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Originally published in Bloomberg Law Reports - Commercial
Insurance
The Capital Bank & Trust decision enforcing a
fidelity bond's termination provision reflects the majority
rule that there is no fidelity coverage for loss from an
employee's acts when the employer knows in advance of the loss
of past dishonesty on the part of that employee. Its holding is
more sound than that of Waupaca Northwoods, which found
the provision ambiguous in a crime policy with respect to knowledge
of pre-policy inception dishonesty and thus unenforceable to bar
coverage for acts by a known dishonest employee. The difference
between these two case holdings illustrates the difference between
applying a provision as written, on the one hand, and straining to
find ambiguity in order to create coverage, on the other hand. The
judge who authored the Waupaca Northwoods decision makes
clear his sympathy for an employer who purchased a company that
seemed to have two bad apples, one of whom knew of the other's
prior termination for knowingly misusing the predecessor
company's resources when he rehired the other as a plant
manager for the new company. However, while sympathy for an
employer (as opposed to an insurer) is not too surprising to
insurance coverage practitioners, sympathy does not make for
soundly decided precedent.
The guiding principle in insurance interpretation is whether
there are two reasonable ways to read the provision, in context. In
the context of fidelity insurance products, the majority rule makes
clear that going forward neither employer policyholders nor
insurers reasonably expect coverage for acts of employees once that
employee's past dishonesty is known to the employer. The
termination provisions state that coverage for that employee
"terminates" upon such knowledge. The Capital Bank
& Trust decision enforces the provision as written,
straightforwardly concluding that where an employer had
pre-inception knowledge of an employee's falsifying signatures
for loan documents, coverage as to that employee "terminated
immediately upon inception." The Waupaca Northwoods
decision, on the other hand, concluded that the word
"terminates" reasonably can be read as requiring some
period of coverage before being terminated. The problem with this
holding is that such a reading is not reasonable in context; it is
not supported by the words or by reasonable expectations. The words
do not say that coverage has to be in force for some period of time
before being terminated, and there is nothing inherently
unintelligible or unexpected about coverage terminating at
inception for an employee known to be dishonest. By straining to
create ambiguity where none exists, the Waupaca Northwoods
decision departs from sound precedent regarding the enforcement of
the termination provision in fidelity insurance policies and
bonds.
Max H. Stern is the head of the Insurance Division of Duane
MorrisLLP. He represents commercial and specialty line insurers.
This reflects the author's opinion, and not that of the firm or
of any client.
This article is for general information and does not include
full legal analysis of the matters presented. It should not be
construed or relied upon as legal advice or legal opinion on any
specific facts or circumstances. The description of the results of
any specific case or transaction contained herein does not mean or
suggest that similar results can or could be obtained in any other
matter. Each legal matter should be considered to be unique and
subject to varying results. The invitation to contact the authors
or attorneys in our firm is not a solicitation to provide
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in the United States and internationally, offers innovative
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