By Shaun Crosner and Kathleen Sullivan
In May, the Washington Nationals Baseball Club sued its commercial crime insurer, Westchester Fire Insurance Company, for alleged “bad faith delays” and “wrongful denial” of the team’s insurance claim. The Nationals’ claim stems from a $1.4 million signing bonus paid to a prospect from the Dominican Republic whom the Nationals believed to be 16 years old but who was in fact 20 years old when he signed the contract. According to the Nationals’ complaint, certain employees within the organization—including the former special assistant to the team’s General Manager and the team’s former Director of Dominican Republic Operations—were aware of the fraud and received kickbacks from the player. The Nationals allege that, had they known the players “true age and identity at the time, more likely than not, the Nationals would have paid [him] no bonus at all.”
After the Nationals uncovered the alleged fraud, the team notified Westchester and sought coverage for what the team called a “complete loss.” According to the Nationals’ complaint, the team promptly submitted a proof of loss package to Westchester detailing the alleged fraudulent scheme. The Nationals claim that, after months of delays, Westchester wrongfully denied coverage for the team’s losses. The Nationals’ lawsuit is currently pending in the U.S. District Court for the District of Columbia.
As this high-profile example makes clear, employee theft is a constant source of potential loss for teams, leagues, franchises, venues, and other sports entities. To alleviate this concern, an increasing number of businesses in the sports industry (and, indeed, all industries) are purchasing commercial crime insurance coverage. Because this important risk management tool can protect an insured’s bottom line against the financial losses that can accompany employee theft and dishonesty, insured companies should take steps to familiarize themselves with the scope of coverage provided by their crime policies. And, in the event of a loss, companies should strive to satisfy all policy terms and conditions so that they can maximize the value of their coverage.
The Coverage Provided by Commercial Crime Policies
Depending on policy language, commercial crime insurance policies can cover losses stemming from employee infidelity, forgery, robbery, burglary, larceny, embezzlement, or fraud. Crime policies frequently cover only prospective acts of employee misconduct, meaning that the misdeed must take place, and be discovered, during the policy period. However, insured companies should not necessarily assume that prior acts of employee dishonesty or misconduct are not covered. Indeed, some crime insurers expressly cover prior undiscovered acts of employee dishonesty or misconduct if the act is first discovered within the policy period.
Generally, the coverage provided by crime policies is limited to acts of dishonesty, fraud, or other wrongdoing committed by “employees” of the insured company. In the sports industry, which features a number of unique employment and employment-like relationships, it is not always clear who qualifies as an “employee” of the insured company. Independent contractors and temporary employees, for instance, are not traditional “employees” but may nonetheless qualify as “employees” under a commercial crime insurance policy. Courts typically evaluate a broad range of factors in determining whether an employment relationship exists between the insured company and the individual or individuals alleged to have caused the loss. Relevant factors include whether the company: (1) pays the individual’s wages, salary, commission, or other compensation; (2) directs or controls the individual’s work and schedule; (3) withholds taxes from the individual’s earnings; and (4) has power to terminate the individual.
Commercial crime coverage is generally limited to an insured company’s so-called “direct” loss. Although courts have in some instances struggled with the distinction between “direct” and “indirect” loss, some courts have held that direct loss requires actual depletion of bank funds or theft of tangible property or assets. For this reason, some courts have ruled that lost profits, lost interest, and income not realized are too indirect to fall within the scope of coverage under a commercial crime policy. That being said, coverage will depend on the terms and conditions of the crime policy at issue, so insureds should carefully review their policies—both at the time of purchase and in the event of a loss.
The “Manifest Intent” Requirement
Commercial crime insurers typically cover losses stemming from an employee’s fraud, dishonesty, or infidelity only if the employee had a “manifest intent” to (1) cause loss to the employer, and (2) gain financial benefit for him/herself or some other party. Courts will apply either an objective test or a subjective test to determine whether the employee had the requisite intent. Under the objective test, if the natural and probable consequence of the employee’s conduct would be a loss to the employer and a gain for the employee, then manifest intent exists. Under the subjective test, the court (or, more often, the jury) will attempt to determine the employee’s actual motive in acting fraudulently, dishonestly, or in some other manner covered by the policy.
Coverage for Third-Party Liabilities
Often, an employee’s act of fraud, dishonesty, or infidelity will cause a loss to a third party, and that third party may then sue the insured company and attempt to hold it vicariously liable for its employee’s theft or misconduct. The resulting legal costs, including defense costs and, possibly, a settlement or judgment, can be significant.
Commercial crime insurers take varying approaches when it comes to coverage for such third-party liabilities. Some insurers expressly agree to cover third-party liabilities, whereas others exclude coverage for such claims. When crime insurance policies are silent on the issue (as is often the case), some courts have recognized that a settlement or judgment constitutes “direct” loss under a crime policy because it reduces the insured company’s assets. Consequently, insured companies should consider the potential for coverage under their crime policies for third-party liabilities resulting from otherwise covered wrongful acts of their employees. Indeed, in many jurisdictions, those insured are entitled to coverage for such claims unless the crime insurer includes a clear and unambiguous exclusion to the contrary.
Discovery of Loss
Coverage under a crime policy is triggered by the insured company’s discovery of a covered loss. Often, an employee’s theft, fraud, or dishonesty will not be uncovered for weeks, months, or even years, but coverage generally is not lost simply because there is some delay in the insured’s discovery of the loss. Indeed, courts generally recognize that discovery of a covered loss does not take place until the insured learns enough facts that would lead a reasonable person to conclude that a covered loss had taken place.
Again, some crime insurers extend coverage to losses predating the policy period that are first discovered during the policy period. Consequently, an insured company should not presume that coverage for prior undiscovered losses is unavailable under its crime policy.
Making a Claim for Coverage
Once an insured company believes it has suffered a loss, it should strive to satisfy the notice provisions in its crime policy. Notice must be given within some specified time period after discovery of the loss and should include a brief statement regarding the nature of the loss. Some notice provisions might require notice within a reasonable time after discovery of a loss caused by employee dishonesty, fraud, or infidelity, or perhaps at the earliest practicable moment after discovery of such a loss. Other notice provisions might require notice within a specified number of days—as few as seven in some policies. Although most courts will not allow an insurer to rely on a late notice argument unless it can show substantial prejudice from the delay, insured companies can avoid coverage disputes simply by providing prompt notice after discovery of a loss caused by employee crime or infidelity.
Because notice of a claim will generally include only minimal details about the loss, many commercial crime insurers also require the insured to file a more detailed proof of loss a number of months after providing notice. The proof of loss gives the insured an opportunity to document its claim and describe the losses that it suffered in greater detail. In addition to providing more information regarding the particulars of the employee’s fraud or dishonesty, the insured’s proof of loss may include a precise valuation and itemization of the funds taken or otherwise lost.
Finally, an insured company should pay close attention to timing-related limitations governing its right to initiate litigation against its commercial crime insurer, should the insured deem such action to be necessary. In some instances, the timeframe in which an insured can file suit is dictated by the express terms of the crime policy; in others, statute or regulation will provide the relevant limitations period. In either case, the insured company should be mindful of the timeframe in which it can initiate coverage litigation against its insurer, as an insured must preserve its right to pursue coverage in order to obtain the full benefits of its commercial crime policy.
Shaun Crosner and Kathleen Sullivan, Los Angeles-based attorneys in Dickstein Shapiro LLP’s Insurance Coverage Group, represent policyholders in disputes with their insurers. Mr. Crosner leads the firm’s Sports Insurance Practice and is an editor and primary author of LexisNexis’s New Appleman Sports and Entertainment Insurance Law and Practice Guide, and Ms. Sullivan is a member of the firm’s Sports Insurance Practice.
