It’s a Crime: Efforts to Constrict the Broad Scope of Fidelity Insurance Coverage

Companies purchase fidelity-insurance policies to protect against loss from employee dishonesty. Fidelity coverage generally falls into two categories: financial fidelity, for banks and other financial institutions, and commercial fidelity, or commercial crime coverage, for other businesses. Financial-fidelity forms are substantially standardized; commercial-fidelity wordings are less uniform, even when they originate with the Surety Association of America or the Insurance Services Office.

Two questions ordinarily drive a commercial-fidelity claim: Is the misconduct covered? And, if so, how much does the policy pay? The first often turns on whether an employee acted with “manifest intent” both to benefit himself or someone else and to harm his employer. Less attention has been paid to the scope of the promised indemnity for “Loss of Money, Securities or other property.” Building One Service Solutions, Inc. v. National Union Fire Insurance Co. of Pittsburgh, PA, Civil No. 02-311-A (E.D. Va. Nov. 26, 2002), addresses both questions. I was lead counsel for the policyholder.

The Building One case involved the head of a subsidiary who, according to the policyholder’s evidence, essentially hijacked the operation for the enrichment of himself and his cronies. The scheme included requisitions to the parent company for fabricated expenses and previously paid expenses, with payments diverted to dummy corporations. To conceal and perpetuate the scheme, the manager allegedly shifted costs among jobs and took on more work, often below cost, creating additional cost centers against which to transfer real and false invoices.

Building One submitted its proof of loss in October 2000 and sued in March 2002. National Union then made a payment of roughly $594,000 in May 2002, but maintained that the policy covered only the documented embezzlement, not the much larger losses Building One attributed to the scheme. Building One sought the balance of its $5 million policy limit, as well as attorneys’ fees for the allegedly unreasonable denial of coverage. The court denied National Union’s motion for partial summary judgment. The case later settled.

On manifest intent, the court found questions of fact that could not be resolved in the insurer’s favor on summary judgment. The same was true of causation. Construing the policy’s “loss resulting directly from” language, the court applied a proximate-cause standard. The competing explanations—fraud on the policyholder’s account, poor business judgment and market conditions on the insurer’s—presented a question for trial. Building One, slip op. at 9–14.

The court then rejected the insurer’s attempt to confine coverage to the dollars that reached the employee’s pocket. Building One’s claim included money lost performing contracts allegedly undertaken to facilitate and conceal the theft. The court held that the contracts’ not having been misappropriated or fraudulently created did not, by itself, put the resulting losses outside 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.” Building One, slip op. at 16.

Next came exclusion (m), which barred “damages of any type for which the Insured is legally liable,” except “direct compensatory damages arising from a loss covered under this Policy.” The court distinguished a claim for liability to third parties from Building One’s claim for its own loss. It concluded that “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.” Building One, slip op. at 16–17.

The point is not that every business loss accompanying employee dishonesty is insured. The policyholder still must prove the required intent, the covered loss, and the causal connection. But “Employee Dishonesty” coverage need not stop at employee embezzlement. Under the language construed here, coverage was not artificially confined to the thief’s take. Whether Building One could prove the larger covered loss remained for trial; the court had not entered a judgment awarding that loss.

Finally, the case involved an effort to prove manifest intent without the employee’s direct testimony. The employee invoked the Fifth Amendment in light of a pending, ultimately successful criminal prosecution. That circumstance need not end the insured’s effort to prove covered dishonesty. In fidelity cases, courts have permitted coverage-favorable inferences from a nonparty witness’s invocation of the privilege. The inference is not automatic: its admissibility and force depend on the circumstances, including corroborating evidence and the court’s assessment of unfair prejudice. See FDIC v. Fidelity & Deposit Co. of Maryland, 45 F.3d 969, 977–78 (5th Cir. 1995); Ralph Hegman Co. v. Transamerica Insurance Co., 198 N.W.2d 555, 557–58 (Minn. 1972). See also Robert E. Johnston & Christopher L. LaFon, Inferring Dishonesty: The Fifth Amendment and Fidelity Coverage, Insurance Coverage Law Bulletin, vol. 2, no. 3 (Apr. 2004). The insurer sold protection against employee dishonesty; the wrongdoer’s refusal to talk should not, by itself, defeat that protection.

Originally published in Insurance Scrawl on June 29, 2005. Republished with updated citation links and editorial revisions. The analysis speaks as of the original publication date.

Related: Insurance Coverage · Marc Mayerson’s biography.

Topics: Fidelity Insurance · Employee Dishonesty · Commercial Crime

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