 was intended to replace and represent the original Certificate No. 2, thus Certificate No. 11 was a counterfeit.
The issue before the U.S. District Court for the Southern District of Alabama was whether Certificate No. 2 and Certificate No. 11 were “counterfeit” under the policy, and whether the Bank’s loss was a result of its good faith reliance on the certificate. The District Court determined that the Bank did not rely on Certificate No. 2 and also concluded that Certificate No. 11 was not covered by the Bond because it was not a counterfeit document. Instead, it was an authentic document that was void at the time it was issued.
The Eleventh Circuit upheld the District Court’s ruling and focused on the distinction between a counterfeit document as opposed to a fraudulently procured document. The Court explained: “An attempt to deceive by means of a document that imitates the appearance of an authentic original is not the same as an attempt to deceive by means of false factual representations implicit in an authentic document.” The Eleventh Circuit applied Alabama law, noting that while no Alabama law seemed to be on point, an Alabama Supreme Court case cited favorably to a Sixth Circuit case that was helpful.
The Eleventh Circuit emphasized that “the falsity at issue lies in the representation of facts contained in Certificate No. 11 and not in the genuineness of its execution.” The Court determined that the Bond only covered losses arising from imitations of the original and focused on the nature of the underlying misrepresentation. “While counterfeit documents deceive by misrepresenting authenticity, Certificate No. 11’s deception concerned a misrepresentation of value.” Thus, the loss was not based on a counterfeit document and was subsequently not covered under the Bond.