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As a respected senior counsel with over 35 years of experience in specialty lines coverage and litigation, David Wilson is a trusted advisor to many of Canada’s leading commercial insurers. David’s practice focuses on professional liability insurance, directors’ and officers’ (D&O) liability insurance and fidelity insurance.

Jump To: The Facts | The Decision | The Conclusion

On April 17, 2018, the Ninth Circuit Court of Appeals released its decision in Aqua Star (USA) Corp. v. Travelers Casualty and Surety Company of America, affirming the decision of the U.S. District Court for the Western District of Washington (see our July 19, 2016 post).  The decision offers guidance to fidelity insurers with respect to the application of the “authorized entry” exclusion found in the base wording of many commercial crime policies (sometimes referred to as the “authorized access” exclusion), and illustrates how this exclusion may operate in the context of a social engineering fraud loss.

Continue Reading Aqua Star: Ninth Circuit applies Authorized Entry Exclusion to Social Engineering Fraud Claim

JUMP TO: THE FACTS | THE CUMIS COVERAGE | THE CONCLUSION

On January 22, 2018, the U.S. District Court for the Southern District of New York released its decision in Hudson Heritage Federal Credit Union v. CUMIS Insurance Society, Inc., dismissing the insured credit union’s claim pursuant to Federal Rule 12(b)(6) for failure to state a claim upon which relief could be granted.

According to its amended complaint, the insured had granted several vehicle finance loans on the strength of photocopies or electronic copies of New York State Department of Motor Vehicles (“DMV”) title documents.  The copies received by the insured had been falsified to misrepresent the names of the owners/sellers.  The Court found that the insured’s complaint failed to plead that its losses had resulted directly from forgery or alteration of an “instrument”, which the bond in issue defined as an “original … document of title”.

Continue Reading Hudson Heritage: U.S. District Court dismisses Fraudulent Loans claim where Credit Union failed to plausibly plead Alteration of Original Documents of Title

Jump To: The Facts | The Ownership Condition | The Conclusion

On November 20, 2017, the Fifth Circuit Court of Appeals released its decision in Cooper Industries, Limited v. National Union Fire Insurance Company of Pittsburgh, PA.  The Court applied a crime policy’s ownership condition in ruling that the insured did not have coverage for the loss of funds incurred when an investment entity to which it had provided funds in exchange for promissory notes collapsed due to the entity’s principals’ Ponzi scheme.

The dispute arose out of the same Ponzi scheme that gave rise to the decision of the Eighth Circuit in 3M Company v. National Union Fire Insurance Company of Pittsburgh, PA (see our June 13, 2017 post).  Although there are important factual distinctions between the two losses, the Fifth Circuit reached the same conclusion as the Eighth Circuit in finding that the insured had not demonstrated that it owned the property in issue.

Continue Reading Cooper Industries: Fifth Circuit applies Crime Policy’s Ownership Condition in finding No Coverage for Loss of Funds in Ponzi Scheme

Jump To: The Facts | The Travelers Coverage | The Conclusion

On October 31, 2017, the U.S. District Court for the District of New Jersey released its decision in Posco Daewoo America Corp. v. Allnex USA, Inc. and Travelers Casualty and Surety Company of America. This case features an interesting twist on the usual social engineering fraud claim scenario, in that it was the intended payee of the funds, not the payor, which asserted a claim under its own crime policy for recovery of funds which the payor had been duped into paying to an impostor. This type of claim has been referred to as a “reverse” social engineering fraud claim. Numerous such claims have been advanced by intended payees recently, typically when it comes to light that the payor did not maintain its own social engineering fraud coverage.

The Court applied traditional concepts of ownership in finding that the intended payee did not “own” the funds at any time, and thus could not establish that its claim met the ownership condition in its policy.

Continue Reading Posco Daewoo: U.S. District Court rejects Creditor’s “Reverse” Social Engineering Fraud Claim under its own Crime Policy

Jump To: The Facts | The Tort of Conversion and the Bills of Exchange Act | The Conclusion

On October 27, 2017 the Supreme Court of Canada released its long-awaited decision in Teva Canada Ltd. v. TD Canada Trust. In a 5:4 decision, the Supreme Court held that two banks that accepted fraudulent cheques procured by a dishonest employee were strictly liable in conversion to the employer, and could not establish the “fictitious or non-existing payee” defence afforded by subsection 20(5) of the Bills of Exchange Act.

The decision is a welcome development for Canadian fidelity insurers who seek to subrogate against banks in respect of certain types of employee cheque frauds. The Supreme Court reversed the decision of the Court of Appeal for Ontario, which had found that the payees were either fictitious or non-existing. The Supreme Court’s decision places fidelity insurers in an excellent position to look to banks as subrogation targets in appropriate circumstances.

Continue Reading Teva: Supreme Court of Canada rejects Fictitious or Non-Existing Payee Defence in finding Collecting Banks Liable for Employee Cheque Fraud

JUMP TO: THE FACTS | THE COMPUTER FRAUD COVERAGE | THE CONCLUSION

On August 1, 2017, the U.S. District Court for the Eastern District of Michigan released its decision in American Tooling Center, Inc. v. Travelers Casualty and Surety Company of America. The Court held that a vendor impersonation fraud loss did not fall within the terms of a crime policy’s computer fraud coverage. In coming to this conclusion, the Court found there was no direct causal link between the receipt of fraudulent emails by an insured requesting payment to the fraudster’s bank account, and the insured’s authorized transfer of funds to that bank account.

Continue Reading American Tooling Center: U.S. District Court finds no Coverage for Social Engineering Fraud Loss under Crime Policy’s Computer Fraud Insuring Agreement

JUMP TO: THE FACTS | THE FUNDS TRANSFER FRAUD COVERAGE | THE CONCLUSION

On July 4, 2017, the Alberta Court of Queen’s Bench released its decision in The Brick Warehouse LP v. Chubb Insurance Company of Canada. The Court found that a vendor impersonation loss did not fall within the terms of a crime policy’s Funds Transfer Fraud coverage. The case represents the first social engineering fraud decision in Canada since the widespread introduction of discrete social engineering fraud coverage, and confirms the principles adopted in several recent American social engineering fraud decisions, including the Ninth Circuit’s decision in Taylor & Lieberman (see our April 3, 2017 post), on which the Court expressly relied.

Continue Reading The Brick: Alberta Court of Queen’s Bench finds no Coverage for Social Engineering Fraud Loss under Crime Policy’s Funds Transfer Fraud Insuring Agreement

JUMP TO: THE FACTS | THE OWNERSHIP CONDITION | THE CONCLUSION

Guest Co-Author: John Tomaine

On May 31, 2017, the Eighth Circuit Court of Appeals released its decision in 3M Company v. National Union Fire Insurance Company of Pittsburgh, PA. The Court affirmed the decision of the U.S. District Court for the District of Minnesota (see our October 13, 2015 post), which had applied a crime policy’s ownership condition in ruling that the insured did not have coverage for the loss of investment earnings incurred when an investment entity in which it had a limited partnership interest collapsed due to the entity’s principals’ Ponzi scheme. The Eighth Circuit’s decision provides a good illustration of the interaction between the ownership condition and statutory and common law concepts of “ownership” as they relate to partnerships.

Continue Reading 3M: Eighth Circuit applies Crime Policy’s Ownership Condition in finding No Coverage for Loss of Undistributed Limited Partnership Earnings in Investment Fraud

JUMP TO: THE FACTS | THE INVENTORY EXCLUSION | THE CONCLUSION

The inventory exclusion precludes an insured from proving an employee theft loss solely by reliance on inventory calculations, independent of other proof of actual employee theft. A recent decision of the Court of Appeals of Kentucky, Khazai Rug Gallery, LLC v. State Auto Property & Casualty Insurance Company, provides a good example of the application of the inventory exclusion, and makes important findings with respect to whether it is appropriate to infer a connection between a demonstrated instance of employee theft and another similar instance for which there is insufficient independent evidence.

Continue Reading Khazai Rug: Court of Appeals of Kentucky applies Crime Policy’s Inventory Exclusion to Alleged Employee Theft Loss

Several recent decisions, such as Telamon Corporation v. Charter Oak Fire Insurance Company (see our March 13, 2017 post), have highlighted the importance of assessing the precise legal status of an alleged defaulter’s work relationship vis-à-vis the insured as part of a proper coverage analysis. The decision of the U.S. District Court for the Central District of California in Commercial Ventures, Inc. v. Scottsdale Insurance Company provides another example of the courts considering this challenging issue. In Commercial Ventures, the Court dealt with an alleged defaulter who was both a minority owner and the President of the insured, and specifically addressed whether contingent ownership distributions constituted “salary, wages or commissions” within the crime coverage’s definition of “Employee”.

The Facts

Commercial Ventures had two affiliated companies, Noblita, LLC (“Noblita”), which operated an apparel business, and Daylight Investors, LLC (“Daylight”), which owned 49 per cent of Noblita. Rik Guido personally owned another 49 per cent of Noblita, and was also its President. As an owner of Noblita, Guido was entitled to receive $27,500 per month, but only under certain conditions.

Noblita’s Limited Liability Company Operating Agreement (the “Operating Agreement”) defined Guido’s compensation as follows:

Mr. Guido will not be paid for such services [as President], but so long as (1) he is President of the Company and rendering his full time services to the Company (and in compliance with the terms of this Agreement) and (2) the company has adequate monies, Mr. Guido will receive a Distribution of twenty–seven thousand five hundred dollars ($27,500) per month.

The Operating Agreement defined “Distribution” as “the transfer of money or property by [Noblita] to one or more Members without separate consideration.”

In November 2013, Daylight sued Guido in state court, alleging that Guido participated in a fraudulent scheme whereby he transferred money and inventory from Noblita to a Florida-based company in which he had an ownership interest.

Commercial Ventures maintained a Business Management Indemnity Policy with Scottsdale, under which both Noblita and Daylight were additional insureds. The policy’s crime coverage included coverage for employee theft. Daylight notified Scottsdale of a potential employee theft loss arising from Guido’s alleged actions.

Scottsdale inquired as to the nature of Guido’s role with Noblita. Noblita’s controller advised that Guido was not entitled to take any distribution from Noblita unless the company had adequate monies or was profitable. The controller added that, during the majority of the months in which Guido worked for Noblita, it had negative operations and Guido was therefore not entitled to any distribution.

In Scottsdale’s view, Guido was a non-salaried member of Noblita, and was therefore not an “Employee” within the meaning of the crime coverage.

The Employee Theft Coverage

Scottsdale moved for summary judgment before the District Court on this issue. The crime coverage defined “Employee” as:

Any natural person while in the services of the Insured, including sixty (60) days after termination of service; provided the Insured:

i. compensates such person directly by salary, wages or commissions; and

 ii. has the right to direct and control such person while performing services for the Insured.

 The parties’ dispute centred on whether Guido’s contingent compensation constituted “salary, wages or commissions”. Commercial Ventures asserted that, because the crime coverage did not define the terms “salary, wages or commissions”, the terms were ambiguous. The Court considered dictionary definitions of those terms:

Salary

  • fixed compensation paid regularly for services.”
  • [a]n agreed compensation for services—esp. professional or semiprofessional services usu. Paid at regular intervals on a yearly basis, as distinguished from an hourly basis.”

Wage

  • a payment usually of money for labor or services usually according to contract and on an hourly, daily, or piecework basis.”
  • [p]ayment for labor or services, usu. Based on time worked or quantity produced; specif., compensation of an employee based on time worked or output of production.”

Commission

  • a fee paid to an agent or employee for transacting a piece of business or performing a service.”
  • [a] fee paid to an agent or employee for a particular transaction, usu. as a percentage of the money received from the transaction.”

The Court noted that the parties were in agreement that “salary, wages or commissions” constituted compensation for a person’s services, and held that:

… the Court finds that the definition of “employee” is unambiguous as it is clearly defined in the policy. In addition, “salary, wages or commissions” — words used to define “employee” — are not ambiguous as they are only subject to one interpretation in this case as well. Therefore, the issue becomes solely whether there is a triable issue of fact as to whether Plaintiff paid Mr. Guido for his services, in turn, meaning whether he was paid “salary, wages, or commissions.” [citations omitted]

The Court then considered whether Guido’s contingent compensation under the Operating Agreement could be considered “salary, wages or commissions”. The Court observed that accepting the insured’s arguments on this issue would entail that the definition of “Distribution”, which specifically indicated that distributions were made “without separate consideration”, would be meaningless, as would the provision stipulating that “Mr. Guido will not be paid for” his services as President. In accepting Scottsdale’s view, by contrast:

… the Court may give these provisions their plain meaning and may still read the Operating Agreement as a cohesive whole. In other words, in the Court’s view, it appears that the parties, as reflected in the Operating Agreement, intended to appoint Mr. Guido as President of Noblita and to provide him with ownership distributions. The Operating Agreement did not intend, however, to compensate Mr. Guido for his services as President; rather, it compensates him in his role as an owner through distributions only. Though the Operating Agreement indicates that Mr. Guido is entitled to his owner distributions only so long as he served as President, this does not mean that his owner distributions are intended to compensate him for his services. [emphasis added]

Consequently, Guido was not an “Employee” and no indemnity was available.

Conclusion

Although the decision is based on the interpretation of the specific contract between Noblita and Guido, Commercial Ventures provides general guidance as to the proper interpretation of the definition of “Employee” found in many crime coverages, as well as the meaning of the specific terms “salary, wages or commissions”. The Court rejected the insured’s contention that these terms were ambiguous, and found that ownership distributions did not fall within their ambit. The interpretive approach adopted in Commercial Ventures will be of assistance to fidelity claims professionals in assessing whether individuals who maintain both ownership and other roles within an insured come within the definition of “Employee”.

Commercial Ventures, Inc. v. Scottsdale Insurance Company, 2017 WL 1196462 (C.D. Cal.)