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October 7, 1991


The opinion of the court was delivered by: Mukasey, District Judge.


Plaintiff, Broadway National Bank ("Broadway") sues its insurer, the Progressive Casualty Insurance Company ("Progressive"), under a Financial Institution Bond (the "Bond"), for losses sustained when credit card sales drafts deposited by a merchant customer proved uncollectible. Progressive contends that recovery is barred by two exclusionary clauses in the Bond. The parties have cross-moved for summary judgment. For the reasons set forth below, plaintiff's motion is denied, and defendant's motion is granted.


In January 1989, Broadway entered into an Associate Agreement ("Agreement") with Chemical Bank, enabling Broadway to process credit card transactions for its merchant customers. Chemical is a member of MasterCard International Incorporated, the network of financial institutions that processes MasterCard and VISA credit card transactions. Under the Agreement, Chemical named Broadway an associate of MasterCard, thereby giving Broadway access to the network through Chemical. (Plaintiff's Rule 3(g) Statement ¶¶ 7-9)

As a member bank, Chemical plays a variety of roles. It issues credit cards, serves as a clearinghouse for credit card transactions, and recruits associate banks to serve as collection agents for credit card sales slips generated by local businesses. (Plaintiff's Rule 3(g) Statement ¶¶ 7-9) An associate bank, such as Broadway, enters into agreements with local merchants — merchants agreements — pursuant to which a merchant agrees to accept certain credit cards in satisfaction of a sale, and the associate agrees to redeem the sales slips either by crediting an account or paying the merchant by check in the amount of the sales slip less a standard discount. (Barton Russell Merchant Agreement ¶¶ 1, 4; Plaintiff's Rule 3(g) Statement ¶ 13)

As set forth in a document entitled the Merchant Bank Program ("Program"), Broadway, as an associate of Chemical, was bound to follow specific procedures in dealing with its merchant customers. The Program specified that on a daily basis, merchants were to place sales slips in a sealed envelope, prepare a summary report, and attach an adding machine tape tallying the enclosed slips. The package would then be mailed or delivered to Broadway, which would reimburse the merchant. Under the terms of the Program, Broadway was entitled to check the merchant's calculations, but could not open the sealed envelope and verify that it contained the slips detailed on the summary report and adding machine tape. (Program pp. 9-12)

After receiving a package of slips from a merchant, it was Broadway's policy to make the amount credited to the merchant's account available for withdrawal after one business day. (Complaint in New York State Action Broadway National Bank v. Barton Russell Corp. ¶ 12) However, it was only after a lengthy procedure that Broadway would learn that some slips were invalid and could not be redeemed: Broadway would send the sealed envelope along with the attached tape and summary report to Chemical for processing. Upon receipt of the slips, Chemical would credit Broadway's maintenance account, and then forward the slips to the network. The network would charge the issuer of the card in the amount of the slip, and the issuer in turn would bill the cardholder, usually by a monthly statement. If the charge was contested, the issuer, on behalf of itself or its cardholder, would remit the charge through the network to Chemical. Without notifying Broadway, Chemical could then send the slip back through the network for reprocessing. If after two attempts at processing, an invalid charge slip was returned unpaid from the network to Chemical, Chemical would then charge back Broadway's service account. That process could take up to six months, and only when it was charged back would Broadway learn that a slip was invalid. Having credited the merchant's account upon receipt of the slips, Broadway would then be left to collect from the merchant in order to avoid a loss on the contested charge. (Cardone Aff. ¶¶ 12-18)

The delay in processing credit card sales slips presents unscrupulous merchants with an opportunity to abuse the system. That opportunity was seized by the officers of the Barton Russell Corporation ("Barton Russell"), an erstwhile merchant customer of Broadway. Barton Russell began its banking relationship with Broadway in November 1987, and began its credit card merchant relationship in January 1988. Ostensibly an art gallery, Barton Russell was in actuality a front for a male escort service. Its business, however, was not limited to the provision of escorts. Through the manipulation of card numbers and authorization codes, Barton Russell employees created numerous fraudulent sales slips which they deposited in the merchant account the corporation maintained at Broadway. Taking advantage of the long lag between the credit to the corporation's account at Broadway and Chemical's notification of Broadway that the slips were fraudulent, they then withdrew the funds before Broadway could act to protect its interests. (Cardone Aff. ¶¶ 19, 20) In its complaint, Broadway alleges that the withdrawals against the fraudulent receipts amounted to $196,065.25, and its loss, after the seizure of Barton Russell funds still on deposit, was $179,479.90.

This dispute arose when Broadway attempted to recover its losses under the Financial Institution Bond it had received from Progressive on July 15, 1988. Broadway notified Progressive of its claim, and a proof of loss was submitted on October 20, 1989. Progressive declined coverage, and this suit was filed on September 28, 1990. (Defendant's Rule 3(g) Statement ¶¶ 33-35) Plaintiff moved for summary judgment, arguing that under the Bond's clear and unambiguous terms it was entitled to recovery. Defendant cross-moved, asserting that under the circumstances of this case, the terms of the Bond exclude coverage of Broadway's claim.


Defendant relies on two exclusionary clauses in the Bond to defeat Broadway's claim. The first excludes from coverage losses that result from the use of various types of credit and charge cards. Referred to as the "Credit Card Exclusion," this provision states:

    This bond does not cover: loss resulting
  directly or indirectly from the use or purported
  use of credit, debit, charge, access, convenience,
  identification, or other cards (1) in obtaining
  credit or funds . . . whether such cards were
  issued, or purport to have been issued, by the
  Insured or by any one other than the Insured.

(Bond § 2(k)) The second clause excludes losses that result from unpaid depository instruments. This clause, which is referred to by the parties as the "Uncollected Funds Exclusion," states:

    This bond does not cover: loss resulting
  directly or indirectly from payments made or
  withdrawals from a depositor's account involving
  items of deposit which are not finally paid for
  any reason, ...

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