No. 05-579
IN THE SUPREME COURT OF THE STATE OF MONTANA
2006 MT 344
FRONTLINE PROCESSING CORP.,
Plaintiff,
v.
AMERICAN ECONOMY INSURANCE CO.,
Defendant.
ORIGINAL PROCEEDING: Certified Question, United States District Court
District of Montana, Butte Division
The Hon. Sam E. Haddon, Presiding Judge
COUNSEL OF RECORD:
For Plaintiff:
Herbert I. Pierce, III, Jeffrey J. Oven, Bryan P. Wilson, Crowley,
Haughey, Hanson, Toole & Dietrich, PLLP, Billings, Montana
For Defendant:
Carey E. Matovich, Brooke B. Murphy, Matovich & Keller, P.C.,
Billings, Montana
For Amicus Curiae:
Lawrence A. Anderson, Montana Trial Lawyers Association,
Great Falls, Montana
Submitted on Briefs: June 1, 2006
Decided: December 27, 2006
Filed:
__________________________________________
Clerk
Justice Patricia O. Cotter delivered the Opinion of the Court.
¶1 In April 2003, plaintiff Frontline Processing Corporation (Frontline), a credit
card processing company, brought this action in the United States District Court for the
District of Montana for breach of contract and violation of Montana’s Unfair Trade
Practices Act. Defendant American Economy Insurance Company (American
Economy) moved for partial summary judgment based in part on its argument that the
definition of the term “direct loss” in the insurance contract at issue precluded Frontline
from recovering many of the damages that it claims are covered and payable under the
policy. The District Court denied summary judgment in July 2005, on the basis that
there was no clear Montana precedent.
¶2 By order dated September 27, 2005, and pursuant to M. R. App. P. 44, the
United States District Court for the District of Montana, Great Falls Division, certified
the following question to this Court:
Does the term “direct loss” when used in the context of employee
dishonesty coverage afforded under a businessowner’s liability policy,
include consequential damages that were proximately caused by the alleged
dishonesty, or is the construction of the term “direct loss” limited to those
damages that directly result from the alleged employee dishonesty?
¶3 We accepted the question in our order dated October 12, 2005, and for the
reasons set forth below, we conclude that the term “direct loss” when used in the
context of employee dishonesty coverage afforded under a business owner’s liability
policy, means all losses proximately caused by an employee’s dishonesty.
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BACKGROUND
¶4 In accordance with M. R. App. P. 44, the United States District Court certified
the facts set forth below in paragraphs 5-17.
¶5 Frontline is a credit card processing company based in Bozeman, Montana.
Chris Kittler is the owner and president of Frontline.
¶6 Ron Reavis was employed as Frontline’s Chief Financial Officer until February
2001.
¶7 Frontline purchased a special Businessowner’s Policy (Policy) from American
Economy in August 1999. At that time, Frontline also purchased $250,000.00 in
optional coverage for employee dishonesty.
¶8 During his employment at Frontline, Reavis was allegedly responsible for filing
Frontline’s payroll taxes, corporate income taxes, and Kittler’s personal income taxes.
¶9 Frontline claims that while employed at Frontline, Reavis engaged in dishonest
acts such as forging Kittler’s signature on Frontline checks, using the company credit
card for his own purposes, and deliberately failing to file Frontline’s payroll taxes and
corporate income taxes.
¶10 As a result of the alleged dishonest acts of Reavis, Frontline retained Heartland
Business Intelligence (Heartland) to conduct a forensic examination of Reavis’s
computer activities to determine the degree and extent of Reavis’s alleged theft.
Frontline claims Heartland’s fees in the amount of $24,050.20 are covered under the
Policy.
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¶11 Frontline similarly retained Karen S. Runyon (Runyon) to perform a forensic
handwriting analysis of certain Frontline checks to determine which ones, if any,
Reavis forged. Frontline claims that the $3,812.50 fee for Runyon’s analysis is also
covered under the Policy.
¶12 Frontline also retained Galusha, Higgins & Galusha (Galusha) to investigate,
evaluate, and rectify the financial situation that Reavis allegedly had caused. It claims
that Galusha’s fees in the amount of $57,654.81 are covered by the Policy.
¶13 Frontline also seeks coverage costs, interest, penalties, and fees assessed by the
Internal Revenue Service (IRS) as a result of Reavis’s alleged deliberate failure to pay
Frontline’s and Kittler’s taxes.
¶14 The “employee dishonesty” coverage afforded by the Policy provides as follows:
A. Employee Dishonesty
i. We [American Economy] will pay for direct loss of or damage to
Business Personal Property and “money” and “securities” resulting
from dishonest acts committed by any of your employees acting
alone or in collusion with other persons (except you or your partner)
with the manifest intent to:
1. Cause you to sustain loss or damages; and also
2. Obtain financial benefit (other than salaries, commissions,
fees, bonuses, promotions, awards, profit sharing, pensions or
other employee benefits earned in the normal course of
employment) for:
a. Any employee; or
b. Any other person or organization.
(Emphasis added by the U. S. District Court.)
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¶15 American Economy maintains that the costs, fees, interest and penalties assessed
by the IRS, as well as the fees paid to Heartland, Runyon, and Galusha, are not “direct
losses” within the meaning of the phrase, and are therefore not covered losses under the
Policy.
¶16 Frontline maintains that the Policy does afford coverage for costs, fees, interest
and penalties assessed by the IRS, as well as fees paid to Heartland, Runyon, and
Galusha because Frontline alleges these losses were proximately caused by Reavis’s
dishonest conduct. 1
¶17 For purposes of this certified question only, American Economy concedes that
Reavis had “manifest intent” as defined in the Policy.
¶18 Based on these facts, the federal court certified the question to this Court. Under
M. R. App. P. 44(c), this Court may answer a question of law certified to it by another
qualifying court. Therefore, our review is purely an interpretation of the law as applied
to the agreed facts underlying the question. Rich v. State Farm Mut. Auto. Ins. Co.,
2003 MT 51, ¶ 11, 314 Mont. 338, ¶ 11, 66 P.3d 274, ¶ 11.
DISCUSSION
¶19 Frontline argues, among other things, that several jurisdictions have interpreted
“direct loss” to mean all losses proximately caused by an employee’s dishonest activity.
See, e.g., Jefferson Bank v. Progressive Cas. Ins. Co., 965 F.2d 1274, 1281 (3rd Cir.
1992); Auto Lenders v. Gentilini Ford., 854 A.2d 378, 386-87 (N.J. 2004); Mid-
1
For purposes of this certified question only, American Economy admits these losses were
occasioned by Reavis’s alleged dishonesty.
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America Bank of Chaska v. American Cas. Co., 745 F. Supp 1480, 1485 (D. Minn.
1990). It maintains that the disputed claimed expenses were losses proximately caused
by Reavis’s actions. Frontline further avers that incurrence of the disputed claimed
expenses was mandated by the policy’s investigation and mitigation of damages
provisions.
¶20 American Economy counters that the losses Frontline is claiming are
consequential, not direct losses, and therefore are not covered by the policy. It relies on
cases from jurisdictions that have expressly declined to apply a proximate cause
analysis to the term “direct loss,” holding instead that a narrower standard was
appropriate. See, e.g., Tri City Nat. Bank v. Federal Ins. Co., 674 N.W.2d 617, 625
(Wis. App. 2003); RBC Mortg. Co. v. National Union Fire Ins. Co., 812 N.E.2d 728,
733 (Ill. App. 1st Dist. 2004). American Economy further maintains that the disputed
claims represent monies that Frontline owes to third parties, thus making them third
party liabilities and not direct losses. Relying on Vons Companies, Inc. v. Federal Ins.
Co., 212 F.3d 489 (9th Cir. 2000), and numerous other cases from the First, Fifth, Sixth
and Seventh Circuits, American Economy urges us to adopt the Ninth Circuit’s rule that
“direct means direct” and that in the absence of a third party claim clause, a policy
covering “direct losses” does not provide indemnity for vicarious liability for tortious
acts of a dishonest employee. Additionally, the insurer argues that the policy did not
require Frontline to incur the expenses it is claiming.
¶21 As noted above, the policy before us insures Frontline against direct losses
caused by the dishonesty of its employees. Many jurisdictions have construed “direct
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loss” or similar language in a fidelity bond or insurance policy. A fidelity policy, also
known as an employee dishonesty policy, is a form of insurance in which the insurer
agrees “to indemnify an employer against a loss arising from the lack of integrity or
honesty of an employee . . . .” Black’s Law Dictionary 804 (Bryan A. Garner, ed., 7th
ed., West 1999). Under a liability policy, by contrast, the policy holder is insured
against or indemnified for, vicarious liability to a third party claimant. RBC, 812
N.E.2d at 733. The policy before us is clearly the former—i.e., it is an employee
dishonesty, or fidelity, policy. See ¶ 7.
¶22 The claims asserted by Frontline are for business expenses and losses it incurred
as a result of its employee’s dishonesty. While American Economy equates the claims
for which Frontline seeks recovery—those of the analysts, the accountants and the
IRS—with the classic third party claims for which there would typically be no coverage
under a fidelity policy, Frontline maintains that these are losses proximately caused by
the employee’s dishonest conduct which the policy was intended to cover. We turn to
the cases cited by the parties for guidance in answering this question.
¶23 In Vons, upon which American Economy relies, Vons was insured for employee
dishonesty by Federal Insurance Company. The policy coverage was limited to Vons’
direct losses incurred as a result of employee misconduct. An employee of Vons
engaged in a dishonest act which resulted in Vons being sued by defrauded third
parties. Vons settled these third party claims, and then submitted a proof of loss to
recover the amount it paid in the settlement. Vons argued the loss from the settlement
of the liability suit was a “direct loss” incurred due to the actions of the employee.
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Vons, 212 F.3d at 490-91. The Ninth Circuit rejected this argument, finding that
coverage did not extend to Vons’ liability settlement of third party claims for losses
arising out of the tortious conduct of its employees. Vons, 212 F.3d at 492. The federal
court continued that “direct means direct” and the third party claims were not direct.
Vons, 212 F.3d at 492.
¶24 Similarly, in Tri City Nat. Bank, employees of a branch of the Tri City Bank
participated in a scheme to obtain fraudulent mortgage loans for insufficiently funded
borrowers. Ultimately, these borrowers defaulted on the fraudulently-obtained loans,
the scheme was discovered, and the mortgage companies sued Tri City to recover their
losses. Tri City sought confirmation from Federal Insurance Company (Federal) that
the fidelity bond in place covered Tri City for either judgments or settlements paid to
the mortgage companies resulting from the fraud. Federal denied coverage on the
ground that the bond covered only those losses “resulting directly from dishonest or
fraudulent acts” of Tri City employees. Tri City settled the claims brought by the
mortgage companies and then sought indemnity from Federal for the settlement
amounts. Federal again denied coverage. Tri City, 674 N.W.2d at 617-20.
¶25 The Wisconsin Court of Appeals noted that Tri City’s claimed losses arose from
settlements with third parties and were not the direct result of its employees’
dishonesty; in fact Tri City’s liability to the mortgage companies did not come into
being until nearly three years after the fraudulent conduct occurred. Tri City, 674
N.W.2d at 623. See also Aetna Cas. & Sur. Co. v. Kidder, Peabody, 676 N.Y.S.2d 559,
246 A.D.2d 202 (N.Y. A.D. 1 Dept. 1998) (If an employee’s dishonesty causes losses to
8
a third party, which then leads to litigation concluding in a judgment or settlement, the
insured has not incurred a “direct loss” under a fidelity bond; the insured’s loss is
“indirect.”); RBC; and Finkle v. St. Paul Fire and Marine Ins. Co., 2002 WL 1359672
(D. Conn.) (not reported in F. Supp.2d).
¶26 Here, unlike in the cases above, Frontline’s disputed claims are not the result of
lawsuits by or settlements made to third parties. Rather, as argued by Frontline, they
arise from costs incurred to investigate the extent of Reavis’s alleged dishonest conduct
and to mitigate and remedy the discovered damage. In making this argument, Frontline
relies in part upon three cases from the Third Circuit Court of Appeals—Jefferson Bank
v. Progressive Casualty Ins. Co., 965 F.2d 1274 (1992); Resolution Trust Corp. v.
Fidelity & Deposit Co., 205 F.3d 615 (2000), and Scirex Corp. v. Federal Ins. Co., 313
F.3d 841 (2002). In these cases, the courts employ a “proximate cause” standard in
determining whether the claim presented by the insured is or is not the type of “direct
loss” covered by the policy.
¶27 In Jefferson Bank, plaintiff Jefferson Bank sought indemnification for direct
losses resulting from a loan created with the aid of an imposter notary, who affixed her
invalid notarization to the mortgage, and then failed to record it. The customer
subsequently placed other mortgages on the same property, at least one of which was
recorded, and when the customer defaulted on all loans, Jefferson Bank was unable to
take possession of the property. Jefferson Bank, 965 F.2d at 1275-76. Progressive, the
defendant insurer, argued that the Bank’s loss was not covered under the bond’s
coverage for losses “resulting directly from” fraudulent signatures, because the loss was
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not caused by the notary’s forged signature, but rather by the fact that the building was
so heavily encumbered. Jefferson Bank, 965 F.2d at 1280-81. The Third Circuit held
that under Pennsylvania law, the “direct cause of a loss” does not have to be the “sole”
or “immediate” cause, but need only be a proximate or substantial cause. The Federal
Court opined that:
“[D]irect cause” or “immediate cause” is a nebulous and largely
indeterminate concept, and one that does not enjoy favor under
Pennsylvania law. As we have suggested, Pennsylvania, consistent with
general notions of proximate causation, requires that plaintiffs in
negligence cases show substantiality, rather than immediacy, in order to
demonstrate proximate cause.
Jefferson Bank, 965 F.2d at 1281.
¶28 Also, in Scirex, the Third Circuit applied the proximate cause standard, relying
on Jefferson, stating, “Pennsylvania law equates ‘direct cause’ with ‘proximate cause.’”
Scirex, 313 F.3d at 843-44. In Scirex, nurse employees for the insured, Scirex (a
pharmaceutical-testing company), failed to follow protocol and engaged in deceptive
record keeping, both of which rendered certain drug studies worthless. As a result,
Scirex was unable to procure and produce results for its contracted sponsor, and Scirex
was forced to replicate the studies using $1.2 million of its own funds. Scirex sought
indemnity for the replication costs from its insurer, Federal, under a blanket employee
dishonesty policy. Federal denied the claim, prompting Scirex to sue Federal for the
losses. The federal district court held that “Scirex’s losses were directly tied to these
studies, and by rendering those studies worthless, the nurses’ behavior proximately, and
therefore directly, caused Scirex’s losses.” Scirex, 313 F.3d at 843-45, 850.
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¶29 In 2004, the New Jersey Supreme Court was asked to consider whether the use
of a proximate cause test for evaluating the nature of a loss was appropriate under an
employee dishonesty policy that requires a direct loss. Auto Lenders, 854 A.2d 378.
The New Jersey Court noted that “the majority of federal courts that have addressed
this question have concluded that the term ‘direct loss’ or its equivalent does, in fact,
call for the application of a proximate-causation standard.” Auto Lenders, 854 A.2d
386. Citing Scirex (applying proximate cause test to “direct loss”), F.D.I.C. v. National
Union Fire Ins. Co., 205 F.3d 66, 76 (2d Cir. 2000) (applying proximate cause test to
policy language covering “loss resulting directly from” employee dishonesty),
Resolution Trust Corp., Jefferson Bank, and First Nat. Bank of Louisville v. Lustig, 961
F.2d 1162, 1167-68 (5th Cir. 1992), the New Jersey Court adopted “the conventional
proximate cause test as the correct standard to apply when determining whether a loss
resulted from the dishonest acts of an employee.” It stated, “[o]ur interpretation
comports with our general principles of insurance law, including our practice of
interpreting coverage provisions broadly. . . . There being no sound reason why a
proximate-cause analysis should not be employed when determining whether a loss is
direct under a fidelity insurance policy, we will apply that approach to such policies,
including the policy at issue in this appeal.” Auto Lenders, 854 A.2d at 387.
¶30 We are persuaded that a proximate cause analysis is appropriate in determining
whether a loss is “direct” under a fidelity insurance policy. Such a position comports,
as well, with our tradition of applying a causation standard to various types of losses
claimed under insurance policies. See, e.g., Green v. Milwaukee Mechanics’ Ins. Co.,
11
77 Mont. 505, 252 P. 310 (1926) (Insurer of a fire insurance policy containing an
“explosion” exemption, is liable for both the fire and explosion damage where the
explosion is caused by a pre-existing fire “since the fire is the proximate cause of the
whole loss and the explosion is a mere incident.”); Newman v. Kamp, 140 Mont. 487,
493-94, 374 P.2d 100, 104 (1962) (For claimant to prevail in industrial accident claim,
he must establish by a preponderance of evidence that such injury was the proximate
cause of his present condition.); Life Ins. Co. of North America v. Evans, 195 Mont.
242, 247, 637 P.2d 806, 808 (1981) (In a negligence action, where an accidental injury
aggravates or triggers a pre-existing dormant disease or physical infirmity, the accident
may be said to have been the proximate cause of the resulting disability within the
terms and meaning of an ordinary accident insurance policy.).
¶31 For the foregoing reasons, we answer the certified question by concluding that
the term “direct loss” when used in the context of employee dishonesty coverage
afforded under a business owner’s liability policy, applies to consequential damages
incurred by the insured that were proximately caused by the alleged dishonesty. We do
not address or resolve the question of whether all of the claims presented by Frontline
for payment under the policy were proximately caused by the dishonest actions of
Reavis, as this is beyond the scope of the certified question.
¶32 Question answered.
/S/ PATRICIA COTTER
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We Concur:
/S/ JAMES C. NELSON
/S/ BRIAN MORRIS
/S/ JOHN WARNER
/S/ JIM RICE
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