Forgery May Not Constitute “Theft” Under an Employee Dishonesty Coverage

Document forgeryRuling in favor of the insurer on a motion for summary judgment, on July 29, 2016 the Fifth Circuit Court of Appeals held that under the terms of a commercial crime policy, proof of a forgery by the insured’s employee in extending $90 million of credit to a customer did not establish an unlawful taking as required by the policy terms. Tesoro Refining and Marketing Co, LLC v. National Union Fire Ins. Co. of Pittsburgh, PA, 2016 U.S. App. Lexis 13838 (5th Cir. 2016).

Tesoro, a refiner and marketer of petroleum products sold fuel on credit to petroleum distributor Enmex. On several occasions the credit director for Tesoro, for unknown reasons, falsified and forged signatures on numerous letters of credit purportedly issued to Enmex. These acts enabled the Enmex debt to Tesoro to grow to $90 million before the forgery was detected. Once the forgery was discovered, Tesoro filed suit against Enmex for breach of contract and fraud, which lawsuit was settled. Tesoro also filed a claim with its insurer National Union under its crime policy. Tesoro claimed the loss fell under the “forgery and alteration” section of the policy (which section did not cover employee forgeries) and then amended its claim to proceed under the “employee theft” portion of the insuring agreement.  National Union denied coverage under both provisions. After suit was brought by Tesoro against National Union for breach of contract and bad faith, cross motions for summary judgment were filed. Ruling in favor of National Union, the federal district court in Western Texas reasoned that the employee theft coverage could include theft that was facilitated by a forgery, but that it did not cover forgery losses independent of a theft, which always required an unlawful taking in order to trigger coverage. Tesoro did not demonstrate that any unlawful taking had occurred and, therefore, the district court granted National Union’s motion for summary judgment. On appeal the Fifth Circuit agreed.

The decision contains an extensive discussion of the divergent interpretation of the “employee theft” insuring agreement proposed by both Tesoro and National Union. “Theft” was defined generally in the policy as “the unlawful taking of property to the deprivation of the Insured.” The last sentence of the employee dishonesty coverage said, however, that “theft” shall also include “forgery.” This language was the focus of the parties’ disagreement, with Tesoro arguing that this meant that a covered forgery could be independent from a theft. The Fifth Circuit disagreed. The Court found the policy provision to be unambiguous, and focused its decision on whether or not an unlawful taking, as it concluded was required for a theft-like forgery, had occurred.

Tesoro also argued that its loss consisted of physical property, i.e. the fuel it sold or its extension of unsecured credit to Enmex when it sold fuel. On the other hand, National Union argued that Tesoro had suffered no real loss because in exchange for the fuel it received what it bargained for, i.e., the binding commitment from Enmex to pay for the fuel. Further, according to National Union, if the lost property was considered to be the extension of credit, it was excluded from coverage because it was “intangible” property. On appeal the Fifth Circuit treated the loss as Tesoro’s sale of fuel.

Analyzing whether an unlawful taking had occurred under Texas law, the Court concluded that theft by deception requires that the owner of misappropriated property be induced to consent to its transfer because of the deceptive act of the wrongdoer. However the court found that Tesoro failed to explain how the forged letters of credit and security agreement induced Tesoro to continue selling fuel to Enmex. In order to establish that deception induced its consent, Tesoro had to show that the forged security documents were a substantial or material factor in its decision to continue selling fuel to Enmex. Tesoro had failed to provide evidence about how the forgeries would have affected its decision making process in the selling of fuel to Enmex. Based on its business conduct, the record demonstrated that Enmex was a sufficiently valued customer that Tesoro had continued to sell fuel to Enmex and on several occasions it had been less than diligent in pursuing Enmex for payment or securing additional letters of credit. Under Texas law proof of theft by deception required the decision maker to be aware of the false statement and induced by it. Here Tesoro failed to connect the evidence of the forged security documents to Tesoro’s decision making process in selling fuel to Enmex, let alone show that the forged documents induced it to go forward with the sale.

While there are numerous forgery schemes which can result in an unlawful taking of property falling within the insuring agreements of  many crime policies, the facts need to be carefully scrutinized to determine the nature of the loss sustained by the insured, and whether the elements of the specific crime coverage is satisfied.

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For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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