08 Aug Criminal Activity Policy Does Not Cover Worker Charge Card Overcharge Losses
A recent coverage dispute involving a Nevada club’s losses resulting from its employees’ theft from the club’s customers’ credit cards raises interesting issues with implications for coverage questions for other kinds of losses for which policyholders are seeking crime policy coverage. In the recent Nevada club credit card fraud case, District of Nevada Judge Andrew Gordon held that the club’s crime policy did not cover the club’s losses from the employees’ theft of funds from the customers’ credit card accounts because the losses did not result directly from the employees’ theft. Judge Gordon’s August 6, 2018 opinion can be found here. An August 7, 2018 post on the Wiley Rein law firm’s Executive Summary Blog about Judge Gordon’s opinion can be found here.
CP Food & Beverage ran a club where patrons could buy “funny money” to tip waitresses or pay for topless dancers. The waitresses and dancers could turn the money back to CP for cash. Several CP employees overcharges customers’ credit cards for funny money the customers did not intend to purchase. The employees then cashed in the funny money with CP. Several customers complained to the policy about the overcharges. CP hired professional services to investigate the credit card charges, incurring hundreds of thousands of dollars in the course of the investigation. CP also ultimately paid chargebacks of nearly $770,000 to customers’ credit cards.
CP submitted the chargebacks and investigative costs to its crime insurer as a claim under the policy. The insurer denied coverage for the claim, saying that the CP’s loss did not result directly from the employee theft, since the employees had stolen from the customers not CP itself. CP filed a lawsuit against the insurer and the insurer filed a motion for summary judgment.
The crime policy provided, among other things, that it covered “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.”
The August 6, 2018 Opinion
In an August 6, 2018 opinion, Judge Gordon granted the insurer’s motion for summary judgment, agreeing with the insurer that CP’s loss did not result “directly” from the employee theft as required under the policy in order for coverage to be triggered.
In its motion, the insurer argued that CP’s loss was not covered because the employee theft scheme stole money from the customers, not CP, and then used the stolen funds to buy funny money from CP. CP argued that because the employees obtained cash from CP using the funny money, they stole from CP, so the loss is covered.
In considering the insurer’s motion, Judge Gordon noted that in reviewing similar policy language about loss resulting directly from employee theft, the courts have fallen into two camps. One camp views the language as equivalent to a proximate cause analysis. The other camp employs a “direct means direct” rule, meaning that the employer’s property must be stolen in order for coverage to be triggered.
Nevada’s court have not addressed these issues, but Judge Gordon predicted that Nevada’s courts would apply a “direct means direct” rule and hold that the policy language at issue does not cover third party claims or claims for investigation costs. The property covered by the policy is limited to property that CP owns or that it holds for others. Thus, the policy contemplates a loss when the insured is deprived of the property, not when a third party is deprived of property. In reaching this conclusion, Judge Gordon noted further that the theft was of the customers’ funds, not CPs, and that CP would not be liable for a chargeback if the customer did not dispute the charge.
It could be argued that Judge Gordon’s ruling here is unremarkable, given the fact that, as he duly noted, the employees stole from the customers’ credit card accounts, and then used the funny money purchased with the stolen funds to obtain cash from CP. There were several intervening steps between the credit card theft and CPs losses.
What makes this case interesting to me is that its analysis of the policy’s use of the word “directly” echoes many of the same issues that have arisen in the many social engineering fraud/ payment instruction fraud cases in which policyholders were seeking to have email scam losses covered by their crime insurers.
The recent American Tooling Center decision, in which (as discussed here), the Sixth Circuit held that the insured’s crime policy Computer Fraud coverage section did cover ATC’s payment instruction fraud losses turned on the same issues of what degree of connection there must be between the criminal act and the loss of funds. In the ATC case, by contrast to this case, the appellate court applied more of a proximate cause analysis than the “direct means direct” analysis that Judge Gordon applied here.
Indeed, in its petition to the Sixth Circuit for rehearing of the ATC case, the insurer primarily relied on the exact case that Judge Gordon cited in his opinion as explaining the differences in the two judicial camps on the interpretation of the term “directly” as well as the meaning of the “direct means direct” interpretation of the term. The insurer’s petition for rehearing is discussed in detail here. The case that the insurer is relying on and that Judge Gordon cited in his opinion here is the Sixth Circuit’s 2012 opinion in Tooling, Manufacturing and Technologies Association v. Hartford Fire Ins. Co. (here).
Ordinarily, I wouldn’t have spent much time focusing on questions concerning crime policy coverage for a strip club’s losses from employee credit card fraud, but the recent focus on the meaning of the term “directly” in crime policy coverage sections makes the issues in this case of heightened interest. To be sure, Judge Gordon was not interpreting the Computer Fraud coverage section that is the focus of the payment instruction fraud cases. But in both this case and in the payment instruction fraud cases, the courts are struggling to interpret the same word, that is, the word “directly.”
Because interpretation of this word is clearly going to be one of the battleground issues in the fight to determine whether or not crime insurers must cover payment instruction loss, Judge Gordon’s analysis of the two schools of thought on the interpretation of the term “directly” provide interesting perspective. His conclusion that the Nevada courts would apply the “direct means direct” standard, and the way he himself applied the standard in this case, is also interesting.
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