First National Bank v. United States Fidelity & Guaranty Co.

O’Donnell, J., delivered the opinion of the Court. This action was instituted by the appellant, First National Bank of Southern Maryland (the Bank), against the appellee, United States Fidelity and Guaranty Company (U.S.F. & G.), upon a banker’s blanket bond, for the recovery of $43,761.39, representing losses ($28,587.02) and attorneys’ fees and costs ($15,174.37) all allegedly incurred as a result of the acts of ⁴⁰² the third-party appellee, G. Robert Sellner (Sellner), who was an assistant vice-president and the general manager of the Marlow Heights Branch of the Bank, in connection with the handling by him of the account of a borrower from the Bank, Continental Electronics, Inc. (Continental). The Bank alleged that Sellner’s acts fell within the provisions of the bond which covered, among other things, “any loss through any dishonest, fraudulent or criminal act of any of the employees” of the Bank. U.S.F. & G., pursuant to Maryland Rule 315, filed a third-party claim against Sellner.

Following a nonjury trial in the Circuit Court for Prince George’s County before Judge James F. Couch, Jr., the trial court filed a written opinion in which findings of fact were made and directed the entry of judgments in favor of U.S.F. & G., as defendant, and in favor of Sellner, as third-party defendant. Aggrieved at this result the Bank appealed; U.S.F. & G. also appealed from the judgment in favor of Sellner in its third-party claim. Sellner filed a cross-appeal. 1 The Bank contends that the trial court was in error in concluding (a) that Sellner’s conduct was not fraudulent or dishonest, and (b) that Sellner’s actions were not criminal. We do not see it that way, however, and shall affirm both judgments.

The pertinent clause of the fidelity bond upon which this action was predicated reads as follows: “THE LOSSES COVERED BY THIS BOND ARE AS FOLLOWS: Fidelity (A) Any loss through any dishonest, fraudulent or criminal act of any of the Employees, committed anywhere and whether committed alone or in ⁴⁰³ collusion with others, including loss of Property through any such act of any of the Employees.” 2 Although we shall later discuss the specific conduct upon which the appellant-Bank relies in support of its contention that its loss was sustained through the “dishonest and fraudulent acts” of Sellner, we think that a recitation of the basic and fundamental relationship of Sellner to Continental’s account would here be apropos. In 1962, Continental, a fledgling corporation, was in need of working capital to help it fulfill a million dollar contract with Western Union for the construction and installation of a microwave relay station. The late Adrian P. Fisher, president of the Bank and chairman of its board, an intimate of Continental’s president, became a moving force in having the Bank’s board extend loan authorization to it. Although Sellner did not feel competent to manage the account, and so expressed his feelings to his superiors, he was commissioned to take it in his charge at the Marlow Heights Branch where the loan file, direct liability ledger and all loan records were maintained, and where he was under the direct supervision of Fisher.

Sellner was under instructions to limit any notes to a 90-day basis, to obtain the signatures of not only the principals of Continental, but their wives to all such notes, to require Continental to assign to the Bank the proceeds expected under its contracts, not to issue the funds advanced at any one time, but to disburse it only as Continental needed it, to deposit all checks received into Continental’s account and to maintain a close scrutiny not only on Continental’s inventory, but its business affairs as well. He complied with these mandates. Shortly after this authorization it appeared that Continental would require additional capital and the board of the Bank directed Fisher and Sellner to seek participation ⁴⁰⁴ by other banks in order to obtain additional financing. Since Continental had no other available security these efforts never came to fruition.

A loan requested from the Small Business Administration was also rejected. Within four months Continental had been advanced by the Bank a total of $96,425. In early 1963 the officers of Continental, in order to obtain the required “security clearance” for Sellner, believed that he should become a member of its board of directors, inasmuch as they were dealing with classified data and equipment and since Sellner inspected their facilities; they voted to present him with 50 shares of stock, and designated him as “financial adviser” to the corporation. Sellner, realizing that as a Reserve Air Force officer he possessed the necessary “security clearance,” rejected the proffered shares of stock.

He testified that although he did attend the meetings of Continental’s board, he did so only to give financial advice and to inspect its inventory, equipment and the holdings placed as security with the Bank. The evidence was uncontradicted that Sellner never received any emoluments as a result of his relationship with Continental. During 1963 Continental received, under its contract with Western Union, a flow of cash in substantial amounts. Sellner, with the concurrence of the Bank’s board, recommended that it “pay down” the line of credit as much as possible and as a result, as of December 13, 1963, Continental’s indebtedness to the Bank had been reduced “to a zero balance.” In late 1963 Continental was negotiating to enter into a number of contracts with agencies of the United States Government and — as had been its predicament under the Western Union contract — needed additional operating capital.

Commencing on December 18, 1963 — approximately 18 months after the original line of credit had been granted, and without any further approbation from the Bank’s board — a series of $10,000 loans were made to Continental, through Sellner, on 30-day notes — renewed for longer periods of time — which reached a total outstanding ⁴⁰⁵ indebtedness to the Bank of over $100,000. In accordance with the instructions initially given Sellner, the signatures of the principals of Continental and their spouses were obtained upon the notes; similarly, as security, Continental made assignments, acknowledged by the United States Government, of the proceeds due under its new contracts with the various governmental agencies. None of this latter series of notes was ever discharged and it was the Bank’s loss thereon which was the basis for the Bank’s claim against U.S.F. & G. Although Continental attempted to sell its business, it succumbed to its economic problems in mid-1965. The national bank examiners directed the Bank to “charge off” the line of credit extended Continental, as of May 20, 1966, in the total amount of $99,393.36, as a “bad debt.” Through the sale of Continental’s inventory and by execution upon judgments obtained against its principals and endorsers on its notes, the Bank was able to reduce the total “charged off” to a net of $28,587.02 — the amount claimed as its loss under the bond.

(a) Dishonest and Fraudulent Acts In particularizing what it asserts were “dishonest and fraudulent acts by Sellner,” the Bank primarily contends that he concealed and misrepresented the poor financial status of Continental. These allegations are premised upon the contention that Continental was granted a one-time loan not to exceed $75,000 rather than a “line of credit;” that the funds he advanced were in excess of the authorization and that, although he was aware that Continental was unable, in late 1963 and 1964, to pay its bills he nonetheless reported to the board — just before Continental’s first loan had been “reduced to zero” that its financial condition was “good.” Both the treasurer of Continental and a member of the Bank’s board in their testimony agreed that Continental had been given a “line of credit;” it was Sellner’s understanding that the line of credit was not limited to $75,000 but was restricted only to the Bank’s regular lending limit which, ⁴⁰⁶ during this interval, approximated $130,000. Although the Bank’s vice president testified that the original transaction constituted a single loan to Continental, it was elicited that upon deposition he testified that the transaction had been handled as a “line of credit.” The original authorization when made in 1962 was apparently the first of this type which the Bank had made in such an amount. Indeed one of the members of the Bank’s board acknowledged that even in cases where a loan has become “shaky” banks often loan additional money when in their judgment such a course appears necessary to revitalize the debtor company and thus hopefully to protect the indebtedness.

That Continental’s fiscal structure was poor was self-evident to the Bank; the purpose of the initial advance was to afford it working capital. Shortly thereafter when it appeared that additional capital was required the board directed Sellner and Fisher, through participation with other lending institutions to attempt to obtain additional capital. Although it is true that in late 1963 and 1964 Continental was unable to pay its current bills there was no showing that Sellner misrepresented its financial condition; its performance under the Western Union contract appeared to be satisfactory, the work was on schedule, and Continental, being paid regularly had a “cash flow” and seemed to be in “good” condition. It was at that time that Continental was able to completely pay-off the initial notes from the proceeds of the Western Union contract.

When, in late 1963 the series of new notes was given by Continental no new application was submitted. Sellner testified that the funds then advanced to Continental were upon the authority of the board’s original resolution; he, as well as a member of the board testified that the “line of credit” had never been terminated. It was Sellner’s testimony that Continental’s account, after December 13, 1963 was handled exactly “in the same fashion as before” and that the same procedure was invoked in connection with ⁴⁰⁷ the second series of notes as had been followed initially, with Continental assigning to the Bank the funds scheduled to be received by it under its contracts with various governmental agencies. The discount committee of the board was apprised weekly of Continental’s financial status; monthly reports were submitted by him concerning all loan accounts at the Marlow Heights branch, where the account was handled.

Adrian Fisher, whose office was located at the branch personally supervised the Continental loan and made his own personal report about it to the board. 3 The Bank’s internal auditor reported to the board semi-annually concerning the account; three members of the board, comprising an auditing committee, audited the accounts twice yearly as did the national bank examiners. The trial court found as a fact — an issue not here seriously challenged by the appellant — that the Bank was supplied with monthly financial statements reflecting Continental’s actual economic status. Secondarily, the Bank argues that Sellner’s “conflict of interest” as a result of his relationship with Continental additionally established dishonesty and fraud on his part. It contends that his endorsement of checks payable to Continental, sent to the Bank pursuant to the assignment and their deposit in its checking account, instead of being applied to discharge the notes, was fraudulent; that his membership on Continental’s board, his services as its “financial advisor” and the issuance of fifty shares of its stock to him established on his part an interest in Continental, in conflict with the interests of the Bank.

Similarly it contends that his conduct was “fraudulent and dishonest” when he instructed a teller to list several renewal notes of Continental’s on the loan and discount sheet after the sheet had been reviewed by the Bank’s board, when he assisted one of Continental’s principals in filling out an incorrect personal financial statement and when he authorized payment to Digitech, Inc. from Continental’s ⁴⁰⁸ funds rather than requiring the application of those funds to the discharge of its indebtedness to the Bank. Pursuant to the assignments made by Continental, checks in payment for its contractual services were forwarded to the Bank; although committed as a source of payment of the loans the checks were endorsed by Sellner and deposited in Continental’s checking account. It was Sellner’s testimony that the procedure followed by him was in accordance with the instructions of Fisher who had directed, in connection with the first series of loans to Continental, that all its checks be deposited in its checking account. Additionally, there was evidence that the checking account was administered, not at the Marlow Heights branch but at the Bank’s main office.

Thus, the Bank’s procedures would appear to mandate a deposit in Continental’s checking account for credit to it and a resultant responsibility on the personnel at the main branch or the principals of Continental to see to it that the checks received were applied to discharge the indebtedness. In connection with Sellner’s membership on Continental’s board and his activities as its “financial adviser,” he testified that he had been directed by Fisher “to keep an eye on” Continental’s operations and to inspect its inventory and equipment (which apparently had been pledged as security for a separate loan); for these purposes he periodically visited its offices. The proffer of the 50 shares of Continental’s stock and his selection as a member of its board was at the suggestion of Continental’s officers only to facilitate his “security clearance;” the shares were returned when Sellner appreciated that he already possessed “security clearance.” It was his testimony additionally that he never considered himself “officially” to be a member of the board, never voted at any of its meetings and did not have access to its minutes. He resigned on August 19, 1963 — approximately four months before the second series of loans was made to Continental.

There was no evidence that his membership was for other than the protection of the best interest of the Bank. This ⁴⁰⁹ asserted “conflict of interest” on his part did not establish evidence of dishonesty and fraud. Indeed, the trial court noted that not infrequently lenders instruct an employee to sit on the board of a corporate borrower in order to protect the interest of the lender in connection with a substantial loan. The several entries made by the teller at Sellner’s direction to which the Bank takes exception involved entries on a loan and discount sheet after that document had been reviewed by the Bank’s board.

The entries represented renewal notes. The teller testified that the note renewals were recorded as well on the Bank’s direct liability ledger maintained at the main branch and the Bank’s internal auditor was apprised of the transaction. It was Sellner’s testimony that the renewal notes merely replaced earlier ones which the board had reviewed; that when the loan and discount sheet was submitted to the board the renewal notes did not contain all the necessary endorsements which were required; he withheld listing the renewal notes, in accordance with the instructions he had been given and the procedures he had earlier followed only because of their lack of the required endorsements. In May, 1963, in connection with the initial notes made by Continental, its principals, as well as their spouses were required to pledge their personal responsibility as endorsers and personal financial data was required as part of the Bank’s records.

One of the directors of Continental listed $22,500 in assets representing a home he reported he owned but which in reality he rented. The testimony, however, showed that the director had an option to purchase the residence and both he and Sellner genuinely believed that under those circumstances they could consider the rental as “equity” and call it a house he “owned.” Finally the Bank contends that Sellner’s conduct was fraudulent and dishonest in writing a letter to Digitech, Inc. advising that Continental would pay its account as soon as it was paid by the Air Force. The Bank argues that since it had priority on the proceeds of Continental’s contracts this action by Sellner constituted a release of its security. ⁴¹⁰ As a prerequisite to the receipts of payments by Continental under United States Government contracts it was necessary that the equipment developed by it be inspected for compliance with governmental specifications. Digitech, Inc. performed these inspectional services.

When Continental found itself in a predicament in which the Government would not release funds to it until the contracted equipment passed inspection and Digitech would not continue its services until paid, Sellner, although he did not discuss his action with his superiors, committed some of Continental’s funds to the discharge of Digitech’s bill. Sellner testified that he believed that this authorization was the only method by which payments might be continued to be received by the Bank from the Government and was taken to protect what he saw as in the Bank’s financial interest, secured as it was by the assignment of the proceeds under those very contracts. There was no evidence that any money was actually paid Digitech pursuant to Sellner’s authorization and hence no showing that the Bank in connection therewith sustained any loss. 4 Notwithstanding all these alleged acts of misconduct on Sellner’s part, it is interesting to note that the Bank’s board, after reviewing a report from the national bank examiners dated October 4, 1965 showing Continental’s dire financial straits and its indebtedness to the Bank totaling $100,185 passed a resolution referring to Messrs. Fisher and Sellner the duty of providing means by which Continental could work out repayment of the indebtedness.

When a bond conditioned for the honest performance of an employee’s duties provides that it shall cover “any dishonest, fraudulent or criminal act” there can be no recovery, in an action upon the bond, for any acts or conduct of the employee which fall short of the dishonest acts of the employee within contemplation of the bond. Fraud and dishonesty are not presumed, they must be proven. See ⁴¹¹ Williams v. U.S.F. & G. Co., 105 Md. 490, 495 , 66 A. 495, 496 (1907). When fraud, dishonesty or criminal conduct is imputed, something more than a mere preponderance of evidence must be produced; the proof must be “clear and satisfactory” and be of such a character as to appeal strongly to the conscience of the court.

Peurifoy v. Congressional Motors, Inc., 254 Md. 501, 517 , 255 A. 2d 332, 340 (1969); Bachrach v. Washington United Cooperative, Inc., 181 Md. 315, 321 , 29 A. 2d 822, 825 (1943); Rent-A-Car Co. v. Fire Insurance Co., 161 Md. 249, 268 , 156 A. 847, 855 (1931). In World Exchange Bank v. Commercial Cas. Ins. Co., 255 N. Y. 1, 5 , 173 N. E. 902, 904 (1930), where a bank teller who paid checks drawn against uncollected items on deposit in violation of a bank rule that such payments should not be made without the consent of an officer of the bank and where the teller believed the checks to be good, gained no benefit from the transaction, had no thought of giving anything to anyone but whose only object was the furtherance of the business of the bank was held not to be guilty, as a matter of law, of a dishonest or criminal act under a similar bond, Chief Judge Cardozo stated for the Court: “Dishonesty, unlike embezzlement or larceny, is not a term of art.

Even so, the measure of its meaning is not a standard of perfection, but an infirmity of purpose so opprobrious or furtive as to be fairly characterized as dishonest in the common speech of men.” This Court in Suburban Properties Management, Inc. v. Johnson, 236 Md. 455 , 204 A. 2d 326 (1964) stated: “The elements of legal fraud are: (1) that a representation made by a party was false; (2) that either its falsity was known to that party or the misrepresentation was made with such reckless indifference to truth to impute knowledge to him; (3) that the misrepresentation was made for the ⁴¹² purpose of defrauding some other person; (4) that that person not only relied upon the misrepresentation but had the right to rely upon it with full belief of its truth, and that he would not have done the thing from which damage resulted if it had not been made; and (5) that that person suffered damage directly resulting from the misrepresentation. Appel v. Hupfield, 198 Md. 374 , 84 A. 2d 94 ; Gittings v. Von Dorn, 136 Md. 10 , 109 Atl. 553 .” 236 Md. at 460 , 204 A. 2d at 329 . A misrepresentation believed by the person making it to be true and not made with a reckless disregard of whether it is true or false, even though induced by negligence or ignorance, will not sustain an action for fraud. Peurifoy v. Congressional Motors, Inc., supra; Lambert v. Smith, 235 Md. 284, 288 , 201 A. 2d 491, 493-94 (1964).

The words “fraud” and “dishonesty” as used in a fidelity bond include any act showing a want of integrity or a breach of trust. See Fidelity & Deposit Co. of Md. v. Bates, 76 F. 2d 160 (8th Cir. 1935); Exeter Banking Co. v. Taylor, 85 N. H. 458, 160 A. 733 (1932); Miners Sav. Bank ofPittston v. Royal Indemnity Co., 336 Pa. 428 , 9 A. 2d 543