Employer's Administrative Services, Inc. v. Hartford Acc. and Indem. Co., 1

Decision Date25 July 1985
Docket NumberCA-CIV,No. 1,1
Citation709 P.2d 559,147 Ariz. 202
PartiesEMPLOYER'S ADMINISTRATIVE SERVICES, INC., an Arizona corporation; and Chester Flaxmayer, as Receiver of Employer's Administrative Services, Inc., Plaintiffs-Appellants, v. The HARTFORD ACCIDENT & INDEMNITY COMPANY, a Connecticut corporation, Defendant-Appellee. 6797.
CourtArizona Court of Appeals

HAIRE, Presiding Judge.

The central issue on appeal is whether a fidelity bond issued by Hartford to Employer's Administrative Services (EAS) covered losses incurred by EAS as a result of the fraudulent acts of Gary Simmons and Bonnie Lindstrom, EAS's sole officers, directors, and shareholders.

EAS was formed as an Arizona corporation in 1976. EAS administered group health plans for businesses which employed EAS's services to receive and disburse premiums, adjust and pay claims and handle various administrative matters. EAS's clients made monthly deposits to savings accounts from which EAS would withdraw funds in the performance of its services.

Following incorporation Simmons and Lindstrom, acting on behalf of EAS, applied for a Hartford fidelity bond. The bond was issued through Marsh and McLennan, Inc., an independent insurance agency. The record demonstrates that Simmons and Lindstrom began to misappropriate funds at the same time that they, acting in the name of EAS, obtained the fidelity bond from Hartford. The receiver identified over $162,000 in improper withdrawals from employer accounts by Simmons and Lindstrom.

In 1979 the Arizona Department of Insurance investigated EAS's financial affairs and discovered irregularities in its records. Thereafter, the state petitioned to place EAS in receivership. A receiver was appointed and Simmons and Lindstrom were restrained from further business operations.

The receiver examined EAS's business dealings and prepared an accounting of its assets and liabilities. The receiver concluded that EAS had no capital structure. At a hearing, claims well in excess of EAS's assets were presented by EAS's creditors.

The receiver, acting on behalf of EAS filed a claim against Hartford on the fidelity bond. Hartford denied coverage and thereafter the receiver brought this suit. Hartford filed a motion for summary judgment and EAS filed a response and a motion for partial summary judgment. The trial court granted summary judgment for Hartford. It is from this decision that the receiver (hereinafter EAS) appeals.

On review of a summary judgment decision we consider the facts and reasonable inferences therefrom in a light most favorable to the party opposing summary judgment. Farmers Insurance Co. of Arizona v. Vagnozzi, 138 Ariz. 443, 675 P.2d 703 (1983). The trial court's legal conclusions, however, will stand or fall on their own merits. Walsh v. Eberlein, 114 Ariz. 342, 560 P.2d 1249 (App.1976).

The fidelity bond issued by Hartford insured EAS against losses resulting from the fraudulent or dishonest acts of its employees. EAS is the insured party under the policy. While the receiver stands in the shoes of EAS and therefore may properly bring suit against Hartford to collect money allegedly due, we reject any suggestion that EAS's creditors have rights as third party beneficiaries under the fidelity bond. See American Empire Insurance Co. of South Dakota v. Fidelity and Deposit Co. of Maryland, 408 F.2d 72 (5th Cir.1969); Kerr v. Aetna Casualty and Surety Co., 350 F.2d 146 (4th Cir.1965). Since the bond is for the protection of EAS and not its creditors, we attach no significance to the receiver's characterization of the embezzled funds as "trust funds." The amount of funds lost due to the dishonest acts of Simmons and Lindstrom is not affected in any way by such characterization.

The threshold question in this case is whether the fidelity bond, by its terms, indemnified EAS against the fraudulent and dishonest acts jointly perpetrated by Simmons and Lindstrom. The bond provided that Hartford:

"[A]grees to indemnify the Insured [EAS] against any loss of money or 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...."

The term "Employee" is defined in the bond as:

"[A]ny natural person ... while in the regular service of the Insured, in the ordinary course of the Insured's business during the Bond 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 ...." (Emphasis added).

EAS alleges that it suffered financial losses due to the fraudulent and dishonest acts of Simmons and Lindstrom and further that Simmons and Lindstrom were indisputably employees of EAS. Since the fidelity bond specifically indemnified EAS against the fraudulent and dishonest acts of its employees, EAS concludes that this is precisely the type of loss for which it obtained the fidelity bond.

Hartford responds that because Simmons and Lindstrom were the sole directors, officers and shareholders of EAS, they were the alter ego of EAS. In essence Simmons and Lindstrom were EAS. Hartford argues that since Simmons and Lindstrom were the alter egos of EAS, they were not "employees" within the contemplation of the bond. The bond defines "employee" as someone whom the insured (EAS) "has the right to govern and direct in the performance of such service." Hartford contends that because Simmons and Lindstrom together completely governed and directed EAS, they could not have been governed and directed by EAS. Thus, Hartford concludes that the terms of the bond preclude coverage for any losses occasioned by the fraudulent and dishonest acts perpetrated jointly by Simmons and Lindstrom.

In construing the terms of a fidelity bond we apply the rules of construction applicable to insurance generally. J.R. Norton Co. v. Firemen's Fund Insurance Co., 116 Ariz. 427, 569 P.2d 857 (App.1977). This court must construe an insurance contract according to its terms where those terms are clear and unambiguous. Industrial Indemnity Co. v. Goettl, 138 Ariz. 315, 674 P.2d 869 (App.1983). Ambiguity exists in an insurance contract when it can be reasonably construed in more than one sense and such construction cannot be determined within the four corners of the contract. Ranger Insurance Co. v. Lamppa, 115 Ariz. 124, 563 P.2d 923 (App.1979).

The bond clearly requires that EAS have the "right to govern and direct" the employees before the employees' fraudulent acts give rise to a compensable claim. This contract language is unambiguous. See First National Life Ins. Co. v. Fidelity & Deposit Co. of Maryland, 525 F.2d 966 (1976), (where the court held that a fidelity bond definition of employee which was substantially similar to the definition contained in Hartford's bond, was narrowly drawn). We will not indulge in forced construction of this policy so as to fasten liability to the insurer which the insurer has not contracted to assume. Stearns-Roger Corp. v. Hartford Accident and Indemnity Co., 117 Ariz. 162, 571 P.2d 659 (1977); Travelers Indemnity Co. v. State, 140 Ariz. 194, 680 P.2d 1255 (App.1984).

There is no dispute that Simmons and Lindstrom were the sole officers, directors, and shareholders of EAS. Furthermore, it is undisputed that Simmons and Lindstrom colluded in their wrongdoing. EAS argues that, notwithstanding these facts, as a separate and distinct corporate entity, it had the right to govern and direct Simmons and Lindstrom, citing Modern Pioneers Insurance Co. v. Nandin, 103 Ariz. 125, 437 P.2d 658 (1968). EAS argues that the bond requires merely that the right to govern and direct exists, not that such right be actually exercised. In other words, all that is necessary is a theoretical right of the corporation to govern and direct its employees. EAS contends that the existence of its theoretical right to govern and direct Simmons and Lindstrom make them employees for the purposes of coverage under the bond. We disagree. 1

Instead we adopt the approach articulated in Kerr v. Aetna Casualty & Surety Co., 350 F.2d 146 (4th Cir.1965). The fidelity bond in Kerr like the Hartford bond required that the insured have the right to "govern and direct" the employees before the employees' fraudulent acts would be covered by the bond. The insured in Kerr argued that the corporation had a theoretical right to govern and direct the defalcating employees and that the existence of this theoretical right was sufficient to bring the employees under the coverage of the bond. The court disagreed, stating:

"As shareholders of Underwriters [the insured] Cudd and Coan [the defalcating employees] elected themselves its sole directors, and as directors they elected themselves its chief executive officers. Since the charter gave the directors the right to manage and control the corporation, Cudd and Coan as directors probably had the technical right to control Cudd and Coan as officers. But such a theoretical and unrealistic right of control did not make Cudd and Coan "Employees" of Underwriters covered by the bond. Such a bond is not intended to cover the fraud and dishonesty of men who are in effect the sole stockholders as well as the only directors of a closely held corporation." Id. at 154.

In like manner, Simmons and Lindstrom must be subject to the actual control of EAS before they can be found to be "employ...

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