National Insurance Co Ltd v. Federal Bank Ltd — 1980 DIGILAW 74 (KER)

JUDGMENT P. Janaki Amma, J. 1. The appeal is against a decree for money based on a policy of fidelity insurance, passed in favour of the Federal Bank Ltd., Alwaye, represented by its Managing Director. The appellant; who was the first defendant in the concerned suit is the Ruby General Insurance Company Ltd., Calcutta (for short the Company), which has got a branch office at Mattancherry, Cochin. Defendants 2 and 3 were employees of the Federal Bank Ltd., Alwaye, at the relevant time. They stand at present discharged from their jobs in the Bank and are employed elsewhere. The first defendant, had a scheme of insurance styled as "Policy Number Bankers (in and out) 112". On 17th October 1962, the plaintiff took a policy paying Rs. 5,493 as premium, and by virtue of the said policy the first defendant undertook to make good to the bank all direct losses to the extent of rupees one lakh that the Bank might during the space of 12 calendar months from the noon of the 4th August 1962 to the noon of 3rd August 1963, discover to have sustained in the manner set forth in Clause.1 to 4 of the policy. The policy is marked Ext. A-1 in the case. 2. The suit was in respect of a claim made by the plaintiff Bank (hereinafter referred to as the Bank) in connection with its dealings with one of its customers. "M/s A. Pareed Pillai and Brothers", a firm of merchants carrying on business in buying and exporting coconut oil to customers outside Kerala. The firm had a cash credit accommodation in the Bank's branch at Alwaye upto a limit of Rs. 50,000. It had a Document Purchase Bill Account (for short the Document Purchase Bill Account), of which the limit had been fixed at Rupees one lakh! The modus operandi followed in connection with the Document Purchase Bill Account was as follows: The firm would collect coconut oil in tins for sending to parties outside the State with whom it used to enter into contract. The goods would then be booked by the Railway. The railway receipt, the invoice for the goods and a demand bill of exchange drawn on the buyer outside the State would be presented at the Bank. The goods would then be booked by the Railway. The railway receipt, the invoice for the goods and a demand bill of exchange drawn on the buyer outside the State would be presented at the Bank. The Bank would debit the amount under the bill in the Document Purchase Bill Account of the firm and give credit of the amount in its current account. The firm would draw amounts from the current account as and when required for its business transactions. The Bank would send the bills for collection through other banks having branches at the places where the purchasers of the goods had offices. These banks would present the bills, collect the amounts and remit the money to the plaintiff Bank. On receipt of the amount, the same would be credited to the Document Purchase Bill Account and the transaction would be closed. Though there was at one time a practice of presenting clean bills (that is, at bills unaccompanied by railway receipts and other documents of title) upto a specified limit and advancing money on their basis, it was stopped as per instructions from the Reserve Bank of India. All those concerned with the Bank and the customers were aware that no amount would be advanced on bills unsupported by railway receipts and other documents of title. 3. Defendants 2 and 3 (hereinafter referred to as employees) were respectively the Agent and Accountant of the Alwaye Branch of the Bank during April 1963. The current account of the firm stood overdrawn during the period upto the maximum extent. In the Document Purchase Bill Account, several bills backed by railway receipts were pending collection even though the normal period of collection of one month had expired in many cases. The face value of such bills amounted to Rs. 3,65,000.75. But since the limit of Rupees five lakhs had not been reached the Document Purchase Bill Account could accommodate further bills. While so the firm won over defendants 2 and 3, the Agent and the Accountant of the Alwaye Branch and made them advance amounts on bills without production of railway receipts. The bills were kept in the possession of the second defendant. He did not send them for collection. The transactions were entered in the Document Purchase Bill Account as though there were supporting documents for the bills. The bills were kept in the possession of the second defendant. He did not send them for collection. The transactions were entered in the Document Purchase Bill Account as though there were supporting documents for the bills. It was the third defendant who wrote the accounts and prepared the necessary statements for transmission to the Head Office. The statements contained the signature of defendants 2 and 3. Since in the returns to the Head Office, the bills were described as Document Purchase Bills, the Bank also classified them as advances under that head and in the statements to the Reserve Bank as secured advances. The Head Office of the Bank was thus purposely kept in ignorance about the real position of the dealings with the firm. On 20th December 1963, the amount due from the firm was found to be Rs. 4,27,143.98. As the affairs of the firm were in a precarious position and there was default in payment of the amount under the bills O.S. No. 43 of 1963 of the District Court, Parur was filed for realisation of the amount from the firm. 4. As soon as the bank discovered the dishonest activities of defendants 2 and 3 and the loss sustained by it, the first defendant insurance company was intimated and complete proof of the Bank's loss was also given to the company. There was protracted correspondence. The company appointed adjusters. The report of the adjusters which was not favourable to the Bank was not accepted by it. On the company repudiating its liability, the suit was filed by the Bank for recovery of Rs. 1,00,000 on the basis of the Bank's "In and Out Policy No. 112." 5. The first defendant company admitted the issuance of the policy Ext. A-1 but disputed that the claim made by the firm fell under any of the clauses of Ext. A-1. The company contended that there were no acts of misfeasance, misappropriation, or breach of trust on the part of the employees. According to the company, it was the practice in the Bank to give special facilities to leading customers having long associations with it. M/s Pareed Pillai and Brothers was a notable customer of the Bank. Amounts used to be advanced to that firm on favourable terms with the concurrence of the Managing Director and the Board of Directors. According to the company, it was the practice in the Bank to give special facilities to leading customers having long associations with it. M/s Pareed Pillai and Brothers was a notable customer of the Bank. Amounts used to be advanced to that firm on favourable terms with the concurrence of the Managing Director and the Board of Directors. The employees while they advanced on clean bills were only following a practice which was already in existence. There was neither dishonesty nor a criminal intent nor any intention to benefit themselves when they accommodated the firm by accepting clean bills. The employees did not get any profit out of the transaction. The Bank could easily realise the whole amount advanced from the firm itself as a suit had been filed on that behalf. No loss has been sustained by the plaintiff on account of its transaction with the firm. Whether the Bank sustained any loss could be made out only after exhausting its remedies against the firm and other defaulting parties including the Railways. There was thus no cause of action against the company for the time being. The company also contended that there were acts of misfeasance and defalcation of amounts by other employees of the Bank on previous occasions, prior to the issuance of Ext. A-1 policy which the Bank was obliged to point out at the time of answering the questionnaire issued by the company. These were not mentioned in the answers to the questions. There was thus non disclosure of material facts which rendered the contract of insurance void and unenforceable. In other words, the company denied that the Bank had any cause of action against it. 6. Defendants 2 and 3, the employees also filed statements denying the acts of dishonesty attributed to them and contended that everything was done with the concurrence of the management and in accordance with the existing practice. 7. The Trial Court did not accept the contention of the defendants that a reprehensible practice was being followed by the Bank itself of advancing amounts to the firm contrary to the written rules and against the directions of the Reserve Bank. 7. The Trial Court did not accept the contention of the defendants that a reprehensible practice was being followed by the Bank itself of advancing amounts to the firm contrary to the written rules and against the directions of the Reserve Bank. The court held that the acts of the employees were unauthorised and that they acted in collusion with the firm and without the knowledge or concurrence of the Board of Management including the Managing Director and that the case fell under clause (4) of Ext. A-1. The case of the company that a cause of action would arise only after exhausting the remedies against the firm was not accepted. The court also did not accept the contention that the contract became unenforceable because there was non disclosure of material facts by the Bank in answering the questionnaire Ext. E-8. The claim was accordingly decreed. 8. The appellant company reiterated the identical contentions in this court. The question therefore is whether there are sufficient reasons for vacating the decree passed against the appellant. 9. The appellant's success in the appeal depends to a considerable extent on whether there was any recognised practice of granting advances to the firm on clean bills, that is dispensing with the production of railway receipts and other documents of title. P.W. 1, the Managing Director of the Bank denied that there was any such practice or that he was aware that clean bills were being accepted by defendants 2 and 3, the employees. D.W. 1 the only witness examined on the side of the company has not sworn that he came to know of the existence of such practice either at the time of issuance of Ext. A-1 or thereafter. Defendants 2 and 3, the employees who put forward such practice did not choose to examine themselves to prove their case. 10. The company placed reliance on Ext. B-1, a copy of the Judgment in O.S. No. 18 of 1967 of the Subordinate Judge's Court, Parur, in support of the case, that a practice was in vogue to the knowledge of the Managing Director and the Directors of the Bank, whereunder amounts used to be advanced to the firm on the basis of clean bills and entries were being made in the Document Purchase Bill Account. Ext. Ext. B-1 suit was instituted by one R. Jagannatha Prabhu, who was the Agent of the Alwaye Branch from 2nd December 1960 to 21st November 1962 and from 1st June 1963 till 23rd August 1963. He was discharged from service for irregularities committed by him while he was Agent of the Bank. The suit was filed challenging the order of dismissal. It would appear that one of the allegations against him was that he colluded with the firm, M/s Pareed Pillai and Brothers, and advanced amounts on clean demand drafts, purported to be documentary bills of the firm unsupported by railway receipts. Jagannatha Prabhu contended that he was not guilty of any irregularities or breach of trust and that the advances were made on the basis of a longstanding practice in the Bank of obliging the firm, which was a standing customer of the Bank by not insisting that railway receipts should accompany the bills presented at the Bank for collection. Amounts were being advanced according to the plaintiff in Ext. B-1 in pursuance of the above practice with the concurrence of the management. The suit was contested by the Bank. The case of longstanding practice of making advances to the firm on clean bills was denied by the Bank and also by the Managing Director, who was examined as D.W. 1 in the case. The Subordinate Judge, Parur, after a detailed discussion of the evidence, found against the practice set up and also overruled the case of the plaintiff that the acts alleged were committed by him with the concurrence and knowledge of the Managing Director. The Bank has also produced Exts. A-20 and A-21, which relate to proceedings of an enquiry conducted in respect of the irregularities and acts of malfeasance and misfeasance committed by defendants 1 and 2 in the present case, and two others. Though the identical contentions were raised by the employees, they were overruled and not acted upon. Since there are no other materials to substantiate the practice, the finding of the Trial Court negativing the plea put forward by the defendants does not call for interference. 11. P.W. 1, the Managing Director of the Bank, has sworn to the details of the amounts advanced to the firm on clean bills by the employees. The fact is not disputed by the defendants. Exts. A-8, A-13 and A-14 are weekly statements of the Bank. Exts. 11. P.W. 1, the Managing Director of the Bank, has sworn to the details of the amounts advanced to the firm on clean bills by the employees. The fact is not disputed by the defendants. Exts. A-8, A-13 and A-14 are weekly statements of the Bank. Exts. A-9 to A-12 are statements of bills prepared by the Agent and the Accountant and sent to the Head Office. Ext. A-15 is the Agent's monthly certificate for the month of April, 1963. The above documents were prepared by the employees and contain their signature certifying the correctness of the entries. According to P.W. 1 there was no occasion for the Head Office of the Bank to suspect that amounts were being advanced to the firm otherwise than on bills supported by railway receipts. It was only when amounts remained uncollected on a number of bills and large amounts became due from the firm that suspicion was roused and the truth was realised. From the materials available it is clearly made out that defendants 1 and 2 were misusing the trust reposed on them by the Bank, in order to help the firm. 12. No doubt, the company contended that there is no evidence to show that the employees were benefited by the transactions with the firm, and, therefore, it is not reasonable to conclude that it was due to their fault that the firm managed to receive advances on favourable terms. But, whether the employees were benefited or not and whether they received any illegal gratification for the help rendered by them to the firm are matters known to them only. For holding that there were acts of misfeasance and malfeasance and also breach of trust on the part of the employees it is sufficient, if it is found, that they acted against the rules of the Bank and the instructions issued to them, to the detriment of the Bank and to the advantage of the firm. Clear cases of breach of trust have been established against the employees. 13. The further question is whether the above acts were sufficient to include the case in one of the four clauses in Ext. A-1, the policy of insurance. The case of the Bank is that the acts come under clause (4) of Ext. A-1. Clear cases of breach of trust have been established against the employees. 13. The further question is whether the above acts were sufficient to include the case in one of the four clauses in Ext. A-1, the policy of insurance. The case of the Bank is that the acts come under clause (4) of Ext. A-1. Clause (4) reads: "By reason of fraud, defalcation, misfeasance, misappropriation, fabrication of accounts or breach of trust committed by the Officers, Accountants, Cashiers, Clerks, Peons and other employees of the assured, whilst in the course of their work within or without the premises either severally or jointly or in collusion with other employees." The employees in the present case being the Agent and Accountant of the Bank are covered by the Policy. The employees transgressed the limits of their authority when contrary to the instructions issued they advanced amounts to the firm on clean bills. The suppression of that fact and the inclusion of the transactions in the Document Purchase Bill Account and sending of incorrect statements to the Head Office amounted to acts of fraud, fabrication of accounts and breach of trust by the employees coming under the above clause. 14. The learned counsel for the appellant referred to the decisions in Haseldine v. Hosken ( (1933) LR (KB) Vol. 1 page 822), Davia v. Hosken ( 1937 (3) AER 192), Philadelphia National Bank v. Price (1937 (3) AER 391 and (1938) 2 AER 199) and Goddad and Smith v. Frew (1939 (4) AER 359). None of the above cases has a bearing in the instant case. They are all cases dealing with the scope and construction of policies of insurance issued, which were mostly policies of indemnity and not fidelity policies as such. The distinction between an indemnity policy and a fidelity policy of insurance is now well established. Fidelity policies are intended to protect an employer against breaches of confidence by his employees. They include policies intended to cover losses due to criminal misappropriation and breach of trust by an employee. The scope of fidelity insurance is dealt in the following passages in Halsbury's Laws of England, 4th Edition, Volume 25, paras 794 and 795: has not been "794. They include policies intended to cover losses due to criminal misappropriation and breach of trust by an employee. The scope of fidelity insurance is dealt in the following passages in Halsbury's Laws of England, 4th Edition, Volume 25, paras 794 and 795: has not been "794. Breach of fidelity as an insurable contingency.- A policy of fidelity insurance is intended to protect the assured against the contingency of a breach of fidelity on the part of a person in whom confidence has been placed. Usually the assured and the person whose fidelity is insured stand to each other in the relation of employer and employee. 795. Extent of protection. A policy of fidelity insurance normally contemplates loss by the criminal misappropriation of money or securities. The perils insured against may be described as the employee's fraud or dishonesty, or his want of integrity, honesty or fidelity. In general the technical terms of the criminal law are used, and the policy refers specifically to losses by theft. Where this is the case, the words must be construed strictly; they bear the same meaning as in an indictment and the assured cannot recover unless he proves that the particular offence described in the policy has in fact been committed. The policy may be extended to cover acts which are not criminal, such as the wilful default or the negligence of the employee, but it does not cover losses due to a crime in respect of which the employee guilty of any fault, for instance where he is robbed of the money belonging to the assured." 15. The respondent Bank has established that it has sustained loss of more than rupees one lakh on account of the acts of dishonesty and breach of confidence of the employees. 16. The next contention put forward is that the contract of insurance stands vitiated, because the Bank failed to disclose material facts, which have a bearing on the agreement itself. Reference is made to question No. 7 in Ext. B-8, a copy of the questionnaire and the answers given by the bank thereto. Question No. 7 and the answer thereto read: "7. Have you ever sustained a loss or losses? If so, please give short particulars in respect of the post five years. Reference is made to question No. 7 in Ext. B-8, a copy of the questionnaire and the answers given by the bank thereto. Question No. 7 and the answer thereto read: "7. Have you ever sustained a loss or losses? If so, please give short particulars in respect of the post five years. No." According to the appellants there were acts of defalcation by the employees of the bank, previous to the issue of the policy of insurance, as a result of which loss was incurred by the bank. This was a material fact, which had a bearing on the contract of insurance, and the bank was obliged to disclose such loss when it answered the questionnaire. Reference was made in this connection to two suits, O.S. No. 25 of 1961 and O.S. No. 24 of 1961 of the Additional District Court, Parur. Ext. B-2 is the plaint in O.S. No. 25 of 1961. The suit was filed by the bank against one A. P. George, who was the Agent of the Bank at Munnar during the period 23rd January 1960 to 9th February 1961, for realisation of amounts which he misappropriated on the basis of some forged documents. Ext. B-3 is the plaint in O.S. No. 24 of 1961, a suit filed by one A. C. Geevarghese against the bank for realisation of Rs. 54,000 stated to be the amount due under a Short Notice Deposit made by him. The above documents were relied upon to show that there were acts of misfeasance and breach of trust by the employees of the bank, even prior to the issue of the policy, Ext. A-1. According to the company, the bank should have mentioned this fact while answering question No. 7, which, according to the appellant, related to losses sustained by the bank, as a result of the acts of its employees. The bank, on the other hand, would say that question No. 7 was understood by the bank as referring to the losses incurred in the business during the previous five years, and as the bank was not functioning at a loss that question was answered in the negative. The bank, on the other hand, would say that question No. 7 was understood by the bank as referring to the losses incurred in the business during the previous five years, and as the bank was not functioning at a loss that question was answered in the negative. In otherwords, according to the bank, it never understood the question as denoting to losses due to misfeasance or malfeasance by its employees and therefore there was no occasion to make mention of O.S. No. 24 of 1961 and O.S. No. 25 of 1961. There is much weight in the contention of the Bank. Question No. 7 does not specifically refer to defalcation or acts of malfeasance or misfeasance by employees of the bank, and, therefore, in the usual course, the question could be understood to refer only to losses sustained by the bank in the ordinary course of business. 17. The Bank has also an alternate case that even assuming that the question referred to the losses incurred as a result of misfeasance, malfeasance or other acts of dishonesty committed by the employees, no loss has been sustained by it in the transactions in the two suits, since the losses, if any, have been recouped. O.S. No. 25 of 1961 was decreed and the amount thereunder has been realised by the Bank. This in borne out by Exts. A-35 to A-38. As regards O.S. No. 24 of 1961 it was renumbered as O.S. No. 47 of 1967 of the Sub Court, Parur. The case again was the offshoot of defalcation by A. P. George. The suit was decreed by the Sub Court, as is seen from Exts. B-11 and B-12. The decree was on 11th October, 1967, long after the date of Ext. B-8. The bank was contesting the claim of the plaintiff in the case. Hence, judged on the state of affairs prevailing on the date of Ext. B-8, the answer to question No. 7 could not be said to be incorrect. 18. The further question is whether there was an obligation on the part of the bank to disclose cases of defalcation otherwise than in answer to question No. 7 of the questionnaire. Contracts of insurance are contracts uberrima fides and they may be avoided unless there has been a full disclosure of all material facts. 18. The further question is whether there was an obligation on the part of the bank to disclose cases of defalcation otherwise than in answer to question No. 7 of the questionnaire. Contracts of insurance are contracts uberrima fides and they may be avoided unless there has been a full disclosure of all material facts. The law on the point is clearly stated by Lord Mansfield in Carter v. Boehm ( 1766 (3) Burr. 1905, 1909), thus: "Insurance is a contract of speculation. The special facts upon which the contingent chance is to be computed lie most commonly in the knowledge of the assured only; the underwriter trusts to his representation, and proceeds upon confidence that he does not keep back any circumstance, in his knowledge, to mislead the underwriter into a belief that the circumstance does not exist. The keeping back such circumstance is a fraud, and therefore the policy is void. Although the suppression should happen through mistake, without any fraudulent intention, yet still the underwriter is deceived and the policy is void; because the risque run is really different from the risque understood and intended to be run at the time of the agreement." 19. Further elucidation of the law so far as it relates to fidelity bonds is contained in the following passage in Mac Cillivray on Insurance Law - 4th Edn. para 830: "Fidelity bond.- In the case of fidelity bonds taken by an employer on the employment of a servant it is the duty of the employer to make full disclosure to the surety on the bond of any previous defalcations on the part of the employee known to him but unknown to the surety. para 830: "Fidelity bond.- In the case of fidelity bonds taken by an employer on the employment of a servant it is the duty of the employer to make full disclosure to the surety on the bond of any previous defalcations on the part of the employee known to him but unknown to the surety. Thus where an employee had to the employer's knowledge at the time when a fidelity bond was executed been guilty of previous defalcation, it was held that a surety whose signature to the bond had been obtained by the employee and who was ignorant of the previous defalcation was discharged from his obligation under the bond." What are material facts are discussed by the same learned author in para 857 thus: "The fact undisclosed may not have appeared to the insured at the time to be material, and yet if it turn out to be material, and in the opinion of the jury was a fact that a reasonable and cautious man proposing insurance would think material and proper to be disclosed, its non disclosure will constitute such negligence on the part of the insured as to void the contract." 20. Raouh Colinvaux in his Law of Insurance, 4th Edn., page 91 gives a list of facts which according to judicial decisions need not be disclosed by the assured. They are: (i) facts which he does not know. (ii) facts which diminish the risk. (iii) facts within the knowledge of the insurers. (iv) facts of which information is waived by the insurer. (v) facts which it is superfluous to disclose by reason of any express or implied warranty. What is a material fact will vary from case to case. When an employer takes a fidelity bond in respect of a named employee, the fact that the particular employee had on a previous occasion committed acts of misappropriation or breach of trust would be a material fact, which, if known to the employer should be disclosed. But in a case where the policy covers a particular class of employees the fact that an employee of that class had on a previous occasion committed acts of bad faith need not necessarily be a material one if that employee had already been discharged from service prior to the issue of the policy of fidelity insurance. But in a case where the policy covers a particular class of employees the fact that an employee of that class had on a previous occasion committed acts of bad faith need not necessarily be a material one if that employee had already been discharged from service prior to the issue of the policy of fidelity insurance. In the instant case A. P. George was the Agent of Munnar Branch of the Bank only upto 9th February 1961 and thereafter his whereabouts were not known. (See Ext. B2). Therefore, on the date of Ext. A-1 he was not an employee of the Bank or a person whose fidelity stood guaranteed by the policy. The non mention of the acts of misappropriation by A. P. George is not shown to have any relevancy for the purpose of guaranteeing the fidelity of the employees working in the Bank during the period covered by the policy. In other words it has not been proved to be a material fact. 21. There is also another aspect to the matter. We have already held that Question No. 7 in the proposal form did not refer to losses incurred through acts of misfeasance etc., by the employees of the Bank but to the business losses of the concern. The fact that particulars were asked for in respect of the losses of the Bank in general and not of losses on account of negligence or misappropriation by individual employees would also suggest that the company did not treat the latter fact as material. 22. The appellant's further case is that the suit would have been maintainable only after the Bank exhausted its remedies against the firm. It is the admitted case of the parties that a suit, O.S. No. 43 of 1963, filed by the Bank against the firm for recovery of amounts due was pending when the present suit was filed. In its replication the Bank has stated that it is agreeable to have appropriate restrictions put in the matter of the execution of the present decree so as to prevent double benefit to the Bank. The Bank, however, contended that it was not obliged to wait till the actual loss is sustained. 23. The law on the point is well settled. The Bank, however, contended that it was not obliged to wait till the actual loss is sustained. 23. The law on the point is well settled. The fact that it is open to the assured to recover the loss incurred from third parties will not absolve the insurance company of its liability under the policy. It is not incumbent on the assured to exhaust his remedies against third parties before claiming the amount due under the policy of insurance. The assured may receive the amount from the insurer and leave it to the insurer to recover the amount from the concerned third party in exercise of the right of subrogation or he may sue the third party himself and account to the insurer for the amount so received. If the suit filed by the assured is decreed before payment under the policy, the amount so received will be taken into account in fixing the liability of the insurance company. If the payment of the third party is after the receipt of amount under the policy, the assured should pay to the insurer the excess available after satisfying the full amount which the assured is entitled to. The rights of the parties in this case will be worked out on the basis of the above principles when execution of the decree is sought by the Bank. No other point remains to be considered. The appeal, accordingly, fails and is dismissed with costs. An oral application was made for certificate under Art.134A of the Constitution. We are not satisfied that the case involves a substantial question of law of general importance which needs be decided by the Supreme Court. We therefore decline leave.