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Utica Mutual Insurance Co. v. Fireman's Fund Insurance Companies

November 16, 1984


Appeal from a final judgment of the Southern District of New York (Lasker, J.), entered after a nonjury trial, dismissing the complaint. The district court held that the insured could not recover under a fidelity bond issued by the defendant because the insured had failed to comply with the contractual requirement that notice of loss be given as soon as practicable after discovery. The judgment is affirmed.

Author: Tenney

Before: KAUFMAN and WINTER, Circuit Judges, and TENNEY, Senior District Judge.*fn*

TENNEY, District Judge:

In this diversity suit, Utica Mutual Insurance Company ("Utica") appeals from a judgment of the United States District Court for the Southern District of New York, Morris E. Lasker, District Judge, dismissing Utica's complaint against Fireman's Fund Insurance Companies ("Fireman's Fund") to recover payment under a fidelity bond issued by Fireman's Fund. Following trial, the court, sitting without a jury, held that Utica was barred from recovery because it had failed to comply with the notice provisions set forth in the fidelity bond. We hold that the district court was clearly correct.

In addition, Fireman's Fund appeals the dismissal of its claim for indemnity against the third-party defendant, Lon Roy Kavanaugh, Jr. ("Kavanaugh"). It is not necessary to address this appeal since the claim for indemnification is predicated on Fireman's Fund's being held liable to Utica under the fidelity bond.

Finally, Kavanaugh argues that the appeal by Fireman's Fund discussed above is frivolous and that he should be awarded costs and fees incurred defending the appeal. We find that the appeal is not frivolous and therefore decline to award costs and fees to Kavanaugh.


The undisputed facts establish that the following events occurred. In 1976, Utica resolved to make certain changes in its investment portfolio. Utica planned to sell certain tax-exempt bonds and replace them with corporate securities that would yield a higher return. It was agreed, however, that this conversion would take place only if it could be accomplished without loss.

From 1976 to 1979, Utica's investment manager, Philip Turner ("Turner"), sold a large number of Utica's tax-exempt bonds at prices substantially above the market rate and then purchased taxable bonds of equal value at prices that were also above the market rate. Kavanaugh acted as the broker-dealer in all of these transactions and received $802,000 in commissions. Kavanaugh set up his own company, Hoffman Kavanaugh Securities Corporation ("HKS"), in order to conduct these transactions, which are commonly known as "adjusted trading" or "overtrading." Utica was the only active account handled by HKS.*fn1 Utica's claim under the fidelity bond -- which covered losses resulting from employee misconduct -- pertains solely to the commissions paid to Kavanaugh as a result of the adjusted trading.

The bond transactions in question first came to light in December of 1978, when a new employee at Utica reviewed Utica's bond portfolio and found that a substantial number of taxable bonds had been purchased at prices that were considerably higher than the market rate. The chairman of Utica, Victor Ehre ("Ehre"), was immediately advised of the problem. On January 12, 1979, the president of Utica, Jack Riffle ("Riffle"), was also advised that certain irregularities in the bond portfolio had been uncovered and, on January 24th, Ehre and Riffle met with Turner to discuss the matter. An investigation was initiated and, by the end of February, employees in Utica's investment department had spent at least 250 hours examining the transactions in question. At the end of February, Turner was relieved of all duties at Utica and he subsequently elected to take early retirement.

On February 22nd, Utica's Audit and Finance Committee met to discuss the problem. Ehre prepared a memorandum for that meeting outlining the facts that were known about the adjusted trading. In his memorandum, Ehre stated that (1) bonds had been purchased at above market rates, (2) such purchases violated IRS rules, (3) Utica was faced with certain tax problems because of the adjusted trading, and (4) excess commission had been paid to the broker. The district court found that -- in light of these facts -- Utica knew, or should have known, by February 22nd, that there had been misconduct resulting in a loss.

Between February 22nd and July 23rd, when notice was ultimately given to Fireman's Fund, Utica continued to investigate the adjusted trading. In May, Utica received a financial report from the accounting firm of Arthur Andersen & Co. stating that there had in fact been a loss -- namely the money paid to Kavanaugh as commissions. In June, Utica was advised by outside counsel that adjusted trading was illegal. In July a second attorney confirmed the prior opinion. The trial court found that no new material facts concerning the loss were uncovered between February and July.

On July 23rd, Utica submitted its notice of loss to Fireman's Fund, claiming that Turner had committed dishonest or fraudulent acts within the meaning of the bond, by engaging in a series of fraudulent and illegal securities transactions, and that Utica had sustained a loss of $802,000 as a result of those transactions.

It is undisputed that, under the terms of the bond, Utica was required to give notice of any loss "as soon as practicable" after discovery of the loss. The trial court found that by February 22, 1979, Utica had enough information to have reasonably determined that a loss had occurred as a result of Turner's misconduct and that the notice requirement was therefore triggered at that time. Because Utica failed to give notice to Fireman's Fund until July 23, 1979 -- six months later -- the trial court held that Utica had failed ...

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