Resolution Trust Corp. v. Fidelity & Deposit Co. of MD,et al. (Part I)

Opinions of the United

2000 Decisions States Court of Appeals

for the Third Circuit

2-4-2000

Resolution Trust Corp. v. Fidelity & Deposit Co. of

MD,et al. (Part I)

Precedential or Non-Precedential:

Docket 98-6368

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Filed February 4, 2000

UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 98-6368

RESOLUTION TRUST CORPORATION,

as Receiver for City Savings, F.S.B., in Receivership,

v.

FIDELITY AND DEPOSIT COMPANY OF MARYLAND;

WILLEM RIDDER; JOHN T. HURST; LYNDON C. MERKLE;

GREGORY DEVANY

Federal Deposit Insurance Corporation, as statutory

successor to Resolution Trust Corporation,

Appellant

On Appeal from the United States District Court

for the District of New Jersey

(D.C. Civ. No. 92-01003)

District Judge: Honorable William H. Walls

Argued December 15, 1999

BEFORE: MANSMANN, GREENBERG, and MCKEE,

Circuit Judges

(Filed: February 4, 2000)

Anthony J. Sylvester

Craig L. Steinfeld

Riker, Danzig, Scherer, Hyland

& Perretti

One Speedwell Avenue

Morristown, NJ 07962

Barbara Sarshik

Ann S. DuRoss

Assistant General Counsel

Colleen J. Boles

Senior Counsel

Daniel Glenn Lonergan (argued)

Counsel

Federal Deposit Insurance

Corporation

550 17th Street, N.W.

Washington, DC 20429

Attorneys for Appellant

Gregory R. Haworth (argued)

Lauren Debruicker

Duane, Morris & Heckscher LLP

One Riverfront Plaza

Newark, NJ 07102

Attorneys for Appellee

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

This appeal arises from a dispute concerning coverage

under a savings and loan blanket fidelity bond the appellee,

Fidelity and Deposit Company of Maryland ("F&D"), issued

to City Federal Savings Bank ("City Federal"), in 1987. In

particular, the Federal Deposit Insurance Corporation

("FDIC"), as statutory successor to the Resolution Trust

Company ("RTC"), appeals the district court's order of

summary judgment entered against it on January 29, 1998,

2

on its action on the bond.1 It contends that the district

court erred in holding that no reasonable jury could

conclude, based on the evidence presented, that City

Federal "discovered" a covered loss within the bond period

as required by the bond's terms for there to be coverage. In

response, F&D asserts that the district court's ruling on the

discovery issue is correct, and that alternatively, it is

entitled to summary judgment because the loss City

Federal sustained is not covered by the bond. For the

reasons that follow, we will reverse the district court's order

of summary judgment, and remand the matter to the

district court for further proceedings consistent with this

opinion.

II. FACTS and PROCEEDINGS

A. Background

We draw the relevant facts from the district court's

opinion and the parties' submissions in the summary

judgment proceedings before the district court. 2 See

_________________________________________________________________

1. The RTC originally filed the complaint in the district court, but the

FDIC, as the RTC's statutory successor, has taken this appeal. See 12

U.S.C. S 1441a(m). As a matter of convenience we refer to the appellant

as the RTC.

2. In this appeal, the parties rely specifically on the "12G Statement of

Undisputed Facts" the RTC submitted in opposition to F&D's motion for

summary judgment, see app. at 125-175, as well as the "12G Statement

of Undisputed Facts" the RTC submitted in opposition to individual

defendant Lyndon Merkle's motion for summary judgment. See SA at 39-

105. Those statements, in turn, set forth the historical facts giving rise

to this dispute. Because neither party has contested the accuracy of the

historical facts set forth in the 12G statements, and in view of the

circumstance that all of the relevant deposition testimony is not in the

record before this court, we have relied on those factual statements and

other portions of the record in deciding this appeal. However, to the

extent that the parties' briefs indicate that there are disputed facts, we

will refer to the RTC's version because we must view the facts in the

light

most favorable to it, the non-movant before the district court.

We also note that the parties submitted separate appendices in this

appeal. We refer to the RTC's appendix as "App. at ___," and F&D's

appendix as "SA at ___."

3

Resolution Trust Co. v. Fidelity & Deposit Co., No. 92-1003,

slip op. (D.N.J. Jan. 27, 1998) (hereinafter "Op. at ___").

Because this appeal is intensely fact-driven, it is necessary

to set forth the factual background in some detail.

On March 22, 1987, F&D issued a "Savings and Loan

Blanket Bond" ("the bond"), Standard Form No. 22, naming

as insureds City Federal and its wholly-owned subsidiary

City Collateral and Financial Services, Inc. ("City

Collateral"). City Collateral was City Federal's mortgage

warehouse lending operation.3 Among other things, the

bond provided fidelity insurance, and stated that F&D

would indemnify City Federal or its subsidiaries up to $5

million against losses it might suffer because of certain

dishonest or fraudulent acts by its employees. The bond

expired on March 22, 1989.

During the effective period of the bond, Willem Ridder

("Ridder"), John Hurst ("Hurst"), Lyndon Merkle ("Merkle")

and Gregory DeVany ("DeVany") were City Federal and City

Collateral employees, serving City Collateral in the following

capacities: (1) Ridder was the president of City Collateral

and Hurst's supervisor; (2) Hurst was a vice president of

City Collateral, the director of financial services and

DeVany's supervisor; (3) Merkle was a senior financial

services officer and also a vice president of City Collateral;

and (4) DeVany was a financial services officer and an

assistant vice president of City Collateral. Unless we

otherwise note, we will refer to these persons collectively as

the "individual defendants."

In June 1987, Kevin Corcoran ("Corcoran"), a City

Collateral loan officer, presented City Federal's Executive

_________________________________________________________________

3. The district court described the nature of a mortgage warehouse

lending operation:

First, a mortgage warehouse lender such as City Collateral advances

money to a mortgage banker to fund mortgages on real property. In

return, the lender is given the mortgage notes as security for the

loan. Then, the mortgage banker sells the mortgage notes to the

Federal Home Loan Mortgage Corporation or some other investor

and tells the lender to forward the mortgage notes to that

investor.

The lender sends the notes to the investor, and then the mortgage

banker uses the proceeds of the sale to repay the lender.

4

Committee ("Executive Committee") and Officer's Loan

Committee ("Loan Committee") with a proposal for a lending

arrangement whereby City Collateral would extend a $30

million warehouse credit line to Northwest Mortgage

Company ("Northwest"). Northwest, a New Jersey company,

originated residential mortgage loans and sold them to

investors individually or in pools. At all times relevant to

this case, Harry Movroydis ("Movroydis") was the president

of Northwest. On June 16, 1987, City Federal and

Northwest executed a "Master Mortgage Loan Warehousing

Agreement" (the "master agreement") and related

documents setting forth the terms and conditions of the

lending arrangement.

In March 1988, Corcoran left employment at City

Collateral, but before his departure, he told Hurst about

certain problems he had experienced with the Northwest

credit line. On or about April 1, 1988, Hurst and DeVany

took over administration of the Northwest credit line. From

approximately April 1, 1988, to November 1988, Merkle

generated "exception reports" pertaining to the Northwest

credit line and delivered those reports to both Hurst and

DeVany. These reports provided the following information:

(1) total amount of collateral that had been shipped to

third-party investors for purchase but for which City

Federal remained unpaid for at least 30 days (referring to

these loans as "shipped loans"), and (2) total amount of

collateral that had not been shipped to third-party investors

for purchase and for which City Federal had not been

repaid by Northwest for at least 180 days from City

Collateral's funding of the loan (referring to these loans as

"warehoused loans"). Despite the fact that the exception

reports for the Northwest credit line indicated numerous

problems with the Northwest collateral, Hurst and DeVany

did not distribute the reports to City Federal officials during

the relevant time period.

In May 1988, Hurst wrote to Movroydis to inform him

that Northwest was in violation of the master agreement.

About the same time, DeVany and another City Collateral

employee found difficulties with Northwest's list of

commitments from third parties to buy notes and

mortgages. DeVany did not report the problems to City

5

Federal's Real Estate Finance Committee. Despite these

problems, Hurst recommended that the Loan Committee

extend the maturity date of the credit line from May 31,

1988, to June 30, 1988. Moreover, Hurst did not inform the

Loan Committee that the Northwest credit line was in

technical default as of that time.

In June 1988, Hurst wrote to Northwest about a

"workout plan" for the credit line to cure the violations of

the master agreement. In July 1988, City Collateral put the

credit line on its internal "watch list," which meant that the

Northwest account had been identified as a problem credit.

The individual defendants did not inform City Federal of

this fact. Moreover, between June and September 1988,

City Collateral continued to extend credit to Northwest

while it closely monitored the loan. As F&D points out in its

brief, the evidence demonstrates that there were

improvements with Northwest's credit line during the

summer of 1988. Northwest was able to reduce its

warehoused loans from $8,036,027 as of June 30, 1998, to

zero as of September 30, 1988. The shipped loans dropped

from $7,040,357 as of June 30, 1988, to $5,695,890 as of

September 30, 1988.

In or about May 1988, and coincidentally around the

same time period that the Northwest credit line's maturity

date was extended for the first time, Ridder, Hurst and

Merkle learned from James McTernan ("McTernan"), a City

Federal officer, that City Federal planned to sell City

Collateral. According to the RTC, upon learning of City

Federal's intent to sell City Collateral, Hurst, Ridder and

Merkle promptly initiated discussions with City Federal

about their potential compensation if the sale were

consummated. Apparently, Ridder, Hurst and Merkle

negotiated what the parties call "golden handcuff

agreements" or "closing agreements" with City Collateral

throughout the summer and into the fall of 1988. See SA at

48.

As part of the effort to sell City Collateral, Drexel

Burnham Lambert, Inc. prepared an offering memorandum

that described City Collateral's business and corporate

structure as well as its loan credits. Ridder, Hurst and

Merkle worked on the credit section of this document, in

6

particular providing information for the section of the

offering memorandum entitled "Workouts and Litigation."

Although the Northwest credit line was in a "workout"

status as of that time, they did not include it in this section

of the offering memorandum. City Federal distributed the

offering memorandum during the summer of 1988 to

potential purchasers.

In September 1988, DeVany (under Hurst's supervision)

prepared a written recommendation to extend and renew

the Northwest credit line to June 1989, and in late

September 1988, DeVany presented it to City Federal's loan

committees. The report, and DeVany's oral presentation,

omitted negative facts relating to the Northwest credit line,

including, inter alia, its "workout" status and Northwest's

technical default under the master agreement. The report

also underestimated Northwest's risk rating in view of the

various problems with the account. Indeed, F&D admits in

its brief that while there appears to be a factual dispute as

to what DeVany said at the committee presentation, giving

the RTC every reasonable inference, "the most that can be

said is that the Employees concealed the Northwest default

and the workout plan in progress in order to induce City

Federal to extend the loan." Br. at 7. Moreover, the record

indicates that in September 1988, Hurst represented to

City Federal that the Northwest credit line would be

included in any future City Collateral sale. Nevertheless,

Hurst told City Collateral employees in August and October

1988, that the Northwest credit line would not be included

in any City Collateral sale.

After the September 1988 presentation, City Federal's

committees accepted DeVany's recommendation to renew

and extend the Northwest credit line, but conditioned its

acceptance on Northwest's completion of certain conditions.

As it turned out, Northwest failed to satisfy the stated

conditions, and on or about December 5, 1988, DeVany

halted funding on the credit line. There is evidence

indicating that DeVany halted funding under Hurst's

direction, but that none of the individual defendants

informed anyone at City Federal of the situation as of that

time.

7

Meanwhile, sometime in the fall of 1988, the parent

corporation of HonFed Bank ("HonFed"), a federally insured

savings bank based in Hawaii, expressed interest in

purchasing City Collateral. The RTC states that"according

to the deposition testimony of Hurst, by late October to

early November, Hurst, Ridder and Merkle were confident

that HonFed was going to purchase City Collateral and that

HonFed planned to employ them after the sale." Br. at 9.

Coincidentally (or not), on October 21, 1988, City Collateral

signed closing agreements with Ridder, Hurst and Merkle,

providing each with substantial sums of money, i.e., the

"golden handcuff payments," if City Federal sold City

Collateral and each of them provided assistance with the

City Collateral sale. Under the agreements each was to

"render such additional assistance as may be necessary to

assist and expedite the sale, transfer or assignment of [City

Collateral]." The amount of compensation Ridder, Hurst

and Merkle received under the agreements depended upon

a number of factors, including, inter alia, City Federal's

gross profit from the sale and whether each obtained

employment with the purchaser after the sale. Also, they

could collect their payments only if the sale occurred before

March 31, 1989, and they were not terminated for cause

before the deal closed. The RTC also states that during the

same time period, presumably by late October or early

November 1988, Hurst, Ridder and Merkle were negotiating

their future employment contracts with HonFed. Br. at 9.

Sometime in November 1988, DeVany began to create a

"customer history" on the Northwest Loan that he kept in

City Federal's files. The history summarized activities

involving the credit line. On November 28, 1988, HonFed

signed a letter of intent to purchase City Collateral and

began its due diligence process. The letter of intent

obligated HonFed to purchase all of City Collateral's loans

except those that were "non-performing or otherwise

substandard." Moreover, the letter of intent expressed that

one of the conditions of the sale was that Hurst, Ridder and

Merkle would agree to join HonFed.

During its due diligence, HonFed reviewed the exception

reports from the Northwest credit line. Testimony from

Kathy Durham of HonFed indicates that HonFed rated the

8

Northwest credit line as a "watch" based on its history of

losses and stale loans. A few days prior to the closing,

HonFed notified City Federal that it was excluding the

Northwest credit line from the sale.

In December 1988, DeVany met with Movroydis to

discuss the situation with the credit line. At the meeting,

which appeared at first in the customer history as having

occurred on December 29, 1988, Movroydis admitted that

he wrongfully had diverted collateral securing the loans

obtained from City Collateral. Apparently, Movroydis was

involved in what the parties refer to as a "kiting scheme,"

whereby he diverted the funds Northwest owed to City

Collateral to cover marketing losses that Northwest had

sustained in April and October 1987. DeVany did not tell

anyone at City Federal of this admission at that time, but

DeVany testified that he told Hurst about it. Apparently,

the RTC learned in discovery that the meeting actually took

place on December 22, 1988, rather than December 29,

1988. DeVany testified at his deposition that he changed

the date of the meeting at Hurst's insistence, but Hurst

denied that he ever ordered DeVany to do so. As described

below, the closing date of the City Collateral sale was

December 29, 1988. DeVany also testified that he changed

the date of the customer history after the HonFed sale, but

insofar as we can tell, his testimony does not indicate when

Hurst asked him to change the date.

In the weeks prior to the closing, Ridder sent Gerry

Czarnecki ("Czarnecki"), the chairman of the board of

HonFed, a memorandum dated December 9, 1988, entitled

"HonFed/CityFed Negotiations." The district court described

the memorandum as containing "various recommendations

that appear to run counter to City Federal's interest." Op.

at 12-13. One of the items Ridder discussed in the

memorandum was the Northwest credit line; in particular,

he recommended that HonFed accept the Northwest credit

line under certain conditions, and suggested the following

course of action: "Your bargaining position [with City

Federal] should be that if the credit does not improve to an

`acceptable' or `pass' level (currently rated substandard by

HonFed) rated by HonFed credit exam by March 31, 1989,

that then all outstandings outstanding at that date are to

9

be repurchased by [City Federal.]" SA at 59. Importantly,

the memorandum confirmed that the Northwest credit line

was in technical default, and that Northwest "had excessive

stale loans in warehouse due to operating problems and

commitment glitches." Id. Ridder did not distribute the

memorandum to anyone at City Federal, nor was it found

in City Federal's files.

Notably, City Federal executive James McTernan testified

at his deposition that no one told him prior to the HonFed

closing about "operating problems" or "commitment

glitches" with the Northwest account. See SA 64-65.

Similarly, McTernan stated in a declaration that he was

certain that he was not aware of any problems with the

collateral securing the Northwest loan, and, in his

deposition, he testified that he did not know that there was

any technical default of the master agreement precluding

the renewal of the credit lines. McTernan also indicated in

his deposition that certain of the statements Ridder made

in the memorandum were contrary to City Federal's

interests, and therefore could have been grounds for

termination. See app. at 552; SA at 65-68. McTernan also

testified that he would have expected Ridder to circulate the

memorandum to his superiors at City Federal, given that it

contained recommendations that ran counter to City

Federal's interests. See SA at 68.

The district court noted that HonFed decided to exclude

the Northwest loan from its purchase of City Collateral's

assets only a "few days" before the closing. Thus, it is

reasonable to infer that the decision to exclude the loan

occurred after Movroydis's admission to DeVany, and after

Hurst became aware of it. See Op. at 13. The record

supports the conclusion that HonFed made its ultimate

decision after its receipt of the December 9, 1988,

memorandum. In late December, and prior to the HonFed

sale, McTernan asked Ridder how HonFed decided to leave

the Northwest credit line with City Federal. McTernan

testified that Ridder replied that HonFed had performed

due diligence and elected not to purchase the credit line.

He also indicated that Ridder did not mention the problems

with the Northwest account at that time.

10

At or about the same time as the closing on December

29, 1988, Ridder, Hurst, and Merkle entered into

employment contracts with HonFed providing for various

benefits including incentive compensation and automobile

expenses. Also, HonFed provided each individual with a

signing bonus: Ridder received $42,000, Hurst received

$26,250, and Merkle received $22,500. They also received

monthly salaries of $11,667, $8,750, and $7,500,

respectively. Ridder, Hurst and Merkle earned the

maximum payments under their "golden handcuff "

agreements: Ridder received approximately $279,000, Hurst

received approximately $206,000, and Merkle received

$150,000. See Op. at 14. Moreover, it appears that DeVany

received $1,000 from a bonus pool Ridder, Hurst and

Merkle established voluntarily. F&D's Br. at 9.

After the closing, City Federal created First Collateral

Financial Services ("First Collateral") to assume City

Collateral's former duties. In January 1989, Northwest

defaulted on its obligations on the credit line; it failed to

make payments due on January 1, 1989, and February 1,

1989. On February 15, 1989, DeVany, who continued to

administer the Northwest credit line after the sale, provided

City Federal with a status report that revealed problems

with the credit line. The district court indicated in its

opinion that DeVany's memorandum marked the first time

that anyone at City Federal had been advised of the

problems with the line. See Op. at 14. We note, however,

that evidence in the record indicates that City Federal

employees, including McTernan, knew generally in late

January 1989, that there were problems with the credit

line. In any event, the important point is that City Federal

officials were kept in the dark with respect to the nature

and severity of the situation until after the completion of

the HonFed sale. On February 24, 1989, Movroydis met

with City Federal executives and admitted that he

misappropriated City Collateral funds. This was thefirst

time that anyone at City Federal learned of the Movroydis

admission and the details of his kiting scheme, despite the

fact that DeVany and Hurst knew about the situation in

December 1988, prior to the HonFed closing.

City Federal's senior in-house counsel, Amy Stein, Esq.

("Stein"), learned of the Northwest situation on March 6,

11

1989. At that point, Stein and A. Eugene Hull, Esq. ("Hull"),

another in-house attorney at City Federal, commenced an

investigation into the Northwest matter because they were

concerned that employee misconduct may have caused the

Northwest loss, thus triggering coverage under the F&D

fidelity bond.

On March 20, 1989, after interviewing DeVany and

Merkle, Hull drafted a letter entitled "Notice of Possible

Loss," and sent it to F&D. The letter essentially tracked the

language of the discovery definition in the bond, but

provided no specific details concerning the factual basis for

City Federal's belief that a covered loss had occurred.

The following day, March 21, 1989, Hull sent a

supplemental letter to F&D. He estimated that City Federal

incurred a $7 million loss on the Northwest account, but he

again provided no specific information concerning the basis

for his belief that employee misconduct caused the loss.

On March 30, 1989, F&D sought additional facts from

Hull concerning the suspect transaction, the losses

sustained to date, the basis for City Federal's suspicion

that employee dishonesty was involved, and any other

information City Federal was willing to share. Unsatisfied

with Hull's response to that letter, F&D wrote to Hull again

on April 25, 1989. Specifically, F&D sought additional

information concerning the factual basis for City Federal's

suspicion that one or more of its employees was involved in

fraudulent or dishonest conduct causing the Northwest

loss. Hull did not respond to the correspondence, and F&D

sent another letter seeking the same information on August

9, 1989. Again City Federal's legal department did not reply

to F&D's correspondence.

Subsequently on December 7, 1989, the Director of the

Office of Thrift Supervision, Department of the Treasury,

declared City Federal insolvent and ordered it closed. The

order also appointed the RTC as receiver for City Federal.

Consequently, the RTC took possession of City Federal on

December 8, 1989, and succeeded to all its rights, titles,

assets, powers and interests, including City Federal's right,

if any, to indemnification under the F&D bond. About two

weeks later, the RTC filed its "Proof of Loss" with F&D. F&D

denied the claim for coverage, and this litigation followed.

12

B. Procedural History

The RTC, as City Federal's successor, filed its complaint

in the district court against F&D, Ridder, Hurst, DeVany

and Merkle on March 6, 1992, asserting various state law

claims. Count 1 of the complaint alleged that F&D

breached its contract with City Federal because it failed to

indemnify City Federal under the bond for the Northwest

loss. Count 2 sought a declaratory judgment of coverage

under the bond, and Count 3 alleged that F&D violated the

implied covenant of good faith and fair dealing by denying

coverage under the bond.4

F&D filed a motion for summary judgment, arguing that

it was entitled to judgment as a matter of law on two

separate grounds. First, it asserted that "Insuring

Agreement A," which we call the fidelity provision, did not

cover the losses caused by the alleged dishonest and

fraudulent conduct by the individual defendants. 5 It

claimed that no reasonable jury could find that the

individual defendants acted with the requisite "manifest

intent" both to cause a loss to City Federal and to obtain

the type of financial benefit for a third party or themselves

that would permit coverage under the bond. Second, F&D

_________________________________________________________________

4. Counts 4 through 20 alleged various state law claims against Hurst,

Merkle, Ridder and DeVany. On October 27, 1995, Merkle filed a motion

for partial summary judgment. The district court denied the motion by

opinion and order entered January 13, 1997. Merklefiled a motion for

reconsideration, which the district court granted by letter order entered

March 6, 1997. However, after considering the issues presented in the

motion for partial summary judgment for the second time, the court

denied the motion in its letter order. Merkle filed a motion for

reconsideration of that last order, which the district court denied by

letter order entered April 15, 1997. These rulings are not at issue in

this

appeal.

5. The bond consisted of separate "Insuring Agreements," each of which

protected against certain internal and external risks. All of the Insuring

Agreements are subject to a common set of general agreements,

definitions, conditions, limitations, and exclusions. The agreements, or

coverages, include: (A) Fidelity, (B) Audit Expense, (C) On Premises, (D)

In Transit, (E) Forgery or Alteration, (F) Securities, and (G) Counterfeit

Currency. In this appeal, the RTC claims coverage only under "Insuring

Agreement A."

13

maintained that under the general discovery definition

found in section 4 of the "General Agreements" portion of

the bond, no reasonable jury could conclude that City

Federal "discovered" the loss during the bond period, as

required for there to be coverage, even viewing the known

facts as of March 22, 1989, the date the bond expired, in

the light most favorable to the RTC. See Op. at 18.

The district court granted F&D's motion in its opinion

and order entered January 29, 1998, and dismissed the

RTC's claims against F&D with prejudice. First, the court

concluded that there were genuine issues of material fact

as to whether the individual defendants acted with the

manifest intent to cause City Federal a loss which, at the

same time, allowed them to obtain the type of financial gain

that would establish coverage under the bond. The court

held in the alternative, however, that summary judgment

was appropriate on the basis that City Federal failed to

discover the loss within the applicable bond period. See Op.

at 31-32. The district court subsequently filed an order

dismissing the action against F&D in its entirety, and after

the remaining parties settled the case, the RTCfiled a

timely notice of appeal of the summary judgment order.

III. JURISDICTION, STANDARD OF REVIEW and

APPLICABLE LAW

The district court exercised subject matter jurisdiction

over this matter pursuant to 12 U.S.C. S 1441a(l)(1), which

grants original jurisdiction to district courts over any action

to which the RTC is a party. The FDIC was subject to

jurisdiction in the district court by virtue of 12 U.S.C.

S 1819(b)(2)(A).

We exercise appellate jurisdiction over this appeal

pursuant to 28 U.S.C. S 1291, as the district court entered

a final order dated September 3, 1998, dismissing the

action. Because the RTC appeals from the district court's

order of summary judgment entered January 29, 1998, our

review is plenary. See Nelson v. Upsala College, 51 F.3d

383, 385 (3d Cir. 1995).

Preliminarily, we note that suits brought by the FDIC are

deemed by statute to arise under the laws of the United

14

States. See 12 U.S.C. S 1819(b)(2)(A). Nevertheless, we treat

this appeal as governed by the substantive law of New

Jersey, inasmuch as both parties assume that New Jersey

law applies, neither party contends that another state's law

governs, and we see no basis for fashioning a federal rule

of decision to resolve the issues we address today. See

O'Melveny & Myers v. FDIC, 512 U.S. 79, 87-88, 114 S.Ct.

2048, 2055 (1994); FDIC v. Insurance Co. of N. Am., 105

F.3d 778, 779 n.1 (1st Cir. 1997); FDIC v. Oldenburg, 34

F.3d 1529, 1538 & n.10 (10th Cir. 1994); FDIC v. New

Hampshire Ins. Co., 953 F.2d 478, 481-82 (9th Cir. 1991).

In this regard, however, we note that many of the germane

cases are from the federal courts as, not surprisingly,

diversity jurisdiction frequently is present in litigation

involving fidelity bonds. The cases often state common law

principles which are not unique to any particular state.

IV. DISCUSSION

A. "Discovery" of the Loss

The RTC contends primarily that the district court erred

in concluding that City Federal failed to discover the basis

for its claim under the bond prior to the bond's expiration

on March 22, 1989, as required for there to be coverage. It

maintains that the issue of when the loss was "discovered"

under the bond is inherently factual and thus properly is

reserved for the trier of fact. It claims that the facts City

Federal knew as of the expiration of the bond period, when

considered in combination, were sufficient under the bond's

discovery standard so that the issue should have been

presented to a jury.

F&D contends in response that the district court's

disposition of the discovery issue was correct, as the court

recognized that the information that City Federal learned

prior to the expiration of the bond period was insufficient to

warrant a jury finding that it "discovered" the loss as of

that time. It argues that, at most, the facts and

circumstances City Federal knew gave rise to suspicions

about the individual defendants' misconduct, but that

"mere suspicion of employee dishonesty or wrongdoing

15

during the bond period does not constitute discovery." Br.

at 24. Citing cases in which the courts ruled in favor of the

insurer on the issue of discovery, F&D claims they support

its position because the insureds in those cases possessed

"far more knowledge of facts about the alleged dishonesty

than City Federal possessed" during the bond period. See

id. at 25-28.

The bond at issue is known in the industry as a

"Standard Form No. 22 bond." It is a "discovery bond,"

which by its terms requires that the insured discover the

loss during the bond period as a condition to coverage.

Thus, coverage expressly is limited by the following section,

which defines "discovery" as the term is used throughout

the various provisions in the bond:

Section 4. This bond applies to loss discovered by the

Insured during the bond period. Discovery occurs when

the Insured becomes aware of facts which would cause

a reasonable person to assume that a loss covered by

the bond has been or will be incurred, even though the

exact amount or details of loss may not then be known.

App. at 100. Moreover, section 5 of the General Agreements

section of the bond states that "[a]t the earliest practicable

moment, not to exceed 30 days after discovery of the loss,

the Insured shall give the underwriters notice thereof." Id.

During the summary judgment proceedings before the

district court, the RTC argued that a reasonable jury could

find that City Federal discovered the loss during the bond

period, given the information City Federal knew prior to the

expiration of the bond period, and the discovery standard

that applied. It relied on several pieces of information of

which members of City Federal's legal department were

aware as of March 20, 1989, the date City Federal sent its

Notice of Possible Loss letter to F&D. Thus, its position

essentially was that the facts City Federal knew showed

that it possessed more than "mere suspicions of

dishonesty." Specifically, it cited Stein's deposition

testimony which detailed the various pieces of information

City Federal's legal department discovered during the bond

period. Because the nature and extent of City Federal's

knowledge is central to resolving the discovery issue, we

16

will set forth in some detail the factual basis for the RTC's

argument.

First, Stein testified that she knew that the Northwest

loss essentially "dropped out of the sky" without City

Federal management receiving prior warning from any of

the individuals responsible for monitoring the loan. She

testified that it was "unprecedented" that a multi-million

dollar loss would just appear out of nowhere, without prior

warning signs being noticed by the employees working on

the account. Yet, to the best of her knowledge at that time,

none of the responsible employees revealed any warning

signs to City Federal personnel.

Second, Stein knew that HonFed specifically excluded the

Northwest credit line from its purchase of City Collateral's

assets. Stein testified that it was incredible and very

peculiar that HonFed would single out the Northwest loan

and exclude it from the sale, particularly while City Federal

employees responsible for the loan seemingly were unaware

of its troubled status. Her testimony in this regard was:

MS. STEIN: I mean, I can't imagine how HonFed could

come up to a conclusion like that [i.e., that the loan

should be excluded], having no ownership of the loan,

where we had bank employees or City Collateral

employees who were responsible for this loan. It just

didn't square up. I mean, why does a buyer kick out a

loan from a purchase? It's just not, you know, karma.

. . . .

I just knew the HonFed deal was going down right

around this time, and it seemed very peculiar to me

that another financial institution kicks this loan out of

its purchase.

MR. KASLOW: Do you know if HonFed conducted any

due diligence?

MS. STEIN: Well, my point is this. If HonFed conducted

due diligence and saw something that made it believe

that this loan was not, you know, acceptable, where

were our employees who were managing this loan and

dealing with this borrower, why didn't they also

17

discover that and why wasn't that brought to

management's attention?

Third, Stein knew that DeVany learned of Movroydis's

fraudulent scheme in late December 1988, but failed to

report his admission to management at City Federal or City

Federal's legal department. She knew that DeVany met with

Movroydis at or around the same time as the HonFed

closing, and learned at that time that Movroydis converted

monies Northwest owed to City Collateral and used the

funds to cover marketing losses Northwest sustained in

1987. Stein testified that it was "bizarre" and contrary to

bank policy that DeVany concealed that information rather

than promptly notifying the legal department that one of its

borrowers perpetrated a fraud. She explained:

A borrower walks in, sits down with an account officer

[DeVany], confesses to a multimillion dollar fraud, and

the account officer doesn't call the legal department for

months, the legal department doesn't even find out

about it through the account officer? That is, you

know, clearly weird. That's just not the way things

worked in the real world, it's just not the way it works.

App. at 352. Stein explained later in her deposition that

City Federal policy required its employees to notify the legal

department of matters that had "a legal consequence or a

legal issue" involved. In view of her belief that"certainly

fraud or theft by a borrower would fall into that category,"

Stein thought DeVany's concealment particularly telling.

App. at 349, 362.

Finally, Stein cited DeVany's demeanor as an additional

factor that led her to believe that he had engaged in

fraudulent or dishonest behavior causing the Northwest

loss. According to Stein, DeVany did not seem credible

during his interview with Hull, which occurred shortly

before the bond period expired and prior to City Federal's

Notice of Possible Loss letter dated March 20, 1989. The

RTC also cited Hull's assessment of both DeVany's and

Merkle's demeanor when he interviewed them. Hull testified

that he did not find either of them forthcoming with

information about the Northwest loss, which seemed

contrary to what one would expect given the circumstances.

18

After reviewing each piece of information, the district

court concluded that no reasonable jury could find that

discovery had occurred as of the bond's expiration date. It

explained that while the circumstances apparently gave rise

to concern or suspicions that employees concealed

information from City Federal, there was "no evidence in

the record to indicate that as of [March] 22, 1989, City

Federal was aware of any specific dishonest conduct by the

employees which proximately caused the Northwest loss."

See Op. at 32. Specifically, the court noted that Stein's

knowledge of the manner in which Northwest learned of the

loss and her awareness of the fact that HonFed decided to

exclude the account from the purchase did not provide a

basis for assuming that the employees responsible for the

administration of the credit lines caused the loss. Moreover,

the court discounted the significance of the fact that Stein

knew that DeVany was aware of Movroydis's scheme prior

to the HonFed closing but failed to alert City Federal

management or its legal department, stating:

DeVany's failure to notify the legal department of the

confession is not a definite basis for a careful and

prudent person to charge him with fraud or

dishonesty. At that time, his omission may have just as

easily been classified as neglect. Further, this

particular concealment was not the dishonest conduct

that directly resulted in the Northwest loss: the culprits

were the earlier ongoing misrepresentations of the

condition of the credit line that proximately caused the

claimed loss from the unpaid loans.

Op. at 33. The court also cited City Federal's failure to

respond promptly to F&D's requests for additional

information, and its admission in litigation with its

subsequent insurer that as of the expiration of the F&D

bond, City Federal had not determined "the specifics of any

employee dishonesty in connection with those problem

loans to Northwest." Op. at 33-34.

In reviewing the district court's grant of summary

judgment, we must determine whether there is a genuine

issue of material fact for trial on the issue of whether City

Federal discovered the loss during the bond period. See

FDIC v. Insurance Co. of N. Am., 928 F. Supp. 54, 58 (D.

19

Mass. 1996), aff'd on other grounds, 105 F.3d 778 (1st Cir.

1997). In this connection, we must view the facts in the

light most favorable to City Federal and determine if a

reasonable jury could conclude that a reasonable person

would have assumed, based on the information City Federal

knew as of March 22, 1989, that a covered loss had or

would be incurred. Stated differently, summary judgment

against the RTC on this issue of discovery was warranted

only if there was no material dispute that the information

City Federal knew provided an insufficient basis for a

reasonable person to assume that a loss covered by the

bond had or would be incurred. See In re ContiCommodity

Servs., Inc., Sec. Litig., 733 F. Supp. 1555, 1578 (N.D. Ill.

1990).6

For the reasons we explain below, we disagree with the

district court's conclusion that no reasonable jury could

find that City Federal "discovered" the Northwest loss

during the bond period. Given the standard of discovery set

forth in section 4 of the bond, we find that a reasonable

jury could conclude, based on the information that City

Federal knew as of the expiration of the bond period, that

it was aware of sufficient facts that would cause a

reasonable person to assume that a loss covered by the

bond had or would be incurred. Accordingly, we will reverse

the district court's summary judgment on this issue.

To explain our result, we first must set forth our

understanding of the concept of discovery under the

standard set forth in the bond. While we recognize that we

addressed the general idea of "discovery" of a loss under a

fidelity bond in Fidelity & Deposit Co. v. Hudson United

Bank, 653 F.2d 766 (3d Cir. 1981), this case presents an

issue of first impression in this circuit inasmuch as it

requires us to interpret the meaning of the discovery

standard found in the Standard Form No. 22 bond. 7 To

_________________________________________________________________

6. In re ContiCommodity Services, Inc., Securities Litigation was a multi-

district litigation case. See 733 F. Supp. 1555 (N.D. Ill. 1990). Other

aspects of the district court's opinion, which are not relevant here, were

affirmed sub nom in ContiCommodity Services, Inc. v. Ragan, 63 F.3d 438

(5th Cir. 1995), and reversed sub nom in Brown v. United States, 976

F.2d 1104 (7th Cir. 1992).

7. It appears that the RTC is willing to assume that the discovery

standard we relied upon in Hudson United provides the rule of law that

20

reiterate, discovery occurs under section 4 of the bond

"when the Insured becomes aware of facts which would

cause a reasonable person to assume that a loss covered by

the bond has or will be incurred, even though the exact

amount or details of the loss may have not then been

known." App. at 565. The date of "discovery" of the loss is

_________________________________________________________________

we should apply here in determining if discovery occurred within the

bond period. Nevertheless, we do not believe that it is self-evident that

its

assumption is correct. In Hudson United, we followed cases holding that

discovery under a fidelity bond occurs "when a bank has sufficient

knowledge of specific dishonest acts to justify a careful and prudent

person in charging another with dishonesty or fraud." Hudson United,

653 F.2d at 774. We also noted that in defining when a bank "discovers"

a loss for purposes of filing a notice of loss with its carrier, courts

have

held that "[a] bank is not under a duty to notify its insurance carrier

until it has knowledge of some specific fraudulent act." Id. (citing,

inter

alia, American Sur. Co. v. Pauly, 170 U.S. 133, 18 S.Ct. 552 (1898)). We

simply cannot assume that the general discovery principles we cited in

Hudson United automatically apply here, as our opinion there addressed

a different issue--namely, whether the insurer was entitled to rescind its

insurance contract based on the insured's failure to disclose a potential

loss prior to the commencement of the bond period. See id. And more

importantly, while we recognize that in Hudson United we found those

general discovery principles helpful in addressing the question of

rescission, section 4 of this bond explicitly provides the applicable

discovery definition at issue in this appeal. See also National Newark &

Essex Bank v. American Ins. Co., 385 A.2d 1216, 1224-25 (N.J. 1978)

(addressing concept of discovery under fidelity bond in absence of

controlling definition). Therefore, inasmuch as the parties contracted for

a specific discovery provision, our analysis must begin with the plain

language of the bond. But cf. First Sec. Savs. v. Kansas Bankers Sur. Co.,

849 F.2d 345, 349 (8th Cir. 1988) (construing same discovery definition

as in the present case and looking to "well-established rule" that insured

under a fidelity bond is not bound to give notice until he has acquired

knowledge of some specific or wrongful act) (citing, inter alia, Hudson

United); see also First Dakota Nat'l Bank v. St. Paul Fire & Marine Ins.

Co. 2 F.3d 801, 807 (8th Cir. 1993) (citing Kansas Bankers). Of course,

we recognize that we may look to prior case law in attempting to

ascertain the intended meaning of the parties' chosen language. See

generally 13 John A. Appleman & Jean Appleman, Insurance Law and

Practice S 7404 (2d ed. 1976). We simply point out here that we do not

share the parties' apparent view that the discovery rules we cited in

Hudson United are dispositive.

21

of practical significance because it not only determines

whether the loss is covered by the bond, but also triggers

the insured's obligation to give notice of the possible loss to

its carrier "at the earliest practical moment, not to exceed

30 days." Id.

We understand this discovery standard as comprised of

a subjective and objective component: the trier of fact must

identify what facts and information the insured actually

knew during the relevant time period, and it must

determine, based on those facts, the conclusions that a

reasonable person could draw from them. Our

understanding in this connection comports with prior case

law addressing the concept of "discovery" in the fidelity

bond context. See United States Fidelity & Guar. Co. v.

Empire State Bank, 448 F.2d 360, 365 (8th Cir. 1971) ("In

determining when discovery has taken place, the trier of

fact must find the pertinent underlying facts known to the

insured and must further determine the subjective

conclusions reasonably drawn therefrom by the insured.")

(applying Missouri law in absence of governing definition in

bond); see also Wachovia Bank & Trust Co. v.

Manufacturers Cas. Ins. Co., 171 F. Supp. 369, 375

(M.D.N.C. 1959) (adopting rule of law that mirrors discovery

standard of Standard Form No. 22 bond, and stating that

"The facts must be viewed as they would have been by a

reasonable person at the time discovery is asserted, and

not as they later appeared in the light of subsequently

acquired knowledge.").

We also agree with F&D's position that the discovery

definition requires that the insured possess more than

mere suspicions of employee dishonesty or fraud. See

Hudson United, 653 F.2d at 774 (citations omitted). Courts

long have recognized the principle that unsupported

suspicions of employee misconduct do not constitute

discovery in the fidelity bond context, see, e.g., National

Newark & Essex Bank v. American Ins. Co., 385 A.2d 1216,

1224 (N.J. 1978), and we believe that the language of the

bond incorporates that requirement by tying the concept of

discovery to "facts" within the insured's knowledge. Indeed,

the language "facts which would cause a reasonable person

to assume" defines the nature of information that the

22

insured must possess in order for it to be charged with

discovery, and we agree with those courts of appeals which

have stated that "discovery" of a loss under section 4 does

not occur until the insured "discovers facts showing that

dishonest acts occurred and appreciates the significance of

those facts." See, e.g., FDIC v. Fidelity & Deposit Co., 45

F.3d 969, 974 (5th Cir. 1995) (quoting FDIC v. Aetna Cas.

& Sur. Co., 903 F.2d 1073, 1079 (6th Cir. 1990)); see also

California Union Ins. Co. v. American Diversified Savs. Bank,

948 F.2d 556, 564 (9th Cir. 1991) (same); Aetna Cas., 903

F.2d at 1079 (citing Empire State Bank, 448 F.2d at 364-

66); cf. Royal Trust Bank, N.A. v. National Union Fire Ins.

Co., 788 F.2d 719, 721 n.2 (11th Cir. 1986) (stating that

same discovery definition does not require that the bank

have enough information to charge its employee with fraud

or dishonesty; "All that is required is that it have enough

information to assume that the employee has acted

fraudulently or dishonestly."). Moreover, we understand the

objective, "reasonable person" component as permitting the

trier of fact to analyze the full range of information the

insured knew so as to determine whether a reasonable

person would assume, based on all of the circumstances,

that a covered loss had or would be incurred. See Wachovia

Bank, 171 F. Supp. at 376-77.

Inevitably, a court must assess each case on its own

facts, keeping in mind the general principle that the

"discovery threshold is low." See California Union, 948 F.2d

at 563; see also Oldenburg, 34 F.3d at 1542 (quoting

California Union and stating that the " `discovery threshold

is low' "). Indeed, by adhering to that general principle, we

remain true to the plain language of the bond. All that it

requires is that the insured possess sufficient information

to lead to a reasonable assumption of a covered loss; it

states specifically that the insured need not know"the

exact amount or details" of the loss to be charged with

discovery under section 4.8

_________________________________________________________________

8. Parenthetically, we observe that our understanding as to the level of

knowledge that the bond requires for discovery to occur is informed by

the reality that, to some extent, the bond places an insured in a

difficult

predicament. Specifically, we point out that under section 5 of the bond,

23

With these basic precepts in mind, we may consider the

specific facts of this case. As we have indicated, our review

of the record leads us to conclude that a reasonable jury

could find that City Federal possessed sufficient knowledge

of facts that would cause a reasonable person to assume

that a covered loss had or would be incurred as of March

22, 1989. Put simply, we believe that there is more than

one reasonable conclusion that could be reached based on

the facts City Federal learned during the crucial days just

prior to the bond's expiration. First, City Federal knew for

a fact that DeVany was aware of the Movroydis scheme,

and committed a dishonest act by concealing the admission

from City Federal and perhaps more significantly, its legal

department.9 This is an important piece of information, and

_________________________________________________________________

if the insured waits for too long a period after it is deemed to have

"discovered" the loss, its insurer may deny coverage. Section 5 requires

the insured to give notice of the loss within 30 days after "discovery of

the loss." Indeed, we found cases addressing the concept of "discovery"

of a loss under a fidelity bond in the context of insurers' claims that,

as

a matter of law, discovery had occurred prior to the time the insured

claimed it had. See, e.g., Interstate Prod. Credit Ass'n v. Fireman's Fund

Ins. Co., 788 F. Supp. 1530, 1533-37 (D. Or. 1992). In these cases, the

insurers asserted that the insured waited too long after "discovery" of

the

loss, thus precluding coverage because of the duty to give timely notice.

Here, in essence, F&D's argument is the opposite: it claims that City

Federal gave its notice too early rather than too late.

9. The district court discounted the significance of this fact, stating

that

"DeVany's failure to notify the legal department of the confession is not

a definite basis for a careful and prudent person to charge him with

fraud or dishonesty. At that time, his omission may have just as easily

been classified as neglect." Op. at 33 (emphasis added). Regardless of the

district court's views on this point, the RTC was not required to

demonstrate that the concealment was a definite basis for a reasonable

person to charge him with fraudulent or dishonest conduct in

connection with the Northwest loss. Instead, the question at this

juncture is whether a reasonable jury could conclude on the basis of that

proof that City Federal possessed sufficient information to constitute

discovery. Moreover, to the extent the district court recognized that the

omission could be classified either as neglect or intentional concealment,

that statement indicates that reasonable minds could differ, thus making

summary judgment inappropriate. Finally, we also note that the court

determined that City Federal's discovery of DeVany's concealment was

not material because that concealment was not the dishonest conduct

that "directly resulted" in the loss. Op. at 33. But we do not interpret

the

discovery definition in the bond as requiring as much.

24

it indicates to us that a jury could conclude that City

Federal possessed more than mere unsupported suspicions

of dishonest conduct. Compare California Union, 948 F.2d

at 564-65 (affirming summary judgment for insurer on

discovery issue where the evidence arguably showed that

the insured knew of infractions of banking regulations, but

there was no testimony to indicate that the non-wrongdoing

employees knew of dishonest acts by other employees);

Aetna Cas., 903 F.2d at 1079 (reversing summary

judgment for FDIC and finding that discovery had not

occurred during the bond period where the insured had

suspected employee dishonesty was involved in a potential

loss, but the suspicions grew from general conditions of

bank and not from knowledge of any facts which indicated

that its employee committed any dishonest acts). Moreover,

City Federal was aware of the circumstance that, even after

the HonFed sale, DeVany did not inform City Federal or its

legal department of the Movroydis fraud; instead, City

Federal learned of it because of Movroydis' admission to its

management in February 1989.

Of course, a reasonable person would evaluate the

significance of these facts in the context in which they

occurred: on or about the same date that Movroydis

supposedly revealed his fraudulent scheme to DeVany, the

HonFed deal closed. And in evaluating the importance of

the timing of the Movroydis admission and DeVany's

concealment, a reasonable person could find it telling that

HonFed specifically excluded this account from the City

Collateral assets it purchased. Indeed, this circumstance

would appear exceptionally suspect in view of the fact that

the Northwest loan loss "dropped out of the sky" in the

sense that City Federal management possessed no

knowledge of any significant problems with this account, or

the existence of any loss, until after the closing date.

Finally, Stein testified that she and Hull perceived DeVany's

demeanor as "elusive" when they questioned him. While

their assessment of his behavior would be insufficient,

standing alone, to satisfy the discovery standard in the

bond because mere suspicions are not enough to constitute

"discovery," it certainly lends support to the conclusion that

a jury could find in favor of the RTC on the discovery issue

when it is considered in conjunction with the other factual

25

information in City Federal's possession during the relevant

time period.

It appears to us that the district court overlooked the

reasonable inferences that a jury could draw from the

totality of information that City Federal knew during the

relevant time period. Rather than considering the probative

force of the information in its totality, the district court

focused on each piece of information in isolation and

resolved a disputed factual issue in F&D's favor. We

recognize that finding the point at which discovery occurred

is difficult, given the inherently fact-driven nature of the

inquiry. It may be extremely difficult, then, to determine on

summary judgment when the insured discovered a loss

caused by employee dishonesty. Given the set of facts

before us, we disagree with the district court's ultimate

finding that the only reasonable conclusion to be drawn

was that City Federal possessed nothing more than

unconfirmed suspicions of employee misconduct relating to

the Northwest account. Compare United States Fidelity &

Guar. Co. v. Maxicare Health Plans, No. 96-2457, 1997 WL

466802, at *5 (E.D. La. Aug. 12, 1997) (finding as a matter

of law at motion for summary judgment that insured

discovered the loss within the meaning of the same bond

definition where the insured possessed a similar level of

knowledge as City Federal); see also Boomershine Pontiac-

GMC Truck, Inc. v. Globe Indem. Co., 466 S.E.2d 915, 917

(Ga. Ct. App. 1996) (reversing order of summary judgment

in favor of insurer in fidelity bond dispute on discovery

issue, stating that as long as there is room under the

evidence for a reasonable difference of opinion as to

whether insured discovered loss, summary judgment is

inappropriate).

In reaching our conclusion we have considered but

rejected F&D's arguments in support of the district court's

resolution of the discovery issue. First, F&D asserts that

City Federal's admissions in litigation against National

Union Fire Insurance Company, its insurer that followed

F&D, belie the RTC's contention that City Federal

possessed sufficient factual information during the bond

period for a jury to conclude that it had discovered the loss

prior to its expiration. Specifically, it argues that "[City

26

Federal] acknowledged the limits of its information in the

related National Union suit where it admitted that it knew

of no specifics of any employee dishonesty in connection

with the Loan prior to March 20, 1989, and further stated

that much of the information in the proof of loss was

learned after the Bond period had expired."10 Br. at 32-33.

Apparently, the district court ascribed significance to the

RTC's position in the National Union litigation, as it noted

that the RTC stipulated in the Final Pretrial Order in that

case that "prior to March 22, 1989, City Federal had not

determined the specifics of any employee dishonesty in

connection with those problem loans to [Northwest]." Op. at

34 (internal quotation marks omitted). It also noted that

City Federal stipulated that it learned much of the

information included in the proof of loss during the course

of the investigation that took place during the late

summer/early fall of 1989. See id.

F&D has not argued before us that the RTC's stipulations

in the National Union litigation are binding in this case

such that City Federal is precluded from asserting that it

discovered the loss within the F&D bond period. See

Hudson United, 653 F.2d at 777-78; see generally 9

Wigmore, Evidence S 2593 (Chadbourn rev. 1981)

(discussing effect of judicial admissions and explaining that

statement qualifying as a judicial admission generally is

binding in subsequent parts of same proceedings between

the same parties). Instead, we understand the thrust of its

argument to be that the RTC's position in the National

Union case undermines its assertion of discovery in this

case.

_________________________________________________________________

10. National Union Fire Insurance Co. ("National Union") issued a fidelity

bond to City Federal which took effect on March 22, 1989, after the F&D

bond expired. National Union filed a complaint in the United States

District Court for the District of New Jersey against the RTC, as receiver

for City Savings Bank, F.S.B. (City Federal's successor), seeking a

declaratory judgment that the bond was void because City Federal had

failed to disclose in its bond application that it had sustained the

Northwest loss. Notably, the RTC did not seek indemnification under the

National Union bond for the Northwest loan loss. See Compl., National

Union Fire Ins. Co. v. City Savings, F.S.B., No. 92-3408 (GEB). We

understand that the National Union litigation is no longer pending before

the district court.

27

In our view, the RTC has the better argument here, as it

recognizes the logical flaw in F&D's argument. Specifically,

the RTC's stipulation that City Federal learned"much of the

information included in the proof of loss," after March

1989, does not mean that sufficient information was not

available to City Federal prior to the expiration of the F&D

bond so as to constitute discovery as of that date. Similarly,

the circumstance that City Federal did not have specific

information about the nature and scope of the employee

dishonesty that caused the Northwest loss does not mean

that what it did know as of March 22, 1989, was

insufficient to warrant a reasonable assumption that a

covered loss had or would be incurred, which is all that the

discovery definition in the bond at issue here requires.

Therefore, the RTC's statements in the National Union

litigation are not incompatible with its position here and do

not persuade us that F&D was entitled to judgment as a

matter of law.

F&D also contends that the vague and conclusory nature

of City Federal's letters to F&D confirm that as of the

expiration of the bond period, City Federal possessed

nothing more than unsupported suspicions of employee

misconduct. It appears that the district court also ascribed

significance to the fact that F&D repeatedly sought more

specific factual information from City Federal, but City

Federal failed to respond to those requests. Apparently, the

argument here is that the tone of the letters and City

Federal's omissions provide objective evidence that it

possessed no specific information of employee wrongdoing.

Again, while these circumstances could be viewed as

supportive of F&D's position, they do not demonstrate

conclusively that F&D is entitled to judgment as a matter

of law on the issue of the date of City Federal's discovery

under the bond. In short, this argument does not overcome

the fact that reasonable minds could differ on the discovery

issue, given the nature of the RTC's proofs submitted at the

summary judgment proceedings.

Next, F&D points out that throughout Stein's deposition

testimony, she repeatedly used the word "suspicious" to

describe her assessment of the circumstances surrounding

the Northwest loan loss and the individual defendants'

28

involvement in that loss. See Br. at 28-29. It claims that

Stein's word choice is indicative of the quantity and quality

of information City Federal possessed at the relevant time,

and that her testimony actually supports its position that

no reasonable jury could conclude that City Federal

discovered the loss during the bond period.

We, however, do not share F&D's belief that Stein's

deposition testimony demonstrates conclusively that she

possessed only unsupported suspicions of employee

misconduct insufficient to constitute discovery under the

relevant standard. Indeed, review of the relevant deposition

testimony demonstrates that F&D's argument focuses too

narrowly on her use of the term "suspicious" without

examining the context of her statements and the overall

content of her testimony. We point out that while Stein

stated that she was suspicious of Ridder, Hurst, Merkle

and DeVany, she used the word "suspicious" in replying

specifically to F&D's attorney's question, which asked her if

she "suspected" that those employees engaged in

misconduct. See SA at 293. In these circumstances, we do

not find her responses particularly telling at all. In any

event, they certainly do not demonstrate that, as a matter

of law, City Federal did not discover the loss during the

bond period. Cf. Interstate Prod. Credit Ass'n v. Fireman's

Fund Ins. Co., 788 F. Supp. 1530, 1536-37 (D. Or. 1992)

(rejecting insurer's argument that testimony of member of

loan committee demonstrated that insured discovered loss

where employee stated only that he had a "feeling" that the

loans were questionable).

Moreover, other aspects of Stein's deposition testimony

confirm that, in her view, the information she knew as of

March 22, 1989, pointed to the conclusion that employee

misconduct was involved in the Northwest loan loss, and

thus that the loss was not the result of an employee's poor

business judgment or negligence. For example, Stein stated

specifically that with respect to DeVany's concealment of

the Movroydis admission, she "ruled out the concept that it

was negligence versus misconduct in regard to the

concealment. . . . I mean, there's no-no way to my way of

thinking that that was the result of negligence." App. at

374. Thus, we are not faced with a situation where the

29

evidence shows only that City Federal knew of the existence

of the loss, but had not yet reached the subjective

conclusion that employee dishonesty somehow was

involved. Compare Block v. Granite State Ins. Co., 963 F.2d

1127, 1130 (8th Cir. 1992) (affirming district court's grant

of summary judgment to insurer where "not one" bank

official testified to a contemporaneous belief that bank

employee misappropriated money during coverage period);

cf. Maxicare Health Plans, No. 96-2457, 1997 WL 466802,

at *5 (granting summary judgment to insurer where it

argued that insured discovered loss prior to commencement

of insurer's bond; court noted that insured's actions in

terminating contract suggested that it subjectively believed

it suffered a loss precipitated by employee dishonesty).

Finally, we note that F&D relies on cases in which the

courts ruled in favor of the insurer on the issue of

discovery, and contends that they are factually analogous

to this case and thus support the district court's finding in

its favor on that point. Br. at 26-27 (citing Block, 963 F.2d

at 1129-30; California Union, 948 F.2d at 564-65; Aetna

Cas., 903 F.2d at 1079). We need not tarry on this

argument, however, as we do not agree with F&D's

assessment that these cases are factually analogous. Put

simply, the cases F&D cites in support of its position do not

compel the conclusion it seeks because the outcome of

each case, as in the present case, turned on its unique

facts. Accordingly, a comparison of the quality and quantity

of information within the insureds' knowledge in those

cases ultimately does not persuade us that the district

court's disposition of the issue at the summary judgment

stage was appropriate.

As the foregoing discussion demonstrates, we disagree

with the district court's assessment of the legal significance

of the known facts as of March 22, 1989. We hold that the

district court erred in concluding that no reasonable jury

could find that City Federal "discovered" the loss during the

bond period, and accordingly, we hold that summary

judgment in F&D's favor was inappropriate.

B. Coverage under the Fidelity Provision

F&D argues in the alternative that if we find that the

district court erred in its analysis pertaining to the

30

discovery issue, we should uphold the district court's order

for summary judgment because the RTC cannot establish

at trial that the Northwest loss falls within the narrow

scope of coverage the bond provides. F&D's overarching

argument is that the fidelity provision of the Standard Form

No. 22 bond provides coverage in very limited instances,

and by its terms only insures against a specific type of risk.

From that initial premise, it claims that the loss City

Federal incurred on the Northwest loan does not fall within

the narrow parameters of coverage.

The RTC contends that the district court's disposition of

these issues is not before us because F&D did notfile a

cross-appeal from the January 29, 1998 order for summary

judgment. We disagree with the RTC's position that F&D

was required to cross-appeal in order to advance these

arguments for our consideration, as it is clear that we may

affirm the judgment on grounds alternative to those on

which the district court relied. See Rite Aid, Inc. v.

Houstoun, 171 F.3d 842, 853 (3d Cir. 1999) (dismissing

cross-appeals and stating "we point out that[appellees] are

not by their cross-appeals seeking additional relief. . . .

Rather, they advance the issue as an alternative ground to

affirm the summary judgment and injunction."); E.F.

Operating Corp. v. American Bldgs., 993 F.2d 1046, 1048

(3d Cir. 1993) ("It is also well established that an appellee

may, without taking a cross-appeal, support the judgment

as entered through any matter appearing in the record,

though his argument may attack the lower court's

reasoning or bring forth a matter overlooked or ignored by

the court."); Cospito v. Heckler, 742 F.2d 72, 78 n.8 (3d Cir.

1984). Accordingly, we will consider F&D's arguments as

alternative grounds to affirm the judgment.

The bond does not afford coverage under its fidelity

provision for all losses resulting directly from fraudulent

and dishonest employee conduct. The fidelity provision sets

forth a subclass or type of dishonest or fraudulent conduct

that may be covered under the bond. It promises to

indemnify the insured for:

(A) Loss resulting directly from dishonest or frau dulent

acts of an employee committed alone or in collusion

with others.

31

Dishonest or fraudulent acts as used in this Insuring

Agreement shall mean only dishonest or fraudulent

acts committed by such Employee with the manifest

intent:

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

(b) to obtain financial benefit for the Employee or for

any other person or organization intended by the

employee to receive such benefit, other than

salaries, commissions, fees, bonuses, promotions,

awards, profit sharing, pensions or other employee

benefits earned in the normal course of

employment.

App. at 562 (emphasis added). Broken down into its

components, this provision requires that the following

elements be present in order for a loss to constitute a

covered event: (1) the insured must incur a loss; (2) the loss

must have "result[ed] directly" from dishonest or fraudulent

acts of an employee or employees; (3) the employee must

have committed the acts with the "manifest intent" to cause

the insured to suffer the loss sustained (which we call

"subsection (a)'s requirement"); and (4) the employee must

have committed the acts with the "manifest intent" to

obtain a financial benefit for the employee or a third party,

and the financial benefit obtained must not be of the type

covered by the exclusionary clause (which we call

"subsection (b)'s requirement"). See Jeffrey M. Winn,

Fidelity Insurance and Financial Institutions in the Post-

FIRREA Era, 109 Banking L.J. 149, 151-52 (Mar.-Apr.

1992). If F&D can establish, as a matter of law, that at

least one of those requirements is not satisfied in this case,

it would not be required to indemnify City Federal because

the Northwest loss would not constitute a covered event. In

that circumstance, we would affirm the district court's

order for summary judgment on this alternative basis.

F&D concedes that the RTC established that City Federal

suffered a loss on the Northwest account, but contends

that the remaining elements necessary for coverage under

the fidelity provision are absent in this case. Specifically, its

arguments may be broken down into two broader

categories. First, F&D asserts that there is insufficient

32

evidence from which a jury could conclude that the

individual defendants acted with the "manifest intent" (1) to

obtain for themselves or a third party a type offinancial

benefit covered by the bond, and in turn (2) to cause City

Federal to sustain the Northwest loss. Second, F&D

maintains that there is insufficient evidence from which a

reasonable jury could conclude that the Northwest loss

"result[ed] directly" from the individual defendants'

dishonest and fraudulent actions that form the basis for

this lawsuit.

We will address these arguments in the following

manner. In subsection (1) below, we first must ascertain

the correct definition of the term "manifest intent" as it is

used in the fidelity provision. We then must decide whether

the RTC has presented sufficient evidence that the

employees acted with the "manifest intent" to obtain a

financial benefit for themselves or a third party that does

not fall within the category of benefits specifically excluded

by subsection (b), as that inquiry informs the remainder of

our analysis. We will conclude by examining whether there

is sufficient evidence from which a reasonable jury could

find that the employees acted with the manifest intent to

cause City Federal to sustain a loss on the Northwest credit

line. In subsection (2), we will address separately F&D's

causation argument, and consider whether there is

sufficient evidence from which a reasonable jury could

conclude that the Northwest loss "result[ed] directly" from

the individual defendants' dishonest and fraudulent acts.

As we will explain in greater detail below, we have

concluded, based on the bond's language and the proofs

the RTC presented at the summary judgment proceedings,

that there are genuine issues of material fact pertaining to

each element described above. Therefore, while we reach

our conclusion on different grounds than those on which

the district court relied, we agree with its ultimate

determination which we described above, that a jury could

find that the Northwest loss falls within the narrow

parameters of coverage.

33

1. Whether the individual defendants committed dishonest

and fraudulent acts with the manifest intent to cause

City Federal to sustain the Northwest loss and to obtain

a certain type of financial benefit for themselves or a

third party

a. The meaning of "manifest intent"

In order to determine if the RTC has presented sufficient

evidence from which a reasonable jury could conclude that

the individual defendants acted with the "manifest intent"

to cause the Northwest loan loss and to obtain a certain

type of financial benefit for themselves or a third party, we

must begin by defining the term "manifest intent" in the

fidelity insurance context. Initially, we point out that it is

rather obvious that the term "manifest intent" refers to the

employee's state of mind in engaging in the allegedly

dishonest or fraudulent acts which the insured claims to

have caused it a loss covered by the fidelity bond.

Inasmuch as the Supreme Court of New Jersey has not

identified the meaning of the term under New Jersey law,

our task is to predict how that court would decide this issue.11

See McKenna v. Ortho Pharm. Corp., 622 F.2d 657, 661 (3d

Cir. 1980). And, as is evident from our discussion that

follows, the answer is not resolved easily, as it appears that

there has been considerable debate among various state

and federal courts concerning the proper formulation of the

standard. See Christopher Kirwan, Mischief or "Manifest

Intent"? Looking for Employee Dishonesty in the Unchartered

World of Fiduciary Misconduct, 30 Tort & Ins. L.J. 183, 186

(Fall 1994) ("In the eighteen years since its introduction the

_________________________________________________________________

11. We note that the New Jersey Supreme Court in National Newark

discussed the meaning of the phrase "dishonest or fraudulent acts" in

the context of a fidelity bond. It held that the phrase encompassed "any

acts which show a want of integrity or a breach of trust," and "conduct

which indicates a reckless, willful and wanton disregard for the interest

of the employer if it be an act manifestly unfair to the employer and

palpably subjects him to likelihood of loss." National Newark, 385 A.2d

at 1222 (internal quotation marks and citations omitted). However, as

F&D correctly notes in its brief, the bond at issue in National Newark did

not contain the manifest intent limitation which is the subject of the

parties' dispute in this case.

34

term `manifest intent' has become the major battlefield in

dishonesty coverage disputes.").

In virtually all of the cases we have found, courts have

interpreted the term "manifest" as meaning that the intent

of the employee must be "apparent or obvious." See, e.g.,

Oldenburg, 34 F.3d at 1539; FDIC v. St. Paul Fire & Marine

Ins. Co., 942 F.2d 1032, 1035 (6th Cir. 1991); North Jersey

Savs. & Loan Ass'n v. Fidelity & Deposit Co., 660 A.2d

1287, 1291 (N.J. Super. Ct. Law. Div. 1993); see also 11

Lee R. Russ and Thomas F. Segalla, Couch on Insurance 3d

S 161:3 (1998). The divergence of opinion, however, stems

from the issue of whether the "intent" aspect of the phrase

"manifest intent" requires an inquiry into the employee's

actual purpose in engaging in the conduct at issue. While

the fidelity provision covers only those dishonest or

fraudulent acts undertaken with the manifest intent both to

(1) cause the insured (who is also the employer) to sustain

a loss, and (2) obtain a certain type of financial benefit, the

question of the meaning of "intent" usually arises in the

context of determining whether the proofs show that the

former requirement has been satisfied. Indeed, in virtually

all of the cases interpreting the term "intent," the analysis

has focused on whether the evidence showed that the

employees possessed a "manifest intent" to cause the

insured's loss. Of course, this is not surprising, given the

fact that most cases turn on this element, as it presents

difficult proof problems for the insured.

Following this method of analysis, succinctly stated, the

initial question is whether the insured must establish that

the employee acted with the specific purpose or desire to

cause the insured to sustain the loss that it did. The

related issue then is the type of circumstantial evidence

relevant to the insured's burden of proof on this point.

In determining the appropriate construction of the

"manifest intent" state of mind requirement, a review of the

purpose and history behind its inclusion in bonds of this

type is instructive. The Surety Association introduced the

"manifest intent" language in its standard form bond in

1976 to ameliorate the effect of previous cases in which the

courts expanded the concept of employee dishonesty to the

point where the term included any act of the employee (or

35

any failure to act), regardless of motive. See Michael Keeley,

Employee Dishonesty Claims: Discerning the Employee's

Manifest Intent, 30 Tort & Ins. L.J. 915, 919 (Summer

1995); see also Winn, supra at 152 ("According to an

influential subcommittee report issued by the Surety

Association of America in January 1976, insurers added

the definition of dishonesty because [a] major factor in poor

results . . . has been a well-established pattern by the

courts to expand the concept of dishonesty to the point

where the term now seems to include any act . . .

regardless of motive, which results in an injury to the

employer.") (internal quotation marks omitted) (quoting

Surety Ass'n of Am. Sub-Committee, Revision of the

Dishonesty Insuring Agreement of Form 24, at 1 (1976)).

Thus, as one commentator explained: "Insuring Agreement

A [which contains the manifest intent requirement] was

revised to clarify the Surety Association's long-standing

intent, dating back to Standard Form No. 1 in 1916, to

limit loan losses to claims in which the culpable employee

acted with the intent or purpose to gain a benefit at the

expense of his employer--in other words, when the

employee intended to defraud the insured bank of money."

Keeley, supra at 919.

Against this background, we must examine the different

standards courts have adopted in defining the bond's

"manifest intent" requirement. To date, the Courts of

Appeals for the Sixth, Seventh and Tenth Circuits have

adopted the following standard of culpability: "Although the

concept of manifest intent does not necessarily require that

the employee actively wish for or desire a particular result,

it does require more than a mere probability. . . . Manifest

intent exists when a particular result is substantially

certain to follow from conduct." See Peoples Bank & Trust

Co. v. Aetna Cas. & Sur. Co., 113 F.3d 629, 635 (6th Cir.

1997) (applying Virginia law and quoting St. Paul Fire &

Marine, 942 F.2d at 1035) (internal quotation marks

omitted); Oldenburg, 34 F.3d at 1539 (citing FDIC v. United

Pac. Ins. Co., 20 F.3d 1070, 1078 (10th Cir. 1994))

(applying Utah law); United Pac., 20 F.3d at 1078

(interpreting "manifest intent" under general principles of

federal common law); Heller Int'l Corp. v. Sharp, 974 F.2d

850, 857-59 (7th Cir. 1992) (applying Illinois law and

36

quoting St. Paul Fire & Marine, 942 F.2d at 1035); St. Paul

Fire & Marine, 942 F.2d at 1035. But cf. First Fed. Savs. &

Loan Ass'n v. Transamerica Ins. Co., 935 F.2d 1164, 1167

(10th Cir. 1991) (affirming order of summary judgment for

insurer, explaining that employee did not possess a

manifest intent to injure the bank, his employer, where

evidence pointed to only one conclusion: that employee

arranged transactions that "hopefully" would be beneficial

to both the bank and borrowers). This standard, which

requires only that the loss was "substantially certain to

follow" from the employee's conduct, was articulated by the

Court of Appeals for the Sixth Circuit in St. Paul Fire &

Marine, see 942 F.2d at 1035, which in turn relied on

language from Hanson PLC v. National Union Fire Insurance

Co., 794 P.2d 66, 72 (Wash. Ct. App. 1990).

In stating that the "manifest intent" standard is satisfied

either by proof of the employee's desire to cause a loss or by

proof that the loss was "substantially certain" to result,

these cases embraced a different, and less culpable mental

state, than if the standard required that the evidence show

that it was the employee's specific purpose or desire to

cause the insured to sustain the loss and obtain afinancial

benefit at the insured's expense. Indeed, one commentator

described this "substantially certain to follow" standard as

requiring, in essence, a level of mental culpability

equivalent to the general intent concept embodied in the

area of criminal and tort law. See Keeley, supra at 937; see

also Affiliated Bank/Morton Grove v. Hartford Accident &

Indem. Co., No. 91-C-4446, 1992 WL 91761, at *4-5 (N.D.

Ill. Apr. 23, 1992) (stating that the definition of intent that

it adopted, i.e., that an employee acts with the manifest

intent when the evidence demonstrates either (1) that the

purpose was to achieve the particular result or (2) that the

person knows that the particular result is substantially

certain to follow from his or her conduct, is consistent with

concept of intent in tort law); see also United Pac., 20 F.3d

at 1078 (stating that jury instructions 36 and 37 provided

"general intent" standard that was a correct explication of

the meaning of "manifest intent"); Hanson PLC, 794 P.2d at

72. Moreover, the concept of general intent is synonymous

with the Model Penal Code's mental state "knowingly," as a

person acts knowingly under the Model Penal Code if he or

37

she is aware that " `a result is practically certain to follow

from his conduct, whatever his desire may be as to the

result.' " See Keeley, supra at 923-24.

Thus for example, in United Pacific, the Court of Appeals

for the Tenth Circuit upheld jury instructions stating, inter

alia: "the concept of manifest intent does not require that

the employee wish or desire for a particular result, but it

does require that the result be substantially certain to

happen' "; " `You may consider it reasonable to draw the

inference and find that a person intends the natural and

probable consequences of acts knowingly done or knowingly

omitted' "; and " `There was an intent to cause the bank to

sustain a loss if the natural result of [the employee's]

conduct would be to injure the Bank even though it may

not have been his motive.' " Id. at 1077-78 (citing Heller,

974 F.2d at 859; St. Paul Fire & Marine, 942 F.2d at 1035;

First Nat'l Bank v. Lustig, 961 F.2d 1162, 1166 (5th Cir.

1992)); see also Oldenburg, 34 F.3d at 1539 (citing United

Pac., 20 F.3d at 1078).

In contrast to the construction of "manifest intent"

adopted by the Courts of Appeals for the Sixth, Seventh

and Tenth Circuits, the Courts of Appeals for the Second,

Fourth and Fifth Circuits have applied the term"manifest

intent" differently, and we read those cases as requiring

that the insured establish that the employee acted with the

specific purpose or desire to both injure the insured and

obtain a benefit. See General Analytics Corp. v. CNA Ins.

Cos., 86 F.3d 51, 54 (4th Cir. 1996); Lustig , 961 F.2d at

1166-67; Glusband v. Fittin Cunningham & Lauzon, Inc.,

892 F.2d 208, 210-12 (2d Cir. 1989) (reversing judgment

for insured's receiver and entering judgment for insurer,

stating that there was insufficient evidence that the

employee acted with the manifest intent to cause a loss and

obtain a financial benefit; court explained that manifest

intent language limits coverage to losses caused by

embezzlement and embezzlement-like acts, and that the

evidence showed only that the employee intended to benefit

the company rather than cause it a loss); Leucadia, Inc. v.

Reliance Ins. Co., 864 F.2d 964, 972-74 (2d Cir. 1988)

(affirming judgment for insurer where the only reasonable

conclusion that could be drawn from the evidence

38

introduced at trial was that the employee's dishonest

actions were the result of attempts to save the employer

from sustaining a large loss).12 In this regard, the "manifest

_________________________________________________________________

12. Interestingly, the Court of Appeals for the Second Circuit has not

stated expressly that the term "manifest intent" covers only those acts

undertaken with the purpose or desire of causing the employer's loss

and obtaining a financial benefit, but a review of the facts and

circumstances in Glusband, see 892 F.2d at 208, and Leucadia, see 864

F.2d 964, indicate that the court applied the manifest intent standard by

focusing on the employee's subjective purpose in engaging in the

wrongful acts at issue. For example, in Leucadia, the employee engaged

in various dishonest and fraudulent acts that eventually contributed to

his employer's substantial losses on loans he originated. See 864 F.2d at

972-74. The nature of the employee's wrongful acts in Leucadia clearly

were such that a jury could have concluded that by engaging in that

course of conduct, he knew that a loss to his employer was substantially

certain to result. See id. Nevertheless, the court affirmed the jury's

judgment for the insurer, reasoning that the evidence did not

demonstrate that the employee's dishonest acts were undertaken with

the manifest intent to cause a loss or obtain afinancial benefit. And the

court in Glusband explained the holding in Leucadia by referencing the

employee's object in engaging in the course of conduct at issue, and

stating that "[b]ecause the employee misguidedly hoped to benefit his

employer and received no personal gain from the transaction, we held

that the requisite manifest intent had not been shown." 892 F.2d at 211.

By referencing the employee's "hopes" (albeit misguided) in engaging in

the misconduct, the court clearly was concerned with the employee's

subjective purpose rather than whether the loss was substantially likely

to result from the employee's actions. See Jane Landes Foster, et al.,

Does a Criminal Conviction Equal Dishonesty? Criminal Intent Versus

Manifest Intent, 24 Tort. & Ins. L.J. 785, 799-800 (Summer 1989)

(interpreting Leucadia as applying a subjective purpose test despite the

fact that the court did not use the word "purposeful" in its opinion).

Similarly, the Court of Appeals for the Fifth Circuit's opinion in Lustig

did not state explicitly that the term "intent" requires proof of purpose

or

desire to cause the a loss and obtain a financial benefit for the employee

or a third party. Nevertheless, insofar as the court's reasoning clearly

focuses on the employee's purpose or motive in engaging in the

dishonest or fraudulent acts at issue and the ways in which the bank

could prove that element, see 961 F.2d at 1165-67, its approach

demonstrates its adherence to a standard of culpability greater than that

suggested by the "substantially certain" or knowingly standard. Compare

id. with United Pac., 20 F.3d at 1077-78; see also Keeley, supra at 932-

33 (stating that Lustig appears to require an inquiry into the employer's

purpose).

39

intent" requirement thus may be analogized loosely to the

concept of "specific intent" in the criminal law context. See

Keeley, supra at 942 (advocating the adoption of a specific

intent standard for purposes of defining "manifest intent");

Judy L. Hlafesak, Comment, The Nature and Extent of

Subrogation Rights of Fidelity Insurers Against Officers and

Directors of Financial Institutions, 47 U. Pitt. L. Rev. 727,

731-32 (1986) (stating that "manifest intent" language of

1976 form rider required proof of the employee's specific

intent to cause a loss).

An instructive example of this approach is found in the

Court of Appeals for the Fourth Circuit's opinion in General

Analytics. See 86 F.3d at 54. There the insured, General

Analytics Corp. ("GA"), sought coverage under a fidelity

bond for losses it incurred as a result of an employee's

actions in altering incoming purchase orders sent by the

insured's customer, the Internal Revenue Service ("IRS"), for

computer products. Not realizing that the purchase orders

had been altered, GA personnel filled the IRS's requests by

ordering parts from a third-party supplier. When GA

delivered the parts to the IRS, it refused acceptance,

causing GA to sustain a large loss. The district court

granted summary judgment to GA against its insurer,

finding that the evidence showed beyond any factual

dispute that the employee acted with the manifest intent to

benefit a third party. See id. at 52-53.

The court of appeals reversed the district court's grant of

summary judgment to GA, finding that reasonable minds

could differ as to whether the loss was caused by employee

misconduct undertaken with the manifest intent to obtain

a financial benefit for a third party. Because the parties

disputed the district court's construction of the term

"manifest intent," the court of appeals analyzed its meaning

in the fidelity bond context. The court recognized that

"employee dishonesty policies" are "designed to provide

coverage for a specific type of loss characterized by

embezzlement, which involves the direct theft of money." Id.

at 53. The court then explained that:

Because employee dishonesty policies like CNA

Insurance's require proof that the employee have acted

to accomplish a particular purpose, they require that

40

the insured establish a specific intent, analogous to

that required by the criminal law. Thus, if a dishonest

act has the unintended effect of causing a loss to the

employer or providing a benefit to the employee, the act

is not covered by the policy. . . .

As a state of mind, intent is often difficult to prove.

And because it is abstract and private, intent is

revealed only by its connection with words and

conduct. . . . Thus, evidence of both words and

conduct is probative of intent, . . . and, because

context illuminates the meaning of words and conduct,

evidence of the circumstances surrounding such words

or conduct, including the motive of the speaker or

actor, similarly is admissible.

Id. at 54 (citations omitted).

The court in General Analytics required proof of the

employee's specific intent or purpose to cause the insured

loss and to obtain a certain type of financial benefit for

herself or a third party, but in adopting that state of mind

requirement as the standard for "manifest intent," it

recognized that the employee's subjective intent may be

proven circumstantially by reference to evidence of the

employee's words, conduct, and the context in which his or

her actions took place. See also Lustig, 961 F.2d at 1166

("When an employee obtains fraudulent loans with reckless

disregard for a substantial risk of loss to the bank, a jury

may infer from his reckless conduct and surrounding

circumstances that he intended to cause the loss. . . . The

jury should be instructed that in answering the question of

intended loss, it should consider the range of evidentiary

circumstances, including the relationship between the

borrowers and the employee, the employee's knowledge of

the likelihood that the loans would not be repaid, and all

other surrounding circumstances bearing on the employee's

purpose.") (citations and quotation marks omitted)

(emphasis added).

Thus in General Analytics the court permitted

consideration of both the reckless nature of the employee's

conduct, and the likelihood that a loss would result from

the employee's conduct (i.e., the employee's knowledge of

41

the substantial likelihood of the result), in determining

whether the employee acted with the "manifest intent" to

cause the insured to sustain a loss. But the court tied the

significance of those circumstances to a standard of

employee culpability that required proof that the employee

acted with the specific purpose to achieve the desired

result, i.e., a specific intent to cause the loss and obtain a

financial benefit for herself or a third party. See also

Susquehanna Bancshares, Inc. v. National Union Fire Ins.

Co., 659 A.2d 991, 998 (Pa. Super. Ct. 1995) ("[W]e hold

that the `manifest intent' of the employee should be

ascertained by deciding his true purpose in causing the

loss. In deciding what the purpose was, both direct and

circumstantial evidence should be considered, including the

employee's own testimony as to his purpose as well as any

evidence indicating the employee knew the loss was

substantially certain to be the result of his acts.").

A review of the different approaches reveals the obvious

distinction between the two lines of cases. As is evident

from our discussion, under either approach, evidence

tending to show that the employee acted "knowingly" would

support a jury finding that the employee intended the

consequences of his actions. Nevertheless, under the

rationale explicitly adopted in General Analytics, proof of an

employee's recklessness, or an employee's knowledge that a

result was substantially certain to occur from the conduct,

are objective indicia--manifestations--of the employee's

specific purpose or intent. But neither an employee's

recklessness or his knowledge that a result was

substantially certain to occur would satisfy the language of

the policy, absent that inference of specific intent. Cf.

Peoples Bank, 113 F.3d at 636 ("Like our sister circuits, we

recognize that reckless conduct might be evidence--a

manifestation--of intent. But recklessness itself, without an

inference of intent, would clearly not satisfy the language of

the policy, any more than recklessness alone would create

culpability for a crime requiring specific intent.") (citing

General Analytics, 86 F.3d at 54). In contrast, those courts

that have equated the term "intent" with the mental state

"knowingly" would find that the employee acted with the

manifest intent where the loss and the benefit were

42

substantially certain to follow, regardless of whether the

employee desired such results.

Interestingly in this case, regardless of the standard we

choose to adopt, we believe that the proofs are sufficient to

demonstrate a genuine issue of material fact concerning the

employees' "manifest intent." Nevertheless, in view of the

circumstance that we must remand this case to the district

court for trial, we believe that it is appropriate at this

juncture to state specifically which standard we adopt as

reflecting what we think the Supreme Court of New Jersey

would hold so as to give guidance to the district court.

We agree with the approach espoused by the Courts of

Appeals for the Second, Fourth and Fifth Circuits, and hold

that the term "manifest intent" as it is used in the fidelity

provision requires the insured to prove that the employee

engaged in dishonest or fraudulent acts with the specific

purpose, object or desire both to cause a loss and obtain a

financial benefit. Inasmuch as we equate the"substantially

certain to result" standard with the mental state

"knowingly," we are of the view that "purposefully" rather

than "knowingly" better captures the meaning of "intent" as

it used in the fidelity provision, given the history that

prompted its inclusion in the dishonesty definition and its

stated purpose. Indeed, we believe that our construction

strikes an appropriate balance because it comports with the

drafters' obvious intent to limit the types of employee

misconduct covered by this provision but ensures that

proof of the employee's recklessness and the substantial

likelihood of loss factor into the ultimate inquiry into the

employee's subjective state of mind. See Keeley, supra at

925 (noting that the Model Penal Code's definition of

specific intent supports equating "manifest intent" with

specific intent); Winn, supra at 152 ("We are ready and

willing to insure against dishonesty, i.e., against improper

acts of employees committed with an intent to deprive their

employer of funds or property. We cannot insure against

violations of instructions or poor business judgment."); see

also Jane Landes Foster, et al., Does a Criminal Conviction

Equal Dishonesty? Criminal Intent Versus Manifest Intent,

24 Tort. & Ins. L.J. 785, 800 (Summer 1989) ("Defining

manifest intent in terms of purpose is also more in keeping

43

with the intent of the fidelity industry. This clause

represented a specific response to a growing number of

decisions that judicially expanded the definition of

dishonesty by recognizing claims based on reckless

misconduct. Thus, it is clear that the drafters intended to

limit coverage by requiring proof of a more particularized

intent to harm.").

We emphasize, however, that by recognizing that the

term "manifest intent" requires proof of the employee's

purpose in engaging in the dishonest or fraudulent acts, we

are cognizant that the employee's actual subjective state of

mind virtually is impossible to prove absent resort to

circumstantial evidence--objective indicia of intent. The

Courts of Appeals for the Fourth and Fifth Circuits have

recognized this proof problem, and permitted the insured to

prove the employee's subjective purpose by introducing

objective evidence of the employee's intent. See Lustig, 961

F.2d at 1166; General Analytics, 86 F.3d at 54; see also

Susquehanna Bancshares, 659 A.2d at 998. And inasmuch

as proof of recklessness and/or the employee's knowledge

of the likelihood that a loss was to result both serve as

manifestations of the employee's specific purpose or design,

we hold that a jury may consider those factors, along with

any other objective indicia of intent, in ascertaining the

employee's state of mind in engaging in the wrongful

conduct. See Couch 3d, supra S 161:3 (stating that

"manifest intent" language meant an intent that was

"apparent or obvious," and indicating that in determining

the employee's intent or purpose, the court should consider

the employee's testimony as to what his or her purpose was

in engaging in the acts, and whether the employee was

substantially certain that a particular result would be

achieved, together with external indicia of subjective intent).

In reaching our conclusion, we recognize that our task

here is limited to deciding the meaning of the term

"manifest intent" as we believe it would have been decided

by the Supreme Court of New Jersey had the case arisen in

the New Jersey courts. See Robertson v. Allied Signal, Inc.,

914 F.2d 360, 378 (3d Cir. 1990). Thus, in addition to

relying on cases from other jurisdictions, we have

considered the well-established rules for contract

44

interpretation as they have developed under New Jersey

law. We note, in particular, that New Jersey adheres to the

principle of contra proferentum, which requires any

ambiguities in an insurance contract to be resolved in favor

of the insured. See Pittston Co. Ultramar Am. Ltd. v. Allianz

Ins. Co., 124 F.3d 508, 520 (3d Cir. 1997). Nevertheless,

"[w]hen the terms of an insurance contract are clear, . . . it

is the function of a court to enforce it as written and not

make a better contract for either of the parties." New Jersey

v. Signo Trading Int'l, Inc., 612 A.2d 932, 938 (N.J. 1992)

(citation and internal quotation marks omitted). Thus, we

must not torture the language of a contract to create

ambiguity where none exists in order to impose liability,

and we must construe the words of an insurance policy so

as to adhere to their ordinary meaning. See Longobardi v.

Chubb Ins. Co., 582 A.2d 1257, 1260 (N.J. 1990). Under

New Jersey law, ambiguity exists in an insurance contract

where "the phrasing of the policy is so confusing that the

average policyholder cannot make out the boundaries of

coverage." Weedo v. Stone-E-Brick, Inc., 405 A.2d 788, 795

(N.J. 1979).

We have not overlooked the possibility that one could

argue that given the divergence of opinion concerning the

correct standard for determining the employee's"manifest

intent," the term is ambiguous, thus requiring us to invoke

the principle of contra proferentum. See, e.g., Oritani Savs.

& Loan Ass'n v. Fidelity & Deposit Co., 821 F. Supp. 286,

290 (D.N.J. 1991) (rejecting that argument in the context of

determining appropriate construction of "manifest intent").

If that were the case, we would be compelled then tofind

that the term "intent" requires only that the loss be

"substantially certain to result," as it is a more lenient

standard of employee culpability. Here, however, we do not

believe that the Insuring Agreement is ambiguous because

we cannot conclude that the "phrasing of the policy is so

confusing that the average policyholder cannot make out

the boundaries of coverage." Weedo, 405 A.2d at 795.

Rather, we find that the principle that courts" `should not

write for the insured a better policy of insurance than the

one purchased' " applies squarely to the facts of this case.

Longobardi, 582 A.2d at 1260 (quoting Walker Rogge, Inc. v.

Chelsea Title & Guar. Co., 562 A.2d 208, 214 (N.J. 1989)).

45

Moreover, we further observe that in performing our task

of "predicting" how the New Jersey Supreme Court would

decide this issue, we have reviewed two cases from other

courts which applied the manifest intent requirement under

New Jersey law in a manner that supports our result. See

McKenna, 622 F.2d at 662. First, in Oritani, the district

court held that the term manifest intent requires the

employee to possess the "subjective intent" to cause the

employer loss. See 821 F. Supp. at 291. In reaching its

conclusion, the court found persuasive the insurer's

argument that the fidelity provision covers only those losses

that were caused by "deliberate" conduct motivated by a

"deliberate" intent. See id. at 288. The court granted the

insurer's motion for summary judgment because it was

undisputed that the employee was not a knowing

participant in the scheme that caused the loss. See id. at

291.

We find the court's requirement of a "subjective intent"

particularly noteworthy because the court could have

reached the same result by adopting the "knowingly"

standard given the facts of the case, but it chose instead to

state the standard as requiring an inquiry into the

employee's motive and subjective state of mind. Thus, the

court determined that proof of the employee's recklessness

or negligence would not suffice under the subjective

standard it adopted, so long as the circumstances

suggested only that the employee exercised poor business

judgment and acted with "a pure heart." See id.

Similarly in North Jersey, the New Jersey Superior Court,

Law Division, granted summary judgment to the insurer in

a fidelity bond dispute because the evidence submitted

pertaining to the question of manifest intent showed only

that the employee exercised poor judgment. See 660 A.2d

at 1292-93. The North Jersey court, citing, inter alia, the

Court of Appeals for the Second Circuit's opinion in

Leucadia, held that the evidence did not permit a

reasonable inference that the employee's "motive" or

"purpose" was to cause a loss to his employer. See id.

In light of the foregoing, we hold that the term"manifest

intent" requires the insured to demonstrate that it was the

offending employee's purpose or desire to obtain afinancial

46

benefit for himself or a third party, and to cause the

insured to sustain a loss. And given that a jury could infer

such an intent based on circumstantial evidence, an

insured may survive a motion for summary judgment by

proffering evidence suggesting that the employee acted

knowing that it was substantially certain that his or her

conduct would cause the insured to sustain a loss that

would inure to the employee's benefit, see Lustig, 961 F.2d

at 1166-67, and by offering any other proof tending to

establish the employee's intent. See also General Analytics,

86 F.3d at 54 (stating that an employee's words and

conduct are probative of intent, and that the context in

which the words and conduct occurred also is relevant).

47