On August 6, 2019 the Eighth Circuit Court of Appeals released its decision in C.S. McCrossan Inc. v. Federal Insurance Company.  The decision addresses a host of coverage issues, including the application of the “Authorized Representative” exclusion and the definitions of “Subsidiary” and “Contractual Independent Contractor.”  The case is instructive for fidelity claims and underwriting professionals, as well as brokers and corporate risk managers.


The Facts

C.S. McCrossan Inc. (“McCrossan”) maintained a subsidiary, Blakeley Properties, LLC (“Blakeley”).  One of McCrossan’s owners also owned a separate company, Stewart Properties, LLC (“Stewart”).   Blakeley and Stewart owned commercial rental properties.  Through intermediate agents not germane to our analysis, each of Blakeley and Stewart retained Balderson Management, Inc. (“Balderson”) to manage the properties.  Blakeley also separately retained Balderson directly.

Balderson’s owner and principal, Cynthia Balderson, managed the properties with the help of her daughter Stephanie Castillo.  Castillo was the primary user of Balderson’s property management software system, the sole copy of which was on her computer. Unlike Ms. Balderson, Castillo was not responsible for signing, and did not have authority to sign, cheques from any accounts.

Over the course of several years, Castillo stole approximately $570,000 from Blakeley and $250,000 from Stewart.  Castillo did so by creating fake invoices in the property management system, printing cheques drawn on Blakeley’s and Stewart’s accounts payable to herself or for her benefit, manipulating the system to show payments to vendors, and forging Ms. Balderson’s signature on each cheque.

Was Stewart a “Subsidiary” of McCrossan?

Each of Blakeley and Stewart submitted claims to Federal under McCrossan’s policy on the basis that they were Subsidiaries of McCrossan.  The policy defined “Subsidiary” in relevant part as:

any entity while more than fifty percent (50%) of the outstanding securities representing the present right to vote for election of or to appoint directors, trustees, managers, members of the Board of Managers or equivalent positions of such entity are owned, or controlled, by the Parent Organization, directly or through one or more Subsidiaries.

Federal accepted that Blakeley was a Subsidiary and was insured under the policy.  However, Stewart was owned not by McCrossan, but by one of McCrossan’s individual owners.  The Court held that Stewart was not insured under the policy:

While the policy was in effect, Stewart was wholly-owned by a McCrossan individual.  Without citing authority, McCrossan argues Stewart is an Insured because it was not in a “materially different position” than other McCrossan-related entities [Federal] admits are covered.  The policy’s language calls for ownership or control by McCrossan.  Ownership and common management by McCrossan individuals, even McCrossan board members, does not meet this test.  Because Stewart does not meet the policy’s definition of Subsidiary, it is not an Insured.

This serves as a useful reminder for brokers and corporate risk managers.  In any business enterprise encompassing multiple corporate or other legal entities, it is essential that the legal nexus among the entities (or lack thereof) be ascertained before presenting the potential risk for underwriting consideration.  Consideration must be given to: (i) the definitions of “Insured” and “Subsidiary” in the crime policy under consideration; and, (ii) whether any entity needs to be added by specific endorsement to the policy.

The Authorized Representative Exclusion

Federal accepted that Castillo’s forging Ms. Balderson’s signature on Blakeley cheques met the requirements of the Forgery insuring agreement.  However, the policy contained an “Authorized Representative” exclusion, the relevant portion of which excluded:

loss or damage due to Theft, Forgery, Computer Fraud, Funds Transfer Fraud, Money Orders And Counterfeit Currency Fraud, Credit Card Fraud or other fraudulent, dishonest or criminal act (other than Robbery or Safe Burglary) committed by any authorized representative of an Insured, whether acting alone or in collusion with others …

McCrossan contended that the exclusion could not apply to Castillo’s conduct, as she was not authorized to sign Blakeley cheques in the normal course.  The Court rejected this argument, holding that:

the authorized representative exclusion unambiguously applies here, where Blakeley’s empowerment of Castillo to act on its behalf enabled her crime. …

 Blakeley authorized Balderson to act on its behalf for property management. Balderson’s duties included managing bank accounts, all accounting (rental billing, deposits, distributions, and disbursements), approving invoices, and maintaining property management software.  Blakeley knew that Balderson performed its duties through [Ms. Balderson] and Castillo.  Blakeley’s grant of authority to Balderson thus empowered them to work on its behalf. … Castillo’s role at Balderson authorized her to conduct the activities that led to her crimes, thus the authorized representative exclusion applies. …

 In light of these facts, Castillo’s lack of check-signing authority does not preclude her from being an “authorized representative,” as McCrossan argues.  The term’s unambiguous meaning does not impose such a requirement. [citations omitted]

The Eighth Circuit rejected the narrow argument that the exclusion only applies where the defaulter was authorized to commit the specific type of act that ultimately resulted in the loss, holding instead that it was sufficient that Blakeley had empowered Castillo to act on its behalf.

The Employee Theft Coverage

The Court briefly considered McCrossan’s contention that coverage was available under the Employee Theft insuring agreement.  Unlike many crime policies, McCrossan’s policy extended the ambit of coverage to acts of a “Contractual Independent Contractor”, which was defined as:

any natural person independent contractor while in the regular service of an Organization in the ordinary course of such Organization’s business, pursuant to a written contract between such Organization, and either (A) such natural person independent contractor, or (B) any other entity acting on behalf of such natural person independent contractor, for services.

The Court held that Castillo did not meet this definition, as she had not contracted directly with Blakeley or with McCrossan:

McCrossan/Blakeley did not have a written contract for services with Castillo. Blakeley did have a contract with Balderson. Viewing the record most favorably to McCrossan, Balderson was not acting on behalf of Castillo.

The Court distinguished a case relied on by McCrossan in which a payroll company had defrauded its client through the actions of the payroll company’s directing minds:

First, Balderson’s contractual relationship with Blakeley started before Castillo joined Balderson. Though she worked there when Blakeley hired Balderson directly, that contract was recommended when the companies’ relationship started (again, before she joined Balderson). Second, [Ms. Balderson] owned Balderson, not Castillo, and the purpose of its existence was not to facilitate Castillo’s crime.

As such, Castillo did not meet the definition of “Contractual Independent Contractor” and no coverage was available under the Employee Theft insuring agreement.

Conclusion

C.S. McCrossan Inc. provides helpful guidance to fidelity claims professionals regarding the application of the “Authorized Representative” exclusion, as well as the definitions of “Subsidiary” and “Contractual Independent Contractor”.  The Eighth Circuit’s interpretation of the “Authorized Representative” exclusion is particularly noteworthy, in that the Court expressly rejected the contention that the exclusion applies only where the defaulter was authorized to commit the specific type of act that ultimately resulted in the loss.

The decision also serves as a useful reminder for brokers and risk managers, on two counts:

  • It is essential to accurately discern the legal relationships among the business entities to be insured before presenting the potential risk for underwriting consideration, and to ensure that all entities meet applicable policy definitions for who is to be insured or, alternatively, are added as insureds by special endorsement to the policy. This precaution might have avoided the situation with Stewart.
  • When dealing with third-party service providers which handle the insured’s funds, such as property/condominium managers or benefits administrators, it is crucial to ensure that coverage for the insured is extended to include losses resulting from the dishonest acts of such third-party service providers and their employees. This will typically not be available under most base-form crime wordings.  Instead, the insured will require an appropriate endorsement to that effect (or, alternatively, the insured will need to confirm that appropriate Client Coverage has been added to the service provider’s own crime policy).  This precaution might have avoided the situation with Castillo.

C.S. McCrossan Inc. v. Federal Insurance Company, 2019 WL 3558550 (8th Cir.)