Scirex Corp. v. Federal Ins. Co.

• Decision Date: 23 December 2002
• Docket Number: No. 02-1172.,02-1172.
• Citation: 313 F.3d 841
• Parties: SCIREX CORPORATION, Appellant v. FEDERAL INSURANCE COMPANY
• Court: U.S. Court of Appeals — Third Circuit

313 F.3d 841

SCIREX CORPORATION, Appellant v. FEDERAL INSURANCE COMPANY

No. 02-1172.

United States Court of Appeals, Third Circuit.

Argued October 15, 2002.

Filed December 23, 2002.

Joseph F. Roda (Argued), Roda & Nast, Lancaster, PA, for Appellant.

Alfred W. Putnam, Jr. (Argued), Drinker, Biddle & Reath, Philadelphia, PA, for Appellee.

Before BECKER, Chief Judge, ROTH and ROSENN, Circuit Judges.

OPINION OF THE COURT

BECKER, Chief Judge.

Plaintiff Scirex Corp. ("Scirex"), a firm specializing in clinical testing of new drugs for pharmaceutical companies, brought this suit against defendant Federal Insurance Company ("Federal") in the District Court for the Eastern District of Pennsylvania, seeking payment under Federal's "Blanket Employee Dishonesty" policy, which covered losses caused by Scirex employees' fraudulent and dishonest acts. Although the protocols for the four clinical trials at issue required Scirex's nurses to observe patients for eight hours and record their observations every thirty minutes, in many cases the nurses sent patients home after as little as an hour, yet they recorded and submitted observations allegedly covering the full eight hours. Their misrepresentations made it impossible for supervisors to discover the breaches of protocol until a former employee tipped them to the practice, at which advanced point the four studies were unfit for Food and Drug Administration review, and therefore were worthless.

Scirex replicated the studies, which cost a combined $1.2 million, at no charge to the sponsors. Federal, however, refused to cover Scirex's losses. It defended on the ground that the nurses' actions were not dishonest because they had acted on their belief that strict adherence to protocol was unnecessary, and that while their actions might have been negligent, "dishonesty" implies a cognizance of one's wrongdoing that they did not possess. Federal also maintained that even if the nurses' actions were dishonest, its policy covered only "direct" losses, and Scirex's losses more strongly resembled ordinary business expenses from failed ventures than losses, such as false claims of working overtime, due directly to employee dishonesty. Finally, Federal contended that even if it were liable for Scirex's losses, it would be liable only in the amount of $280,000, the policy limit for one occurrence, because the losses across the four ruined studies were related.

Following a bench trial, the District Court held that Scirex could not recover against Federal because "dishonesty" implies a culpable intent, and the nurses' "stubborn belief that the drug companies... were imposing unnecessary requirements" did not equate to dishonesty. Scirex Corp. v. Fed. Ins. Co., 2001 WL 1491133, *3-4, 2001 U.S. Dist. LEXIS 19088, *8-9 (E.D.Pa.2001). It therefore denied Scirex's claim, but noted in dicta that, were the nurses' actions to be found dishonest, the losses they caused would be direct, and therefore Federal's policy would cover them. Id. 2001 WL 1491133 at *4, at *11. It also opined that, at all events, the policy would limit Federal's liability to $280,000, the ceiling for one occurrence. Id. 2001 WL 1491133 at 5, at *14.

Because we conclude that the nurses' actions were dishonest, as well as negligent, we hold that they are covered by Federal's policy, and we reverse the District Court's holding to the contrary. We are satisfied that, whatever may be said of the decision to send patients home early in violation of protocol, the nurses' practice of submitting records containing observations they did not make is ineluctably and irrefutably dishonest. However, we agree with the District Court that the nurses' actions directly caused Scirex's losses. Pennsylvania law equates "direct cause" with "proximate cause," Jefferson Bank v. Progressive Casualty Ins. Co., 965 F.2d 1274, 1281-82 (3d Cir.1992), and the nurses' conduct rendered those studies worthless to their sponsors, and therefore worthless to Scirex. Finally, although we believe that Federal's policy covers Scirex's losses, we agree with the District Court that Federal's liability is limited to $280,000 for the four studies.

I. Background Facts and Procedural History

In 1997 and 1998, Scirex conducted four clinical studies for three different sponsors. Each tested a pain medication for patients who had undergone dental surgery, and each had a protocol, written by the pharmaceutical company sponsoring the study, which specified in great detail the procedures to be followed in that study. The four protocols required patients to remain under the observation of Scirex nurses, at Scirex's clinic, for at least eight hours after being given the first medication dose. Because the effects of pain medication to some extent vary by individual, the pharmaceutical companies anticipated that there would be a certain number of test subjects for whom the medication would be ineffective, and for these subjects, the protocols mandated providing supplemental pain medication. Subjects who received such supplemental medication were termed "rescued," while those who took only the drug being studied were termed "unrescued."

Although the protocols provided for rescuing certain subjects, they did not provide for treating those subjects otherwise differently; specifically, they stated that "[s]ubjects are required to remain at the study facility for the entire eight-hour postdosing observation period, even if the supplemental analgesic medication is taken." (R.W. Johnson Protocol.) During one of the four studies, however, Algos, the study's sponsor, told Scirex that rescued patients did not have to remain in the clinic for the full eight hours. That excepting instruction applied only to Algos's study, and even then, only to rescued subjects. The other three studies were to proceed strictly according to protocol.

During the course of a subject's eight-hour stay, the protocols required Scirex's nurses to observe the subject and record their observations. The records had to be "timely, accurate and complete," because they were what the FDA evaluated: "[t]imely, accurate, and complete reporting and analysis of safety information from clinical trials is crucial for the production of subjects, investigators, and the sponsor, and is mandated by regulatory agencies worldwide." (R.W. Johnson Protocol.) Nurse Mary Ellen Conforto, a Scirex supervisor and tenured employee, testified that she understood the need for the records to be accurate, and agreed that if a patient were released early, the records should have reflected the change. She explained, however, that it was common for nurses to fill out a patient's record ahead of time, in order to cut down on paperwork at the end of the day, and that the nurses in doing this would predict and record in advance the time that a patient would leave if he or she remained for the required eight hours. Still, she acknowledged that if a patient whose record had been so prepared then left earlier than anticipated, an addendum to that patient's record should have been prepared and submitted.

Despite these understandings, over the course of the four studies, at various times Scirex nurses released both rescued and unrescued patients early, that is, before eight hours had passed, but they submitted records for those patients that made it appear that the nurses had followed the protocols and observed them for the full eight hours. These discrepancies were discovered when Scirex received a tip from an ex-employee, following which it conducted an "audit" of test subjects that involved calling them and asking what time they were discharged. The audit showed that unrescued patients were often released early, sometimes after as little as one hour. One of the audits reported that "[a]ll of the unrescued subjects stated they were discharged from the unit before the completion of the 8-hour follow-up period, indicating follow-up periods of 1 to 7 hours. However, in all cases the nurses' notes indicated the subjects were discharged after 8 hours." (Compliance Audit Report, Algos Protocol.) As the FDA's clinical testing requirements are exacting and inflexible, the discrepancies between the actual release times and the recorded release times rendered the four studies worthless, and Scirex had to make financial amends to the pharmaceutical companies. Indeed, Scirex performed each study again without charge to its sponsor.

At the time of these events, Scirex had an insurance policy with Federal that had a limit of $280,000 and covered direct loss caused by any fraudulent or dishonest acts committed by its employees. It provided that:

The most we will pay for any loss under Blanket Employee Dishonesty for any loss caused by any employee whether acting alone or in collusion with others, either resulting from a single act or any number of acts, regardless of when those acts occurred during the period of this insurance or prior insurance, is the amount of loss, not to exceed the Limit of Insurance for Blanket Employee Dishonesty shown in the Declarations.

(Policy at 6, "Limits of Insurance.") A separate provision limited liability for multiple related acts, stating that "[a]ll losses resulting from an actual or attempted fraudulent or dishonest act or series of related acts at the premises ... whether committed by one or more persons will be deemed to be one occurrence or event." (Policy at 7.)

Scirex submitted a claim to Federal under this policy, contending that the actions of the nurses in sending patients home early, and submitting data sheets that falsely indicated that the patients had remained for the required eight hours, were "fraudulent or dishonest" and were therefore covered under the policy. It ultimately sought compensation for the loss of its investment in the four studies, an amount that included employee salaries, facility rentals, and other task-specific expenses. It claimed $185,000 on the R.W. Johnson study,...