Insights

Evaluating Coverage Based on Policy Language, Not Labels: The Sixth Circuit Gets It Right In First Defiance Financial Corporation v. Progressive Casualty Insurance, Insurance Policyholder Advocate

Most of us (that is, policyholder counsel) have had to respond to an insurer that has denied a claim because the "type" of policy it issued doesn't cover this "kind" of loss. To which the obvious response often is: What if the plain language of the policy says otherwise? When insurers insist that a matter is not covered because the policy wasn't intended to cover the "type" of claim or loss at issue, it's often a good sign that the insurer doesn't have a compelling argument for denying coverage based on the facts and the policy language. From time to time, however, courts will buy into insurance industry pronouncements as to what "types" of claims a particular line is supposed to cover and side with the insurer, notwithstanding policy language that, if read literally, would provide coverage.

In resisting coverage under fidelity bonds (also known as commercial crime loss policies), insurers frequently appeal to notions as to what is (or is not) supposed to be covered under "this type" of policy. Most commonly, insurers inform policyholders in reservation of rights and denial letters that the loss isn't covered to the extent it constitutes "indirect loss." A "direct loss" limitation typically is found in both the fidelity bond policy's insuring agreement (which usually requires that the "loss" be directly caused by an employee's theft, fraud or dishonesty) and in an exclusion for "indirect loss." But this concept of directness is a fluid one, at best. Unfortunately, with more frequency than we believe justified, courts have accepted insurers' arguments about what constitutes a lack of "directness" based on either drafting history of the fidelity bond forms or a judge's own felt response that the employee's theft was not a "direct" cause of the loss, even if it was a proximate one. This has led some courts to issue overly broad, general pronouncements that losses arising from an employer's vicarious liability to third parties are "indirect losses."

The Sixth Circuit's recent decision in First Defiance Financial Corporation v. Progressive Casualty Insurance, Nos. 10-3943, 10-3944, decided August 1, 2012 is a welcome counterpoint to this knee jerk approach to construing fidelity bonds and a return to focus on actual policy language. In a 2-1 ruling, the Sixth Circuit affirmed the district court's holding that a fidelity policy covered a bank that was forced to reimburse customers whose money had been stolen by an employee managing its customers' investments. The insurer had denied the claim asserting that there was no "direct" loss because the bank's loss was the result of vicarious liability to third parties. In rejecting that argument, the Sixth Circuit looked to the policy language to determine the scope of coverage, not to simple notions of what types of claims "should" be covered under this type of policy.

The Sixth Circuit began its analysis where all courts should: construing the language of the relevant provisions at issue. The court first examined whether the stolen proceeds met the relevant definition of "covered property," which was "property . . . owned and held by someone else under circumstances which make the Insured responsible for the Property prior to the occurrence of the loss." Because the accounts were obviously held by "someone else," the first part of the definition was satisfied. The Court of Appeals then found that the property was held "under circumstances that make the insured responsible for the property" because the accounts were discretionary accounts over which the bank had authority and thus responsibility before the loss arose. The Court of Appeals rejected the insurer's argument that the term "responsibility" meant the same thing as "liability." The court held that fiduciary responsibility for the property prior to the loss was enough, even though there were no pre-existing agreements between the bank and its customers that the bank would reimburse money stolen from those accounts.

The insurer also argued that the employee did not directly cause the bank's losses because the money was stolen from customer accounts, not the bank's assets, and thus the bank had no "interest" in the stolen money. The Sixth Circuit rejected that argument, holding that the bank's fiduciary responsibility for the money was a sufficient interest. As for a guiding principle for determining "directness," the Sixth Circuit held that the unifying theme of most cases was no more than this: "losses contingent on things other than an employee's fraud are not 'direct' under most fidelity policies." (My emphasis.)

The dissent (which would have found in favor of the insurer) picked up on the hoary notion that "a fidelity bond, 'unlike a general liability policy, provides no coverage for an employer's vicarious liability for employee torts.'" To which the majority correctly responded, in essence, "unless it does."

While First Defiance will be important to policyholders seeking coverage under fidelity bonds for losses arising from employee theft of another's property, it also will be useful to resist bald assertions by insurers that a loss is not covered under a particular line of coverage simply because of its "type."

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