The recent decision of the Eleventh Circuit Court of Appeals in Scottsdale Indemnity Company v. Martinez, Inc. addresses the difficult issue of what happens where the application for fidelity coverage has been completed by the same employee who is perpetrating a fraud against the insured. In deciding in favour of the insurer, the Eleventh Circuit relied on the wording of the crime coverage's misrepresentation warranty, and did not expressly address the "adverse interest" principle or the "sole representative" exception to that principle.
The insured, Martinez, Inc. ("MBS"), carried on business as a building maintenance company servicing commercial properties. The principal of MBS, Greg Martinez, spent most of his time performing building maintenance services for MBS's clients. In 2004, MBS hired Brenda Walters as its accountant. Walters later became the Chief Financial Officer and Chief Executive Officer. Walters' duties included handling the company's financial accounting, in which capacity she had authority to make withdrawals from MBS's bank accounts.
In August 2011, Martinez discovered that Walters had been embezzling funds since at least 2006. Walters' activities included writing cheques to herself and others, as well as misuse of company credit cards. The total loss was in excess of $2 million.
MBS had obtained a Business and Management Indemnity Insurance policy from Scottsdale. This policy included crime coverage. MBS's application was completed by Walters herself. In the course of completing that application, Walters answered "yes" to the following questions:
- "Is there an annual audit or review performance by an independent CPA on the books and accounts, including a complete verification of all securities and bank balances?"; and,
- "Are bank accounts reconciled by someone not authorized to deposit or withdraw from those accounts?"
Both of Walters' answers were false.
The Crime Coverage
MBS submitted a claim under its crime coverage with Scottsdale. The policy included a warranty, which provided that:
In the event the Application ... contains any misrepresentation or omission made with the intent to deceive, or contains any misrepresentation or omission which materially affects either the acceptance of the risk or the hazard assumed by Insurer under this Policy, this Policy ... shall not afford coverage to the following Insureds for any Claim alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving, any untruthful or inaccurate statements, representations or information: ...
any ... Insured, if any past or present chief executive officer [or] chief financial officer ... knew the facts misrepresented or the omissions, whether or not such individual knew of the Application, such materials, or this Policy.
The insurance policy also provided that the application was incorporated into, and constituted a part of, the policy. Scottsdale concluded that, as a result of Walters' misrepresentations, these provisions were engaged and no coverage was available to MBS.
Scottsdale commenced a declaratory action, relying on Walters' misrepresentations in the application. MBS relied on the adverse interest exception in arguing that Walters' misrepresentations should not be imputed to MBS.
The District Court characterized MBS's attempt to take the benefit of the policy application, without the burden of Walters' misrepresentations therein, as an "I want to have my cake and to eat it, too" argument. Applying the plain language of the misrepresentation warranty, and with the benefit of evidence from Scottsdale's underwriter, the District Court concluded that Walters' misrepresentations were material to Scottsdale's terms of acceptance of the risk.
Turning to the issue of whether general agency principles prevented Scottsdale from relying on the misrepresentation warranty, the District Court rejected MBS's "adverse interest" argument, relying on the "sole representative" exception. Generally speaking, where the agent is the sole representative of the principal in a transaction with a third party, her acts and knowledge are imputed to the principal in relation to that transaction, even if she is acting adversely to the principal. (This exception has also been recognized in Ontario law, in decisions such as jjBarnicke Ltd. v. Commercial Union Assurance Co. of Canada.)
The Eleventh Circuit Court of Appeals affirmed the District Court's analysis with respect to the misrepresentation warranty. The evidence demonstrated that Walters' answers to the two questions were false. Further, the underwriting evidence demonstrated that the misrepresentations were material to Scottsdale's terms of acceptance of the risk. The Court also observed:
Finally, that Walters' criminal conduct itself was allowed to continue over a lengthy period of five to seven years, when it likely would have been found had the controls inquired about in Questions 3 and 4 been in place, indirectly exemplifies the materiality of the misrepresentations.
In affirming the District Court's conclusion, the Eleventh Circuit did not expressly address the applicability of the "adverse interest" principle or the "sole representative" exclusion, confining its analysis solely to the relevant policy provisions themselves.
The injection of agency principles into the misrepresentation analysis makes coverage analysis more difficult and, on a broader level, raises numerous competing considerations, such as underwriting accuracy, the reasonable expectations of both insureds and insurers, the principle that only fortuitous losses should be covered, and general notions of fairness. Martinez, Inc. provides an example of an appellate court applying a well-worded misrepresentation warranty to find no coverage, without express resort to the application of agency law principles.
Scottsdale Indemnity Company v. Martinez, Inc., 2015 WL 3823728 (11th Cir.)
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