Travelers Casualty & Surety Company of America , Inc . v. Northwestern Mutual Life Insurance Company

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 05-4134
T RAVELERS C ASUALTY & S URETY C OMPANY
OF A MERICA , I NC .,
Plaintiff-Appellant,
v.
N ORTHWESTERN M UTUAL L IFE I NSURANCE C OMPANY and
M ERRILL L YNCH , P IERCE , F ENNER & S MITH I NC .,
Defendants-Appellees.
____________
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 03 C 4590—Rebecca R. Pallmeyer, Judge.
____________
A RGUED O CTOBER 16, 2006—D ECIDED M ARCH 13, 2007
____________
Before P OSNER , R IPPLE , and W OOD , Circuit Judges.
P OSNER , Circuit Judge. Kenneth Zahner was the chief
financial officer of a company named Volwood. He wrote
checks on Volwood’s bank account payable to Northwest-
ern Mutual and to Merrill Lynch, but directed North-
western to use the money to buy him a life insurance policy
and Merrill Lynch to deposit the money in his personal
account with Merrill Lynch. Volwood owed no money to
either defendant; nor had it authorized Zahner to transfer

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2 No. 05-4134
these corporate funds to himself. Zahner was embezzling.
He is now in prison.
Travelers, the plaintiff, had insured Volwood against
losses from employee embezzlers. So after receiving the
insurance proceeds from Travelers, Volwood assigned to
it whatever rights Volwood might have to shift the loss
to the defendants on the ground that the defendants had
failed to alert Volwood to the suspicious circumstances of
the deposits. Travelers then filed this suit against the
defendants in the federal district court in Chicago, basing
federal jurisdiction on diversity. The parties agree that the
substantive issues in the case are governed by California
law, and as usual we defer to their choice. Wood v. Mid-
Valley, Inc., 942 F.2d 425, 426-27 (7th Cir. 1991). The district
judge dismissed the claim against Northwestern Mutual
on the ground that the amount in controversy was below
the statutory minimum, since the total amount of the
checks that Zahner had written on Volwood’s account
to Northwestern Mutual had been only $17,000. The
judge dismissed the claim against Merrill Lynch as barred
by the statute of limitations.
If the judge was right about the amount in controversy,
the claim against Northwestern Mutual must indeed be
dismissed for want of federal subject-matter jurisdiction;
it cannot be retained as a supplement to the claim against
Merrill Lynch, because it arises out of a different trans-
action. 28 U.S.C. § 1367(a); Hutchinson ex rel. Baker v.
Spink, 126 F.3d 895, 898, 902 (7th Cir. 1997); Highway
Equipment Co. v. FECO, Ltd., 469 F.3d 1027, 1038-39 (Fed.
Cir. 2006); Kirschner v. Klemons, 225 F.3d 227, 239 (2d Cir.
2000). Travelers argues, however, that the amount in
controversy is not $17,000 but is instead the present value
of a $700,000 life insurance policy (actually two policies,

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No. 05-4134 3
but we’ll suppress that irrelevant detail) that Zahner
bought from Northwestern Mutual with the money that
he had embezzled from Volwood.
Zahner didn’t actually want life insurance. He wanted
cash. Two years after obtaining the life insurance policy,
he surrendered it to Northwestern Mutual in exchange
for its cash surrender value, some $13,000. So not only
was the loss to Volwood from Zahner’s embezzlement of
the company’s account with Northwestern Mutual a
meager $17,000, but the gain to Northwestern Mutual was
even smaller ($4,000—the $17,000 in premium payments
that it received from Volwood minus the almost $13,000
that it paid Zahner when he surrendered the policy).
Travelers seeks, however, to impress a constructive trust on
the policy in its favor as Volwood’s assignee, on the ground
that it is the beneficial owner of the policy. “Constructive
trust” is legalese for seeking to wrest ownership of a
thing from its nominal owner, which is to say the holder
of legal title. It is not a real trust; in law, “constructive”
often and here means “fictional.”
Now it is far from certain, and indeed unlikely, that the
present value of a $700,000 policy of insurance on the life
of a man age 44 (as Zahner now is) exceeds $75,000. In a
competitive market, one expects the cost of a future bene-
fit to be the actuarial equivalent of that benefit: $17,000
would thus be the present value of the insurance policy.
No doubt the assumption can be challenged. The life
expectancy of a 44-year-old American male is 33.7 years,
and the present value of $700,000 to be received that
far hence is $28,000 at a discount rate of 10 percent.
Well, that is still a good deal less than $75,000. But 10
percent is a guess; we do not know what discount rate
would be appropriate; at a rate of 5 percent, the present

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4 No. 05-4134
value of a $700,000 insurance policy leaps to almost
$140,000—though that would raise acutely the question
why the insurance company would accept $17,000 to confer
such a benefit. But maybe the insurance company has
a higher discount rate than an individual insured.
Still another complication is that $17,000 was just the
amount of premiums that Zahner paid during the first
two years of the insurance policy. Travelers would have
to keep paying premiums to keep the policy in force, and
that would reduce the policy’s net present value. But
maybe Travelers hopes somehow to force Zahner to pay
the premiums, and perhaps even reimburse it for the
$17,000.
All this is a great muddle. But since satisfaction of the
jurisdictional minimum in the diversity statute requires
merely that the plaintiff have a colorable, which is to say a
nonneglible, prospect of being able to recover that amount
in a trial, e.g., Freeman v. Sports Car Club of America, Inc.,
51 F.3d 1358, 1362 (7th Cir. 1995), we shall give Travelers
the benefit of the doubt and assume, though with con-
siderable reluctance, that if it does have a constructive
trust in the insurance policy, it has satisfied the amount
in controversy requirement. That is a giant if. But it is
important to keep jurisdictional issues separate from the
merits of a plaintiff’s claim. Otherwise, suits that lacked
merit would be dismissed on jurisdictional grounds,
allowing the plaintiff to start over in state court. Johnson
v. Wattenbarger, 361 F.3d 991, 992-94 (7th Cir. 2004).
Remember that Travelers’ (that is to say Volwood’s) loss
as a result of Northwestern Mutual’s alleged negligence in
failing to prevent Zahner’s embezzlements was only
$17,000. And while a tort victim can seek restitution of the
defendant’s gain as an alternative to seeking damages for

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No. 05-4134 5
his own loss, on the theory that making the wrongdoer’s
wrongful conduct worthless to him is a good method of
deterring such conduct, e.g., In re African-American Slave
Descendants Litigation, 471 F.3d 754, 760 (7th Cir. 2006);
Williams Electronics Games, Inc. v. Garrity, 366 F.3d 569,
576 (7th Cir. 2004); Douglas Laycock, “The Scope and
Significance of Restitution,” 67 Tex. L. Rev. 1277, 1288-90
(1989), Northwestern Mutual’s net gain was, as we know,
even less.
The meagerness of both Travelers’ loss and Northwestern
Mutual’s gain is the reason Travelers is trying to get its
hands on the $700,000 life insurance policy that North-
western Mutual issued to Zahner; more precisely, to force
Northwestern Mutual to issue an identical policy on
Zahner’s life to Travelers. The imposition of a constructive
trust is a standard equitable remedy in restitution cases,
Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204,
212-14 (2002), but it requires the plaintiff to trace property
that is rightfully his to the defendant. A life insurance
policy is property, but there is no life insurance policy on
which to impress a constructive trust in this case because
Zahner, the owner of the policy, surrendered it in ex-
change for cash. And while when a defendant takes
property that is rightfully the plaintiff’s and then sells it the
plaintiff can seek to impress a constructive trust on the
proceeds, United States v. Pegg, 782 F.2d 1498, 1500 n. 2 (9th
Cir. 1986) (California law); 1 Dan B. Dobbs, Dobbs Law of
Remedies § 4.3(2), pp. 589-90 (2d ed. 1993), the proceeds
here were a meager $4,000—way less than Travelers’ loss.
A constructive trust of the proceeds would yield Travelers
less than its damages remedy would.
Anyway Travelers could not be the beneficiary of a
policy on Zahner’s life, even if there were such a policy,

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6 No. 05-4134
because it has no insurable interest in that life. “A man
cannot take out insurance on the life of a total stranger,
nor on that of one who is not so connected with him as
to make the continuance of the life a matter of some real
interest to him.” Connecticut Mutual Life Ins. Co. v. Schaefer,
94 U.S. 457, 460 (1877); see also Mortenson v. National Union
Fire Ins. Co., 249 F.3d 667, 672 (7th Cir. 2001); Harley-
Davidson v. Minstar, Inc., 41 F.3d 341, 343 (7th Cir. 1994);
Herman v. Provident Mutual Life Ins. Co., 886 F.2d 529, 533
(2d Cir. 1989). “A contract of insurance upon a life in
which the insured has no interest is a pure wager that
gives the insured a sinister counter interest in having the
life come to an end.” Grigsby v. Russell, 222 U.S. 149, 154
(1911) (Holmes, J.).
But as Holmes went on to explain, this rule does not
preclude an insured from voluntarily assigning the policy:
“The danger that might arise from a general license to all
to insure whom they like does not exist. Obviously it is a
very different thing from granting such a general license,
to allow the holder of a valid insurance upon his own life
to transfer it to one whom he, the party most concerned, is
not afraid to trust.” Id. at 155. Such assignments are
common. We learn from a recent newspaper article that
“two years ago, Mr. Margolis bought a large life insurance
policy. Now, he’s considering selling it to a group of
investors, a deal that should give him as much as $2
million to enjoy in his final years. In return, the investors
will get the policy’s $7 million payout when he
dies—which they hope will be soon, so they can stop
paying his premiums . . . . Such policies are known as
speculator-initiated life insurance, or ‘spin-life’ policies.
Investors estimate that spin-life policies worth as much as
$13 billion will change hands next year.” Charles Duhigg,
“Late in Life: Finding a Bonanza in Life Insurance,” N.Y.

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No. 05-4134 7
Times, Dec. 17, 2006, p. 1. Travelers, however, is asking that
Northwestern Mutual be compelled to issue it a policy on
Zahner’s life even though Travelers has no insurable
interest in Zahner and Zahner has not consented to hav-
ing his life insured for the benefit of Travelers.
There is still more that is wrong with Travelers’ claim for
a constructive trust in the insurance policy. The imposition
of a constructive trust is, as we said, a device for obtain-
ing restitution. And restitution is available only in cases
in which the defendant’s wrong has enabled the defend-
ant to profit at the plaintiff’s expense. See, e.g., Cross v. Berg
Lumber Co., 7 P.3d 922, 935-36 (Wyo. 2000); Warren v.
Century Bankcorporation, Inc., 741 P.2d 846, 851-52 (Okla.
1987); Nelson v. Serwold, 687 F.2d 278, 281 (9th Cir. 1982);
1 Dobbs, supra, § 4.1(1), p. 555. That is why restitution is
not awarded in a run-of-the-mill accident case; in such a
case the defendant’s wrong confers no benefit on him. See
Restatement of Restitution, ch. 7, introductory note (1937).
Northwestern Mutual’s alleged wrong did not result in
Northwestern Mutual’s obtaining an insurance policy. It
resulted in its obtaining $4,000. Since the present value
of a $700,000 insurance policy on Zahner’s life is more
than $4,000, imposing a constructive trust in such a policy
in favor of Travelers (the only relief it seeks) would
give Travelers a benefit greater than Northwestern Mu-
tual’s wrongful gain.
So Travelers’ claim against Northwestern Mutual fails,
and we move on to its claim against Merrill Lynch. The
claim is that Merrill Lynch was negligent, and, worse,
violated its fiduciary duty to Volwood, by allowing
Zahner to deposit a check issued by Volwood to Merrill
Lynch in Zahner’s personal account. Section 3-307 of the
Uniform Commercial Code, in force in California, makes
any taker of a negotiable instrument (such as a check)—and

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8 No. 05-4134
thus Merrill Lynch—liable to the drawer of the instrument
if the taker knows that the instrument is signed by a
fiduciary of the drawer (an agent, as Zahner clearly
was) yet it is deposited in the fiduciary’s personal account
rather than in his principal’s account.
Travelers might well have a good claim (cf. Travelers
Casualty & Surety Co v. Wells Fargo Bank N.A., 374 F.3d 521,
525-26 (7th Cir. 2004)) were it not for the statute of limita-
tions for suits under section 3-307, which is three years.
UCC § 3-118(g). The last transfer from Volwood’s bank
account to Zahner’s account with Merrill Lynch was
made in 1998; the suit was not filed until 2003. But Travel-
ers contends that Volwood did not discover the fraud
until 2001, and in the present posture of the case we
must assume that the contention is true.
Merrill Lynch ripostes that a claim under section 3-307
accrues when the fraud is complete, not when it is discov-
ered, because section 3-118(g) does not mention discovery.
But courts often graft a discovery rule onto a statute of
limitations that does not mention discovery. E.g., Field v.
Century 21 Klowden-Forness Realty, 63 Cal. App. 4th 18,
25 (1998); Strasberg v. Odyssey Group, Inc., 51 Cal. App. 4th
906, 915-16 (1996); Hopkins v. Dow Corning Corp., 33 F.3d
1116, 1120 (9th Cir. 1994) (California law); Fidelity National
Title Ins. Co. v. Howard Savings Bank, 436 F.3d 836, 839-
40 (7th Cir. 2006). The Uniform Commercial Code is not
self-contained. It was promulgated against an ever-chang-
ing background of common law principles on which
judges draw to complete the law’s edifice. The Code itself
states that “unless displaced by the particular provisions
of the [Code], the principles of law and equity, including
the law merchant and the law relative to capacity to
contract, principal and agent, estoppel, fraud, misrepresen-

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No. 05-4134 9
tation, duress, coercion, mistake, bankruptcy, or other
validating or invalidating cause shall supplement its
provisions.” UCC § 1-103(b); see California Commercial
Code § 1103(b); Roy Supply, Inc. v. Wells Fargo Bank, 39 Cal.
App. 4th 1051, 1058 (1995) (“the general law applies
when a case is not covered by statute”). If a discovery
rule is a sensible graft onto section 3-118(g), either gener-
ally or with respect to claims under section 3-307, grafted
it will be.
In favor of the graft is that a plaintiff can hardly prepare
and file a suit if he doesn’t know he’s been injured. Against
the graft in a case such as this is the length of the stat-
utory period and the fact that the kind of injury that
Volwood sustained occurs in an information-rich environ-
ment, as the weapon that inflicted an injury was the
victim’s own check. There is the additional fact that
tolling doctrines—principally equitable tolling and equita-
ble estoppel—enable a plaintiff to extend the statute of
limitations in exigent circumstances. The decisive con-
sideration is that someone who fails to discover within
the statutory period that his property has been stolen has
only himself to blame for the belatedness of his discovery.
So we are not surprised that the overwhelming majority
of cases reject a discovery rule for conversion of a negotia-
ble instrument. E.g., Pero’s Steak & Spaghetti House v.
Lee, 90 S.W.3d 614, 616, 620-24 (Tenn. 2002); Menichini v.
Grant, 995 F.2d 1224, 1229-30 (3d Cir. 1993); Haddad’s of
Illinois, Inc. v. Credit Union 1 Credit Union, 678 N.E.2d 322,
325-26 (Ill. App. 1997).
In any event the rule would not help Travelers. A
discovery rule postpones accrual not to when the claim is
discovered, but only to when the claim should have been
discovered. Fox v. Ethicon Endo-Surgery, Inc., 110 P.3d 914,

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10 No. 05-4134
919-20 (Cal. 2005); McKelvey v. Boeing North American, Inc.,
74 Cal. App. 4th 151, 160 (1999); Borello v. United States Oil
Co., 388 N.W.2d 140,145-46 (Wis. 1986); Barry Aviation Inc.
v. Land O’Lakes Municipal Airport Commission, 377 F.3d 682,
688 (7th Cir. 2004); Restatement (Second) of Torts § 899,
comment e (1977). Volwood should have discovered the
embezzlement long before 2001. Elementary controls over
employees, such as Zahner, who have check-writing
authority would have matched the checks he wrote on
Volwood’s bank account to Northwestern Mutual and
Merrill Lynch with debts that Volwood owed those com-
panies, and quickly revealed that there were no debts,
so that the money was either being pocketed by the two
payees by mistake or had been diverted into someone
else’s pocket. Cf. UCC § 4-406(c) (duty of bank’s customer
to be reasonably prompt in notifying bank of any discrep-
ancy between the bank’s statement and the customer’s
records—a provision inapplicable to this case because
Volwood was not a customer of Merrill Lynch). Volwood
was of course responsible for the laxness of its employees
who failed to notice the defalcation. Sun’n Sand, Inc. v.
United California Bank, 582 P.2d 920, 941 (Cal. 1978).
Such laxness is a general feature of cases in which the
victim of conversion tries to sue after the statute of limita-
tions (dated from the conversion) has run, and it makes
us wonder whether the cases we cited earlier reject, or
exemplify, the discovery rule. We need not pursue that
issue.
Travelers also tries to get out from under the statute of
limitations in section 3-118(g) by recharacterizing its
claim against Merrill Lynch as something other than a
claim under section 3-307, such as a common law fraud
claim. Since section 3-307 fits the facts of the case to a T, no

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No. 05-4134 11
room is left for recharacterizations intended to circum-
vent the statute of limitations applicable to such claims. It
is one thing to fill gaps in the Uniform Commercial Code
and another to contradict it by calling a UCC claim some-
thing else. Lee Newman, M.D., Inc. v. Wells Fargo Bank, 87
Cal. App. 4th 73, 79-80 (2001); Stenseth v. Wells Fargo Bank,
41 Cal. App. 4th 457, 465-66 (1995); United Catholic Parish
Schools v. Card Services Center, 636 N.W.2d 206, 213 (Wis.
App. 2001); A. Brooke Overby, “Check Fraud in the Courts
After the Revisions to U.C.C. Articles 3 and 4,” 57 Ala. L.
Rev. 351, 391-92 (2005).
The judgment of the district court is modified to make
the dismissal of the plaintiff’s claim against Northwestern
Mutual a dismissal on the merits rather than for want of
federal jurisdiction, and as so modified is
A FFIRMED .
R IPPLE , Circuit Judge, concurring in the judgment. In
my view, the district court correctly dismissed the case
against Northwestern for lack of jurisdiction. In all other
respects, I agree with the disposition reached by my
colleagues.

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12 No. 05-4134
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—3-13-07

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