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Exchange State Bank, St. Paul, Kansas v. Kansas Bankers Surety Co.

March 14, 2008

EXCHANGE STATE BANK, ST. PAUL, KANSAS, APPELLANT,
v.
THE KANSAS BANKERS SURETY COMPANY, APPELLEE.



Appeal from Crawford District Court; A.J. WACHTER JR., judge.

SYLLABUS BY THE COURT

When an insurance policy provides coverage for a bank's losses due to check-kiting but excludes coverage for any loss that is the result of the "willful extension of credit" by the insured through the payment of checks drawn on uncollected funds, that bank has no coverage when it consciously decided to pay checks against uncollected funds over a period of months, charged overdraft fees, manually forced payment of the overdrafts, and routinely called the customer to get additional checks for deposit to cover the overdrafts.

The opinion of the court was delivered by: Leben, J.

Affirmed.

Before MARQUARDT, P.J., LEBEN, J., and KNUDSON, S.J.

Exchange State Bank of St. Paul, Kansas, bought a "check kiting fraud indemnification policy" from Kansas Bankers Surety Company. Exchange Bank certainly suffered a substantial loss from check-kiting, and it seeks to recover on the policy. We must decide whether its loss was covered under the policy's terms. The policy's key provisions will focus our consideration.

The first sentence of the policy said that it was "intended to protect the Insured from loss sustained because of the classic check kiting fraud." In a classic check-kiting scheme, a bank customer uses two or more checking accounts to take advantage of the practice of most banks to allow immediate funds access, thus allowing "uncollected funds" to be used. Uncollected funds are not yet transferred between banks to reflect the deposited check. A check-kiting scheme might involve the establishment of an account with Bank Aspera with a $500 deposit. The customer then writes a check from Bank Aspera for $50,000 and uses that check to open an account with Bank Buffalo. The customer then deposits a check from Bank Buffalo to Bank Aspera for $50,000. If these banks allow regular customers to write checks against uncollected funds, the check-kiting scheme takes advantage of the time it takes to process checks in the check-collection system. The check-kiting customer continues to make regular deposits from each account to the other unless or until the scheme is discovered. At that point, the "kite" collapses, and one of the banks is stuck with the loss. Exchange Bank sought to insure against that potential loss.

Section II of the policy is the "Insuring Agreement"; it provides a definition of check-kiting for purposes of the policy. That definition appears to track fairly well with the common understanding of check-kiting. It covers the "constant systematic back and forth deposit of funds between . . . two or more accounts utilizing checks of approximately the same amount to create the appearance of valid funds in the account" involving "deposits with the Insured drawn against uncollected funds deposited in another institution to create the appearance of valid funds in the account at the other institution," so long as "the Insured is, in fact, deceived by such deposits."

Section VIII contains exclusions from coverage; it excludes coverage "for any loss which is the result of the willful extension of credit by the Insured through the payment of checks drawn on uncollected funds." (Emphasis added.) Specific provisions in a contract control over general ones, Colburn v. Parker & Parsley Dev. Co., 17 Kan. App. 2d 638, 649, 842 P.2d 321 (1992), and genuine ambiguities in an insurance contract are resolved against the insurance company. Lee Builders, Inc. v. Farm Bureau Mut. Ins. Co., 281 Kan. 844, 858, 137 P.3d 486 (2006). Our primary task in this case is to determine whether Exchange Bank's losses resulted from "the willful extension of credit" so as to be excluded from insurance coverage.

We conclude that Exchange Bank did make a willful extension of credit in this case. The bank's customer, Cash Grain of Weir, Inc., had checking accounts at both Exchange Bank and at Labette Bank in Cherokee, Kansas. The kite in this case collapsed in August 2004. Before then, Cash Grain was regularly listed on Exchange Bank's internal overdraft reports. Whenever that occurred, personnel at Exchange Bank called Cash Grain to request new deposits to cover the amounts. When checks were deposited from Cash Grain's Labette Bank account, Exchange Bank approved the specific use of uncollected funds by Cash Grain. In these circumstances, there was a willful extension of credit, and the policy does not provide coverage for Exchange Bank's losses.

The District Court's Decision

The district court found that the exclusion from coverage applied and granted summary judgment to Kansas Bankers Surety Company. The district court concluded that Exchange Bank willfully extended credit simply by allowing its customer, Cash Grain, to draw against uncollected funds:

"Plaintiff argues that by paying checks of Cash Grain of Weir, Inc. when there were insufficient collected funds in Cash Grain of Weir, Inc.'s account to cover the checks, that plaintiff did not extend credit to Cash Grain of Weir, Inc. Webster's Collegiate Dictionary (10th ed.) defines 'credit' as 'an amount or sum placed at a person's disposal by a bank.' By paying checks written by Cash Grain of Weir, Inc.[] on its account with plaintiff when Cash Grain of Weir, Inc. did not have sufficient collected funds in its account to cover the checks written, plaintiff was placing its own funds at the disposal of Cash Grain of Weir, Inc. until the checks deposited by Cash Grain of Weir, Inc. were collected. Simply put, plaintiff extended credit to Cash Grain of Weir, Inc. by payment of checks on uncollected funds.

"Did plaintiff 'willfully' extend credit to Cash Grain of Weir, Inc. through payment of checks drawn on uncollected ...


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