In the recent decision of CP Food & Beverage, Inc. v. United States Fire Insurance Company, the U.S. District Court for the District of Nevada held that coverage was not available under a crime policy where the insured’s employees had defrauded the insured’s customers through misuse of customer credit cards. The decision makes important findings regarding the appropriate test for “direct loss” causation in a crime policy, and reaffirms the general principle that crime policies are not intended to indemnify insureds for their vicarious liability arising from employees’ theft of third parties’ property.

The Facts

CP Food & Beverage Inc. (“CP”) operated an adult entertainment club. Customers could purchase “funny money” to tip performers and service staff. The performers and service staff could turn the funny money back to CP for cash. Several employees of CP overcharged customers’ credit cards through various methods, including charging cards multiple times for the same bill; charging cards for alcohol which the employees kept for themselves; and charging cards for funny money which the employees kept and cashed in with CP.

After the scheme came to light, CP paid chargebacks to its customers’ credit cards totalling $768,617, both in response to its contractual requirements with the credit card companies and as part of an agreement with law enforcement. CP also incurred significant professional fees to investigate and resolve issues with law enforcement and customers.

The Employee Theft Coverage

CP submitted a claim to its insurer (“U.S. Fire”) under the Employee Theft coverage of its commercial crime policy. That coverage insured against:

loss of or damage to ‘money’, ‘securities’ and ‘other property’ resulting directly from ‘theft’ committed by an ‘employee’, whether identified or not, acting alone or in collusion with other persons.

“Theft” was defined as “the unlawful taking of property to the deprivation of the Insured”. Property covered by the policy was limited to property that CP owned or leased or that CP “h[e]ld for others whether or not [CP was] legally liable for the loss of such property”. The policy excluded loss “that is an indirect result of an ‘occurrence’ covered by this policy including, but not limited to, loss resulting from … Payment of costs, fees or other expenses you incur in establishing the existence or the amount of loss under this policy.”

U.S. Fire took the position that the policy did not respond because CP was not the direct victim of the fraud; rather, CP was attempting to recover for its own vicarious liability to its customers. CP contended that, because the employees exchanged the funny money for cash from CP, and because CP had to reimburse the customers for credit card charges, the employees stole from CP.

The District Court granted U.S. Fire’s motion for summary judgment. The Court first considered whether the loss was one “resulting directly” from employee theft, and observed that there was no controlling Nevada authority on point. The Court noted that many other courts have adopted the “direct means direct” approach to causation, which requires that the loss follow immediately in time and place from the defaulter’s conduct, rather than merely being the proximate result thereof. Following established authorities such as Vons Cos., Inc. v. Fed. Ins. Co. (9th Cir. 2000), the Court held:

I predict Nevada would follow the “direct means direct” rule and hold the policy language at issue does not cover third party claims or investigation costs. Starting with the policy’s plain language, it covers loss resulting “directly” from an employee’s theft. If proximate cause were sufficient, that would render the word “directly” superfluous. [emphasis added; citations omitted]

The Court then applied the “direct means direct” causation requirement in the context of the loss claimed by CP:

The policy thus contemplates a loss when the insured is deprived of property (either its own or property it holds as trustee or bailee), not when a third party is deprived of property and the third party later sues the insured or requires repayment under a contractual provision. This is consistent with the reasonable expectations of the insured because this is not a policy designed to cover CP for liability to third parties for its vicarious liability due to its employees’ theft of its customers’ property. …

Given the policy language and keeping in mind the purpose for which CP purchased this policy, CP would not expect coverage for the chargebacks or the investigation costs. The employees stole customers’ money through unauthorized charges to the customers’ credit cards. The employees then used that stolen money to purchase alcohol and funny money from CP. But the theft was of the customers’ (or perhaps the credit card companies’) funds, not CP’s. [emphasis added]

The Court also observed that the investigative costs did not directly result from the employees’ thefts. Instead, they resulted from CP attempting to investigate the thefts; to assure law enforcement that the owners were not involved in the scheme; and to support CP’s insurance claim. While the Court’s analysis is valid as a matter of applying the “direct means direct” causation requirement (and the specific language of the policy in issue), it should be noted that many forms of commercial crime coverage will include a separate sublimited coverage grant for investigation expenses incurred in connection with establishing a covered loss.

Conclusion

CP Food is notable for two reasons. First, like Hantz Financial Services (see our September 29, 2015 post) and Taylor & Lieberman (see our July 14, 2015 post), it provides another example of a court embracing the “direct means direct” approach to causation in a commercial crime policy, and rejecting the notion that proximate (or “tort”) causation is sufficient. Second, CP Food reaffirms the general principle that commercial crime policies are not intended to cover insureds for their vicarious liability to third parties arising from employees’ theft of third parties’ property.

CP Food & Beverage, Inc. v. United States Fire Insurance Company, 2018 WL 3993408 (D. Nev.)