Frontline Proc. Corp. v. Am. Econ. Ins. Co.

• Decision Date: 27 December 2006
• Docket Number: No. 05-579.,05-579.
• Citation: 335 Mont. 192,149 P.3d 906,2006 MT 344
• Parties: FRONTLINE PROCESSING CORP., Plaintiff, v. AMERICAN ECONOMY INSURANCE CO., Defendant.
• Court: Montana Supreme Court

149 P.3d 906

2006 MT 344

335 Mont. 192

FRONTLINE PROCESSING CORP., Plaintiff, v. AMERICAN ECONOMY INSURANCE CO., Defendant.

No. 05-579.

Supreme Court of Montana.

Submitted on Briefs June 1, 2006.

Decided December 27, 2006.

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.

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.

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.

¶ 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.)

¶ 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., 181 N.J 245, 854 A.2d 378, 386-87 (2004); Mid-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., 268 Wis.2d 785, 674 N.W.2d 617, 625 (App. 2003); RBC Mortg. Co. v. National Union Fire Ins. Co., 349 Ill.App.3d 706, 285 Ill.Dec. 908, 812 N.E.2d 728, 733 (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 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, 285 Ill.Dec. 908, 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...