Maryland Cas. Co. v. Clements

• Decision Date: 28 July 1971
• Docket Number: No. 1,CA-CIV,1
• Citation: 15 Ariz.App. 216,487 P.2d 437
• Parties: MARYLAND CASUALTY COMPANY, a corporation, Home Indemnity Company, a corporation, Appellants, v. C. A. CLEMENTS and E. Ray Cowden, copartners, to the use and benefit of C. A. Clements et al., Appellees. 1063.
• Court: Arizona Court of Appeals

Page 437

487 P.2d 437

15 Ariz.App. 216

MARYLAND CASUALTY COMPANY, a corporation, Home Indemnity Company, a corporation, Appellants, v. C. A. CLEMENTS and E. Ray Cowden, copartners, to the use and benefit of C. A. Clements et al., Appellees.

No. 1 CA-CIV 1063.

Court of Appeals of Arizona, Division 1, Department B.

July 28, 1971.

Rehearing Denied Oct. 4, 1971.

Jennings, Strouss & Salmon by Lee E. Esch and William F. Haug, Phoenix, for appellant Home Indemnity Co.

O'Connor, Cavanagh, Anderson, Westover, Killingsworth & Beshears by Robert G. Beshears and David L. Haga, Phoenix, for appellant Maryland Casualty Co.

Snell & Wilmer by John E. Lundin, Phoenix, for appellees.

HAIRE, Judge.

Several questions are presented on this appeal from the judgment entered by the trial court against the defendant-appellant fidelity insurers. Appellant Maryland Casualty Company (Maryland) raises five specific questions, with appellant Home Indemnity Company (Home) joining as to the first question only.

We will first discuss the mainstream facts relevant to the question raised by both appellants. This question concerns whether prior to the issuance of the fidelity policies here involved, the plaintiff-insureds had knowledge of past fraudulent or dishonest acts committed by one of their employees, defendant Mike Harris. The parties all admit that if such knowledge existed, then because of pertinent policy provisions there was no coverage for the subsequent defalcations of the employee Mike Harris which are the subject of the lawsuits here involved.

Four separate actions were filed involving the corporate plaintiff, Maricopa Drug Co., Inc., and C. A. Clements and E. Ray Cowden, co-partners, dba Westwood Pharmacy, ¹ as plaintiffs against defendants Mike and Louise Harris, and the appellant fidelity insurers, Maryland and Home, to recover losses arising out of acts of the Harrises while employed by the partnership and the corporation. These four separate actions were consolidated for trial, and resulted in the entry of judgment against the Harrises and the appellant insurers. The Harrises are not parties to this appeal. The evidence shows that in 1951, plaintiffs C. A. Clements and E. Ray Cowden, and defendant Mike Harris formed a partnership for the operation of a drug store business. Defendant Harris was a pharmacist and assumed the duties of pharmacist and manager of the store. This business was incorporated in 1958 as Maricopa Drug Company, Inc., with Harris, Cowden and Clements initially, and at all pertinent times thereafter, serving as president, vice-president and secretary-treasurer respectively. The corporation, Maricopa Drug Company, Inc., is the corporate plaintiff here involved.

In 1956 these same three individuals formed a second partnership for the operation of a different drug store business and commenced doing business as Westwood Pharmacy. Defendant Mike Harris was also an active partner in the Westwood Pharmacy operation at all times pertinent to this appeal. The responsibility for daily record-keeping for both the corporation and partnership stores was mainly assumed by Louise Harris, the wife of the defendant Mike Harris. Mrs. Harris' duties included posting transactions to the sales journal, the check ledger and the accounts payable ledger. At the end of each month Mrs. Harris would give the sales journal, check and accounts payable ledgers to Mr. Clements, who would then post to the general ledger and prepare the profit and loss statement.

In June of 1963 facts came to the plaintiffs' attention which eventually resulted in the termination by plaintiffs of the employment of defendants Mike and Louise Harris on July 9, 1963. An audit of the plaintiffs' books was commenced, and in September 1963 a completed audit report was received from Dennis, Parker & Schmich, a firm of certified public accountants. That audit reflected that during the time periods covered by appellants' policies, the defendants Mike and Louise Harris, acting in collusion, had engaged in a practice of taking funds from the businesses and concealing these defalcations by false and misleading accounting entries.

Prior to the time of the incorporation of Maricopa Drug, defendant Mike Harris customarily followed the practice of drawing partnership funds from time to time for his own personal use, noting the withdrawals on the accounts receivable ledger in the name of Mike Harris, which draws would ultimately be applied against his earnings from the partnership. Subsequent to the incorporation of Maricopa Drug, defendant Mike Harris to a limited extent continued this course of conduct, notwithstanding the fact that he was told by plaintiff Clements that 'this was a corporation and that we would have to wait until the end of the year to see what the profit figure looked like before we could make any distribution like that.' Defendants point to six specific instances commencing in 1958 and extending over a two year period where defendant Mike Harris withdrew corporate funds for his personal use, notwithstanding that he had been advised by plaintiff Clements that this was improper and should not be done. At the time of each of these withdrawals the Harrises made appropriate notations in the corporate books so as to reflect the withdrawals as accounts receivable from Mike Harris, with no attempt at concealment. These withdrawals were all repaid by offset against corporate bonuses or otherwise, and do not in any way constitute a part of the claims asserted by plaintiffs in this litigation. However, defendants contend that plaintiff Clements' admitted knowledge of these transactions constituted undisclosed knowledge of prior dishonest acts committed by Mike Harris sufficient to invalidate coverage. Plaintiff Clements testified that while he knew of these withdrawals by Harris, he did not feel that there was anything dishonest in what Harris had done. There is no contention that Clements had knowledge of any prior withdrawals by Harris which Harris concealed or attempted to conceal.

Based upon the foregoing facts the trial court held that the plaintiffs did not have knowledge of prior 'fraudulent or dishonest' acts by Mike Harris, and that therefore there was coverage under the policies. We agree.

The defendants do not contend that plaintiffs knew of any prior 'fraudulent' acts committed by Harris, but do contend that the plaintiffs had sufficient knowledge so that they should have recognized or characterized his acts as 'dishonest'. In analyzing the problem presented we have considered the many decisions submitted by both counsel and do not find any of them particularly helpful, since none present fact situations which are sufficiently analogous to serve as a basis for comparison with the material facts here involved. However, certain principles do emerge from the various decisions, which shed some light on the perspective which the Court must take in considering this question. First, the fact that plaintiff Clements might not have actually recognized or subjectively characterized defendant's acts as 'dishonest' is not necessarily dispositive. Rather, the question in such a situation is whether Clements, as a reasonable person, based upon the facts known to him at that time, Should have perceived that the acts were 'dishonest'. Wachovia Bank & Trust Co. v. Manufacturers Casualty Insurance Co., 171 F.Supp. 369 (M.D.N.C.1959); See Ciancetti v. Indemnity Insurance Co. of North America, 168 Cal.App.2d Supp. 785, 335 P.2d 1048 (Super.Ct.App.Dep't.1959). Second, in considering the matter from the viewpoint of whether the insureds should have recognized the known acts as being dishonest, there exists a presumption of honesty, Salley Grocer Co., Inc. v. Hartford Accident & Indemnity Co., 223 So.2d 5 (Ct.App.La.1968), or, as stated in Wachovia, Supra, such known acts '* * * if as consistent with the integrity of employees as their dishonesty, does not constitute a discovery (of dishonesty), even though dishonest acts may later be found to exist.' 171 F.Supp. at 376.

In the case at hand the defendant Mike Harris and the individual plaintiffs had engaged in a lengthy, well established informal relationship as partners, where it had become customary for him to withdraw company funds for his own use to be repaid from future profit distributions. After incorporation this practice was continued by the defendant notwithstanding plaintiffs' advice to him that this practice shouldn't be followed under the new corporate setup. Moreover, there was a continued open disclosure of these personal draws without any attempt at concealment and with later repayment thereof. Under these circumstances we cannot say, as a matter of law, that plaintiffs should have recognized these acts as dishonest, if dishonest they in fact were. Webster's Third New International Dictionary 1086 (P. Grove ed. 1969) defines 'honest' as 'free from fraud or deception', and 'dishonest' as 'characterized by lack of truth, honesty, probity, or trustworthiness or by an inclination to mislead, lie, cheat or defraud'. Id. at 650. Many cases could be cited, dissected and analyzed as to their discussion and treatment of the word 'dishonest' as sued in fidelity bonds. See, e.g., Waite v. Standard Accident Insurance Co., 132 Mont. 220, 315 P.2d 989 (1957); Sade v. National Surety Corp., 203 F.Supp. 680 (D.D.C.1962); Salley Grocer Co., Inc. v. Hartford Accident & Indemnity Co., 223 So.2d 5 (Ct.App.La.1968); Sherwood & Roberts-Kennewick, Inc. v. St. Paul Fire & Marine Insurance Co., 322 F.2d 70 (9th Cir. 1963); Mortgage Corporation of New Jersey v. Aetna Casualty & Surety Co., 19 N.J. 30, 115 A.2d 43 (1955). See also 12A Words & Phrases pp. 413--420. However, we think that the thread running throughout is that while criminal acts are not required, still there must be some conduct from which can be implied an intent to deceive, cheat or defraud. Such conduct is evident in all the cases relied upon...