In re Payroll Express Corp.

Decision Date01 August 1998
Docket NumberNos. C92163400F and C92163500,SPHERE,Docket No. 98-7289,s. C92163400F and C92163500
Citation186 F.3d 196
Parties(2nd Cir. 1999) In Re: PAYROLL EXPRESS CORPORATION, ET. AL., Debtor. JOHN S. PEREIRA, ESQ., as Chapter 11 Trustee of the Estate of Payroll Express Corporation, et. al., Plaintiff-Appellant, v. AETNA CASUALTY & SURETY COMPANY, FEDERAL INSURANCE COMPANY, CHUBB GROUP OF INSURANCE COMPANIES, ANGUS JOHN ROBERTS, an Underwriter at Lloyd's, London, on behalf of himself and all those other Lloyd's Underwriters subscribing to Insurance PolicyDRAKE INSURANCE, PLC, INSURANCE COMPANY OF NORTH AMERICA (UK) LIMITED "G" ACCOUNT, ZURICH RE (UK) LIMITED, NIPPON INSURANCE COMPANY OF EUROPE LIMITED, EXCESS INSURANCE COMPANY, LTD., OCEAN MARINE INSURANCE COMPANY, LTD., ASSICURAZIONI GENERALI S.P.A., THE THREADNEEDLE INSURANCE CO., LTD., PHOENIX ASSURANCE PLC LSA ACCOUNT, COLONIA INSURANCE (UK) LIMITED "TR" ACCOUNT, THE PRUDENTIAL ASSURANCE COMPANY LIMITED TRUST ACCOUNT NO. 2, CORNHILL INSURANCE PLC LONDON U.K. "D" ACCOUNT, SIRIUS (UK) INSURANCE PLC, NORWICH NO. 1 "M" ACCOUNT, COMMERCIAL UNION ASSURANCE CO. PLC, PHOENIX ASSURANCE PLC, WURTTEMBERGISCHE FEUERVERSICHERUNGS AG "AW" ACCOUNT, NORTHERN ASSURANCE COMPANY LIMITED NO. 6 ACCOUNT, YORKSHIRE INSURANCE COMPANY LIMITED and LONDON AND HULL MARITIME INSURANCE COMPANY LIMITED AXA T ACCOUNT, Defendants-Appellees. ENGLISH & AMERICAN INSURANCE COMPANY, LTD. and THE ORION INSURANCE COMPANY PLC T A/C, Defendants
CourtU.S. Court of Appeals — Second Circuit

Appeal from summary judgement entered for the defendants in the United States District Court for the Southern District of New York (Shira A. Scheindlin, Judge).

Affirmed.

[Copyrighted Material Omitted] Robert M. Horkovich, New York, NY (Adam A. Reeves, Peter J. Andrews, Anderson Kill & Olick, P.C., New York, NY, on the brief), for Plaintiff Appellant.

Arthur N. Lambert, New York, NY (Alan M. Goldberg, Lambert, Weiss & Pisano, New York, NY, on the brief), for Defendant-Appellee Aetna Casualty & Surety Company.

James M. McCullough, III, New York, NY (Jeffrey M. Winn, Anjele D. Bonie, Sedgwick, Detert, Moran & Arnold, New York, NY, on the brief), for Defendants-Appellees London Excess Underwriters.

William R. Mait, New York, NY (Michael C. Simmons, Mait, Wang & Simmons, New York, NY, on the brief), for Defendant Appellee Federal Insurance Company.

Before: NEWMAN, CARDAMONE, PARKER, Circuit Judges.

PARKER, Circuit Judge:

John S. Pereira, Esq., acting as the Chapter 11 Trustee of the Estate of Payroll Express Corporation appeals from a final judgment of the United States District Court for the Southern District of New York (Shira A. Scheindlin, Judge) entered February 25, 1998 implementing an opinion and order dated August 6, 1997 granting summary judgment for Federal Insurance Company ("Federal"), and another opinion and order dated October 1, 1997 granting summary judgement for the London Excess Underwriters ("LEU"), and partial summary judgement for the Aetna Casualty & Surety Company ("Aetna").

I. BACKGROUND
A. Facts

Payroll Express Corporation is a New Jersey corporation ("PEC-NJ") which maintained its principal place of business in New Jersey during its period of operations, from the late 1960s to May 1992. Payroll Express Corporation of New York ("PEC-NY") is a related corporation whose principal place of business was New York. The companies (collectively "PEC" or "Payroll Express") provided payroll check cashing and cash distribution services in New Jersey and New York. Customers included nursing homes, hospitals, New York University, the New York City Transit Authority, and the Payroll Administration of the City of New York, among many others.

On a biweekly or monthly basis PEC's customers wire-transferred millions of dollars into PEC's bank accounts. Subsequently, PEC would arrive at the customer's place of business on its payday and provide teller services to its employees, such as exchanging cash for an employee's endorsed paycheck. Payroll Express would then return the cashed paychecks to the customer along with any unused portion of the money initially deposited into its account by the customer.1

Not surprisingly, PEC's customers required PEC to maintain full insurance coverage to safeguard their money while it was being held by PEC. Payroll Express thus obtained insurance to cover theft, including employee theft, from each of the defendant insurance companies, with Marshall & Sterling of Poughkeepsie, New York ("M&S") acting as an insurance broker.

From 1987 through May 1992, Robert Felzenberg-founder, president, CEO and half-owner of PEC and his wife Barbara Felzenberg-the Secretary and other half-owner of PEC-diverted PEC funds for their own benefit. They used the money to fund at least four other companies in their control, to acquire various personal items, and to cover PEC's cash flow needs. Other PEC employees also engaged in these activities including PEC's comptroller George Gillmore, Howard Messer, Robert Gussow (B. Felzenberg's father), and Rose Felzenberg (Robert Felzenberg's mother).

Until about July 1991, funds were diverted by simply failing to return unused monies to customers in a timely manner. After July 1991, the defalcating employees turned to another strategy. They engaged in a check kiting scheme whereby they simultaneously inflated PEC account balances in two banks by continually depositing worthless checks of small amounts in each PEC bank account, drawn on the PEC account from the other bank. This fraudulent activity was discovered in May 1992. As of June 5, 1992, PEC had liabilities of approximately $36.2 million and assets of only about $3 million.

On July 13, 1993, Robert Felzenberg pleaded guilty to a federal Criminal Information charging him with felonies relating to the fraud at PEC. See United States v. Felzenberg, No. 93 CR. 460(SS), 1998 WL 152569 (S.D.N.Y. Apr. 2, 1998)(ruling on Robert Felzenberg's section 2255 petition, describing the background of the criminal case). Felzenberg admitted to diverting millions of dollars from PEC over the years. He was sentenced to 78 months' imprisonment and ordered to pay $36 million in restitution. Gillmore also pleaded guilty in a related proceeding and was sentenced to five years' probation and restitution of $20,000.

On June 5, 1992, PEC-NJ and PEC NY filed their respective Chapter 11 petitions with the United States Bankruptcy Court for the Southern District of New York. In re Payroll Express Corp., Chapter 11 Case No. 92 B 43150. On June 8, 1992, the Bankruptcy Court authorized the joint administration of both cases and on June 26, 1992, John S. Pereira, Esq. was appointed as Trustee of PEC.

In June 1993, the Trustee submitted a Proof of Loss prepared by Price Waterhouse, L.L.P. to LEU, Aetna, and Federal, seeking to recover a total of $33,666,080 under the policies for funds lost due to the fraudulent conduct of the Felzenbergs and other PEC employees. The Trustee submitted a supplemental proof of loss statement in July 1994. The insurance companies each denied the Trustee's claim against its respective policy or policies.

1. The Aetna Policy

On or about February 19, 1976, Aetna issued to PEC-NJ a Comprehensive Dishonesty, Disappearance, and Destruction Policy (the "Aetna Policy"). The policy was amended to make it noncancellable unless PEC failed to pay the premiums. Aetna attempted to cancel the policy on May 2, 1980. PEC brought an action in federal district court for an injunction preventing Aetna from canceling the policy. The district court ordered the relief sought and this Court affirmed. See Payroll Express Corp. v. Aetna Cas. & Sur. Co., 659 F.2d 285 (2d Cir. 1981). PEC-NY was added to the policy effective June 22, 1988.

The Preamble and Insuring Agreement I of the Aetna Policy provide in pertinent part: "The Company . . . agrees with the Insured . . . to pay the Insured for: . . . Loss of Money, Securities, and other property which the Insured shall sustain . . . through any fraudulent or dishonest act or acts committed by any of the Employees, acting alone or in collusion with others." Section 3 of the Conditions and Limitations portion of the Aetna Policy defines "employee" as:

any natural person (except a director or trustee of the Insured, if a corporation, who is not also an officer or employee thereof in some other capacity) while in the regular service of the Insured in the ordinary course of the Insured's business during the Policy Period and whom the Insured compensates by salary, wages or commissions and has the right to govern and direct in the performance of such service.

Endorsement 28 of the Aetna Policy excludes PEC's President Robert Felzenberg from this definition of employee. Section 2(a) of the Exclusions segment of the Aetna Policy states that the policy does not apply "to loss due to any fraudulent, dishonest or criminal act by any Insured or a partner therein, whether acting alone or in collusion with others."

2. The LEU Policies

LEU issued three policies to PEC effective February 7, 1992 for a twelve month period: (1) London Primary Layer Policy; (2) First LEU Excess Policy; and (3) Second LEU Excess Policy (collectively, the "LEU Policies"). The Primary Layer Policy and the First LEU Excess Policy provided coverage for "Employee Theft, Premises Loss and Transit Loss." The Second LEU Excess Policy provided for "Employee Theft" occurring at PEC's NJ and NY offices; and "Premises Coverage" at those same two locations. The application form for these policies was submitted through M&S on January 16, 1992, and signed by Robert Felzenberg as PEC's president.

Question 10 of the LEU application asked, "[h]as the proposer suffered a loss during the past five years? If "Yes" give brief details and amount involved." Felzenberg replied, "YES, SECURITY SYSTEM FOR PREMISES & VAULT WAS BREACHED DURING NON OPERATING HOURS. BURGLARY AMOUNT...

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