On February 18, 2016, the U.S. District Court for the Northern District of California released its decision in Western Alliance Bank v. National Union Fire Insurance Company of Pittsburgh, Pa. The Court dismissed a creditor bank's direct action against a fidelity insurer for indemnity in respect of alleged thefts by the debtor insured's employees of assets over which the bank held a security interest. The decision reinforces the first-party nature of commercial crime coverage and is consistent with other recent U.S. and Canadian case law on "third party direct actions" against fidelity insurers.
Sorrento Networks GmbH ("Sorrento") carried on business in the fibre optic industry. In 2011, Sorrento granted a security interest in all of its personal property (including insurance proceeds) to Western Alliance Bank (the "Bank").
In January 2014, Sorrento's president announced that the company was going out of business, and asked all employees worldwide to leave company property where it was. The next month, Sorrento's president attended at Sorrento's office in Stuttgart, Germany, only to find that almost all of the company's property was missing.
The Bank sued Sorrento's crime insurer, National Union, contending that the property must have gone missing as a result of employee theft and that, because the Bank held a continuing security interest over both those assets and any insurance proceeds accruing to Sorrento, it was entitled to recover its loss from National Union.
The National Union Coverage
Under the terms of its Commercial Crime Policy, National Union agreed to indemnity Sorrento for "loss of or damage to ... 'other property' resulting directly from 'theft' committed by an 'employee'" and "for loss of or damage to 'other property'" resulting from either a "robbery" or a "safe burglary."
The policy included a non-assignment clause, which provided that the insured's "rights and duties under this policy may not be transferred without [National Union's] written consent." The policy also stated that "this policy is for [the insured's] benefit only"; that "[i]t provides no rights or benefits to any other person or organization"; and that "[a]ny claim for loss that is covered under this policy must be presented by" the insured.
National Union brought a preliminary motion to challenge the Bank's right to assert the claim. The District Court granted National Union's motion, with leave to the Bank to amend its pleading. The Court's reasoning rests on two conclusions:
- The Bank's Security Interest extended to Insurance Proceeds, not the Insurance Policy: The Court noted that, while the Bank held a security interest over insurance proceeds owing to Sorrento, it did not hold a security interest over the policy itself. A creditor's claim to insurance proceeds conferred by a security agreement is not the same as a creditor's right to bring an action on its debtor's behalf. The security interest alone did not confer standing on the Bank to pursue the claim.
- There was No Valid Assignment of the Policy (nor could there be): The Court held that the Bank could not sue as assignee of Sorrento's benefits under the policy, for the simple reason that Sorrento did not assign those rights to the Bank (nor could it have done so, given the non-assignment provision in the policy).
The Court also rejected the Bank's claim for breach of the implied covenant of good faith and fair dealing, holding that, without contractual privity or a valid assignment, the Bank lacked standing to pursue this claim.
The Court granted leave to the Bank to amend, but the general tenor of the decision suggests that it might be difficult for the Bank to amend in such a way as to assert a cognizable cause of action against National Union.
A Canadian Comparison
"Third party direct actions" have been successfully challenged in Canada on the basis of standing. A 2013 Ontario decision, Swinkels, dealt with this issue in the context of an alleged investment advisor fraud. The plaintiff invested funds with an advisor who, she alleged, had stolen the funds. The plaintiff commenced a direct action against the fidelity insurer of one of the companies to which the advisor had been connected.
The decision involves numerous complex issues (including the advisor's status as an alleged alter ego of the insured), but the Court made it clear that the bond in issue was intended to provide first-party indemnification, rather than third-party liability coverage, and that the bond would not respond absent: (i) the insured sustaining the underlying loss; and, (ii) the insured bringing the corresponding claim for indemnification. The Court granted summary judgment dismissing the plaintiff's action.
Generally speaking, fidelity insurance is a form of first-party property insurance; as such, third parties lack standing to assert a direct claim. Although third party direct actions are becoming increasingly rare, they still arise from time to time. However, U.S. and Canadian courts appear to generally accept that such claims are misconceived, in that they try to convert fidelity insurance into a form of third-party coverage.
Western Alliance Bank featured an added twist, in that the Bank held a security interest over any insurance proceeds accruing to Sorrento. However, the District Court distinguished between an interest in insurance proceeds and an interest in the policy itself in holding that the Bank lacked standing to assert a claim under Sorrento's Commercial Crime Policy.
Western Alliance Bank v. National Union Fire Insurance Company of Pittsburgh, Pa., 2016 WL 641648 (N.D. Cal.)
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