Lengthy Crimes, Limited Coverage: Recent Case Law Follows the 'One Policy Limit' Approach

This review of recent fidelity bond insurance case law indicates that choice of law can be dispositive. The insurer paid $2 million as opposed to $17 million in PBSJ (applying Florida law); $1 million as opposed to $4 million in Hartman & Tyner (applying Michigan law); and $350,000 as opposed to $1.5 million in Madison Materials (applying Mississippi law). Under other precedents, insurers may be held liable up to the limit of each policy in place throughout a multi-year crime. The recent wave of high-profile Ponzi schemes has made employers, investors, and regulators more aware of the potential for employee crimes, and crime insurance may be the focus of new lawsuits. In disputes over the language of a crime insurance policy, policyholders may seek out those courts following the minority rule that is more favorable to them. Accordingly, insurers may want to consider filing declaratory judgment actions to secure an adjudication of their rights and obligations in a jurisdiction that will enforce the terms of their crime policies.

Mary Beth Forshaw and Lynn K. Neuner are partners in the New York office of Simpson Thacher & Bartlett LLP. They have substantial experience in litigating complex insurance coverage disputes and counseling their corporate clients on myriad insurance issues. Hema V. Shenoi is a law clerk in the firm.

In recent years, newspaper headlines have focused on a variety of financial scandals that have unfolded over long periods of time. The largest Ponzi scheme in history, arising from the activities of former NASDAQ chairman Bernard Madoff, resulted in $50 billion of investor losses over 15 years. Attorney Mark Dreier sold $100 million of false promissory notes to third parties over a four-year period, while Florida attorney Scott Rothstein is alleged to have operated a five-year, $1 billion Ponzi scheme. Some commentators posit that commercial crime insurance may provide coverage for such losses. That proposition is highly debatable, and, even if such coverage is available, it is unlikely to provide significant protection, given recent precedents construing how claims arising from long-ensuing criminal activities should be allocated between and among successively issued policies.

By way of background, commercial crime insurance (also known as “fidelity bonds,” “fidelity insurance,” and “employee dishonesty insurance”) generally provides coverage to employers for losses related to an employee's fraudulent conduct. Policies typically contain limits of coverage that apply on an “occurrence” basis, often defined as “an act or series of acts” by an employee. In insurance law generally, the majority of courts define an occurrence in terms of its cause. Barry R. Ostrager & Thomas R. Newman, 1 Handbook on Insurance Coverage Disputes ' 9.02 (15th ed. 2009). In the crime policy context, however, courts are split as to whether a crime committed by an employee over a multi-year period constitutes one occurrence or multiple occurrences or can trigger more than one policy.

In this article, we provide an overview of two differing approaches taken by federal courts on these issues. Under the first approach, followed by a majority of courts, claims arising from a multi-year crime are treated as arising from a single occurrence, single act, or a single loss, subject to the limit of one policy as opposed to successive policies. Three recent federal cases ' from the Fifth and Eleventh Circuits and the Eastern District of Michigan ' are illustrative. Under the second approach, courts treat multi-year crimes as occurrences that can trigger multiple policies in effect during the crime. Decisions from the Ninth and Fourth Circuits, Eastern District of Virginia, and District of Maryland have applied this rationale.

The 'Single Occurrence' Approach

The Fifth Circuit's Decision in Madison Materials

In Madison Materials Co. Inc. v. St. Paul Fire & Marine Insurance Co. , 523 F.3d 541 (5th Cir. 2008), the Fifth Circuit Court of Appeals evaluated an insurance coverage claim arising from a financial officer's embezzlement of $1.5 million over a 10-year period. Among other things, the fraud involved the creation of false accounts in suppliers' names and the writing and depositing of checks into the fraudulent accounts. Upon discovery of the embezzlement, Madison sought insurance coverage in the amount of the fraudulent checks. The insurer paid Madison $350,000, the limit of the policy in effect when Madison discovered the crime and made a claim. The policy limited coverage to “loss in any one occurrence” and defined occurrence as “an act or series of related acts involving one or more employees.” Id. at 543. Mississippi courts had previously held that an occurrence in an insurance policy was determined by the cause of the injury. Madison sued to recover under other policies in effect during the period of embezzlement. The district court held that because the embezzlement was caused by one employee, it constituted one occurrence of crime, subject to one policy limit.

On appeal, Madison argued that even if there was one occurrence, that occurrence had taken place over time and triggered the coverages available under multiple policies in effect during the decade-long commission of the crime. It further argued that the policies were, at best, ambiguous because they covered loss resulting from “events occurring during the policy period” and did not make explicit whether a single occurrence could span multiple policy periods. Id. at 544. Rejecting the policyholder's contractual construction, the Fifth Circuit concluded that, “[a]s there was but a single cause of Madison's injury, and as the policy states that multiple related acts are to be treated as a single occurrence, there was only one occurrence of employee dishonesty over the ten year period.” Id. at 543-544. The court further ruled that even if the policy terms were ambiguous, a “Loss Covered Under This Insurance and Prior Insurance Coverage” provision barred cumulative liability in successive policies and liability for prior loss if it exceeded the limits of the insurer's maximum liability under the policy in effect. Id. at 545-546. Accordingly, the Fifth Circuit upheld the insurer's refusal to pay the crime-related claim under multiple policies during the 10-year period in which the embezzlement took place.

The Eleventh Circuit's Decision in PBSJ v. Federal

The Eleventh Circuit also recently found that a policyholder could not recover under a series of insurance policies for a claim involving a multi-year crime. In PBSJ Corp. v. Federal Insurance Co., No. 08-15533, 2009 WL 3150472, at *3 (11th Cir. Oct. 1, 2009), the Eleventh Circuit refused to allow PBSJ to recover for losses involving three employees' embezzlement of $42 million over the course of 13 years. During each year of the embezzlement scheme, PBSJ had purchased crime insurance with a per-policy limit of $2 million for “a single act or any number of such acts” of employee theft. Id. at *4. The insurer maintained it was liable for only $2 million under the most recent policy period, and PBSJ sued to recover a total of $17 million, alleging it should be paid under all of the policies issued during the period in which the criminal activity took place.

The district court rejected the policyholder's claim, based primarily on three policy provisions. PBSJ Corp. v. Federal Insurance Co., No. 07-22248-CIV, 2008 WL 4070760, at *2-3 (S.D. Fla. Aug. 28, 2008). First, the court noted that when a new policy begins, the prior one terminates and obligations to pay new claims under the terminated policy cease. Second, the court found that the policy in effect when the claim was reported limited the insurer's total liability to $2 million despite coverage for prior losses. Third, the court ruled that the notice provisions supported the conclusion that the insurer was not liable for losses that occurred in prior years.

On appeal to the Eleventh Circuit, PBSJ argued that its crime coverage was “occurrence-based” and not “claims-made” in an attempt to obtain coverage under successive policies in effect during the commission of the crime. PBSJ Corp., 2009 WL 3150472, at *1. PBSJ contended that its “Crimes Coverage” was not listed in the Declarations section alongside four other coverage sections specifically described as “written on a claims made basis.” Id. at *1. The Eleventh Circuit, applying Florida law, rejected this argument by holding that the policy should be read as a whole and that the text of the policy indicated that it operated on a claims-made basis with respect to the crime coverage. In addition, the court found that the presence of “Non-Accumulation of Liability” and “Limit of Liability” provisions limited the insurer's coverage obligations to one policy period. Id. at *2, 4. The policies plainly provided that, “[R]egardless of the number of years coverage shall continue in force ' the liability ' with respect to any loss or losses shall not be cumulative from year to year or from period to period.” Id. at *4. The general “Limit of Liability” section capped the insurer's maximum liability to $2 million “for any loss or losses caused by any Employee ' resulting from a single act or any number of acts, regardless of when, during the period of this coverage section or prior thereto, such acts occurred ' ” Id.

The Eastern District of Michigan's Decision in Hartman & Tyner

A recent federal district court opinion issued from the Eastern District of Michigan also supports a finding that claims arising from multi-year crimes are payable, if at all, under a single insurance policy. Hartman & Tyner, Inc. v. Federal Insurance Co., No. 08-12461, 2009 U.S. Dist. LEXIS 90004, at *9-12 (E.D. Mich. Sept. 28, 2009), involved a four-year scheme in which one employee and two outsiders created false purchase orders and invoices and stole $4.6 million. Although the crime involved the creation of multiple false documents and payments over a long period, the court found that the events giving rise to the claim constituted a “single loss” payable under the limits of only one policy. The holding was grounded in policy language providing that, “all loss resulting from a single act or any number of acts of the same Employee or Third Party, and all loss whether such act or acts occurred before or during the Policy Period, will be treated as a single loss.” Id. at *3. Furthermore, as in PBSJ, the court found that “Coverage for Prior Losses” provisions limited the insurer's obligation to pay to $1 million, the limit for a single policy. Id. at *5.

In addition, citing Omne Services Group v. Hartford Insurance Co. , 2 F. Supp. 2d 714, 719 (E.D. Pa. 1998), the court held that losses resulting from a multi-year embezzlement scheme constituted “one occurrence” subject to just one policy limit if they are caused by one factor, such as “the continued dishonesty of one employee.” In Omne , the court applied both New Jersey and Pennsylvania law and concluded that, “[b]ecause Omne has claimed that the employee dishonesty ' was the cause of the losses for which it made a claim to [the insurer], there is but one 'occurrence' and [the insurer] cannot be liable for indemnity in excess of $100,000,” despite total theft of $600,000. Id.

The 'Multiple Occurrences' View

The Ninth Circuit's Decision in Karen Kane

In contrast to the foregoing authorities, older precedents have deemed crime policies to be ambiguous as to whether successive policies should respond to cover multi-year, crime-related losses. In Karen Kane v. Reliance Insurance Co. , 202 F.3d 1180, 1185-1186 (9th Cir. 2000), the Ninth Circuit, applying California law, found that the term “occurrence” in a crime policy could mean either: a) one series of criminal acts within a policy period, or b) one series of criminal acts that spanned numerous policy periods. The case involved claims arising from the falsification of invoices by three individuals, resulting in losses of more than $1 million over three years. The employer sought to recover $750,000 under three, back-to-back employee dishonesty policies. The insurer paid $250,000, the limits of one policy, explaining that while the crime “took place over a span of 3 years, it's considered 1 occurrence ' ” and only one policy is implicated. Id. at 1182. The policy defined an “occurrence” of employee crime as “all loss caused by, or involving, one or more employees, whether the result of a single act or series of acts” and limited coverage to losses “occurring during the Policy Period.” Id. at 1182, 1187. Additionally, a “prior loss” provision limited the insurer's total liability to the limit of the current or prior policy alone. Id. at 1183. Based on these provisions, the district court ruled that the insurer correctly determined that it was obligated to provide coverage under only one of the three policies at issue.

On appeal, the Ninth Circuit reversed, finding that the policy was ambiguous. Citing A.B.S. Clothing Collection, Inc. v. Home Insurance Co. , 34 Cal. Rptr. 2d 166 (Cal. Ct. App. 1995), the Ninth Circuit held that insurers will be liable for claims arising from continuous crimes up to the policy limit for each separate policy issued during the crime's commission, unless the insurer can show that the parties entered into a single, continuous insurance contract. Karen Kane, 202 F.3d at 1186-1187. The Ninth Circuit found that the insurer had not met this burden with respect to the policies at issue. Specifically, the court found that the policy's “occurrence” definition could refer either to the entire embezzlement scheme or to a series of thefts occurring in one policy year within the entire embezzlement scheme. Id. at 1185. In light of these two plausible interpretations, the court refused to find that the “Prior Loss” provision sufficed to establish the clear and unambiguous intent necessary for a continuous contract. Id. The Ninth Circuit further opined that although the policies defined “occurrence” to include “all loss,” which could suggest that there was only one payable occurrence across policy years, other policy language restricting liability “for any one occurrence” suggested the contrary. Based on this conflict, the Ninth Circuit concluded that
the policies were silent as to whether the term “occurrence” refers to a single act or series of acts within a single policy period or across multiple periods. Id. at 1187. Accordingly, the Ninth Circuit concluded that “occurrence” was an ambiguous term with respect to temporal limitations and imposed an obligation on the insurer to provide coverage under each of the three policy periods in effect when the crime at issue took place.

The Fourth Circuit's Decision in Spartan Iron & Metal

The Fourth Circuit in Spartan Iron & Metal Corp. v. Liberty Insurance Corp., No. 00-1694, 2001 WL 301111, at *1-2 (4th Cir. 2001), in applying South Carolina law and relying on Karen Kane's analytical framework, found ambiguity in a crime policy and affirmed an employer's right to recover under two successive, one-year policies in effect when the crime occurred. In Spartan Iron, an employee stole more than $200,000 over the time period spanning the two insurance policy periods. The policyholder submitted a claim for $200,000, seeking the payment of full policy limits under the back-to-back crime policies. The insurer paid $100,000 on the claim under a single policy, on the ground that the employee theft was one occurrence. The policy language provided that an “occurrence means all loss caused by, or involving, one or more 'employees,' whether the result of a single act or series of acts.” Id. at *2.

Describing the issue as “a close question,” the Fourth Circuit rejected the insurer's coverage determination based on ambiguities in the policy as to whether the insurer was liable for losses arising from continuous crimes under successively issued crime policies. Id. at *3. Specifically, the court found that the “series of acts” could be construed as either being limited in time to one policy term or including acts occurring outside the policy term. Id. at *2. The court declined to resolve contractual ambiguity through the common law definition of the term “occurrence” despite arguments by defendants. Citing differing interpretations of “Prior Insurance” and “Non Cumulation” provisions, the court concluded that these provisions are amenable to more than one reading, further rendering the policy ambiguous as to whether a loss continuing over successive policies was intended to be covered under every policy in effect during the employee's dishonest acts or only the first of those policies. Id. at *3-5.

Other Cases Finding Multiple Policies Were Implicated

Other courts have followed Karen Kane and Spartan Iron, but applied a slightly different analysis. In Adolf Jewelers v. Jewelers Mutual Insurance Co. , 614 F. Supp. 2d 648, 652, 654-656 (E.D. Va. 2008), the court applied Virginia law and held that a multi-year embezzlement scheme that caused a jewelry company to lose hundreds of thousands of dollars constituted a single occurrence. The court nonetheless concluded that the one occurrence was comprised of a series of acts that triggered successive policies in effect throughout the crime. Similarly, in Glaser v. Hartford Casualty Insurance Co. , 364 F. Supp. 2d 529, 534, 537-538 (D. Md. 2005), the court applied Maryland law and ruled that multiple occurrences of forgery, unauthorized use of credit cards, and embezzlement over three years resulting in $100,000 of losses arose from a single occurrence. The court ruled, however, that successive policies with varying premiums were separate and distinct contracts and that plaintiff was entitled to recover under each. The court stated: “[T]o interpret the successive policies as narrowly as suggested by the Defendant would essentially render the coverage of successive policies and the payment of premiums meaningless.” Id. at 538.

Conclusion

The recent decisions in Madison Materials, PBSJ, and Hartman & Tyner provide further support for the majority view that coverage for a multi-year crime is limited to one policy period despite successive policies in effect during the crime. In these cases, courts consistently relied upon Non-Accumulation of Liability and Prior Loss Coverage provisions to interpret the policy and rule in favor of the insurers. From a policy perspective, the majority rule may reflect a societal interest embedded in the language of the policy of encouraging employers to diligently weed out employee crime before it poses a significant loss to the company.

On the other hand, a handful of courts have found that multiple policies may be implicated by multi-year crimes in the absence of clear and unambiguous language to the contrary. Courts have reached these results in varying ways. Some interpret a multi-year crime as consisting of multiple occurrences, each of which triggers a successive policy, while others find that such crimes constitute a single occurrence that triggers multiple policies. These courts discount Non-Accumulation of Liability and Prior Loss Coverage provisions that would limit the insurer's liability, deeming the policy provisions to be ambiguous.

This review of recent fidelity bond insurance case law indicates that choice of law can be dispositive. The insurer paid $2 million as opposed to $17 million in PBSJ (applying Florida law); $1 million as opposed to $4 million in Hartman & Tyner (applying Michigan law); and $350,000 as opposed to $1.5 million in Madison Materials (applying Mississippi law). Under other precedents, insurers may be held liable up to the limit of each policy in place throughout a multi-year crime. The recent wave of high-profile Ponzi schemes has made employers, investors, and regulators more aware of the potential for employee crimes, and crime insurance may be the focus of new lawsuits. In disputes over the language of a crime insurance policy, policyholders may seek out those courts following the minority rule that is more favorable to them. Accordingly, insurers may want to consider filing declaratory judgment actions to secure an adjudication of their rights and obligations in a jurisdiction that will enforce the terms of their crime policies.

Mary Beth Forshaw and Lynn K. Neuner are partners in the New York office of Simpson Thacher & Bartlett LLP. They have substantial experience in litigating complex insurance coverage disputes and counseling their corporate clients on myriad insurance issues. Hema V. Shenoi is a law clerk in the firm.