In the recent decision of Starr Insurance Holdings, Inc. v. United States Specialty Insurance Company, the Supreme Court of the State of New York held that the termination condition applied to terminate coverage in respect of losses allegedly caused to an insured insurance company (itself a holder of a fidelity bond issued by two other carriers) by the insured’s managing general agent (“MGA”)/broker. Finding that the insured knew of the MGA’s dishonest acts prior to obtaining fidelity coverage, the Court applied the bond’s termination condition to hold that coverage terminated in respect of the MGA as of the inception of the bond.

The Facts

On August 1, 2012, Starr began insuring warranty contracts purchased by buyers of consumer electronics. Starr entered the warranty market with an experienced warranty producer/broker, Global Warranty Group LLC (“GWG”). GWG sold service contracts and loss/theft insurance for Starr as a MGA and/or broker, and administered claims made on those contracts. GWG was operated and controlled by Pipia, a fact which was known to Starr.

The terms of GWG’s contract with Starr required GWG to set up separate trust accounts for the claim funds furnished by Starr to GWG and the premiums collected by GWG that were to be remitted to Starr within 60 days from the sale of a contract.

Early on in its relationship with GWG, Starr learned that GWG had cash flow problems arising from an agreement with a prior insurer, Fortegra. Starr knew that GWG was not receiving new premiums from Fortegra business; that Fortegra was withholding all claim funding; and that GWG was required to pay claims on the legacy contracts that Fortegra insured.

By May 2013, Starr discovered how GWG was managing its cash flow problem. Starr learned that GWG was using its general operating account to commingle claim funds that Starr was advancing to GWG and premiums GWG owed to Starr. Starr further learned during 2013 that GWG was paying its liabilities from that account, including sums due on Fortegra’s claims. Finally, Starr learned from a review conducted in May 2013 that GWG was paying premiums to Starr with funds Starr had transferred to GWG to pay claims, in breach of GWG’s contract with Starr. A November 2013 audit review confirmed that GWG had continued these prohibited practices. The Court found that members of Starr’s management, as well as at least one member of Starr’s legal department, had either actual or constructive knowledge of GWG’s activities.

The Court also found that Starr learned in 2013 that over $747,000 was missing from the account which GWG had told Starr was for Starr’s benefit only, and that Starr learned that GWG and Pipia were raiding the purported claims account by diverting funds from that account to a GWG general operating account and recycling claim funds from Starr to pay premiums. The Court quoted from a series of emails received by Starr on November 18, 2013, one of which stated: “We have to send [GWG] this cash so they can pay it back to us in a few days in their premium payment! Ridiculous!

The Termination Condition

Starr submitted a claim under its fidelity bond in November 2014, seeking indemnity for loss resulting directly from dishonest or fraudulent acts committed by an “Employee”, as defined.

The Court first questioned whether GWG could be considered an “Employee” under the bond’s definition, as the definition excluded coverage for agents and brokers and extended to cover the acts of third-party administrators (TPAs) only where they “solely” performed TPA services for the insured. In view of its ultimate disposition, the Court did not resolve this issue.

The Court’s reasons do not quote the termination provision in issue, but they suggest that it was in standard form, providing for the termination of coverage in respect of any individual as soon as the insured learns of any dishonest act committed by that individual.

The Court noted that the bond incepted on January 1, 2014. Based on the evidence establishing Starr’s knowledge of GWG’s dishonesty during 2013, the Court held that coverage terminated as of bond inception:

Starr’s knowledge of any dishonest act by GWG is sufficient to trigger the termination clause in the Bond; knowledge of a theft is not required under the Bond’s terms. Starr’s assertion that the “critical missing facts” [i.e.,] that it did not know funds maintained in the claims account were insufficient or used by GWG for impermissible uses[,] is untenable on this summary judgment record. … Starr’s legal position that the insurers may be liable on the Bond because Starr did not know of a theft and corresponding loss is not the law in New York. See Capital Bank & Trust Co. v. Gulf Ins. Co. … (“no loss” is required to trigger a termination provision). …

Because Starr “discovered” GWG’s alleged dishonest acts which gave rise to Starr’s claims before the Bond period (January 1, 2014 to January 1, 2015), the Bond is exonerated, and Starr’s [claim was] properly rejected by defendants.

The Court’s contrasting knowledge of any dishonest act with specific knowledge of GWG’s thefts is instructive. Insureds sometimes contend that prior knowledge of the specific dishonest activity alleged to give rise to the claimed loss is necessary for the termination condition to be invoked. This contention is not supported by the language of the standard termination condition, and has been rejected in both the United States and Canada. In Iroquois Falls Community Credit Union Limited v. Co-operators General Insurance Company, 2009 ONCA 364, the Court of Appeal for Ontario observed:

The language used in the condition for “Termination” is very broad. It would appear to apply to knowledge of dishonest acts that may have been committed before the employee entered the insured’s employ, in relationships other than employment, and that may not have resulted in the type of loss insured under the bond. …

As stated, a dishonest act that satisfies the condition for “Termination” need not meet the Insuring Agreement’s requirements — i.e., the dishonest act need not result in direct loss or be committed with the manifest intent to cause a direct loss.

Conclusion

Starr Insurance provides a fairly straightforward application of the termination condition to facts involving reasonably clear knowledge of prior dishonesty. The case is nevertheless noteworthy to fidelity claims professionals for two reasons. First, it affirms the principle that the classes of dishonest acts which, if known to the insured, will trigger the termination condition are broader than the classes of dishonest acts which can form the basis of a claim for indemnity. Second, it supports the view that an insured’s pre-inception knowledge is relevant to the termination condition and, where the insured acquires sufficient knowledge prior to policy inception, such knowledge will result in the termination condition applying as of policy inception.

Starr Insurance Holdings, Inc. v. United States Specialty Insurance Company, Index No. 652164/2016 (N.Y. Supr. Ct. 2019) [Note: this decision does not appear to be available on WestLaw. Please contact us if you would like a copy.]