Typically, when the CEO of an organization makes a material misrepresentation on an insurance application as to knowledge (including his or her own) of acts, errors or omissions that might give rise to a claim, an insurer would be able to successfully rescind that policy. A recent decision, however, illustrates why that may not always be the case. Bancinsure, Inc. v. U.K. Bancorporation Inc./United Kentucky Bank of Pendleton County, Inc., C.A. No. 11-109-DLB-CJS, 2011 WL 5570704 (E.D. Ky., November 16, 2011).

In this case, the bank CEO had been embezzling funds from the bank for more than five years to the tune of over $2 million. She was also the signatory on the application completed after or during the course of her embezzlement scheme. The policy at issue was a combined financial institution bond and professional liability policy. Although not quite explicit in the Court’s Opinion, it would appear that the claim made was under the bond portion and where the insured would be the bank itself.

The Court declined to impute the knowledge of the CEO to the bank. Although normally there would be such imputation, the Court relied on an “adverse interest exception” theory to not impute. Under that theory, an agent’s (the CEO) knowledge is not imputed to her principal (the insured bank) when she would have no reason to communicate that knowledge to it, i.e. she would not have reason to disclose her embezzlement to her employer. Further, the CEO was not a de facto alter ego of the bank and was not acting in the bank’s interests by falsifying the insurance application. More specifically, although she had authority to complete the application, the Court held that such authority extended only to completing it honestly.

Finally, and perhaps this is why the result here may be specific to the nature of fidelity insurance, the Court held that the bond was specifically intended to cover the bank for the very loss caused by the embezzlement. If the application had been completed by any other bank officer, there would be no question that the CEO’s knowledge could not be imputed to the bank.*

This decision is another illustration of why successful rescission of a bond or policy is never a “slam dunk”.

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It does not appear that the application or the policy contained any provisions addressing imputation of knowledge or severability of interests.