UNDERSTANDING CRIME POLICIES AND PRESENTMENT OF CLAIMS

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1 UNDERSTANDING CRIME POLICIES AND PRESENTMENT OF CLAIMS Gabrielle T. Kelly BROUSE McDOWELL 600 Superior Avenue, Suite 1600 Cleveland, Ohio As fraud and embezzlement in the workplace are being detected with more regularity, companies are purchasing fidelity insurance policies, also known as crime policies, to protect them from losses. Commercial crime policies typically provide coverage for losses from criminal acts, such as employee dishonesty, forgery, and computer fraud. When a company experiences a loss at the hands of one of its employees, there are a number of issues that may arise while handling the claim. Therefore, the policyholder has to understand the types of claims that are covered and the requirements for establishing coverage under the policy. I. COVERAGE GRANT Commercial crime policies contain multiple grants of coverage. Each type of coverage will have its own insuring agreement that specifies the types of loss that is covered under the policy. The most common coverages are fidelity, forgery, computer crime, and claim expenses. A. Fidelity The fidelity grant of coverage, also called employee theft coverage or employee dishonesty coverage, insures against employee theft of the insured s property and employee theft of client property held by the insured. An example of the more common coverage grants is as follows: The Company will pay the Insured for the Insured s direct loss of, or direct loss from damage to, Money, Securities and Other Property directly caused by Theft or Forgery committed by an Employee, whether identified or not, acting alone or in collusion with other persons. Under the coverage grant, there are several important elements that are required, including 1) losses of money, securities, or property; 2) direct loss; and 3) theft or forgery by an employee. Policyholders must satisfy all three requirements to obtain coverage. Therefore, the policyholder must do more than simply establish that a loss occurred. 1

2 B. Forgery Forgery is usually a specifically defined term in the policies. An example of a definition of forgery is: The signing of the name of another natural person or organization, with the intent to deceive, but does not mean a signature that includes, in whole or part, one s own name, with or without authority, in any capacity for any purpose. Mechanical or electronic reproductions of handwritten signatures shall be treated the same as handwritten signatures. An electronic signature is not treated the same as a mechanical or electronic reproduction and is not a Forgery. As stated, a person cannot forge his or her own signature. The insurance policy is intended to cover another s misuse of a signature. Further, a machine-made signature is treated the same as a handwritten signature; but an electronic signature, which is becoming much more common in today s computer age, is not treated in the same manner and its misuse is not forgery. C. Computer Crime This coverage grant has two components. First, it covers direct loss of money, securities, and other tangible property caused by computer fraud. Computer fraud is narrowly defined as the use of a computer to fraudulently transfer property from inside the insured s premises to a person or place away from the premises. The first component of computer crime does not cover any intangible property beyond securities, and thus excludes business goodwill, licenses, and other information data. The second component covers the cost to restore lost or damaged computer programs and data caused by a computer violation, which is defined as vandalism or a malicious computer virus. The coverage provided by this policy is limited to the costs of restoration and does not provide the same manner of coverage as policies designed to protect against data breaches. D. Claim Expenses The Claim Expenses provision provides coverage for reasonable expenses to establish the existence, amount, and to prepare the insured s proof of loss. Many policies have a separate limit of liability for investigative expenses, which is applied towards the costs of outside accountants, attorneys, consultants, and experts that the policyholder needs to establish the amount of loss. 2

3 II. CONDITIONS TO COVERAGE A. Notice Notice is due once the insured discovers a loss. Some policies will require notice once the loss reaches a certain amount, whereas other policies require notice upon the first indication that there might be a claim. When notice is required, the policyholder must notify the insurer of a claim as soon as possible. In some cases, providing late notice to the insurer can be fatal to a claim. Notice provisions are conditions precedent to coverage under an insurance policy, and as a result, failure to give notice in a timely fashion as required by the policy can be a bar to coverage. Goodyear Tire & Rubber Co. v. Aetna Cas. & Sur. Co., 2002-Ohio-2842, 95 Ohio St.3d 512. When a provision in the insurance policy requires the insured to give notice to the insurer as soon as practicable, the insured is required to give notice within a reasonable time in light of all the surrounding facts and circumstances. Ormet Primary Aluminum Corp. v. Employers Ins. of Wausau, 2000-Ohio-330, 88 Ohio St.3d 292. However, notice deadlines in claims-made policies (e.g. crime policies) are more strictly enforced by courts. Thus, the policyholder must notify the insurer in the requisite amount of time, in the manner specified in the policy to ensure coverage for the claim. In addition to notifying the insurance company, the policyholder may have other duties under the policy. Those duties may include 1) notifying law enforcement personnel of the loss; 2) submitting to an examination under oath; 3) cooperating with the insurer; 4) keeping records of stolen property so the insurer can verify the amount; transferring the policyholder s right of recovery to the insurer; and providing a detailed, sworn proof of loss. B. Discovery A crime policy provides coverage for loss that takes place at any time before the policy ends, and is discovered during the policy period. A loss is discovered when a reasonable person would realize that a theft had occurred, even if the exact details are unknown. Discovery of a loss under the provision does not occur until the policyholder discovers facts showing dishonest acts occurred and appreciates the significance of those facts. Resolution Trust Corp. v. Fidelity & Deposit Co. of Maryland, 205 F.3d 615 (3d Cir. 2000). Knowledge and discovery will be imputed to the company when an executive, partner, insurance representative, or management staff member becomes aware of the facts necessary to assume that a loss has occurred. Therefore, a policyholder should determine and carefully document the date of its discovery of the loss and be prepared to provide that information to its insurer. 3

4 C. Proof of Loss Many crime policies have a requirement that the policyholder provide a signed statement attesting to the nature and amount of loss. The statement is a sworn proof of loss, and may serve as a condition precedent to recovery under the policy. A failure to submit a sworn proof of loss statement as required by an insurance policy precludes payment of a claimed loss. Chong v. Am Family Ins. Co., 6th Dist. Lucas No. L , 2005-Ohio-5022, at 33. Further, the proof of loss must be more than a general statement that property belonging to the policyholder is missing. Crime policies exclude losses where the proof of which depends solely on an inventory computation or physical count, or a profit and loss computation. Courts have consistently held that inventory calculations and general assumptions about the cause of loss are insufficient to establish coverage under a crime policy. See Performance Autoplex II. Ltd. v. Mid-Continent Cas. Co., 322 F.3d 847, 855 (5th Cir. 2003) (Without specific evidence linking employee to loss, insurer was entitled to summary judgment under crime policy); Ernie Von Schledorn Ltd. v. United Fire & Cas. Co., 635 N.W.2d 27 (Wisc. 2001) (Insured must first show a loss with independent evidence before inventory computations can be used to support a claim for loss based on employee dishonesty); United States Smelting Ref. & Mining Co. v. Aetna Cas. & Sur. Co., 372 F. Supp. 489 (S.D.N.Y. 1974). It is not enough for the policyholder to have inventory shortages or evidence that an employee was near the missing items prior to their disappearance. The policyholder must have other evidence that creates more than a mere suspicion or supposition that an employee is responsible for the loss. Commercial crime policies require the policyholder to possess sufficient evidence that the only reasonable conclusion can be that an employee committed the theft. D. Loss, Deductible and Limits Crime policies typically provide for single loss limits of insurance and retentions or deductibles. There can also be an aggregate limit of insurance. Single loss is typically defined to mean (a) an individual act; (b) the combined total of all separate acts; or (c) a series of related acts committed by an employee or committed by more than one employee acting alone or in collusion with other persons both during and before the policy period. Depending on the policyholder s limits and deductibles, multiple thefts that seem unrelated could result in no coverage if each loss is within the deductible. Therefore, it is policyholder s interest to explore all aspects of any thefts and determine whether the thefts were part of a single pattern, scheme or plan, or whether there was collusion, in order to maximize the available insurance coverage. III. EXCLUSIONS 4

5 A. Indirect Loss Crime policies typically exclude losses that are indirectly imposed upon the policyholder. For example, one provision states that the policy precludes the following: Loss that is an indirect result of any act or occurrence covered by this Policy including, but not limited to, loss resulting from * * * payment of damages of any type for which the Insured is legally liable: But, this Company will pay compensatory damages arising directly from a loss covered under this Policy. An issue arises of whether the obligation repay a loss caused by the policyholder s employee is considered a direct loss and covered under the policy. Generally, loss means the deprivation or dispossession of money or property of the [insured] due to dishonest, criminal or fraudulent acts of the insured s employees. Fireman s Fund Ins. Co. v. Special Olympics Int l., Inc., 249 F.Supp.2d 19, 26 (D. Mass. 2003). Courts that have analyzed the direct/indirect loss issue are split on whether an organization s vicarious liability to a third party constitutes a direct loss under the policy. Several courts have held that a fidelity policy only indemnifies the insured for direct losses and does not provide coverage for the insured s liability to third parties. See Finkel v. St. Paul Fire & Marine Ins. Co., 2002 U.S. Dist. LEXIS (D. Conn. June 6, 2002). Particularly, in Lynch Properties, Inc. v. Potomac Ins. Co., the Fifth Circuit rejected the corporate policyholder s assertion that it suffered a direct loss for funds where the company s losses resulted from its reimbursement of funds stolen by its employee from the personal bank accounts of the policyholder s President. The Court held, Employee dishonesty policies insure against the risk of property loss through employee dishonesty. Liability policies, by contrast, require an insurer to discharge an obligation of the insured to a third party for some act of the insured or its employee. Although employee dishonesty policies may cover the loss of third-party property in the possession of the insured, [], these policies do not serve as liability insurance to protect employers against tortious acts committed against third parties by their employees. 140 F.3d 622 (5th Cir.1998). The loss suffered by the policyholder was solely from the reimbursement of property belonging to others, and was not the result of employee theft of its own property. Accordingly, the court found the loss too tenuous for coverage under the crime policy. See Meriter Health Services, Inc. v. Travelers Cas. and Sur. Co. of Am., 313 Wis. 2d 660 (Wis. App. 2008)(holding that employee dishonesty coverage of commercial crime policy did not cover insured s vicarious liability and the insured did not claim to be bailee or trustee of the stolen funds); Vons Companies, Inc. v. Federal Ins. Co., 212 F.3d 489 (9th Cir. 2000) (holding that employee dishonesty coverage did not cover insured s vicarious liability for losses suffered by third parties arising from its employee s tortious conduct); cf. First Defiance Fin. Corp. v. Progressive Cas. Ins. Co., 688 F.Supp.2d 703, 707 (N.D. Ohio 2010) (holding that the employer incurred a direct loss resulting from the theft of customer funds held in trust by the employer under fidelity bond), aff d in part, 688 F.3d 265 (6th Cir. 2012). 5

6 On the other hand, several courts have adopted the conventional proximate-cause test in determining whether an insured suffers a direct loss under an insurance policy. These cases provide more support for the position that a policyholder suffers a direct loss when it has to reimburse the losses of others. See, e.g., Auto Lenders Acceptance Corp. v. Gentilini Ford, Inc., 181 N.J. 245, 259 (2004) ( There being no sound reason why a proximate-cause analysis should not be employed when determining whether a loss is direct under a fidelity insurance policy, we will apply that approach to such policies ); Scirex Corp. v. Fed. Ins. Co., 313 F.3d 841, 850 (3rd Cir. 2002) (applying the proximate cause test and determining that the insured suffered a direct loss within the meaning of an employee dishonesty policy when the insured was required to repeat clinical drug trials for its clients due to its nurses failure to follow protocol and falsification of records). While it is likely that an insurer would seek to deny claims for payments made to others because the employee did not directly take the money from policyholder, an insured has strong support for coverage of its claim. B. Potential Income Commercial crime policies specifically state that the policy covers direct losses to the policyholder. Even when a loss is attributable to the policyholder, there are still coverage issues that may arise. One type of exclusion, the potential income exclusion, provides Coverage under the Policy will not apply to... loss that is an indirect result of any act or occurrence covered by this Policy including, but not limited to, loss resulting from * * * the inability to realize income that would have been realized had there been no loss of; or loss from damage to, covered property. While the plain language of the exclusion states that the policy will not cover income that would have been realized without a loss, it can be difficult to determine whether such loss falls within that category. Courts interpreting potential income and similar exclusions generally interpret them as precluding coverage for future profits or losses associated with the income generating potential of the asset. In United States Gypsum Co. v. Ins. Co. of N. America, the insured s employee leaked the trade secret of a sealant to a competitor, who then sold the product to a customer of the insured. The insured brought an action under a comprehensive crime insurance policy seeking to recover a loss in the amount of gross revenue made on the sealant by the other company. In holding that the potential income exclusion barred coverage for the lost revenue, the Seventh Circuit reasoned that the insured has the most control over how much it will suffer in the market as a result of the dishonesty of its employees and the exclusion precluded coverage for the loss of revenue. United States Gypsum Co. v. Ins. Co. of N. America, 813 F.2d 856, (7th Cir. 1987). Similarly, the Fifth Circuit Court of Appeals held that loss of profits from the policyholder s failure to obtain a contract was potential income that was not covered under its crime policy. Diversified Group, Inc. v. Van Tassel, 806 F.2d 1275 (5th Cir. 1987). In 6

7 Diversified Group, Inc., employees of the insured, through their wholly-owned corporations, secretly submitted bid proposals lower than those that they had prepared and submitted on behalf of the insured, resulting in the employees corporations obtaining the contract. The insured brought an action to recover the loss of profits that it would have received had it been awarded the contract, under a comprehensive crime policy. In ruling for the insurer, the Court ruled that the potential income exclusion is clear and unambiguous. It excludes coverage for the loss of future profits, or future income flow, resulting from the fraudulent or dishonest acts of employees. To conclude otherwise would be to distort the plain meaning of the words. Id. at Thus, policyholders have an uphill battle obtaining coverage for losses that are not directly from a theft by an employee. C. Unintentional Acts The theft must have been intentional. The loss cannot have resulted accidentally, from inadvertent or negligent acts. This is sometimes referred to as the manifest intent requirement, and courts adopted several approaches for determining whether an employee intentionally committed a crime. Depending on the jurisdiction, the court may employ the objective test, the subjective approach, or the substantial certainty approach. During the investigation, the policyholder and its investigators should focus on and document the apparent intent of the employee. IV. CONCLUSION Although the coverage provided by commercial crime policies can appear straightforward, a careful review of the policy language is necessary to ensure that the policyholder understands the coverage provided and is following all the conditions set forth in policy. Each situation necessarily will turn on its particular facts and on the precise terms of the fidelity policy issued to the company. These are just some of the coverage grants, conditions and exclusions that need to be considered when a policyholder discovers that employee theft has occurred. 7