In Taylor & Lieberman v. Federal Insurance Company, the U.S. District Court for the Central District of California applied the "direct means direct" approach to causation in holding that a business management firm did not have coverage in respect of client funds which it was fraudulently induced to wire overseas.
Taylor & Lieberman ("T&L") was an accounting firm which also performed business management and account oversight services for various clients, including the client in issue. Clients' funds were held in separate bank accounts maintained with City National Bank. Clients granted Powers of Attorney over their accounts to a designated individual at T&L, permitting transactions to be made in the accounts.
A fraudster obtained access to the client's email account and sent two emails from that account to a T&L employee:
- The first email directed the employee to wire $94,280 to an account in Malaysia. The employee did so, and then sent a confirming email to the client's email account.
- The next day, the employee received another email from the client's account directing her to wire $98,485 to an account in Singapore. The employee again complied, and again sent a confirming email to the client's email account.
The employee then received a third email, purportedly from the client, but sent from a different email address. The employee contacted the client by phone, and discovered that all three emails were fraudulent. T&L was able to recover some of the funds, but had to reimburse its client and incurred a net loss of nearly $100,000.
Direct Loss Requirement
T&L submitted a claim under each of its Forgery Coverage; its Computer Fraud Coverage; and its Funds Transfer Coverage. The Court noted that each of these coverages required "direct loss sustained by an Insured" and held that, as a matter of law, no direct loss had been sustained.
The Court observed that there are differing approaches with respect to the causation requirements found in fidelity policies, but noted that most courts have adopted the principle that "a loss is not direct unless it follows immediately and without intervening space, time, agency, or instrumentality" – more commonly known as the "direct means direct" approach.
The Court held that the client's loss was a third-party loss. While T&L may have been liable to the client for the loss of the funds, the Federal coverage was first-party indemnity coverage only, and T&L had not suffered any direct loss of its own funds. T&L asserted that its Power of Attorney over client funds effectively made it tantamount to a bailee or trustee of client funds (an argument which would bring the funds within the policy's ownership condition, relied on in such decisions as Vons Companies) which, the argument ran, made the loss a direct loss. Federal's response was that T&L was not a bailee or trustee of the funds, because the client's funds were held not by T&L in its own account, but in a separate account in the client's name.
The Court accepted Federal's position. Relying on Vons Companies and on Pestmaster (which we discussed in our January 6 post), the Court held:
The Court finds Defendant's reasoning more persuasive. If the funds had been held in an account owned or attributed to Plaintiff, such as an escrow account ... and a hacker had entered into Plaintiff's computer system and been able to withdraw funds such that Plaintiff's accounts were immediately depleted, then Plaintiff would be correct in asserting coverage from the Policy.
Here, however, a series of far more remote circumstances occurred: Client gave Plaintiff power of attorney over Client's money held in Client's own account; a perpetrator of fraud motivated Plaintiff's agent to use the power of attorney to transfer funds out of Client's account; Plaintiff discovered this fraud and attempted to recover the funds; Client requested repayment of the lost funds and Plaintiff obliged; Plaintiff now requests Defendant indemnify it for the losses that were transferred from Client to Plaintiff. These are not the circumstances that dictated the results in Vons ... and they are not the circumstances [which] appear to be within the contemplation of the Policy.
In view of these intervening steps, T&L could not establish a direct loss of the client funds. As a result, it was unnecessary for the Court to analyze the other requirements of the three coverages in issue. Notably, the Court did not mention the Federal policy's ownership condition in its analysis.
Discussion and Conclusion
Taylor & Lieberman is notable insofar as it reinforces the "direct means direct" approach to causation under fidelity policies, an approach which the majority of courts have embraced.Given the number of intervening events between the fraud and the ultimate pecuniary loss to T&L, the loss was not one which followed "immediately and without intervening space, time, agency, or instrumentality" from the fraud.
In our view, it is interesting that the Court relied on ownership condition concepts (such as whether T&L could be considered to be the equivalent of a trustee or bailee of the client's funds) in its direct loss analysis. The ownership condition arguably reinforces the circumscribing intent of the direct loss requirement, but the coverage requirementand the condition are analytically distinct; client funds which do not fall within the ownership condition constitute property which falls outside of the policy entirely. It is arguable that the ownership condition in the Federal policy constituted a second, independent basis for denying coverage in this case.
Taylor & Lieberman v. Federal Insurance Company, 2015 WL 3824130 (C.D. Cal.)
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