Bank of R.I. v. Progressive Cas. Ins. Co.

• Court: U.S. District Court — District of Rhode Island
• Writing for the Court: JOHN J. McCONNELL, JR., District Judge.
• Citation: Bank of R.I. v. Progressive Cas. Ins. Co., 19 F.Supp.3d 378 (D. R.I. 2014)
• Decision Date: 15 May 2014
• Docket Number: C.A. No. 13–164–M.
• Parties: BANK OF RHODE ISLAND, Plaintiff, v. PROGRESSIVE CASUALTY INSURANCE COMPANY, Defendant.

19 F.Supp.3d 378

BANK OF RHODE ISLAND, Plaintiff

v.PROGRESSIVE CASUALTY INSURANCE COMPANY, Defendant.

C.A. No. 13–164–M.

United States District Court, D. Rhode Island.

Signed May 15, 2014.

Adam M. Ramos, William R. Grimm, Hinckley, Allen & Snyder LLP, Providence, RI, for Plaintiff.

Gordon P. Cleary, Vetter & White, Providence, RI, Darius N. Kandawalla, Sabrina Haurin, Bailey Cavalieri LLC, Columbus, OH, for Defendant.

MEMORANDUM AND ORDER

JOHN J. McCONNELL, JR., District Judge.

Bank Rhode Island (“BankRI”) lost a civil trial in Rhode Island Superior Court and the jury rendered a multimillion-dollar damages award against it. BankRI is now before the Court seeking its defense costs and indemnification from its insurer. The question presented in this case is whether BankRI's Directors and Officers (“D & O”) insurance policy (“Policy”) with Progressive Casualty Insurance Company (“Progressive”) covers defense costs and/or indemnifies the settlement. More specifically, this Court must decide whether the Policy provides coverage for the loss and, if so, whether the Policy's “Internet Services Exclusion” excludes any coverage. Also at issue is the applicability of the Policy's “Allocation Provision.” The Court concludes that the Amended Judgment represents a covered loss, that the Internet Services Exclusion does not apply to significant aspects of the loss but does apply to some aspects of the loss, and that the Allocation Provision governs how the determination is made between covered and uncovered losses.

I. FACTS¹ AND TRAVEL

A. Underlying EMC v. BankRI Litigation in State Court

Empire Merchandising Corporation and its principal, Joseph Pietrantonio (collectively “EMC”), had been a BankRI (or its predecessor² ) customer since establishing a checking account there in 1971. In 1983, it established a line of credit with the bank³ with Mr. Pietrantonio as the only person authorized to borrow from the line of credit.

Beginning around 2003, an EMC employee, Rhonda Hastings engaged in a scheme to embezzle funds from EMC. The state court trial justice, Justice Michael A. Silverstein, in his post-trial motions decision, described the embezzlement scheme as follows:

With access to and control of EMC's daily cash flow, in or about 2004, Ms. Hastings began to embezzle EMC's funds. As part of her scheme, Ms. Hastings would properly record EMC's sales on the weekly sales and reconciliation reports, but withhold amounts of cash from its bank deposits for her own personal use. During this time, approximately 946 checks were presented for payment to BankRI upon insufficient funds as a result of cash shortfalls in EMC's accounts.

In an attempt to conceal the fact that she had been diverting monies generated from EMC's daily operations, Ms. Hastings obtained online access to EMC's line of credit and transferred funds to its operating accounts. In so doing, Ms. Hastings was able to substitute missing cash with line of credit borrowings and cover checks drawn on these otherwise deficient accounts. Additionally, Ms. Hastings further concealed her scheme by altering and/or manipulating several monthly bank statements from BankRI, various weekly reconciliation reports, Dunbar Armored Services reports, bank deposit tickets, and disbursement checks. Between March 2005 and August 2005, Ms. Hastings maxed-out EMC's $250,000 line of credit with BankRI, and overall, she embezzled approximately $540,000 of EMC's cash.

After discovering that Ms. Hastings had accessed EMC's line of credit, Mr. Pietrantonio contacted BankRI to inform them that an employee had accessed it without his authorization and requested that BankRI forgive the debt. BankRI refused and thereafter continued to charge interest on EMC's balance. On or about January 23, 2006, Bank RI, through counsel, informed EMC and Mr. Pietrantonio that the entire outstanding balance (including interest, attorneys' fees, and costs) was immediately due and payable. BankRI informed EMC and Mr. Pietrantonio “that if the Indebtedness ... [was] not paid to BankRI in full via certified funds or bank check on or before March 8, 2006, BankRI [would] exercise its rights and remedies to collect the Indebtedness from each of [EMC] and [Mr. Pietrantonio].”

In the aftermath of Ms. Hastings' embezzlement scheme, EMC required immediate financing in order to continue purchasing merchandise, meeting its ongoing payroll obligations, and paying business expenses. EMC, however, was unable to obtain additional financing. In particular, on or about March 31, 2006, Rockland Trust denied Mr. Pietrantonio's application for a $300,000 loan. Rockland Trust stated that its reason for denying the application was EMC's “inability to provide collateral as [the] existing lender [was] unwilling to release [its] collateral ... [and EMC's] inability to repay the requested loan based on historical operations.” Despite a personal loan to EMC from Mr. Pietrantonio in the amount of $75,000 and an additional $100,000 bank loan from Citizens Bank, by the end of 2006, EMC lacked sufficient funding to continue its operations. On January 31, 2007, EMC notified its creditors that of its remaining stores, the Cumberland Store had closed on January 5, 2007, and the Pawtucket Store would close on February 4, 2007.

Empire Merch. Corp., 2011 WL 4368923, at 2–3 (internal citations omitted).

EMC filed a seventeen-count complaint⁴ against BankRI in Rhode Island Superior Court in May of 2008⁵ alleging “mismanagement of EMC's commercial bank accounts and line of credit, as well as its alleged misconduct in connection with an embezzlement scheme executed by an EMC employee.” Id. at 2. “One of the bases for EMC's negligence claim was [BankRI's] alleged failure to notify EMC of certain actions committed by EMC employee Rhonda Hastings.” (ECF No. 23 at ¶ 9.)

A month-long trial proceeded in Rhode Island Superior Court in February 2011.⁶ EMC presented evidence regarding BankRI's failure to notify EMC of the increase in checks returned “insufficient funds,” of cash deposits Ms. Hastings made, as opposed to those an armored service usually made, and of deposits made to EMC accounts from Ms. Hastings' personal accounts. (ECF No. 22 at 5–6.) The evidence also showed that “Ms. Hastings' transfers from the line of credit to cash accounts were made exclusively through the banks' internet banking system.” (ECF No. 26–1 at 7.)

The jury returned a mixed verdict. (ECF No. 23–5.) It found for EMC on its breach of written contract claim and breach of implied covenant of good faith and fair dealing, finding “BankRI breached its ‘business loan agreement’ with plaintiffs by providing online access to Ms. Hastings,” but finding that BankRI did not breach its “deposit account agreement.” (Id. at 1–2.) It also found for EMC on its negligence claim, finding that “BankRI breached its duty of ordinary care owed to Plaintiffs,” but again finding that it did not breach its “deposit account agreement.” (Id. at 3.) It also found 15% comparative fault by EMC. (Id. at 4.) Finally, it found for EMC on its “Intentional Infliction of Emotional Distress” claim. (Id. at 5.)⁷ The jury awarded $1,415,047 as the value of EMC's business that was lost, $147,960 for Mr. Pietrantonio's lost wages, and $347,718.47 for his emotional distress. (Id. at 8.)

B. BankRI's Insurance Policy and Claim Against It

Progressive issued a claims-made D & O Policy to BankRI, effective during the pertinent time period from June 1, 2005 through June 1, 2008. (ECF No. 23 at ¶ 1.) The Policy includes an Entity Errors and Omissions Liability Endorsement that provides up to $5 million of coverage per claim for losses resulting from claims arising from “Wrongful Acts” made during the policy period. (Id. at ¶ 2.) The Policy defines “Wrongful Acts” to include “any actual or alleged ... neglect or breach of duty by the Company or by any person or entity for which the Company is legally responsible.” (Id. at ¶ 3.) The Policy also contains an “Internet Services Exclusion” that excluded coverage for a loss arising out of “(1) services through the transmission of data to or from an Internet website.” (ECF No. 23–2 at 39–40.)

In the face of EMC's initial claim and the resulting Rhode Island Superior Court litigation, BankRI timely notified Progressive of the potential loss. (ECF Nos. 29–9, 29–11.) Progressive informed BankRI that it believed “the vast majority of the Lawsuit is outside the scope of coverage afforded by the policy or excluded from coverage under the Policy [and therefore] it will be necessary for Progressive and the Bank to agree upon a fair and reasonable allocation of defense counsel's fees and expenses between covered and uncovered matters.” (ECF No. 29–12 at 7.)⁸ BankRI informed Progressive that it did not agree with its assessment of the coverage issues. (ECF No. 29–13.)⁹ Nevertheless, the state court case proceeded to trial.

C. Travel of this Litigation

After the state court trial, and knowing Progressive's position on coverage, BankRI filed this four-count action against Progressive.¹⁰ BankRI seeks a declaratory judgment that “Progressive must indemnify [BankRI] for the loss it sustained as a result of the EMC suit, including the amount it was obligated to pay EMC and any costs and legal fees that it has incurred in the EMC suit.” (ECF No. 1–1 at 7.) BankRI also filed counts for breach of contract, breach of implied covenant of good faith and fair dealing, and for bad faith.¹¹

BankRI moved for summary judgment as to Counts I and II (declaratory judgment and breach of contract) (ECF No. 22), to which Progressive filed an opposition and a cross-motion for summary judgment. (ECF No. 26.) BankRI filed an objection to Progressive's cross-motion (ECF No. 38) and a reply to Progressive's objection to its Motion for Summary Judgment. (ECF No. 39.) Progressive filed a reply to BankRI's objection to its cross-motion. (ECF No. 44.) Both parties filed numerous statements of disputed and undisputed facts. (ECF Nos. 23, 28, 32, 40,...