Employee dishonesty is the quintessential coverage afforded by fidelity bonds. At first blush, employee dishonesty and employee theft insuring agreements appear self-explanatory. However, interpretation of fidelity bonds has not been immune to variance in judicial determinations nor the ever-changing methods by which employees steal from their employers, especially given the evolution of technology in business operations. But despite the complexity of today’s employee dishonesty claims, certain common patterns and themes remain constant. This article will explore and discuss the basics of fidelity coverage and walk through some of the more nuanced aspects of handling a fidelity claim.
Fidelity Bond History
One such obligation that sureties can secure is an employee’s obligation to remain faithful to an employer. However, surety arrangements required a separate agreement for each employee, which proved to be fairly cumbersome.
In addition to fidelity coverage,
The coverage afforded by these policies varied based on the needs of the insured entity.
Of course, at least one type of coverage has been consistently present in fidelity bonds: employee dishonesty coverage. The exact terms of fidelity coverage afforded by these bonds, however, have evolved over the years, often in response to courts interpreting the policies in ways unintended by the drafters. Therefore, it is important to carefully assess the subject bond’s language as such provisions will control over case law interpreting similar, but not identical, language.
The Fidelity Insuring Agreement
Fidelity coverage afforded by bonds can vary significantly. As such, claim professionals, even the most experienced who often “know it when they see it,” should always pay close attention to the often nuanced language of the bond. That said,
The first, the employee dishonesty insuring agreement, has evolved significantly over the years.However, To counteract these decisions that were turning the bond into credit insurance and contrary to the drafters’ intent, c Employee dishonesty insuring agreements, in their current form, generally provide coverage for
loss resulting directly from dishonest acts committed by an employee, whether identified or not, acting alone or in collusion with other persons, with the manifest intent to:
a. Cause you to sustain a loss; and
b. Obtain an improper financial benefit for:
(1) The employee; or
(2) Any person or organization intended by the employee to receive that benefit.
Even with the changes to the employee dishonesty insuring agreement, courts still disagreed as to what constitutedMoreover, some in the industry believed that the term “theft” would be more readily understood than As such, The modern employee theft insuring agreement provides coverage for
loss of or damage to “money,” “securities[,]” and “other property” resulting directly from “theft” committed by an “employee,” whether identified or not, acting alone or in collusion with other persons.
“Theft” is generally defined as the unlawful taking of money or other covered property to the deprivation of the insured.
Despite these variances, rest assured: the all-too-common sticky-fingered bookkeeper loss will typically satisfy any iteration of the insuring agreement.
Fidelity Coverage Analysis
Analysis of a fidelity claim will vary depending on whether it covers employee dishonesty or employee theft and based on the circumstances surrounding the fraudulent scheme perpetrated by the employee. However, certain coverage issues are always present in fidelity claims, regardless of the foregoing specifics.
Thereafter, However, in reality and in practice, much of the claim investigation and coverage analysis is occurring simultaneously: the insured is gathering its supporting documentation, and the insurer is assessing the facts and circumstances while considering each required element of a covered loss.
Usually, a final determination of coverage cannot (and arguably should not) be made until all pertinent facts are known. At the outset, it may not be apparent what facts are pertinent or not, and it is therefore important to cast a wide net to gather as much information as possible to be in a position to view the loss from different angles. It is like a jigsaw puzzle—you start at the corners, work around the edges, then start filling in the middle so that you have a clear view of the image. In assessing coverage for a fidelity claim, we cannot simply get a sense of what the loss “image” looks like but rather must put all of the pieces of the puzzle together.
Who? First is the who of a claim, which is really a two-part inquiry: Who committed the acts causing the subject loss, and who suffered the loss? Is the individual involved an “employee,” as defined, and is the entity from which the individual purportedly stole an “insured,” as defined?
As such, it is important to identify the entity that suffered the purported loss because unless it is the insured, coverage is unlikely to be afforded. There are certain caveats to this premise, however. Second, the standard definition of “discovery” contemplates a third-party liability scenario whereby a third party seeks to hold the insured liable under circumstances that, if true, would constitute a covered bond loss (e.g., a lawsuit seeking to hold the insured liable for the loss or destruction of the plaintiff’s property in the insured’s custody or control at the hands of the insured’s employee).
Modern fidelity bonds and crime policies contain relatively uniform definitions for “employee,”However, as companies have evolved to retain and rely upon a nontraditional workforce to perform tasks, some policies have amended the definition to include In interpreting these various definitions, courts will often look beyond the terms of an employee contract or retainer agreement and
In order to determine whether an individual is an employee, it is best practice to obtain a personnel file, employment contract, or retainer agreement for the individual. A review of this documentation should reveal whether the individual is an employee.
What? After the who comes the what portion of the analysis, which assesses what property was taken by the employee. In a simple embezzlement scheme where an employee steals from an insured’s accounts, the loss is the money taken from the accounts.Query what an insured loses if an employee retains a vendor that renders legitimate services to the insured at a fair price but pays a kickback to the employee for the procurement of the service contract. Likewise, determining the amount of a loss can be difficult where an employee makes a combination of authorized and unauthorized purchases. As previously noted, it is the insured’s burden to prove that a loss (from both a liability and quantum perspective) satisfies the insuring agreement.
Determining the what is often a time-consuming exercise as it involves a review of each purportedly dishonest transaction perpetrated by an employee. Claim professionals should be sure to obtain full and complete records detailing the amounts purportedly taken by the employee, including items such as credit card statements, invoices, audit reports, general ledgers, and bank statements (depending on the scheme perpetrated by the employee).
When? Following the what comes the question of when the loss was sustained and discovered. Financial institution bonds were originally written on a “loss sustained” basis, i.e.,However, modern financial institution bonds and commercial crime policies are typically written on a “loss discovered” basis, i.e.,
This component of the analysis requires the claim professional to consider, cumulative of the earlier steps, who knew what when. The standard definition of “discovery,” the triggering event under the typical bond, bears on when the insured (or a designated individual) first became aware of facts which would cause a reasonable person to believe that a loss of the type covered under the bond has been or will be incurred, even if all facts and circumstances surrounding same (including as to the amount of loss) are not yet known. It is critical to examine exactly when suspicions may first have arisen, who had such suspicions, and what was done in response to those suspicions. An insured that buries its head in the sand in the face of conduct that would cause a “reasonable person” to believe that a loss had or would occur may find itself on the outside looking in—i.e.,Further, if discovery occurred earlier than as presented by the insured (even if within the instant bond period), the claim professional must also consider the timeliness of notice and submission of the proof of loss, both of which run from the date of “discovery.”
Accordingly, the question of when dictates whether the bond has been triggered (discovery) and whether an insured has abided by all the bond’s requirements and conditions precedent. Most fidelity bonds require that the insured provide notice “as soon as practicable” or within a set amount of time after discovery. The insured will also need to submit a sworn proof of loss detailing, “with full particulars,” the putative loss within a specific amount of time following discovery. Insurers may attempt to deny coverage where an insured fails to provide timely notice or a sworn proof of loss.
How? After determining who, what, and when, the claim professional gets to the heart of the analysis—how—which is often complex as it bears on the core issue of whether the covered peril has been satisfied. How did the loss occur? Was it the result of an accounting error or other form of negligence? Or was there in fact a misappropriation, embezzlement, or some unlawful act that directly caused the loss? If so, the claim professional must go further to understand how the subject property was misappropriated. Did the employee simply reach into the company till and take physical cash? Was it a vendor kickback scheme? Was a computer involved in the subject transactions and/or transfer of funds? Did the scheme involve payroll or expense reimbursement? Was there a falsification or alteration of documents that helped facilitate or cover up the misappropriation? Obtaining answers to these and other questions is necessary to determine whether the scheme constitutes a dishonest act with the manifest intent to cause a loss or an unlawful taking, respectively, as required by the insuring agreement, and whether the subject conduct directly caused the claimed loss.
While employee theft language was created to alleviate confusion with respect to “manifest intent” language, certain policies still utilize the older employee dishonesty language.While “dishonest act” arguably, in and of itself, However, courts still struggle with the exact requirements posed by the manifest intent language. This disagreement has produced three tests to analyze the issue of manifest intent: Fortunately, for run-of-the-mill embezzlement losses, these tests generally result in the same outcome (i.e., an employee who steals from an insured’s cash register would satisfy any of the foregoing tests).
Under the employee theft standard, an insured must prove that an employee “unlawfully took” property to its deprivation.Other courts have taken a broader and more wholistic approach to lawfulness by Courts have also grappled with the exact conduct necessary to constitute a taking. The current trend, however,
In order to determine whether the circumstances surrounding a putative loss satisfy employee dishonesty or employee theft insuring agreements, a claim professional should discuss the scheme in detail with the insured and obtain supporting documentation of the putative fraud perpetrated by the employee. Typically, what comes with the proof of loss will not be sufficient to satisfy the claim professional that every box is checked leading to a covered loss. Multiple conversations, requests for information, and possible examinations under oath or other in-person meetings are often warranted. Often, the answer to one question leads to other questions—the insured should be apprised of the process from the outset to manage expectations so as to avoid the “Here’s my proof of loss. When do I get my check?” inquiry.
Further, identifying the steps in the employee’s scheme is necessary to determine whether a loss results directly from employee dishonesty or employee theft. The first step in this analysis is to identify the jurisdiction whose law applies to the interpretation of the bond.For courts applying the “direct means direct” approach, loss occurs where there is an For courts applying the proximate cause standard, coverage is afforded where a covered peril Once it is determined which standard applies, a claim professional will want to assess the timeline of purported misappropriation and any intervening factors that may break the causal connection between the employee’s conduct and the insured’s loss.
This argument is a double-edged sword, however, in that multiple losses also mean that multiple per-loss retentions apply. Typical “single loss” policy wording is clear and broad enough to effectively address this without significant dispute. Understanding how the employee perpetrated the fraud is vital to determining the number of putative losses suffered by the insured.
Exclusions and Other Provisions
Of course, satisfying the insuring agreement is only part of the analysis. A claim professional must also determine whether any exclusions or other provisions apply to preclude coverage. While there are many exclusions that could potentially apply to preclude coverage depending on the specifics of a claim, certain exclusions and provisions are more commonly triggered.
For instance, related to the question of directness is the indirect/consequential loss exclusion. This exclusion precludes coverage for a loss that is an indirect result of a covered act or occurrence.
Prior knowledge exclusions and/or bond termination provisions will preclude or terminate coverage for an employee with a history of prior theft of which the insured has knowledge.Others, however, In response to this unintended split, The language used in the bond is key to analyzing the fact scenario at hand.
Fidelity bonds generally also contain a voluntary parting exclusion precluding coverage for an insured that voluntarily parts with property to a third party.
Courts have created three standards when applying the inventory loss exclusion:
Finally, the alter ego doctrine allows an insurer to assert a defense to coverage where an insured is totally dominated and controlled by the defalcating employee.
These are some of the potentially applicable exclusions and provisions, but remember, the policy terms rule! Be sure to carefully review each term, condition, and exclusion of the bond for other potentially applicable provisions.
Fidelity Claim Example and Checklist
While the foregoing coverage issues are certainly not intended to be exhaustive, evaluation of employee dishonesty claims generally follows a similar pattern. Take, for instance, a scenario in which the controller of an insured automotive dealership, ABC Auto, has been understating the dealership’s sales in the books in order to hide funds that he has been taking from the dealership’s operating accounts. This is a fairly straightforward embezzlement claim that likely proceeds in the following manner after notification of the loss (which often will not provide much detail).
- The insurer issues an acknowledgment letter and general reservation of right with a blank proof of loss form citing to the bond’s proof of loss deadline (triggered of course by the date of discovery, which may not at this point be known and is subject to investigation as discussed above).
- Next, it typically helps to have an introductory phone call with the insured (and broker) to discuss the overall claim process, gather known facts and the status of the internal investigation to date, determine whether any criminal authorities have been identified and the status of any such investigation or prosecution, identify items you would expect to see in the forthcoming proof of loss, identify any potential recovery sources and determine any immediate steps that can or should be taken to secure same, and discuss a general timeline of the next six to 12 months and beyond.
- Upon receipt of the sworn proof of loss with supporting documentation, a review will reveal whether additional information and documentation are needed (which is almost invariably the case).
- Assuming additional information is necessary, the insurer will issue requests for information seeking specific documentation needed to fully assess the following coverage issues:
- Is the controller an employee of ABC Auto, as that term is defined? Request personnel files and employment contracts.
- Who is the insured, and whose money was stolen? Request organizational charts and statements showing that property was taken from the insured.
- What and how much was stolen from the insured’s accounts? Request bank statements, financial documentation, and whether the insured anticipates any recoveries.
- What are the mechanics of the scheme perpetrated by the controller? Request a detailed narrative of the fraudulent scheme and documentation supporting same.
- Does the controller’s conduct constitute employee dishonesty or an employee theft?
- Employee dishonesty: Did the controller commit dishonest or fraudulent acts with the manifest intent to cause ABC Auto to suffer a loss and to obtain a financial benefit that was not a benefit earned in the course of employment?
- Employee theft: Did the controller unlawfully take money or other covered property to the deprivation of ABC Auto?
- Did the controller’s conduct result directly in a loss without any intervening factors? Request the insured’s policies and procedures pertaining to the prevention of similar embezzlement schemes.
- Are there any exclusions or other provisions that could limit or preclude coverage?
Employee dishonesty and theft coverage is the backbone of the fidelity bond, and case law interpreting the insuring agreement is vast. Nevertheless, courts still disagree on the requirements, scope, and extent of coverage provided by such insuring agreements. Therefore, when analyzing potential coverage, it is important to remain cognizant of the evolving landscape of fidelity coverage and be mindful of the myriad methods by which employee theft can occur.