Insurance & Reinsurance
A recent decision by the Federal Court provides judicial insight on the interpretation of several key issues on the coverage of fidelity or employee theft insurance policies, including “employee” and “direct loss”
The decision also considers how an insureds’ duty of disclosure interacts with the requirement to disclose fraudulent misappropriation by senior management, in this case by the company’s sole director. All Class Insurance Brokers Pty Ltd (in liquidation) v Chubb Insurance Australia Limited (No 2)  FCA 782 concerned a claim by All Class Insurance Brokers Pty Limited under an employee theft policy for money stolen by its sole director.
With the market for fidelity/crime policy significantly hardening in Australia and London, and the rarity of coverage decisions in this class of business, the decision is a must read for financial lines underwriters, brokers and claims managers.
Prior to its liquidation, All Class was an Insurance Broker and member of a larger broking group. Mr Leroy Bowmaker was All Class’ sole director and shareholder and he was also the responsible officer for All Class’ ASF Licence.
As a member of the broking group, All Class was covered by a group policy of insurance, including crime coverage. The Policy was underwritten by Chubb.
Between June 2008 and March 2013, Mr Bowmaker fraudulently misappropriated client monies in All Class’ trust account, diverting them to the office account as well as personal bank accounts. In 2011, All Class’ auditor wrote to Mr Bowmaker informing him of discrepancies and confirming that they would be reporting their findings to ASIC. No further action was taken to rectify the trust account issues.
In early 2013, Mr Bowmaker’s fraudulent conduct was discovered and he was admitted to hospital for treatment. His wife, acting as his power of attorney, notified the conduct to Chubb in March 2013. Shortly after All Class was placed into external administration and All Class was served with a Notice from ASIC concerning suspected breaches of the Corporations Act.
In October 2014, the administrator provided a proof of loss to Chubb in relation to the claim. Thereafter Chubb issued several requests for information, with the administrator responding after lengthy delays. Proceedings were commenced in April 2019 and in November 2020 Chubb formally denied liability. The administrator claimed $2,054,732.99 including fraudulent payments of $2,031,086.87 plus investigation expenses incurred by All Class to establish the loss.
Chubb’s denial was made on three grounds:
Mr Bowmaker was the guiding mind of All Class and had breached his duty to disclose to Chubb the fraudulent misappropriations. As a result, Chubb claimed pursuant to the Insurance Contracts Act it was entitled to either avoid the policy or alternatively to reduce its liability with respect to the claim to nil.
Mr Bowmaker was not an Employee within the meaning of the Policy.
All class sustained no direct loss from the theft and the insuring clause had not been engaged.
The relevant insuring clause of the Policy stated:
The Company shall pay the Principal Organisation for direct loss of Money, Securities or Property sustained by an Insured resulting from Theft, fraud or dishonesty, committed by an Employee, whether acting alone or in collusion with others, which direct loss is Discovered during the Policy Period or Extended Discovery Period.
The term Employee relevantly meant a natural person:
(a) while in the regular service of an Organisation in the ordinary course of such Organisation’s business whom such Organisation has the right to govern and direct in the performance of such service whether the Organisation compensates such person by salary, wages and/or commissions or whether such person is a volunteer;
(b) who is an Executive while performing acts within the scope of the usual duties of an employee as described in paragraph (a) of this definition;
Executive was defined to mean “a natural person who is duly elected or appointed director or officer, or equivalent positions in any jurisdiction, of an Organisation”. The parties agreed that All Class would be considered part of “the Organisation “for the purpose of the Policy.
The key question in relation to All Class’ duty of disclosure was whether Mr Bowmaker was the guiding mind of All Class and whether Mr Bowmakers knowledge should be imputed to All Class. All Class submitted that the purpose of the Crime Policy was to protect the company and its clients from the fraudulent actions of employees and executives and that Mr Bowmaker’s knowledge of the fraudulent misappropriations should not be attributed to All Class for the purpose of assessing whether All Class made a non-disclosure when entering the Policy. Chubb submitted that Mr Bowmaker was the guiding mind and will of the company and, by acting in a fraudulent manner, he was acting as the embodiment of All Class itself.
In determining this issue, the Chief Justice considered that the purpose of the crime cover was to provide cover for an innocent party deprived of money by the acts of a dishonest employee. However, that was not happening in this situation. Mr Bowmaker’s fraud was designed to benefit the company as he was using money in the trust account to keep All Class solvent. Therefore, it would not be counter to the purpose of the policy to attribute Mr Bowmaker’s knowledge to All Class. His Honour also accepted that the non-disclosure was fraudulent as Mr Bowmaker had been an insurance broker for many years and he should have known that his conduct was dishonest and if disclosed, would lead to any insurer declining cover.
On the issue of Employee, both parties agreed that Mr Bowmaker was an Executive as defined by the policy, the dispute was whether his actions transferring the funds from the trust account was within the scope of his usual duties as an employee. Chubb sought to argue that under the Policy, an Executive could only be an Employee when the organisation was able “to govern or direct his performance”. In the circumstances in which Mr Bowmaker was the guiding mind of All Class, it was impossible for him to govern or direct his own performance and therefore he could not be an Employee. All Class submitted that this interpretation would defeat the commercial purpose of the Policy, as it would mean that no single person company would make a claim if the fraud involved its director. In determining the issue, His Honour considered what a reasonable businessperson would understand the wording to mean. He considered that Mr Bowmaker's actions in dealing with the trust accounts were within the scope of his duties an executive and therefore he was considered to be an Employee for the purpose of the insuring clause.
Chubb also argued that All Class had not suffered “a direct loss” by Mr Bowmaker’s fraud. Chubb submitted that All Class was required to identify whether the transfers by Mr Bowmaker were legitimate or otherwise and that they had failed to do so. All Class responded by arguing that, by removing the money from the trust account to the general office account to support the business, Mr Bowmaker left All Class liable to the trust creditors for the loss they might suffer. His Honour accepted Chubb’s argument; holding that All Class’ liability to its clients was not a direct loss of money by theft, fraud or dishonesty but a liability to compensate or account for a breach of fiduciary duty. His Honour confirmed that All Class was required to undertake an investigation to establish whether there had been a direct loss. His Honour determined that, but for the fraudulent non-disclosure, All Class’s entitlement to an indemnity would be limited to any amount taken by Mr Bowmaker for his own financial gain but not for the sums which were directed for the benefit or the advantage of the company in its operations.
The case provides important clarity on several important interpretation issues under Crime and Fidelity Policies. Firstly, the case confirms that subject to the policy definition and the nature of the work undertaken, it is possible for a director, even a sole director, to be considered an employee for the purpose of a Crime policy. Secondly, non-disclosure by a sole director perpetrator of the crime is sufficient to negate cover. Finally, in seeking to establish a direct loss for a company it is not sufficient to establish a potential liability but must establish that the loss arose by reason of theft, fraud or dishonesty rather than merely breach of fiduciary duty.