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The Fidelity

Law Journal

published by

The Fidelity Law Association

Volume XXI, November 2015

Editor-in-Chief Michael Keeley

Associate Editors Howard M. Bernstein

Carla C. Crapster Robert J. Duke

Adam P. Friedman Ann I. Gardiner Jeffrey S. Price Daniel J. Ryan Joel Wiegert

Cite as XXI FID. L.J. ___ (2015)

THE FIDELITY LAW ASSOCIATION

Executive Committee

President Timothy Markey, CNA

Immediate Past President Michael Retelle, CUMIS

Vice President and Treasurer Robert Olausen, Insurance Services Office, Inc.

Secretary Dolores Parr, Zurich

Members Tracey Santor, Travelers Mark Struthers, CUMIS

Michael V. Branley, The Hartford

Advisors Emeritus Samuel J. Arena, Jr., Stradley, Ronon, Stevens & Young, LLP

Robert Briganti, Belle Mead Claims Service, Inc. Michael Keeley, Strasburger & Price, LLP

Harvey C. Koch, Montgomery Barnett, LLP Armen Shahinian, Chiesa Shahinian & Giantomasi PC

Advisors Michael Davisson, Sedgwick LLP

CharCretia V. Di Bartolo, Hinshaw & Culbertson LLP

The Fidelity Law Journal is published annually. Additional copies may be purchased by writing to: The Fidelity Law Association, c/o Chiesa Shahinian & Giantomasi PC, One Boland Drive, West Orange, New Jersey 07052. The opinions and views expressed in the articles in this Journal are solely of the authors and do not necessarily reflect the views of the Fidelity Law Association or its members, nor of the authors’ firms or companies. Publication should not be deemed an endorsement by the Fidelity Law Association or its members, or the authors’ firms or companies, of any views or positions contained herein. The articles herein are for general informational purposes only. None of the information in the articles constitutes legal advice, nor is it intended to create any attorney-client relationship between the reader and any of the authors. The reader should not act or rely upon the information in this Journal concerning the meaning, interpretation, or effect of any particular contractual language or the resolution of any particular demand, claim, or suit without seeking the advice of your own attorney.

The information in this Journal does not amend, or otherwise affect, the terms, conditions or coverages of any insurance policy or bond issued by any of the authors’ companies or any other insurance company. The information in this Journal is not a representation that coverage does or does not exist for any particular claim or loss under any such policy or bond. Coverage depends upon the facts and circumstances involved in the claim or loss, all applicable policy or bond provisions, and any applicable law.

Copyright © 2015 Fidelity Law Association. All rights reserved. Printed in the USA. For additional information concerning the Fidelity Law Association or the Journal, please visit our website at http://www.fidelitylaw.org.

Information which is copyrighted by and proprietary to Insurance Services Office, Inc. (“ISO Material”) is included in this publication. Use of the ISO Material is limited to ISO Participating Insurers and their Authorized Representatives. Use by ISO Participating Insurers is limited to use in those jurisdictions for which the insurer has an appropriate participation with ISO. Use of the ISO Material by Authorized Representatives is limited to use solely on behalf of one or more ISO Participating Insurers.

Carla C. Crapster is an associate with Strasburger & Price, LLP in Dallas, Texas. Peter G. Hilbert is a Senior Attorney with ABA Insurance Services, Inc. in Mayfield Heights, Ohio. 1

SURVEY ON FIDELITY LAW: 2014-2015

Carla C. Crapster Peter G. Hilbert

I. INTRODUCTION

This article summarizes the key decisions in the area of fidelity law that were issued between July 1, 2014 and July 1, 2015. It is meant to serve as a resource for fidelity practitioners who strive to stay informed on recent case law in their area. Several important opinions were issued during the period that this article covers. There were some poorly reasoned decisions that very obviously go to any lengths to find coverage. For example, the Court of Appeals of Ohio examined at least four different clauses in an insurance policy that were clearly designed to prevent an insured from recovering under each of many back-to-back policies the insured had purchased over the years.1 The court found tortured ways to make each provision inapplicable, allowing the insured to recover the policy limits of every policy it had purchased. There were also several very carefully reasoned opinions that will likely benefit the insurance industry for years to come. For example, two cases made clear that when a dishonest employee who is stealing from his employer also bears responsibility for filling out the application for the bond and lies on that application to conceal his theft, the onus of the loss caused by that employee falls on the insured, rather than the insurer.2 This article will examine these and many other opinions in detail.

1 E.J. Zeller, Inc. v. Auto Owners Ins. Co., No. 4-14-04, 2014 Ohio

App. LEXIS 4876 (Ohio Ct. App. Nov. 10, 2014). 2 Middleburg Volunteer Fire Dept., Inc. v. McNeil & Co., Inc., No.

1:14-cv-458, 2014 U.S. Dist. LEXIS 159701 (E.D. Va. Nov. 12, 2014); Scottsdale Indem. Co. v. Martinez, Inc., No. CV-12-BE-2146-S, 2014 U.S. Dist. LEXIS 135129, *1-10 (N.D. Ala. Sept. 25, 2014).

2 Fidelity Law Journal, Vol. XXI, November 2015

II. THE REQUIREMENT FOR “MANIFEST INTENT” TO

CAUSE A LOSS

In Keybank National Ass’n v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania,3 a dishonest employee of the insured had been releasing liens on condominium units without obtaining from the borrower or developer the agreed-upon payments necessary for such a release. The bond provided coverage only if the dishonest employee had been acting with the “manifest intent” to cause the insured a loss or to obtain a financial benefit for himself or another person or entity. The court found material questions of fact as to whether the employee’s conduct manifested intent to harm his employer or obtain a financial benefit for another person or entity. The court reached this conclusion despite a New Jersey court’s conclusion in a related case that the employee’s “sole motivation” was to get the insured repaid; the court said the other court’s finding was not conclusive because it was not reached in the same context. The court also noted that there was conflicting expert testimony as to how the dishonest employee had been using the misappropriated funds, and that no forensic accounting had been employed to shed light on that question. It took these facts into account in concluding that summary judgment was inappropriate.4

III. CASES THAT SHED LIGHT ON THE DEFINITIONS

OF KEY TERMS

A. The Meaning of “Loan”

Keybank also discusses another issue: the meaning of “loan.”5 The insured in the case sought to recover under a fidelity bond for losses due to an employee’s permitting the release of liens on condominium units without first obtaining the agreed-upon payments from the borrower/developer. The insurer argued that because the loss involved a loan, the “loan loss” exclusion applied to preclude coverage. The court disagreed. The bond defined a loan as “all extensions of credit by the

3 124 A.D.3d 512, 514-15 (N.Y. App. Div. 2015). 4 Id. at 513-15. 5 Id. at 512-13.

Survey on Fidelity Law: 2014-2015 3

Insured and all transactions creating a creditor relationship in favor of the Insured and all transactions by which the Insured assumes an existing creditor relationship.” On the insured’s motion for summary judgment, the court held that the losses did not result from a bad loan because the “the risk had nothing to do with [the insured]’s making a poor credit decision. Rather, the risk related to the employee’s alleged misconduct in failing to follow bank procedures and diverting funds to the developer. Although this may have prevented the reduction of the loan balance, it did not create a new extension of credit, i.e. it was not a new loan.”6 In other words, the court seemed to imply that even though, technically, a loan was involved, the loss did not result from a loan because it did not result from a poor credit decision by the bank.

B. The Meaning of “Counterfeit”

The Eleventh Circuit, in Bank of Brewton v. Travelers Cos., Inc.,7 upheld the award of summary judgment in favor of the insurer. The insured bank had suffered a loss when a customer defaulted on a loan that was secured by a valueless stock certificate. The customer had originally presented a color copy of the stock certificate as collateral, although bank policy required the customer to produce an original. When someone later realized that the certificate was a copy, the customer explained that he had misplaced the original and would obtain a replacement certificate from the company that issued the stock certificate. In reality, the customer had pledged the true stock certificate to another bank to obtain a loan. But the insured bank was unaware of this deception. The customer produced the replacement stock certificate to the insured bank. When it was discovered that the certificate was merely replacing a certificate that had already been pledged to someone else, the bank sought to recover the loss from its insurer. The bond at issue covered loss resulting from reliance on a counterfeit. The insurer argued successfully to the lower court that the term “counterfeit” did not apply here because the certificate was genuine. The customer’s lie was not in presenting a fake document but in representing the facts surrounding the issuance of that certificate. The Eleventh Circuit held, as

6 Id. at 513. 7 777 F.3d 1339 (11th Cir. 2015).


the lower court had, that the bond covered losses resulting from reliance on a fake, but not on every document “tainted by fraud.”8

C. Whether “Loss of Money” Includes Interest That Could Have Been Earned on the Misappropriated Money

In Town of Ira v. Vermont League of Cities and Towns,9 the insured was a town whose former treasurer had embezzled over $300,000. The town had also lost a significant sum in lost interest on the embezzled funds. The town sought to recover both the embezzled funds and the interest from its fidelity insurer. But the insurer refused to pay the lost interest. The fidelity bond at issue covered any loss of money, and the town argued that the “loss of money” included the interest lost because the money was not available to invest or hold to earn interest.10 The court examined surety cases holding that the surety was liable for the loss of use of money. The court found these cases persuasive, and it also noted that the phrase “loss of money” was ambiguous, meaning that it must be construed in favor of the insured.11

The court refused to follow a North Carolina case that the insurer cited, holding that interest on embezzled funds was not covered because it did not fall within the policy’s definition of “money.” The court criticized that opinion for not clearly explaining whether it rejected the argument that interest was “money” because interest never physically existed or because the interest was not listed in the definition.12 Regardless, the court found that “money” referred to liquidity and not to the form of the asset.13 The court also noted that the policy at issue failed to include a potential-income exclusion, which reinforced the court’s view that the language was at least ambiguous.14

The court also rejected the argument that if interest were allowed as an item of recovery, the town could not also recover prejudgment

8 Id. at 1343. 9 No. 13-373, 2014 Vt. LEXIS 120 (Vt. Oct. 31, 2014). 10 Id. at *2-3. 11 Id. at *8-11. 12 Id. at *13-14. 13 Id. 14 Id. at *14.


interest, as that would impermissibly result in interest on interest. The court held that if it did not award interest on the policy liability (including interest), it would encourage the insurer to drag its feet in making payment, and ultimately not award the insured the full amount of its loss.15 The court did not agree that it would be impermissible to award “interest on interest” in this particular scenario.16

D. The Meaning of “Employee”

In Certain Underwriters at Lloyd’s v. Taylor, Bean & Whitaker Mortgage Corp.,17 the controlling shareholder of the insured caused over $87 million to be transferred for his own personal benefit.18 The insured sought to recover its loss from its fidelity insurers, which refused to provide coverage and sought rescission based on material misrepresentations and failure to disclose material information in the application for the bonds at issue. The insurers filed a declaratory judgment action for rescission and a declaration that coverage could not apply because the dishonest person who caused the loss, Lee Farkas, was not an “employee.” The insured, TBW, counterclaimed for breach of the bonds, and the insurers moved for summary judgment on the coverage defenses, but not on rescission.19

The court first examined the argument that Farkas was not an employee. The bond at issue defined employee as follows:

(i) one or more of [TBW’s] officers, clerks and other natural persons while employed in the regular service of [TBW] in the ordinary course of [TBW’s] business and whom TBW compensates by salary, wages or commissions . . . and who the [TBW] has the right to govern and direct in the performance of such service, and

15 Id. at *16. 16 Id. at *17. 17 No. 3:09-bk-7047, 2015 Bankr. LEXIS 624 (M.D. Fla. Feb. 19,

2015). 18 Id. at *13-16. 19 Id. at *10-11.


. . . .

It is understood, however, that the term Employee does not include any Major Shareholder of [TBW], nor, except as provided above, any director of [TBW].20

It was undisputed that Farkas was a “Major Shareholder” of TBW. But TBW argued that Farkas, though a Major Shareholder, was covered if he was acting “in the capacity” of an employee. The court noted that TBW did not explain the difference between “being an employee” and “acting in the capacity of an employee.” But the court nonetheless held that under the bond a person could be both an employee and a Major Shareholder.21

The next key question was whether TBW had the right to “govern and direct” Farkas. Though the court noted that the insurers did not present evidence that Farkas had formal control of TBW, the court found it undisputed that Farkas “exercised such complete control over the corporation as to render the corporation’s right to control him illusory” and that he had “total dominance of the corporation . . . .”22

The court recognized that when a single shareholder dominates a corporation, his acts are the corporation’s acts. Thus, allowing the corporation to recover for the dominating shareholder’s acts would allow the corporation to recover insurance for its own dishonest actions. The court recognized that fidelity bonds are designed to insure corporations against the dishonest acts of employees, not the corporations themselves. The court concluded that Farkas was TBW’s alter ego, not an employee or someone acting in the capacity of an employee.23

The court next examined TBW’s argument that other TBW employees colluded with Farkas and that coverage existed due to their dishonest actions. The court found this to be an “unusual situation where a majority shareholder, an alter ego of the corporation, initiates dishonest acts, directs his subordinate’s involvement, and the subordinate renders

20 Id.at *17-18. 21 Id.at *18-19. 22 Id. at *19-21. 23 Id. at *20-23.


her assistance in the fraudulent scheme.” The court concluded that coverage under such circumstances would improperly allow TBW to recover for the actions of its alter ego simply because Farkas used TBW employees to carry out his misdeeds.24

E. The Meaning of “Theft”

Tesoro Refining & Marketing Company LLC v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania,25 involved an insured in the oil-refinery business. After refining the fuel, the insured would sell it to a third party, Enmex, on credit. Unfortunately, Enmex could not afford to buy as much of the fuel from the insured as it was actually purchasing. One of the employees in the insured’s credit department was lying and falsifying documents to make it appear that Enmex had more collateral available to secure its purchase of the fuel than it actually had. The dishonest employee’s misdeeds included forging signatures on purported letters of credit. The insured thus continued to provide Enmex with fuel on credit. When Enmex was ultimately unable to pay for the fuel, the insured suffered a loss and sought to recover it from the insurer.

The policy at issue covered direct loss from employee theft, which was defined as unlawful taking to the deprivation of the insured. The Employee Theft insuring agreement added that “For purposes of this Insuring Agreement, ‘theft’ shall also include forgery.”26 The insured relied on this language to argue that “theft” had occurred here because the dishonest employee had been forging letters of credit. But the court disagreed. It held that this provision unambiguously covered “losses resulting from unlawful takings by employees by means of forgery, not any loss resulting from an employee’s forgery.”27 The court also held that an unlawful taking required either possession of the property by the employee or the employee’s dominion or control over the property. The fuel sold to Enmex had therefore not been part of a “theft” because the dishonest employee did not exercise control over the fuel at any time, he merely ensured that it was sold to Enmex. The court granted the insurer

24 Id. at *23-28. 25 No. SA:13-CV-931-DAE, 2015 U.S. Dist. LEXIS 45168 (W.D. Tex.

Apr. 7, 2015). 26 Id. at *13. 27 Id. at *14.


summary judgment, and denied the insured’s motion for partial summary judgment. The court did not analyze whether there had been a “direct loss,” which was another argument the insurer advanced.

F. “Loss” Does Not Include the Return of Ill-Gotten Gains

In Twin City Fire Insurance Co. v. CR Technologies, Inc.,28 the insured rented hardware and software to provide voice-over internet protocol services to its customers. But the insured refused to return certain of the rented equipment when the lease period was up. The company that was leasing the equipment to the insured filed suit against it for, among other things, breach of contract and civil theft. The jury found that the insured was engaged in civil theft and awarded the plaintiff treble damages. The insured sought coverage for its loss from its fidelity insurer. But the insurer sought a declaratory judgment that it was not obligated to indemnify the insured for the judgment in the civil-theft case.29 The policy at issue covered “loss” resulting from a wrongful act by the insured entity.30 But the policy excluded the following items from its definition of “Loss”: “taxes, fines or penalties imposed by law, the multiple portion of any multiplied damage award, or matters that may be deemed uninsurable under the law pursuant to which this Policy shall be construed.”31

The insurer argued that the definition of “Loss” in the policy did not include the restoration of ill-gotten gains. The court agreed and held that civil theft is not insurable as a matter of law and that the treble damage award constituted a “multiple portion of [a] multiplied damage award” which was expressly excluded from the policy.32 The court went on to state that even if the judgment were considered a “loss,” an exclusion for criminal acts or willful violations of the law would apply.33 The court also held that the crime coverage part of the policy did not apply because it was meant to reimburse an employer when its

28 No. 9:13-cv-80998, 2015 U.S. Dist. LEXIS 32285 (S.D. Fla. Mar.

11, 2015). 29 Id. at *3-4. 30 Id. at *6. 31 Id. at *7. 32 Id. at *7-9. 33 Id. at *10.


employees stole from it, not when the employer itself stole from a third party.34

G. The Meaning of “Discovery”

In Spear v. Westfield Insurance Co.,35 the plaintiff sought to recover under an employee theft and forgery policy. The policy required that the insured sue within two years of “discovery” of the loss. The bond defined “discovery” in the typical manner: “the time when [the insureds] first become aware of facts which would cause a reasonable person to assume that a loss of a type covered by this insurance has been or will be incurred, regardless of when the act or acts causing or contributing to such loss occurred, even though the exact amount or details of loss may not then be known.”36 The court followed cases holding that the insured must have “more than mere suspicions of employee dishonesty or fraud” and that “the discovery threshold is low.”37 But the court held that it was not clear when the insured’s knowledge moved past mere suspicion to “discovery.” The court therefore denied the insurer’s motion for judgment on the pleadings. It instead held that the parties should engage in “a limited period of discovery on the issue of exactly when Plaintiffs discovered their loss.”38

H. The Meaning of “Customer”

First National Bank of Northern California v. St. Paul Mercury Insurance Co.,39 is a Ninth Circuit opinion that affirms the award of summary judgment to the insurer. The loss at issue in the case was caused by fraudulent requests for a wire transfer. The bank unwittingly made the transfers from the Edwards Living Trust, based on what were eventually revealed as fraudulent requests. After reimbursing the Trust, the insured sought to recover the loss under its bond. The court held that the “critical question” was whether the Edwards family, which had

34 Id. at *15. 35 No. 15-cv-582, 2015 U.S. Dist. LEXIS 75540 (E.D. Pa. June 11,

2015). 36 Id. at *10. 37 Id. at *13. 38 Id. at *19. 39 No. 13-15587, 2015 U.S. App. LEXIS 7896 (9th Cir. May 13, 2015).


created the Trust, were “customers” of the insured within the meaning of the bond.40 To qualify as a “customer,” an individual or entity had to have a written agreement with the insured bank that allowed the bank to rely on wire transfer instructions communicated by phone or fax. The undisputed facts showed that there was no such written agreement. The insured argued that the signed signature card the Edwards family had on file with the bank satisfied the requirement for a written agreement. But the court easily rejected this argument. Thus, the court held that the district court had properly awarded summary judgment to the insurer.

IV. BONDS COVERING LOSS RESULTING FROM COMPUTER

SYSTEMS FRAUD

In Pestmaster Services, Inc. v. Travelers Casualty and Surety Co. of America,41 the insured was a pest-control company called Pestmaster. Pestmaster hired a third-party payroll company to handle preparation of its payroll, pay its payroll taxes, and deliver payroll checks. Pestmaster authorized the payroll company to take the funds necessary to complete these tasks directly out of Pestmaster’s bank account. One day, the IRS made a surprise visit to Pestmaster’s office. The IRS informed Pestmaster that it owed nearly $400,000 in payroll taxes. Pestmaster had been tricked by the payroll company. It had been pocketing all funds it was purportedly taking to satisfy Pestmaster’s payroll taxes.42

Pestmaster sought coverage for its loss under a policy that covered “Funds Transfer Fraud” and “Computer Fraud.” In the coverage dispute that ensued, the court held that coverage could not apply under either insuring agreement. The Funds Transfer Fraud agreement did not cover authorized or valid electronic transactions. And here, Pestmaster had specifically authorized the payroll company to access its bank account. The court held that the purpose of the Funds Transfer Fraud coverage was to protect the bank from someone breaking into the

40 Id. at *2. 41 No. CV 13-5039-JFW, 2014 U.S. Dist. LEXIS 108416 (C.D. Cal.

July 17, 2014). 42 Id. at *4-8.


electronic fund transfer system and stealing money by altering the electronic instructions, which had not occurred here.43

The court held that the Computer Crime insuring agreement could not apply because there was no unauthorized use of Pestmaster’s computer. The court held that the Computer Crime insuring agreement applied only when someone hacked or obtained unauthorized access or entry to a computer to make an unauthorized transfer. The court also reasoned that the use of a computer was merely incidental to Pestmaster’s loss.44 Pestmaster’s loss did not actually occur until the payroll company used the funds that it had legitimate access to for a purpose other than Pestmaster had directed. The computer was not critical to that step.

The court also concluded that Pestmaster had not sustained a “direct loss,” as required by both the Funds Transfer Fraud and Computer Fraud insuring agreements. The court took a “direct means direct” approach and stated that Pestmaster’s loss was contingent on a series of events and decisions, including the payroll company’s decision to divert the funds rather than using them to pay federal payroll taxes.45 The court also concluded that two exclusions applied: the indirect loss exclusion and the exclusion for potential income. For all these reasons, the court awarded summary judgment to the insurer.

Another opinion favorable to insurance companies that reaches a similar result is Universal American Corp. v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania.46 There, the insured was a health insurance company that suffered a loss as a result of fraudulent claims for healthcare services that were never actually performed. The perpetrators of the scheme submitted the claims for “reimbursement” through the company’s electronic system. When the insured discovered what had happened, it sought coverage under the portion of its bond that covered loss resulting from computer systems fraud. The bond provided coverage only if there had been a fraudulent entry of electronic data into the insured’s computer system. The court held that no coverage could

43 Id. at *16-18. 44 Id. at *19-22. 45 Id. at *24-25. 46 No. 95, 2015 N.Y. LEXIS 1434 (N.Y. June 25, 2015).


apply under that insuring agreement. The perpetrators of the scheme were authorized to have access to the insured’s computer system. They merely abused that authorization to enter incorrect data. The court recognized the difference between fraudulent entry of data and entry of fraudulent data and held: “the Rider applies to losses resulting directly from fraudulent access, not to losses from the content submitted by authorized users.”47 In other words, “the policy does not cover fraudulent content entered by authorized users, but rather ‘wrongful acts in manipulation of the computer system, i.e., by hackers.’”48

Another recent case examines coverage for computer systems fraud, but reaches a far less favorable result. In State Bank of Bellingham v. BancInsure, Inc.,49 the insured was a bank that suffered a loss when criminals were able to access the bank’s computer system to complete two wire transfers that no employee had authorized. The criminals were apparently able to carry out their scheme because one of the bank’s employees had left her “token” that generated passwords plugged into the computer and left the computer running.50 The insured sought to recover its losses from its insurer. The bond in place covered loss resulting from “computer systems fraud.” But the insurer pointed out that there was an exclusion for “loss caused by an employee.”51 It contended that it was the failure of the insured’s employees to follow proper protocol that caused the loss. The court disagreed. It held: “When there are multiple causes of an insured’s loss, one of which is a ‘covered peril’ and the other of which is an ‘excluded peril,’ Minnesota’s concurrent causation doctrine provides that the availability of coverage or the applicability of the exclusion depends on which peril was the ‘overriding cause’ of the loss.”52 Although there had clearly been a breach of the bank’s protocol by the employee, the court held that “neither the employees’ violations of policies and practices (no matter how numerous), the taking of confidential passwords, nor the failure to update the computer’s antivirus software was the efficient and proximate cause

47 Id. at *6. 48 Id. at *5-6. 49 No. 13-cv-900, 2014 U.S. Dist. LEXIS 136849 (D. Minn. Sept. 29,

2014). 50 Id. at *5-8. 51 Id. at *50. 52 Id. at *52.


of Plaintiff’s loss.” It reasoned that all this carelessness could have occurred and not caused a theft. It was only the infiltration of the computer system by a hacker that actually resulted in a loss.

The insurer also argued that coverage could not apply because the insured had failed to cooperate in its investigation of the loss. The insureds had apparently been much less than forthcoming in admitting to all the errors its employees had committed and other steps it could have taken to prevent the type of attack that caused a loss.53 The court found this unpersuasive, as well. It held that the failure to cooperate could prevent coverage only if it had substantially prejudiced the insurer, and the court found no evidence of such prejudice.

V. THE REQUIREMENT FOR A DIRECT LOSS

Avon State Bank v. BancInsure, Inc.54 is an Eighth Circuit opinion that affirms the award of summary judgment in favor of an insured. An employee of the insured had received a scam e-mail stating that there was a large estate in Africa that the sender wanted to transfer to America. The scammer offered a large piece of the estate in exchange for helping to facilitate the transfer to America and paying part of the fees and taxes upfront. The bank employee ultimately put $60,000 of his own money into the “investment.” Predictably, things “took longer” than the scammer expected and the scammer eventually asked for more money. The bank employee convinced two other people (not bank customers) to invest, and in the course of doing so stated that the bank had sanctioned this investment and that the transaction would go through the bank. The two new victims wrote large checks to Avon Bank and the employee wired them to offshore accounts. The victims never saw their money again.

The victims sued the bank, arguing that its employee had defrauded them. The bank sought coverage under a fidelity bond for the amount it had to pay the victims. The insurer contended that the fidelity bond did not apply because the insured had not suffered a direct loss. It

53 Id. at *59-62. 54 Nos. 14-1265 and 14-2202, 2015 U.S. App. LEXIS 9120 (8th Cir.

June 2, 2015).


reasoned that the fidelity bond applied only to loss of the bank’s money or money that the bank was holding for third parties. The bank had never held the victims’ money but merely acted as a conduit. The lower court disagreed and held that the bank’s role was much more substantial. It noted that a bank employee had urged the two victims to write checks to the bank, the bank had held the check (for an undetermined amount of time), and then the bank wired the money to an offshore account (a bank officer signed off on this wiring based on the dishonest employee’s representations that the funds were to pay for legitimate banking services). The lower court held that fidelity bonds cover loss of third-party property that is in the insured’s possession, but not theft committed against third parties by its employees. Here, because the money was held (apparently briefly) by the bank, the court reasoned that the theft was of property the bank was holding on behalf of a third party, and not theft of that third party directly.

The Eighth Circuit affirmed the lower court’s opinion. It rejected the insurer’s argument that the loss was not direct but was instead a third-party loss. The Court agreed with the reasoning of the lower court that because the insured held the property, the loss was direct rather than vicarious. The court also agreed that the employee had the manifest intent to cause the loss “because he committed the fraudulent acts to preserve his investment in the advance money scheme.”55 The Eighth Circuit also rejected the insurer’s argument on statute of limitations and late proof of loss. The court was persuaded by the fact that the insured had kept the insurer informed of the claims against it. The Eighth Circuit also affirmed the award of prejudgment interest from the date of first demand for coverage, pursuant to a Minnesota statute, even though that meant the insured received interest for a time before it actually paid the two claimants (the two victims of the scheme).56

The insured in Fidelity National Financial, Inc. v. National Union Fire Insurance Co.,57 suffered a loss as a result of a Ponzi scheme that was “masterminded by Rollo Richard Norton which was executed with the assistance of certain employees of Chicago Title.” The victims

55 Id. at *13. 56 Id. at *18-20. 57 No. 09-CV-140-GPC-KSC, 2014 U.S. Dist. LEXIS 140030 (S.D.

Cal. Sept. 30, 2014).


of the scheme entrusted their savings to Norton, who had inherited his father’s financial planning business. In 1998, Norton’s Safe Harbor company purchased an apartment complex with both Norton’s money and the money of others. When the complex later converted to condominium units, Norton devised a scheme to extract equity from the property by using his clients’ identities to sell and refinance individual units.58 Between 2002 and 2005, Norton instigated over 300 escrow transactions to steal his clients’ money for his personal use. Norton used employees of Chicago Title to help him carry out his scheme. Among other misdeeds, those employees would forge signatures on escrow documents.

The insured was Chicago Title. It had a number of different insurance policies in place. The opinion examines, among other things, whether coverage applied under Insuring Agreement (D) of a Financial Institution Bond.

The insurer argued that Insuring Agreement (D) could not apply because there had been no direct loss. The insured had made settlement payments to compensate the victims of the Ponzi scheme, but had not had funds stolen directly from it. The court disagreed, noting that the insured had been holding the funds that were part of the Ponzi scheme in escrow. Because the insured was holding the misappropriated funds, the loss was direct.59

The court also analyzed whether the insured had transferred funds “on the faith of” forged documents. Employees at Chicago Title had forged signatures on documents to make the escrow transactions go through. The insurer argued that the transfer could not have been “on the faith” of those documents because some of the insured’s employees knew the documents were forged. The court disagreed. It concluded that “on the faith of” did not mean “in good faith.” It stated that the insured’s employee’s knowledge was therefore irrelevant.60

The insurer also argued that a written instruction or advice meant a check or draft or similar instrument, but not a forged escrow document.

58 Id. at *7. 59 Id. at 24-48. 60 Id. at *49-53.


The court did not agree.61 It reasoned that the bond involved broad language, referring to “any written instruction.” It stated: “The forged escrow documents involved here plainly satisfy the common dictionary definition of either ‘instructions’ as an ‘order or direction,’ or ‘advice’ as ‘a formal or official notice sent by one person or office to another concerning a business transaction.’”62

The insurer also contended that discovery occurred outside the bond period. The bond at issue required discovery by the Risk Management or Legal departments. The court found that no one in those departments knew, before the bond incepted, facts that would have caused a reasonable person to assume that a loss covered by the bond would occur. The court reached this conclusion despite evidence that a lawyer in the insured’s Legal department knew of complaints regarding two settlement transactions. The court stated: “This evidence does not establish that a reasonable person would have accused Norton of forgery before November 18, 2005.”63

The automatic termination provision was also at issue. The insurer argued that it applied because the insurer knew of dishonest acts by its employees before the bond incepted, but the court held that even if the insured did have such knowledge, it would not bar the claim based on Norton’s forgery of documents because: “The Termination Provision of coverage for an employee is not relevant to coverage under the Forgery Insuring Agreement by a non-employee.”64 For all these reasons, the court awarded summary judgment to the insured.

The court also held that as a matter of law the insurer breached its obligation of good faith in handling the claim. The court stated that the insurer should have considered the claim under the forgery insuring agreement, as well as the employee dishonesty insuring agreement, but failed to do so.65

61 Id. at *47-49. 62 Id. at 49. 63 Id. at *84. 64 Id. at *95-96. 65 Id. at *116-117.


In Taylor and Lieberman v. Federal Insurance Co.,66 the Central District of California applied a narrow definition of “direct loss.” The court succinctly summarized the facts of the case: “Client gave Plaintiff power of attorney over Client's money held in Client's own account; a perpetrator of fraud motivated Plaintiff's agent to use the power of attorney to transfer funds out of Client's account; Plaintiff discovered this fraud and attempted to recover the funds; Client requested repayment of the lost funds and Plaintiff obliged; Plaintiff now requests Defendant [the insurer] indemnify it for the losses that were transferred from Client to Plaintiff.”67 The court held that under these circumstances, the insured (the Plaintiff) was merely making the Client—a third party—whole, but had not directly sustained a loss itself. The court distinguished this circumstance from those where the bank is holding funds in an account owned by the plaintiff. Because that had not occurred here, the court held that the insured’s loss was not “direct,” and granted summary judgment to the insurer.

Federal Deposit Insurance Corp. v. RLI Insurance Co.,68 affirmed the district court’s summary judgment for the insured. The loss at issue resulted from forged lease agreement. The insured’s customer had a dishonest employee who forged an equipment leasing agreement. The lease purported to require payment to the customer every month for the lease of equipment. The insured bank extended loans on the faith of the forged equipment leases. But as it turned out, the equipment purported to be leased did not even exist.

The FDIC took over as receiver for the insured bank. In a dispute over whether the bank’s loss was covered under a financial institution bond, one issue was whether the bank’s loss was “direct.” The insurer argued that the loss did not result directly from the forged schedules to the lease agreement because the computer equipment never existed. In other words, even if the signature on the lease agreement had been authentic, the lease agreement was still worthless because there was no collateral to back it up. The court disagreed. It held: “The bond does not say that the loss must have resulted directly from a forgery; it says that

66 No. 14-cv-3608, 2015 U.S. Dist. LEXIS 79358 (C.D. Cal. June 18,

2015). 67 Id. at *11. 68 784 F.3d 1104 (7th Cir. 2015).


the loss must have resulted directly from reliance upon a security agreement that contained a forgery.” The court also held that the collateral consisted of the leases themselves not the equipment.

The court also rejected the insurer’s argument that the suit was barred by the two-year limitations period set forth in the bond. The court held that this contractual period of limitations could not apply because the FDIC had taken over as receiver, meaning that 12 U.S.C. § 1821(d)(14) governed the limitations period instead of the contract.

VI. CASES ON RESCISSION: WHEN THE DISHONEST EMPLOYEE

SIGNS THE BOND APPLICATION

Three recent cases examined whether coverage applies when the dishonest employee that is causing the insured to suffer a loss is also the employee who fills out the application for a fidelity bond and lies on that application to cover up his own theft. In Middleburg Volunteer Fire Department, Inc. v. McNeil & Company, Inc.,69 the insured was a volunteer fire department. Unfortunately, one of its employees, Paul Draisey, embezzled large sums from it. Even more unfortunate, Paul Draisey was the employee responsible for obtaining fidelity insurance on behalf of his employer. In the application for the fidelity policy he purchased on the fire department’s behalf, he lied in response to an important question: whether there had been any changes in the “exposures” of the organization.

Draisey obviously knew that there was one critical new “exposure” that existed as a result of his own embezzlement. But in responding to that question, though Draisey answered “yes,” he did not disclose his embezzlement. Draisey also increased the amount of fidelity insurance coverage the fire department had in place. Presumably, Draisey took this step to make sure that the insurance company would bear the brunt of his misdeeds, rather than his employer.

After Draisey’s embezzlement came to light, he took his own life. In a bizarre twist that made clear his intent that the insurer and not

69 No. 1:14-cv-458, 2014 U.S. Dist. LEXIS 159701 (E.D. Va. Nov. 12,

2014).


the fire department bear the loss he had caused, Draisey left a suicide note with specific instructions on how to “[get] the $250k in coverage for my acts.”70

The insurer refused to cover the loss, citing the law against recovery of losses already incurred or in progress. The insurer also sought to rescind the bond due to Draisey’s failure to reveal his own embezzlement in the bond application. Virginia law, which governed the dispute, permitted rescission only if the representation in the application was both material to the risk and untrue. The court did not allow the insurer to rescind the bond because it held that Draisey had not technically lied on the application. The application asked whether there had been any changes in the insured’s “exposures,” and Draisey had honestly answered “yes” to this question. He merely had not gone on to explain what the exposure was. The court found that because Draisey’s response was technically true, rescission was improper.

But the bond did include language stating that coverage was void if the insured intentionally concealed or misrepresented a material fact concerning the insurance or a claim under the insurance. The court held that this exclusion applied. It rejected the insured’s argument that Draisey’s knowledge did not trigger this exclusion because he was also the dishonest employee that caused the loss. The court stated that this result “comports with the common sense principle that no one should be able to obtain insurance coverage to cover losses for embezzling activities they are engaging in or planning to engage in.” The court found that although most of the insureds were just as innocent as the insurer, it was “sensible to allocate the loss to the insured because ‘between the innocent insured and the innocent insurance company [the insured] who had the opportunity to know [the party committing the misrepresentation] best—should bear the loss.’”71

In Scottsdale Indemnity Co. v. Martinez, Inc.,72 the insured made false statements in its application for the insurance policy at issue. The

70 Id. at *6. 71 Id. at *20 (quoting Great Am. Ins. Co. v. Gross, No. 3:05cv159, 2008

U.S. Dist. LEXIS 10079, at *13 (E.D. Va. 2008)). 72 No. CV-12-BE-2146-S, 2014 U.S. Dist. LEXIS 135129, *1-10

(N.D. Ala. Sept. 25, 2014).


insured’s CEO signed the application. But it was unfortunately also the CEO of the insured who was engaged in the wrongdoing that caused the loss the insured sought to recover from its insured. The CEO had stolen funds from the insured both before and after submitting the application.

The court found that the CEO lied on the application with the intent to deceive and that the misrepresentations were material because the insurer would have charged a higher premium if the applications had been answered honestly. The lies on the application related to the “checks and balances” that the insured had in place to prevent employee dishonesty. But here, the CEO “was engaged in the very misconduct that the checks and balances were designed to prevent.”73 Thus, to reveal to the insurer (or anyone) that the insured was lacking important safeguards, the CEO would have risked exposing the scheme.

The insured argued that the CEO was obviously acting adversely to the insured’s own interest, and that the insured should therefore not be bound by the lies told in the application. But the court refused to follow this reasoning. It held that the CEO was, in effect, the sole representative of the insured that interacted with the insurer.74 As a result, it would be unfair to expect the insurer to bear responsibility for the risk that the only person it had ever dealt with was lying to it. Following this same reasoning, the court also held that the dishonest employee’s knowledge of her own thefts was imputed to the insured, resulting in the thefts being discovered before commencement of the policy, and not during the policy period.75 Accordingly, the court granted summary judgment to the insurer. More recently, the Eleventh Circuit affirmed the award of summary judgment in the insurer’s favor.76

In yet another case with a similar fact pattern, National Credit Union Administration Board v. Cumis Insurance Society, Inc.,77 the receiver for the insured sued the insurer, seeking recovery for a loss

73 Id. at *28-29. 74 Id. at *34-37. 75 Id. at *19-32. 76 No. 14-14958, 2015 U.S. App. LEXIS 10427 (11th Cir. June 22,

2015). 77 No. 1:11-cv-1739, 2015 U.S. Dist. LEXIS 45281 (N.D. Ohio Apr. 7,

2015).


resulting from employee dishonesty. The employee accused of dishonesty had pleaded guilty to criminal charges and had been ordered to pay over $70 million in restitution. He was found guilty of taking bribes to make fraudulent loans and falsify records to conceal delinquent loans.

It was the dishonest employee who had responsibility for signing and submitting the application for fidelity bonds each year. On each application, the dishonest employee represented that he had no knowledge of any act that might give rise to a claim. These were obviously false statements, and the insurer sought to rescind the bond on those grounds. But under Ohio law, the false statement had to be incorporated into the bond by reference in order to justify rescission. Here, the bond provided that “a statement made by or on behalf of you, whether contained in the application or otherwise, is a warranty that the statement is true to the best of the knowledge and belief of the person making the statement.”78 But the court held that this language did not unequivocally incorporate the misstatements into the bond. Thus, the insurer was not entitled to rescind the bond as void ab initio.

The insurer also argued that, before the bond took effect, the employee’s dishonesty was discovered by a “supervisory staff” member, meaning that coverage was never effective. The court found that there were issues of fact as to whether the person who had discovered the dishonesty was a “supervisory staff” member, as well as whether there had ever been any actual discovery. In reaching this conclusion, the court noted that the term “supervisory staff” was ambiguous. It was not defined in the policy, and the court felt it was unclear whether it would apply to a person who had “some authority (such as the authority to authorize leave or implement employee procedures, for example) but not the authority to hire or fire.”79

The court did not reach the parties’ legal dispute over whether the automatic termination provision applied. The insurer argued that several facts known to the insured’s board of directors, would have caused a reasonable person to make inquiries and discover the loss. Chief among those facts was that the insured bank had been reporting, for

78 Id. at *47. 79 Id. at *65.


many years, that it had zero delinquent loans. The dishonest employee would cover up any delinquencies to prevent investigation into his schemes. As a result, every single loan that the bank had for a period of several years showed up as never having a late payment. The insurer argued that this was highly irregular and that it should have been a huge red flag. But the court found issues of fact as to when discovery occurred.

Finally, the insurer argued that the insured could not demonstrate the amount it had lost by reason of fraud and dishonesty. Many of the insured’s losses (though it was not clear how much) had been incurred via legitimate bad loans. The court noted that the amount of the covered loss would have to be addressed at trial, but the court could not find that the insured had altogether failed to establish some covered loss.

After the court issued its ruling on the motion for summary judgment, the plaintiff moved for reconsideration of the court’s holding that the term “supervisory staff” was ambiguous.80 The court denied that motion, noting the high standard that must be overcome to prevail on a motion for reconsideration. The court noted that for purposes of trial, each party should submit its own proposed definition of “supervisor,” which the court would then consider before instructing the jury on its meaning.

VII. THE “INVENTORY COMPUTATION” EXCLUSION

In W.L. Petrey Wholesale Co., Inc. v. Great American Insurance Co.,81 the insured supplied goods to convenience stores. The insured hired sales people for its delivery routes. Each sales person would order goods from the insured to satisfy the needs of the convenience stores on his or her route. The insured discovered that one member of its sales force had taken approximately $123,000 in merchandise that was purportedly ordered for a customer. The insured submitted a proof of loss to its insurer, which was primarily based on the insured’s

80 Nat’l Credit Union Admin. Bd. v. Cumis Ins. Soc’y, Inc., No. 1:11-

cv-1739, 2015 U.S. Dist. LEXIS 62757 (N.D. Ohio May 13, 2015). 81 No. 2:14-cv-868-csc, 2015 U.S. Dist. LEXIS 10036 (M.D. Ala. Jan.

29, 2015).


comparison of sales and inventory records with the results of the physical inventory of remaining merchandise.82

The insurer denied coverage under the “inventory shortage” exclusion, which provided that the insurer “will not pay for . . . [l]oss, or that part of any loss, the proof of which as to its existence or amount is dependent upon: a) an inventory computation; or b) a profit and loss computation.”83 Because the insured relied on its inventory as proof of the loss, the court held that the insured’s calculations of the loss were “inventory computations” within the meaning of the exclusion.84 The insured argued that the phrase “dependent upon,” as used in the exclusion, applied only when the proof of loss is wholly, as opposed to partially, dependent on inventory calculations. The court disagreed and held that the other “evidence” the insured presented to substantiate its claim was nothing more than an extension of the inventory computations.85 Without any evidence of the loss independent of those calculations, the court held that the exclusion applied.86 The court also rejected the insured’s argument that the exclusion rendered coverage for employee dishonesty illusory.87

In Natrona Heights Supermarket Inc. v. Fireman’s Insurance Co. of Washington D.C.,88 the insured was a supermarket chain who suffered a loss when some of its employees stole inventory and permitted others to take inventory without paying for it. Although the insured’s policy covered employee theft, the “Inventory Shortage” exclusion applied if the proof of the loss depended on an inventory computation or a profit-and-loss computation. There was, however, an exception to the exclusion that permitted the use of inventory records to support the amount claimed if the insured showed that it sustained a loss wholly apart from the inventory. In other words, the exclusion did not bar coverage for a loss the proof of which was not solely dependent on

82 Id. at *6-11. 83 Id. at *14. 84 Id. at *14-15. 85 Id. 86 Id. at *16-19. 87 Id. at *20-25. 88 No. 7565 of 2010, 2013 Pa. Dist. & Cnty. Dec. LEXIS 105 (Pa.

Cnty. Ct. 2013), aff’d 105 A.3d 787 (Pa. Super. Ct. Jul. 9, 2014).


inventory records or profit and loss computations. Affirming the trial court’s judgment for the insured, the court found that independent evidence of employee theft established the loss and that the insured could prove the amount based on an inventory computation.

VIII. ISSUES RELATING TO THE INSURER’S ENFORCEMENT OF

ITS SUBROGATION RIGHTS

Two cases, involving very similar procedural set-ups, made clear that when an insurer pays a claim and subrogates to its insurer’s rights, the insured should not be dragged into the subsequent dispute between the insurer and the party it is suing in an attempt to recover the amount paid to the insured. In Cumis Insurance Society, Inc. v. CU Pacific Audit Solutions, LLC,89 the insurer had paid an employee dishonesty loss. The insurer then sued, as subrogee of the insured, the insured’s former accounting firm, which had caused the insured’s loss. That accounting firm filed a third-party complaint against the insured and the insured’s dishonest employees. It then sought to be re-aligned as the plaintiff in the case instead of a third-party complainant. If that argument had succeeded, the federal court in which the case was pending would have lost diversity jurisdiction over the case because there would no longer be complete diversity between all plaintiffs and defendants. But the insured moved to dismiss the third-party complaint by the accounting firm, which the court granted, making the request for realignment moot. The court held that the insurer was the real party in interest to assert the claims against the accounting firm as subrogee and that diversity jurisdiction was present.90 The court also found that most of the third-party claims were really defenses that the accounting firm could assert against the subrogated insurer’s claims. The court thus dismissed the claims brought by the accounting firm with prejudice.91

89 No. 14-00140, 2014 U.S. Dist. LEXIS 167733, *3-6 (D. Haw. Dec.

1, 2014). 90 Id. at *7-14. 91 Id. at *15-17.


In Travelers Casualty and Surety Co. v. Washington Trust Bank,92 the insurer paid an employee dishonesty loss and, as the assignee and subrogee of the insured, sued a bank. The bank filed a third-party complaint against the insured for failure to examine bank statements and breach of presentment warranties. The insured moved to dismiss the third-party complaint. The court granted the insured’s motion to dismiss, finding that the factual basis for the third party complaint could be asserted as defenses to the insurer’s claims.93

IX. WHEN MULTIPLE EMPLOYERS EMPLOY THE SAME

PERSON

In Transtar Electric, Inc. v. Charter Oak Fire Insurance Co.,94 one individual owned two companies. Each company had separate employees, separate bank accounts, and separate insurance policies. But there was some overlap between the two. For example, they were run out of the same office, and one bookkeeper worked for both corporations. Unfortunately, that bookkeeper was dishonest. He was stealing—but only from the second company. The insurer for the second company paid the applicable limit of its policy for the loss. The other company then also submitted a claim and sued its insurer, seeking to recover the remainder of the loss. In a brief opinion, the court granted summary judgment to the insurer. The court emphasized the language in the policy stating that it covered theft “to the deprivation of the insured.”95 Here, it was not the insured that suffered the loss but the other company, which, although owned by the same person, was distinct.

In Dataflow, Inc. v. Peerless Insurance Co.,96 the plaintiffs were three related legal entities with the same owner. All three entities were in the business of blueprint and microfilm services. Certain employees of

92 No. CV-13-0409-JLQ, 2014 U.S. Dist. LEXIS 123582, *2-4 (E.D.

Wash. Sept. 3, 2014). 93 Id. at *3-8. 94 No. 3:13-cv-1837, 2015 U.S. Dist. LEXIS 44202 (N.D. Ohio Apr. 3,

2015). 95 Id. at *7-8. 96 No. 3:11-cv-1127, 2014 U.S. Dist. LEXIS 138042 (N.D.N.Y. Sept.

30, 2014).


the insureds, including those in accounting, performed work for all three entities. One of these accounting employees embezzled over $1 million from accounts belonging to all three of the entities.

Each of the three entities had an insurance policy that covered employee dishonesty and theft. The insurer paid on one of the three policies, but it refused to pay under the policies that the other two companies had in place.97 In the coverage dispute, the first question the court analyzed was whether the dishonest accountant was an “employee” of the other two entities. The policies defined “employee” as a person whom the insured compensated directly and whom the insured had the right to direct and control while performing services for the insured.98 The insured contended that the employee was an employee of all three entities because it was paid out of an account to which all three entities contributed. The court agreed with this argument, and also reasoned that the definition of “employee” was ambiguous, requiring the definition to be construed in the insured’s favor.99

The parties also disputed whether the dishonest accountant had engaged in one or multiple acts of dishonesty.100 The court analyzed this question by asking whether there was a close temporal and spatial relationship between the incidents giving rise to the loss, and whether the incidents could be viewed as part of the same causal continuum, without intervening agents or factors. The court held that there was insufficient evidence to determine whether this test was satisfied.101

The court did agree, however, with the insured’s argument that where, as here, there was a single occurrence spanning multiple policy periods, the coverage limits had to be applied separately to the losses sustained in each period. The court stated that the policy language indicated that the policies were intended to operate as independent contracts that each established a recovery limit.102

97 Id. at *2-4. 98 Id. at *7. 99 Id. at *11-12. 100 Id. at *14-15. 101 Id. at *15-18. 102 Id. at *19-20.


X. MISCELLANEOUS

A. Denial of a Motion to Dismiss Due to Ambiguity

In Allion Healthcare, Inc. v. Arch Insurance Co.,103 the insured was a specialty pharmacy and disease-management company. Its former employee had been responsible for purchasing pharmaceuticals for the insured. But unfortunately, that employee was obtaining pharmaceuticals for his employer from illegal sources. The employee would then dispense those medications to the insured’s customers, most of whom were on Medicaid. When the scheme came to light, the New York State Attorney General sued the insured for claiming and obtaining reimbursement from Medicaid for the pharmaceuticals that were not eligible for reimbursement since they were obtained outside “legitimate” streams of commerce. The insured sought coverage for the resulting loss under both a canopy and crime insurance policy and liability policy for criminal acts committed by a former employee. When the insurer denied coverage, the insured brought a claim for breach of contract and breach of the duty to defend. The insurer moved to dismiss the complaint.104

The court denied the motion to dismiss, noting that dismissals are hard to come by—they are appropriate only if the terms in the policy are clear and unambiguous. But here, the court held that there were ambiguities in the policy language. With very little analysis, and no explanation of which terms were ambiguous, the court held that whether a “theft” had occurred could not be decided on a motion to dismiss because several of the key terms were open to different interpretations.

B. Recovery Under Multiple Back-to-Back Policies

In E.J. Zeller, Inc. v. Auto Owners Insurance Co.,105 the insured was a long-time customer of the insurer. It had purchased “Tailored Protection Policies” from the same insurer for many years. These

103 No. CV 14-0147, 2014 U.S. Dist. LEXIS 137282 (E.D.N.Y. Sept.

23, 2014). 104 Id. at *2-4. 105 No. 4-14-04, 2014 Ohio App. LEXIS 4876 (Ohio Ct. App. Nov. 10,

2014).


policies provided coverage for commercial crime and employee dishonesty.106 The insured discovered, in August 2008, that one of its employees had been embezzling from it for all of the nearly three years she had been employed with the insured. The insurer paid the policy limits of the policy that was in place at the time of the discovery, but it argued that the policy limits of the other policies were not available. The insured sued to recover the policy limits under the previous policies.

The court of appeals of Ohio, in a lengthy and poorly reasoned opinion, agreed that the insurer was entitled to coverage under multiple policies. The court examined five different provisions in the policy, most of which appeared to preclude exactly the kind of policy-stacking that the insured was requesting. The court concluded that none of these provisions applied.

First, the court examined a clause stating that coverage applied only to loss sustained through acts committed during the policy period. The court found that this provision did not “clearly state that coverage under prior policies for those losses is excluded by the current policy.”107 Instead, the court reasoned, this language was “merely a limit of coverage under the current policy.”108

Second, the court examined the “Discovery” provision, which provided that coverage applied only to loss discovered no later than one year from the end of the policy period. The court concluded, probably correctly, that this provision did not preclude recovery under multiple policies. Many fidelity bonds state that discovery of the loss must occur within the policy period for coverage to apply. But because this policy instead required that discovery occur within a set time frame that was broader than the policy period, it left open the possibility that multiple policies could apply.

Third, the court examined a “Prior Loss” provision, which stated that if loss was covered partly by the current policy and partly by any prior insurance, “the most we will pay is the larger amount of the amount

106 Id. at *2. 107 Id. at *19. 108 Id.


recoverable under this insurance or the prior insurance.”109 The court found that this language did not prevent the insured from recovering under both the policy in place when it discovered the loss and previous policies because the provision “only applies when a loss spans multiple policy periods,” as opposed to when an “occurrence” does.110 In other words, the court stated that the provision applied to “individual losses, not to an aggregation of losses.”

Fourth, the court looked at the “Non-Cumulation” provision, which stated that “no Limit of Insurance cumulates from year to year or period to period.”111 The court found that this provision applied only when the current policy covers multiple years, not when there are multiple individual policies issued over the course of several years.

Finally, the Court examined the “Limit of Insurance” clause, which stated that “the most we will pay for loss in any one ‘occurrence’ is the applicable Limit of Insurance shown in the Declarations.”112 The court had held earlier that all of the employee’s misdeeds constituted one “occurrence.” But it nonetheless held that this provision did not limit the insured to recovery under one policy. It reasoned that the limit of insurance would apply only when there was actually coverage—without coverage, there is no recovery to limit. And it then concluded that part of the loss at issue here was already excluded from coverage because it was not discovered at the right time. Thus, it concluded that the “limit of Insurance operates only to define the extent of liability for losses that are otherwise covered … [t]here is no need to limit liability for losses that are otherwise already excluded from coverage.”113 In other words, the court seemed to hold that because coverage would not necessarily apply under each successive policy due to other exclusions and provisions, those other exclusions and provisions were the only relevant limitation to coverage—not the “Limit of Insurance” provision.

109 Id. at *21. 110 Id. at 22-23. 111 Id. at *23. 112 Id. at *26. 113 Id. at 27.


C. Evidence of Collusion

In FDIC v. Fidelity & Deposit Co. of Maryland,114 the FDIC as a receiver for Integra Bank, sued to recover under a fidelity bond the insured had purchased. The insured’s loss was a result of loans made to entities related to Louis Pearlman. Pearlman and his related entities obtained several loans from the insured, Integra, totaling approximately $29 million. Pearlman submitted false financial reports and documentation during the loan process to one particular employee of Integra, Stuart Harrington, who allegedly knew the documents were false but nevertheless secured the loans for Pearlman. When Pearlman and his related entities defaulted on the loans, Integra was left with a loss of $23 million.115

The receiver for Integra sought to recover this loss from the fidelity insurers that had sold bonds to Integra. The insurer refused to provide coverage in part because there was insufficient evidence of collusion between an employee of Integra and Pearlman. The court found that questions of fact precluded summary judgment on both these grounds.

In concluding that there were issues of fact as to collusion, the court relied on the following facts: 1) Harrington received payments from Pearlman while employed at the insured; 2) Harrington worked for Pearlman after leaving the insured and received substantial payments while in his new position for Pearlman; 3) Pearlman said he and Harrington had a “wink wink” understanding; and 4) Harrington asserted his Fifth Amendment rights when questioned about his involvement in the scheme at his deposition. The insurer claimed the evidence of collusion was nothing more than speculation and self-serving statements, which could not defeat summary judgment.116 The court disagreed, and held that the evidence, though circumstantial, could persuade a reasonable jury that collusion had occurred. In particular, the court held

114 No. 3:11-cv-00019, 2014 U.S. Dist. LEXIS 166808, *16-19 (S.D.

Ind. Dec. 2, 2014). 115 Id. at *2. 116 Id. at *17-18 (citing Knowledge AZ, Inc. v. Jim Walters Res., Inc.,

617 F. Supp. 2d 774, 794 (S.D. Ind. 2008) (holding that speculative and conclusory affidavit could not defeat summary judgment on collusion issue)).


that Harrington’s assertion of his Fifth Amendment rights could be considered as evidence of collusion.117

D. The Requirement to File a Proof of Loss

In Federal Deposit Insurance Corp. v. Kansas Bankers Surety Co.,118 the insurer sought summary judgment on the grounds that its insured had not provided a proof of loss as the bond required. The insured was a bank that had recently been taken over by a receiver. The bond provided that it terminated immediately upon a receiver taking over for the insured. The bond also required that the insured provide a proof of loss with full particulars of the circumstances that caused the loss. By the time the receiver took over, the bank had not provided any proof of loss to its insurer. The insurer argued that by that time, the bond had terminated and it was too late to provide a proof of loss at that point. The court agreed. It noted that the bond required a proof of loss before the termination or cancellation of the bond.119 Because the bank had failed to do so, the court awarded summary judgment to the insurer.

E. Removal: The Citizenship of a Federally Chartered Financial Institution

In Arlington Community Federal Credit Union v. Berkley Regional Insurance Co.,120 the defendant insurer removed on diversity grounds. The defendant was a citizen of Delaware, but the plaintiff’s citizenship was less clear. It was a federally chartered financial institution. The plaintiff sought remand, arguing that, as a federally chartered corporation, it was not a citizen of any state, and certainly not a citizen of Virginia, as the defendant had alleged in its notice of removal. The court disagreed. It noted that the citizenship of a federally chartered corporation was determined by where the entity was “localized.” It applied a four-factor test to decide where the plaintiff in this case was localized. It found that it was localized in Virginia because its principal

117 Id. at *16-19. 118 No. 1:13-cv-2344, 2015 U.S. Dist. LEXIS 66505 (D. Colo. May 21,

2015). 119 Id. at *13. 120 No. 1:14cv1022, 2014 U.S. Dist. LEXIS 154723 (E.D. Va. Oct. 31,

2014).


place of business was in Virginia, along with most of its customers and all its branches. The plaintiff’s website was another persuasive factor: it stated that the plaintiff served “all those who live, work, worship, go to school, volunteer, or consistently do business in Arlington County [Virginia].”121

The court next examined whether the defendant’s notice of removal was defective because it did not allege that the plaintiff was “localized” in Virginia. The notice of removal recited only that Virginia was the plaintiff’s principal place of business. The court refused to remand on these grounds. Although the defendant had “imperfectly” stated the grounds for removal, the court reasoned that the defect was small and that the defendant should have a chance to amend.

F. Motion for Reconsideration

Fidelity National Financial, Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pa.,122 denied the insurer’s motion for reconsideration of a grant of summary judgment to the insured. The standard for a motion for reconsideration is, of course, high and difficult to overcome. The court recited that high standard and held that the opinion granting the insured’s motion for summary judgment did not involve the “clear error” necessary to grant a motion for reconsideration.123 Rather, the court noted that the insurer was merely advancing the same arguments or new arguments that it should have made before. In particular, the insurer argued that an exclusion clearly applied to preclude coverage. But the insurer had never raised the application of that exclusion before. In a response to an interrogatory asking about which exclusions the insurer intended to rely on, the insurer did not mention it. The court found it was too late to raise the exclusion in a motion for reconsideration.124

121 Id. at *14. 122 No. 09-CV-140, 2015 U.S. Dist. LEXIS 46822 (S.D. Cal. Feb. 19,

2015). 123 Id. at *3. 124 Id. at *8-10.


G. Motions in Limine

In two back-to-back opinions, the District Court of Colorado examined motions in limine filed by both an insurer and insured. In Centrix Financial Liquidating Trust v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania,125 the insured alleged that five of its former officers had fraudulently diverted at least $83 million. The insured sought to recover the diverted funds from its fidelity insurer. National Union, the insurer, declined to cover the loss, contending that the suit was filed outside the two-year limitations period set forth in the bond and that the plaintiff had failed to show that the acts causing their loss were dishonest or fraudulent.126 The court’s opinion addressed several motions in limine filed by National Union. The insured planned to offer evidence showing that National Union was not prejudiced by the late filing of the suit. But the court refused to admit such evidence, reasoning that if the suit was filed past the statute of limitations, the question of prejudice was irrelevant. The insured also planned to offer evidence showing that National Union had delayed in processing the claim. The court also kept this evidence out, because there was no claim of bad faith or any other claim relevant to claims handling. The court also excluded evidence of fraud or dishonesty by individuals whom the insured had not identified as having engaged in dishonest or fraudulent conduct during the discovery process.

In another opinion addressing motions in limine in the same case, the District Court of Colorado kept out evidence of rather salacious conduct by the insured that would have had no bearing on the actual coverage dispute.127 The conduct included outings to strip clubs and charges of sexual harassment. The court held that this evidence, if offered by the insurer, would serve to do nothing but cast the insured in a negative light.128 The court also ruled that evidence relating to spoliation would not be admitted. The court granted the insured’s motion to keep out evidence of the insured’s decision to hire a law firm to help it

125 No. 09-cv-1542, 2015 U.S. Dist. LEXIS 70497 (D. Colo. June 1,

2015). 126 Id. at *3. 127 Centrix Fin. Liquidating Trust v. Nat’l Union Fire Ins. Co. of

Pittsburgh, Pa., 2015 U.S. Dist. LEXIS 68367 (D. Colo. May 26, 2015). 128 Id. at *9-10.


investigate possible misdeeds by its employees. The insured’s hiring of this law firm suggested that the insured suspected or had discovered the loss earlier than it admitted. There had also been a dispute earlier in the case as to whether the insured and that law firm spoliated evidence relevant to when the insured discovered the loss. But the insurer’s motion for a spoliation finding had been denied. Thus, the court ruled to keep out any evidence of those prior proceedings and all facts relevant to spoliation.

H. Acting as a Securities Broker

In Jacobson Family Investments, Inc. v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania, 129 the insured had allegedly suffered losses at the hands of Bernie Madoff’s Ponzi scheme, and sought to recover its loss under a financial institution bond. The key language in the bond stated that it covered: “Loss resulting directly from the dishonest acts of any Outside Investment Advisor, named in the Schedule below, solely for their duties as an Outside Investment Advisor . . .” Madoff was listed in the referenced “Schedule” as an Outside Investment Advisor. But the bond also excluded loss resulting from dishonest acts of any “securities . . . broker, agent or other representative of the same general character.”130 The insurer argued that Madoff had been acting, when he caused the loss, as an Outside Investment Advisor and a securities broker. It thus argued that the exclusion precluded coverage. The New York Appellate Division agreed with the insurer.

The court held that the bond provided coverage for actions taken by Madoff as an Outside Investment Advisor only when he had acted solely in that capacity. The court held that the relevant evidence showed the insured’s losses “were due to Madoff acting not only as an Investment Advisor, but also as a securities broker.”131 Thus, coverage could not apply under the language quoted above, which required that the dishonest acts be committed by an Outside Investment Advisor acting solely in that capacity. And in any event, the exclusion applied, the court

129 No. 14802, 2015 N.Y. App. Div. LEXIS 5175 (N.Y. App. Div. June

18, 2015). 130 Id. at *3. 131 Id. at *6.


held. The Court reversed judgment for the insured and directed entry of judgment for the insurer.

XI. CONCLUSION

As these cases make clear, the cases issued between July 1, 2014, and July 1, 2015, were a mixed bag for the insurance industry. Many were favorable, but several cases stand out as hurdles that insurers will likely be jumping for years to come. The E.J. Zeller opinion that permits insureds to stack policy limits is among them.132 Also troublesome is the opinion holding that an insurance policy covering “loss of money” also covers the loss of interest that could have been earned on the lost funds.133 But there were many excellent opinions. The Brewton case applied a common-sense definition of “counterfeit” to conclude that the term did not encompass a genuine stock certificate.134 And in Pestmaster, the court correctly held that when a trusted entity uses its authorized access to an insured’s computer system, the resulting loss is not recoverable under a bond that covers hacking.135 Ultimately, no clear trends either in favor of or against the insurance industry emerged. As always, the real impact of all these decisions will become clearer with time.

132 No. 4-14-04, 2014 Ohio App. LEXIS 4876 (Ohio Ct. App. Nov. 10,

2014). 133 Town of Ira v. Vt. League of Cities and Towns, No. 13-373, 2014

Vt. LEXIS 120 (Vt. Oct. 31, 2014). 134 777 F.3d 1339 (11th Cir. 2015). 135 No. CV 13-5039, 2014 U.S. Dist. LEXIS 108416 (C.D. Cal. July 17,

2014).

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