Canada: Posco Daewoo: U.S. District Court Applies Ownership Condition In Rejecting Creditor's "Reverse" Social Engineering Fraud Claim Under Its Own Crime Policy

Last Updated: November 29 2018
Article by David S. Wilson, Christopher McKibbin and Stuart M. Woody

On November 19, 2018, the U.S. District Court for the District of New Jersey released its decision in Posco Daewoo America Corp. v. Allnex USA, Inc. and Travelers Casualty and Surety Company of America. The decision represents a "sequel" to the Court's 2017 decision arising out of the same claim (see our November 6, 2017 post). The case features an interesting twist on the usual social engineering fraud claim scenario, in that it was the intended payee of the funds, not the payor, which asserted a claim under its own crime policy for recovery of funds which the payor had been duped into paying to an impostor. This type of claim has been referred to as a "reverse" social engineering fraud claim. Numerous such claims have been advanced by intended payees recently, typically when it comes to light that the payor did not maintain its own social engineering fraud coverage.

The 2017 decision dismissed the claim of the insured, Posco Daewoo America Corp. ("Daewoo"), under Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief could be granted (this is similar to Ontario's Rule 21.01(1)(b)). However, the Court granted leave to Daewoo to re-plead its claim. In so doing, Daewoo made some novel arguments concerning the scope of the ownership condition.

The Facts

Daewoo is an importer and exporter of chemicals. Allnex USA ("Allnex") is a vendor of specialty chemicals, and was a customer of Daewoo. Daewoo supplied Allnex with product for which Allnex owed payment. An impostor posing as an employee of Daewoo's accounts receivable department sent emails to an employee of Allnex, requesting that payments to Daewoo on certain outstanding receivables be remitted to "new" Wells Fargo accounts.

Allnex paid $630,058 into the Wells Fargo accounts. By the time that the fraud was discovered, $367,613 had been transferred from the Wells Fargo accounts to accounts overseas. Daewoo never had possession of any of the funds owed to it by Allnex at any time.

Daewoo maintained a Wrap+ policy with Travelers. Daewoo submitted a claim to Travelers, asserting that the impostor's emails to Allnex, coupled with Allnex's transfers to the Wells Fargo accounts, constituted a covered loss to Daewoo. Travelers took the position that Daewoo had not satisfied the ownership condition in the policy. This condition provided as follows:

Ownership of Property; Interests Covered

The property covered under this Crime Policy ... is limited to property:

(i) that the Insured owns or leases;

(ii) that the Insured holds for others:

(a) on the Insured's Premises or the Insured's Financial Institution Premises; or

(b) while in transit and in the care and custody of a Messenger; or

(iii) for which the Insured is legally liable, except for property located inside the Insured's Client's Premises or the Insured's Client's Financial Institution Premises.

Travelers took the view that, while Daewoo was undoubtedly owed money by Allnex, Daewoo never actually owned or held the funds, nor had Daewoo been legally liable for them.

The Court agreed with Travelers' position in the 2017 motion, finding that Daewoo's failure to meet the ownership condition was dispositive. Until such time as funds were actually transferred to Daewoo, Daewoo had, at most, a receivable and a chose in action (i.e. a right to sue) in the event that it was not paid. This did not meet the ownership condition. As a result, the Court granted Travelers' Rule 12(b)(6) motion, but granted leave to Daewoo to re-plead its claim.

The Re-Pleaded Claim and the 2018 Decision

Daewoo proceeded to re-plead the claim in 2018, advancing several arguments as to why it "owned" the funds in Allnex's possession. These included:

  1. Daewoo owned the stolen funds because Allnex had taken the position that it does not owe Daewoo any additional money, because Daewoo "owns" such funds;
  2. Daewoo owned an account receivable, "which is 'tangible property' of Daewoo within the meaning of the Policy." An account receivable is a "tangible asset" for "accounting purposes", so it is also "tangible property" under the policy and therefore covered; and,
  3. Once Allnex placed the funds into the funds transfer system, "Daewoo would have had the right and ability to impose a constructive trust over the funds."

Travelers brought a further Rule 12(b)(6) motion in respect of the re-pleaded claim. The Court granted the motion in respect of the new pleadings. The first contention was dealt with fairly summarily; the Court held that Allnex's characterization of who owned the funds has no impact on whether the policy actually covers the alleged loss.

Daewoo's contention regarding "tangible property" required more nuanced consideration. The Court found that the characterization of the receivable as tangible property was irrelevant to the separate and discrete issue of whether the ownership condition was met. In other words, Daewoo could not establish that its alleged loss of the receivable met the ownership condition, meaning that it was irrelevant whether an account receivable could be considered "tangible" property. An insured must establish both a loss of covered property (usually Money, Securities or Other Property, each as defined) and that any such loss meets the ownership condition.

However, the Court went further and also rejected the argument that an account receivable is "tangible" property:

The Court also disagrees with Plaintiff's argument that its account receivable is tangible property because such receivable is considered a tangible asset for accounting purposes. The dispute concerns insurance coverage under the Policy; it is not an accounting matter. Moreover, the Policy does not indicate that terms are to be given the same meaning as they would for accounting purposes. ... certain New Jersey courts have found that accounts receivable constitute intangible property. See, e.g., J.B. Williams Co. ("It is well established that accounts receivable and other intangible personal property may acquire a situs for purposes of taxation at some place other than the technical domicile of the owner."); M. Rutkin Elec. Supply Co. (observing that an account receivable "is an intangible" for Uniform Commercial Code purposes). [citations omitted]

Finally, the Court rejected Daewoo's contention that the alleged constructive trust which attached to the funds once they were wired by Allnex served to satisfy the ownership condition:

Daewoo's constructive trust argument is unavailing to establish that Daewoo has ever owned the funds. Constructive trusts are an equitable remedy used to prevent unjust enrichment or fraud. A constructive trust can be imposed when "the holder of the legal title may not in good conscience retain the beneficial interest" of the property. ... A constructive trust is an equitable remedy which courts may compel following adjudication; the remedy does not mean that Daewoo owned the funds in the first instance.

As a result, Travelers' second Rule 12(b)(6) motion was successful, and Daewoo's claim was dismissed. This time, the Court granted the motion with prejudice.

Conclusion

Like its predecessor, the second Posco Daewoo decision provides helpful guidance to fidelity claims professionals regarding the proper interpretation and application of the ownership condition. The Court effectively rejected the notion that Daewoo's status as a creditor made it a "constructive" owner of the funds in Allnex's possession. Fidelity insurers occasionally face creative arguments concerning "constructive" ownership, and both of the Posco Daewoo decisions provide examples of a court rejecting such arguments. The Court's analysis reaffirms the fundamental coverage requirement that an insured must own, hold or have antecedent legal liability for the property which forms the subject of a claim.

Posco Daewoo also provides helpful commentary as to whether an account receivable is properly considered "tangible" property. In our view, the Court correctly rejected this argument, while also correctly finding that an insured must establish both a loss of covered property and compliance with the ownership condition.

Finally, the decision reinforces the importance of social engineering fraud coverage – in this case, for companies in the position of Allnex. Although it is not clear from the Court's reasons, one surmises that Allnex did not maintain social engineering fraud coverage, which might have responded to the loss in issue here. Given the increasing frequency of vendor impersonation and other social engineering fraud losses, insureds would be well-advised to consult with their brokers about the risks that social engineering fraud poses to their business, and the availability of social engineering fraud coverage.

Posco Daewoo America Corp. v. Allnex USA, Inc. and Travelers Casualty and Surety Company of America, 2018 WL 6077983 (D.N.J.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
David S. Wilson
Christopher McKibbin
Stuart M. Woody
Events from this Firm
6 Feb 2019, Other, Toronto, Canada

When it comes to class actions, costs regimes vary across Canada. Ontario follows the traditional two-way costs regime while other jurisdictions like British Columbia have adopted a no cost regime.

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