April 5, 2006
What You See Is Not What You Get: Renewal Policies
One aspect of insurance practice that I like is the seemingly unlimited number of nooks and crannies in insurance law. But like a tree falling in the forest, the existence of one pro-policyholder rule or another in a given state has little impact on human behavior -- or trial outcomes -- unless that rule is called upon. One such rule is the "renewal rule."
When a policyholder renews an insurance policy with its carrier, the insurer must provide prior notice to the insured if it intends to reduce coverage under the newly issued policy. In one of my cases, a corporate client had purchased a primary-layer CGL policy from one insurer in 1969, renewed it in 1970, and then renewed it again. The sudden-and-accidental pollution exclusion was introduced in early 1970 (see Mayerson, Affording Coverage for Gradual Property Damage Under Standard Liability Insurance Policies: A History, 8 Coverage 3 (Sept./Oct. 1998)), so for the final policy the insurer issued its then-standard CGL form and stapled to it the pollution exclusion. The question presented was whether the pollution exclusion in this last policy -- which had been provided to the policyholder, a large multinational chemical company -- was to be given effect.
For a first policy with an insured, the insurer does not have the same duty to point out a limitation on the coverage. Generally speaking, insureds are charged with knowledge of the content of their insurance policies, even if it is undisputed that the insured never actually read the policy at the time it was issued. See generally Western World Ins. Co. v. Stack Oil. Co., 922 F.2d 118, 122 (2d Cir. 1990); Metzger v. Aetna Ins. Co.,, 125 N.E. 814, 816 (N.Y. 1920). (By the way, did you read the insurance policy issued to you before completing the purchase?) But this general rule that insureds are charged with knowledge of the terms of their policies does not overcome the application of the more particular rule regarding renewal of insurance policies. If this were not so, then the well-established notice-of-reduction rule would be without effect. See Davis v. USAA, 273 Cal. Rptr .224, 227 (1990); Magness Constr. Co. v. Ohio Farmers Ins. Co., 261 A.2d 537, 539 (Del. Super. 1969); Walton v. Sterling Fire Ins. Co., 197 N.Y.S.2d 277, 280 (N.Y. App. 1960) ("Implicit in such renewal is that the terms of the existing policy are to be contained in he absence of a contrary intention.").
The renewal rule is not a matter of reformation, see 91 ALR 2d 546, 549 & n.10, or fraud in the factum, and is not subject to a contractual limitations period. The insured may defend against the effort to enforce a coverage-reduction in a renewal policy without pleading and proving the elements of reformation; instead, the (purported) coverage reduction is of no effect. The insurer must prove that in renewal it gave notice before the policy took effect of the desired coverage restriction (and it is not enough for the insurer to send along a notice enclosed with a copy of the renewal -- the insured must be given the opportunity ex ante to object to its inclusion, negotiate its elimination, or take its business elsewhere).
Insureds are under no obligation to disabuse the carrier of a belief that its limitation or exclusion was effective. There is no authority of which I am aware that holds that, when a carrier attempts to reduce coverage in a renewal policy without notice, the insured can be prevented from objecting to enforcement of the unauthorized reduction. Otherwise, an insured would be required to be forever vigilant, guarding against the risk that its carrier might slip an unannounced new exclusion into the renewed policy.
In the case I handled mentioned above, we were litigating the question more than two decades later (the 20-year-old policy nevertheless having been triggered), and no peep was ever made by the insured or its broker at the time. No matter, though. Neither contemporaneous objection nor (detrimental) reliance by the insured is an element of this legal doctrine. In my case, because in the renewal process the insurer did not provide specific advance notice of the reduction in coverage the court had little trouble in concluding that the exclusion -- physically a part of the policy -- was of no legal effect.
Given the state of the law, the outcome we obtained was hardly surprising (to me at least, I'm not so sure about how the insurer thought about it). A more difficult question was presented in a Sixth Circuit case decided in 2003 where a follow-form excess insurer sought to rely on a coverage restriction that was included in the underlying policy, which in turn was a renewal. See Amway Distributors Benefits Ass'n v. Northfield Ins. Co. (6th Cir. 2003). By way of definition, a following-form insurer issues a couple-page policy that principally adopts the terms of the underlying wording and incorporates it as its own. Coca-Cola Bottling Co. v. Columbia Cas. Ins. Co., 11 CA 4th 1176,1182-83, 14 Cal. Rptr. 2d 643, 647 (1992) ("Following form policies 'are typically written on the same terms and conditions as the coverage provided by the underlying primary coverage. They are generally short, consisting of one or two pages, with an endorsement or provision that incorporates by reference the underlying policy coverages, except for the premium, the liability limits, and the obligation to investigate, defend, or pay costs of defense'."); Monsanto Co. v. American Centennial Ins. Co., 1991 WL 35714 (Del. Super. Ct. Feb. 20, 1991); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 828 (9th Cir. 1988); following-form carriers may add additional terms and coverage restrictions per other endorsements in the policies they issue. See Home Ins. Co. v. American Home Products, 902 F.2d 1111, 1113 (2d Cir. 1990).
In Amway, here's how the court framed the dispute:
The real question, then, is whether an excess carrier . . . is bound as a matter of law by the underlying carrier's failure to comply with the renewal rule. We believe that the answer is "yes," because the "follow form" linkage between an excess insurer and the primary insurer should logically apply to procedural as well as substantive obligations to their common insured. In effect, an excess insurer who lives by the sword must die by the sword.
Id. The majority rejected the insurer's implicit argument that the insured's position was really the invention of its lawyers and that the coverage -- which would otherwise be barred for the particular claims being fought over -- were not all that important to the insured at the time it bought the policy. Seeming to the relish being confronted with this unusual insurance-law rule, the court states:
This type of extra-contractual argument, if successful, would require those purchasing insurance to affirmatively validate the importance of each and every coverage purchased. We find no authority supporting such an obligation. Furthermore, we suspect that any such obligation would turn the world of insurance upside down, since one has to be either super-diligent or a masochist to read an insurance policy with a fine-toothed comb.
Id. Furthermore, the Sixth Circuit rejected the argument that the presence of a broker as an intermediary on behalf of the insured negates application of the renewal rule. See id. (Kennedy, J., dissenting) ("Where brokers are involved in negotiating the terms of the policy, the rationale for a 'renewal rule' such as Michigan's is diminished, since there would be less need to protect unknowing insureds from the passive misrepresentations of their insurers."). The rejection of the insurer's argument that the renewal rule does not apply if a broker is involved means that just because the insured and its agents are "sophisticated" or possess "bargaining power" does not negative application of the rule, nor is it relevant that the brokers may know (as in the case I handled) that the new exclusionary language was "in the air" as it were, being discussed in trade publications, speeches, industry-form-drafting-organization [now, ISO] press releases, and other vectors of inculcation.
Both the majority and the dissent agreed further that, if an excess insurer was to be bound by the misdeeds of the primary that failed to provide notice of the reduction in coverage, the excess insurer would have recourse against the primary. As the court explained,
This triangular relationship between the primary insurer, the excess insurer, and the insured presents the classic problem of which one of the two relatively "innocent" parties must suffer when the "wrongdoer" causes a loss. IN the present situation, we believe that . . . the excess insurer ] was in a much better position than the insureds to analyze unannounced changes in the underlying policy that it had agreed to follow. As between [the excess insurer] and the insureds, therefore, [the excess insurer] should be bound to provide the greater coverage and be the one to seek indemnity back against the [primary].
This assumption -- which serves as what I tend to call an existential escape valve for the court -- may not be so straightforward; the question whether a primary insurer owes any legal duties directly to excess insurers and the theory under which such a claim is pursued is highly controverted, with much of the judicial commentary falling into obiter dicta rather than ratio decidendi. The nature of the duty and its limits may not be so clear. E.g., Continental Casualty Co. v. Reserve Ins. Co., 307 Minn. 5,10 239 N.W. 2d 862,865 (1976); Certain Underwriters at Lloyd's v. The Fidelity and Casualty Ins. Co. of N.Y., 4 F.3d 541, 547 (7th Cir. 1993). One can imagine such an action being pursued as an equitable contribution or indemnity claim by the excess insurer, but I have not puzzled through how that outcome would be resolved in a well-presented case by both sides. (In turn, the tagged excess or primary might make an claim under its insurance company professional-liability or errors-and-omissions (E&O) coverage or its reinsurance under, in particular, a follow-the-fortunes clause (and then be greeted with negligent underwriting claims as in Bonner v. Cox., known as the Aon 77 case).)
The focus here, of course, from the perspective of the policyholder lawyer, is the renewal doctrine, or the rule that in renewal policies that coverage restrictions are not effective if the insured had no prior notice from the insurer itself of their inclusion. In the case I handled, a chemical company presented with a standard-form CGL policy in 1970 that had a pollution exclusion included. That exclusion was "accepted" by the broker and the insured without objection -- no one ever pointed out any error or confusion about the terms of the coverage. Yet, two different courts looked at the same facts (why two courts is a different story) and each concluded independently that the renewal rule unquestionably applied, and so a primary policy with defense (in additional to limits) coverage was found to apply to several major environmental-liability, site clean-up, natural-resources damages, and toxic-tort administrative and court proceedings, liabilities the carrier would have skated out of (it claimed) if this particular exclusion applied. What we saw -- what both sides saw -- in the file as the actual, bona fide copy of the policy was indeed what we ended up with -- sans an outcome-determinative exclusion.
While the notice-of-reduction-in-a-renewal-policy rule is a favorable one that policyholders should press when presenting or litigating claims against their insurance company, it cannot do so unless the policyholder's counsel is aware of this particular rule; if not, then the insured's lawyer better be an insured lawyer.
Tags: Insurance, Blawg, Renewal Policy, Reduction in Renewal Policy, New Exclusions, Insurance Litigation, Insurance Coverage, Policyholder Lawyer
Posted by Marc Mayerson at 12:11 AM | Comments (3) | TrackBack
What You See Is Not What You Get: Renewal Policies
One aspect of insurance practice that I like is the seemingly unlimited number of nooks and crannies in insurance law. But like a tree falling in the forest, the existence of one pro-policyholder rule or another in a given state has little impact on human behavior -- or trial outcomes -- unless that rule is called upon. One such rule is the "renewal rule."
When a policyholder renews an insurance policy with its carrier, the insurer must provide prior notice to the insured if it intends to reduce coverage under the newly issued policy. In one of my cases, a corporate client had purchased a primary-layer CGL policy from one insurer in 1969, renewed it in 1970, and then renewed it again. The sudden-and-accidental pollution exclusion was introduced in early 1970 (see Mayerson, Affording Coverage for Gradual Property Damage Under Standard Liability Insurance Policies: A History, 8 Coverage 3 (Sept./Oct. 1998)), so for the final policy the insurer issued its then-standard CGL form and stapled to it the pollution exclusion. The question presented was whether the pollution exclusion in this last policy -- which had been provided to the policyholder, a large multinational chemical company -- was to be given effect.
For a first policy with an insured, the insurer does not have the same duty to point out a limitation on the coverage. Generally speaking, insureds are charged with knowledge of the content of their insurance policies, even if it is undisputed that the insured never actually read the policy at the time it was issued. See generally Western World Ins. Co. v. Stack Oil. Co., 922 F.2d 118, 122 (2d Cir. 1990); Metzger v. Aetna Ins. Co.,, 125 N.E. 814, 816 (N.Y. 1920). (By the way, did you read the insurance policy issued to you before completing the purchase?) But this general rule that insureds are charged with knowledge of the terms of their policies does not overcome the application of the more particular rule regarding renewal of insurance policies. If this were not so, then the well-established notice-of-reduction rule would be without effect. See Davis v. USAA, 273 Cal. Rptr .224, 227 (1990); Magness Constr. Co. v. Ohio Farmers Ins. Co., 261 A.2d 537, 539 (Del. Super. 1969); Walton v. Sterling Fire Ins. Co., 197 N.Y.S.2d 277, 280 (N.Y. App. 1960) ("Implicit in such renewal is that the terms of the existing policy are to be contained in he absence of a contrary intention.").
The renewal rule is not a matter of reformation, see 91 ALR 2d 546, 549 & n.10, or fraud in the factum, and is not subject to a contractual limitations period. The insured may defend against the effort to enforce a coverage-reduction in a renewal policy without pleading and proving the elements of reformation; instead, the (purported) coverage reduction is of no effect. The insurer must prove that in renewal it gave notice before the policy took effect of the desired coverage restriction (and it is not enough for the insurer to send along a notice enclosed with a copy of the renewal -- the insured must be given the opportunity ex ante to object to its inclusion, negotiate its elimination, or take its business elsewhere).
Insureds are under no obligation to disabuse the carrier of a belief that its limitation or exclusion was effective. There is no authority of which I am aware that holds that, when a carrier attempts to reduce coverage in a renewal policy without notice, the insured can be prevented from objecting to enforcement of the unauthorized reduction. Otherwise, an insured would be required to be forever vigilant, guarding against the risk that its carrier might slip an unannounced new exclusion into the renewed policy.
In the case I handled mentioned above, we were litigating the question more than two decades later (the 20-year-old policy nevertheless having been triggered), and no peep was ever made by the insured or its broker at the time. No matter, though. Neither contemporaneous objection nor (detrimental) reliance by the insured is an element of this legal doctrine. In my case, because in the renewal process the insurer did not provide specific advance notice of the reduction in coverage the court had little trouble in concluding that the exclusion -- physically a part of the policy -- was of no legal effect.
Given the state of the law, the outcome we obtained was hardly surprising (to me at least, I'm not so sure about how the insurer thought about it). A more difficult question was presented in a Sixth Circuit case decided in 2003 where a follow-form excess insurer sought to rely on a coverage restriction that was included in the underlying policy, which in turn was a renewal. See Amway Distributors Benefits Ass'n v. Northfield Ins. Co. (6th Cir. 2003). By way of definition, a following-form insurer issues a couple-page policy that principally adopts the terms of the underlying wording and incorporates it as its own. Coca-Cola Bottling Co. v. Columbia Cas. Ins. Co., 11 CA 4th 1176,1182-83, 14 Cal. Rptr. 2d 643, 647 (1992) ("Following form policies 'are typically written on the same terms and conditions as the coverage provided by the underlying primary coverage. They are generally short, consisting of one or two pages, with an endorsement or provision that incorporates by reference the underlying policy coverages, except for the premium, the liability limits, and the obligation to investigate, defend, or pay costs of defense'."); Monsanto Co. v. American Centennial Ins. Co., 1991 WL 35714 (Del. Super. Ct. Feb. 20, 1991); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 828 (9th Cir. 1988); following-form carriers may add additional terms and coverage restrictions per other endorsements in the policies they issue. See Home Ins. Co. v. American Home Products, 902 F.2d 1111, 1113 (2d Cir. 1990).
In Amway, here's how the court framed the dispute:
The real question, then, is whether an excess carrier . . . is bound as a matter of law by the underlying carrier's failure to comply with the renewal rule. We believe that the answer is "yes," because the "follow form" linkage between an excess insurer and the primary insurer should logically apply to procedural as well as substantive obligations to their common insured. In effect, an excess insurer who lives by the sword must die by the sword.
Id. The majority rejected the insurer's implicit argument that the insured's position was really the invention of its lawyers and that the coverage -- which would otherwise be barred for the particular claims being fought over -- were not all that important to the insured at the time it bought the policy. Seeming to the relish being confronted with this unusual insurance-law rule, the court states:
This type of extra-contractual argument, if successful, would require those purchasing insurance to affirmatively validate the importance of each and every coverage purchased. We find no authority supporting such an obligation. Furthermore, we suspect that any such obligation would turn the world of insurance upside down, since one has to be either super-diligent or a masochist to read an insurance policy with a fine-toothed comb.
Id. Furthermore, the Sixth Circuit rejected the argument that the presence of a broker as an intermediary on behalf of the insured negates application of the renewal rule. See id. (Kennedy, J., dissenting) ("Where brokers are involved in negotiating the terms of the policy, the rationale for a 'renewal rule' such as Michigan's is diminished, since there would be less need to protect unknowing insureds from the passive misrepresentations of their insurers."). The rejection of the insurer's argument that the renewal rule does not apply if a broker is involved means that just because the insured and its agents are "sophisticated" or possess "bargaining power" does not negative application of the rule, nor is it relevant that the brokers may know (as in the case I handled) that the new exclusionary language was "in the air" as it were, being discussed in trade publications, speeches, industry-form-drafting-organization [now, ISO] press releases, and other vectors of inculcation.
Both the majority and the dissent agreed further that, if an excess insurer was to be bound by the misdeeds of the primary that failed to provide notice of the reduction in coverage, the excess insurer would have recourse against the primary. As the court explained,
This triangular relationship between the primary insurer, the excess insurer, and the insured presents the classic problem of which one of the two relatively "innocent" parties must suffer when the "wrongdoer" causes a loss. IN the present situation, we believe that . . . the excess insurer ] was in a much better position than the insureds to analyze unannounced changes in the underlying policy that it had agreed to follow. As between [the excess insurer] and the insureds, therefore, [the excess insurer] should be bound to provide the greater coverage and be the one to seek indemnity back against the [primary].
This assumption -- which serves as what I tend to call an existential escape valve for the court -- may not be so straightforward; the question whether a primary insurer owes any legal duties directly to excess insurers and the theory under which such a claim is pursued is highly controverted, with much of the judicial commentary falling into obiter dicta rather than ratio decidendi. The nature of the duty and its limits may not be so clear. E.g., Continental Casualty Co. v. Reserve Ins. Co., 307 Minn. 5,10 239 N.W. 2d 862,865 (1976); Certain Underwriters at Lloyd's v. The Fidelity and Casualty Ins. Co. of N.Y., 4 F.3d 541, 547 (7th Cir. 1993). One can imagine such an action being pursued as an equitable contribution or indemnity claim by the excess insurer, but I have not puzzled through how that outcome would be resolved in a well-presented case by both sides. (In turn, the tagged excess or primary might make an claim under its insurance company professional-liability or errors-and-omissions (E&O) coverage or its reinsurance under, in particular, a follow-the-fortunes clause (and then be greeted with negligent underwriting claims as in Bonner v. Cox., known as the Aon 77 case).)
The focus here, of course, from the perspective of the policyholder lawyer, is the renewal doctrine, or the rule that in renewal policies that coverage restrictions are not effective if the insured had no prior notice from the insurer itself of their inclusion. In the case I handled, a chemical company presented with a standard-form CGL policy in 1970 that had a pollution exclusion included. That exclusion was "accepted" by the broker and the insured without objection -- no one ever pointed out any error or confusion about the terms of the coverage. Yet, two different courts looked at the same facts (why two courts is a different story) and each concluded independently that the renewal rule unquestionably applied, and so a primary policy with defense (in additional to limits) coverage was found to apply to several major environmental-liability, site clean-up, natural-resources damages, and toxic-tort administrative and court proceedings, liabilities the carrier would have skated out of (it claimed) if this particular exclusion applied. What we saw -- what both sides saw -- in the file as the actual, bona fide copy of the policy was indeed what we ended up with -- sans an outcome-determinative exclusion.
While the notice-of-reduction-in-a-renewal-policy rule is a favorable one that policyholders should press when presenting or litigating claims against their insurance company, it cannot do so unless the policyholder's counsel is aware of this particular rule; if not, then the insured's lawyer better be an insured lawyer.
Tags: Insurance, Blawg, Renewal Policy, Reduction in Renewal Policy, New Exclusions, Insurance Litigation, Insurance Coverage, Policyholder Lawyer
Posted by Marc Mayerson at 12:11 AM | Comments (3) | TrackBack
June 29, 2005
It’s a Crime: Efforts to Constrict the Broad Scope of Fidelity Insurance Coverage
Companies purchase fidelity-insurance policies to cover them against the risk of loss from employee dishonesty. Fidelity coverage generally is divided into two types: financial fidelity, which covers banks and other financial institutions, and commercial fidelity (or commercial crime coverage), which covers other types of businesses. On the financial-fidelity side, there is significant standardization of policy forms; on commercial fidelity, though the policy language often springs from the Surety Association of America or the Insurance Services Office, there is less standardization in the wordings.
Generally speaking, two key issues are presented in any commercial fidelity claim: is the misconduct covered and, if so, how much does the policy pay for. The first question typically involves whether the employee acted with “manifest intent” to benefit himself (or someone else) and to harm its employer. The manifest-intent concept was introduced in 1976 and has spawned 30 years of litigation (and increasingly the manifest-intent concept is being abandoned by policy drafters). Less attention has been paid to the scope of the indemnification provided insureds for the “Loss of Money, Securities or other property.” The case, Building One Services Solutions, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, Civil No. 02-311-A (E.D. Va. Nov. 26, 2002), available at 7-24 Mealey’s Emerg. Ins. Disp. § C (Dec. 17, 2002) (on LEXIS), addresses both issues (I note that I was lead counsel in this case).
The Building One case involved a manager of a subsidiary who essentially highjacked it for the personal enrichment of himself and his cronies. A key aspect of the operation was to have the parent company pay for costs and expenses through regular requisitions from the subsidiary. Unbeknownst to the parent company, the subsidiary submitted requisitions for fabricated expenses and previously paid expenses. Payments for the fabricated expenses and false charges were remitted to dummy corporations controlled by the manager or his associates. (In this way, the money was siphoned out of the company.) Cf. Hanson PLC v. National Union, 794 P.2d 66, 71-72 (Wash. App. 1990). To cover up the submission of these false expenses, the manager cooked the books of the subsidiary by shifting on paper the costs associated with one job to other jobs, so as to make the older jobs appear profitable. A key component of the claim was the insured’s contention that the subsidiary aggressively took on more and more work (often below cost) in order to have additional cost centers against which to transfer real and fake invoices, all to cover-up, perpetuate, and facilitate the theft and embezzlement from the parent company. Compare J.R. Norton Co. v. Fireman’s Fund Ins. Co., 569 P.2d 857, 860 (Ariz. App. 1977).
Building One timely submitted its sworn proof of loss, but the insurer refused to make any payment. Building One initiated a suit for coverage, including seeking an award of its attorneys’ fees on the grounds that the carrier denied coverage unreasonably and in bad faith. National Union’s fundamental contention was that the policy indemnified the insured only for the amounts it could prove were embezzled (and not for the full monetary loss due to the employee’s misconduct). Shortly before trial was to begin, the court denied National Union’s motion for summary judgment and adopted the rulings on the meaning of the policy sought by the insured. (After the summary-judgment decision rejecting National Union’s defenses to payment, the case settled.)
As to manifest intent, the court held that questions of fact precluded summary judgment in the insurer’s favor. The court next addressed the insurer’s contention that the losses suffered by Building One were not “sustain[ed] resulting directly from” the employee’s bad acts. The court held that “direct losses” covered by the Blanket Crime Policy at issue included all amounts of monetary loss that were proximately caused. See generally Imperial Ins. Inc. v. Employers’ Liability Assur. Corp., 442 F.2d 1197, 1198-99 (D.C. Cir. 1970) (“The loss here was a pecuniary depletion of [the insured’s] monetary assets. . . Moreover, the definition of [covered] money . . . does not clearly exclude liability to compensate for payments made from the insured’s funds, if due to the misconduct described.”); James B. Lansing Sound, Inc. v. National Union, 801 F.2d 1560, 1566 (9th Cir. 1986); Couch on Insurance § 161:58 (Supp. 2002). After holding that the covered loss of money is whatever the insured shows to be proximately caused from the covered misconduct of its employee, the Building One court found that factual disputes barred summary judgment.
The court then addressed two final arguments of the insurance company.
First, the court found that the insurance policy covers the money lost by the insured in performing the contracts entered into by its subsidiary (contracts that it would not have entered had it known the true facts). As the court held, “in rejecting National Union’s motion for summary judgment on this issue, the Court rejects National Union’s argument that simply because the contracts themselves were not misappropriated or created fraudulently, losses deriving therefrom are non-compensable under the insuring agreement. Although the ‘resulting directly’ language of the insuring agreement limits the scope of the insurer’s risk significantly, it does not limit that risk solely to the money that is eventually found in the embezzler’s pocket.” See also Peoples Bank & Trust Co. v. Aetna Cas. & Sur. Co., 113 F.2d 629, 631-32 (6th Cir. 1997); Southside Motor Co. v. Transmerica Ins. Co., 380 So.2d 470, 472 (Fla. App. 1980); Citizen’s State Bank v. New Amsterdam Cas. Co., 224 N.W 251, 453 (Minn. 1929). This ruling was significant because the amounts lost by Building One were “far more extensive than the gains [the employee] received.”
Second, the court rejected the application of Exclusion (m), which bars coverage for “damages of any type for which the Insured is legally liable, except direct compensatory damages arising from a loss covered under this Policy.” In construing this provision, though the court recognized that third-party claims standing alone were insufficient to trigger coverage, once coverage was triggered, “the exception to exclusion (m) provides enough latitude that all compensatory damages associated with the employee’s dishonesty are covered, not just the amounts the employee embezzled, but also those proximately related to the entire scheme.” Compare Arlington Trust Co. v. Hawk-Eye Security Inc. 301 F. Supp. 854 (E.D. Va. 1969).
In short, the court recognized that “Employee Dishonesty” coverage is not artificially limited to employee embezzlement and instead affords coverage for whatever “Loss of Money . . . the Insured shall sustain resulting directly from” covered misconduct, so long as the requisite causal link is shown between the actual money loss and the employee’s misconduct.
Finally, it’s worth noting that the Building One case involved the policyholder’s effort to adduce proof of wrongdoing with the requisite manifest intent without the direct testimony of the malefactor, who refused to testify as to his intent and state of mind due to the pendency of an eventually successful criminal prosecution. In the fidelity-insurance context, such a lack of direct evidence of manifest intent will not lead to a failure of proof. To the contrary, there is a unique rule in this area that the malefactor’s invocation of the Fifth Amendment privilege may be used against the insurance company as evidence that covered loss occurred. See Robert Johnston, Inferring Dishonesty: The Fifth Amendment and Fidelity Coverage, available at http://www.spriggs.com/news/pdfs/ACFB9AE.PDF.)
Posted by Marc Mayerson at 2:44 PM | Comments (0) | TrackBack
It’s a Crime: Efforts to Constrict the Broad Scope of Fidelity Insurance Coverage
Companies purchase fidelity-insurance policies to cover them against the risk of loss from employee dishonesty. Fidelity coverage generally is divided into two types: financial fidelity, which covers banks and other financial institutions, and commercial fidelity (or commercial crime coverage), which covers other types of businesses. On the financial-fidelity side, there is significant standardization of policy forms; on commercial fidelity, though the policy language often springs from the Surety Association of America or the Insurance Services Office, there is less standardization in the wordings.
Generally speaking, two key issues are presented in any commercial fidelity claim: is the misconduct covered and, if so, how much does the policy pay for. The first question typically involves whether the employee acted with “manifest intent” to benefit himself (or someone else) and to harm its employer. The manifest-intent concept was introduced in 1976 and has spawned 30 years of litigation (and increasingly the manifest-intent concept is being abandoned by policy drafters). Less attention has been paid to the scope of the indemnification provided insureds for the “Loss of Money, Securities or other property.” The case, Building One Services Solutions, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, Civil No. 02-311-A (E.D. Va. Nov. 26, 2002), available at 7-24 Mealey’s Emerg. Ins. Disp. § C (Dec. 17, 2002) (on LEXIS), addresses both issues (I note that I was lead counsel in this case).
The Building One case involved a manager of a subsidiary who essentially highjacked it for the personal enrichment of himself and his cronies. A key aspect of the operation was to have the parent company pay for costs and expenses through regular requisitions from the subsidiary. Unbeknownst to the parent company, the subsidiary submitted requisitions for fabricated expenses and previously paid expenses. Payments for the fabricated expenses and false charges were remitted to dummy corporations controlled by the manager or his associates. (In this way, the money was siphoned out of the company.) Cf. Hanson PLC v. National Union, 794 P.2d 66, 71-72 (Wash. App. 1990). To cover up the submission of these false expenses, the manager cooked the books of the subsidiary by shifting on paper the costs associated with one job to other jobs, so as to make the older jobs appear profitable. A key component of the claim was the insured’s contention that the subsidiary aggressively took on more and more work (often below cost) in order to have additional cost centers against which to transfer real and fake invoices, all to cover-up, perpetuate, and facilitate the theft and embezzlement from the parent company. Compare J.R. Norton Co. v. Fireman’s Fund Ins. Co., 569 P.2d 857, 860 (Ariz. App. 1977).
Building One timely submitted its sworn proof of loss, but the insurer refused to make any payment. Building One initiated a suit for coverage, including seeking an award of its attorneys’ fees on the grounds that the carrier denied coverage unreasonably and in bad faith. National Union’s fundamental contention was that the policy indemnified the insured only for the amounts it could prove were embezzled (and not for the full monetary loss due to the employee’s misconduct). Shortly before trial was to begin, the court denied National Union’s motion for summary judgment and adopted the rulings on the meaning of the policy sought by the insured. (After the summary-judgment decision rejecting National Union’s defenses to payment, the case settled.)
As to manifest intent, the court held that questions of fact precluded summary judgment in the insurer’s favor. The court next addressed the insurer’s contention that the losses suffered by Building One were not “sustain[ed] resulting directly from” the employee’s bad acts. The court held that “direct losses” covered by the Blanket Crime Policy at issue included all amounts of monetary loss that were proximately caused. See generally Imperial Ins. Inc. v. Employers’ Liability Assur. Corp., 442 F.2d 1197, 1198-99 (D.C. Cir. 1970) (“The loss here was a pecuniary depletion of [the insured’s] monetary assets. . . Moreover, the definition of [covered] money . . . does not clearly exclude liability to compensate for payments made from the insured’s funds, if due to the misconduct described.”); James B. Lansing Sound, Inc. v. National Union, 801 F.2d 1560, 1566 (9th Cir. 1986); Couch on Insurance § 161:58 (Supp. 2002). After holding that the covered loss of money is whatever the insured shows to be proximately caused from the covered misconduct of its employee, the Building One court found that factual disputes barred summary judgment.
The court then addressed two final arguments of the insurance company.
First, the court found that the insurance policy covers the money lost by the insured in performing the contracts entered into by its subsidiary (contracts that it would not have entered had it known the true facts). As the court held, “in rejecting National Union’s motion for summary judgment on this issue, the Court rejects National Union’s argument that simply because the contracts themselves were not misappropriated or created fraudulently, losses deriving therefrom are non-compensable under the insuring agreement. Although the ‘resulting directly’ language of the insuring agreement limits the scope of the insurer’s risk significantly, it does not limit that risk solely to the money that is eventually found in the embezzler’s pocket.” See also Peoples Bank & Trust Co. v. Aetna Cas. & Sur. Co., 113 F.2d 629, 631-32 (6th Cir. 1997); Southside Motor Co. v. Transmerica Ins. Co., 380 So.2d 470, 472 (Fla. App. 1980); Citizen’s State Bank v. New Amsterdam Cas. Co., 224 N.W 251, 453 (Minn. 1929). This ruling was significant because the amounts lost by Building One were “far more extensive than the gains [the employee] received.”
Second, the court rejected the application of Exclusion (m), which bars coverage for “damages of any type for which the Insured is legally liable, except direct compensatory damages arising from a loss covered under this Policy.” In construing this provision, though the court recognized that third-party claims standing alone were insufficient to trigger coverage, once coverage was triggered, “the exception to exclusion (m) provides enough latitude that all compensatory damages associated with the employee’s dishonesty are covered, not just the amounts the employee embezzled, but also those proximately related to the entire scheme.” Compare Arlington Trust Co. v. Hawk-Eye Security Inc. 301 F. Supp. 854 (E.D. Va. 1969).
In short, the court recognized that “Employee Dishonesty” coverage is not artificially limited to employee embezzlement and instead affords coverage for whatever “Loss of Money . . . the Insured shall sustain resulting directly from” covered misconduct, so long as the requisite causal link is shown between the actual money loss and the employee’s misconduct.
Finally, it’s worth noting that the Building One case involved the policyholder’s effort to adduce proof of wrongdoing with the requisite manifest intent without the direct testimony of the malefactor, who refused to testify as to his intent and state of mind due to the pendency of an eventually successful criminal prosecution. In the fidelity-insurance context, such a lack of direct evidence of manifest intent will not lead to a failure of proof. To the contrary, there is a unique rule in this area that the malefactor’s invocation of the Fifth Amendment privilege may be used against the insurance company as evidence that covered loss occurred. See Robert Johnston, Inferring Dishonesty: The Fifth Amendment and Fidelity Coverage, available at http://www.spriggs.com/news/pdfs/ACFB9AE.PDF.)
Posted by Marc Mayerson at 2:44 PM | Comments (0) | TrackBack