Payments to third parties do not qualify as a “loss” under commercial crime policies because such payments are not an “unlawful taking” by the employee.

The United States District Court (New Jersey) recently had occasion to consider the interpretation of two commercial crime policies. The policies covered losses for “employee theft” stating that:

“We will pay for the 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 is defined in the policies as the “unlawful taking of property to the deprivation of the insured.” The policies exclude any loss resulting from a dishonest act other than theft. The operative clause is similar to that found in most South African based policies.

The loss resulted from the insured’s invitation to tender for the installation of structural steel storage systems. The employee colluded with the contractor to inform it of other contractor’s bids thereby allowing the contractor to inflate its bid but still win the tender, with the result that the padding on the bid would be split between the contractor and the insured’s employee, a situation which is not unknown in SA.

The court considered the plain language of the policy and the essential nature of a theft being that “the actor appropriates property of the victim without his consent.” It found that generally unlawful payments by the insured to third parties do not qualify as a “loss” under commercial crime policies because such payments are not an “unlawful taking” by the employee even if they are the result of collusion with the employee.

The insurance protected the insured from employee theft, not against a less favourable deal from a deceitful contractor.

The insured did not assert that the underlying transaction was fraudulent and that the independent contractor did not perform its work nor did it argue that the bids were unreasonably priced or not the lowest. The insured set an internal budget and expected that any independent contractor would make a profit on their service and as such it was not “unknowingly deprived of money”. Consequently the loss is at its core an inability to obtain the lowest price which is not a basis to raise a claim under the crime policy. The court found that the claim for the alleged losses from the inflated amounts paid to and received by the independent contractor was not covered by the crime policy.

The court then turned to consider whether the employee’s share of the inflated bids was covered. It found that the employee’s actions were no different than if he had inflated the bids himself and skimmed a portion off the top. As such, the fact that the money had passed through an intermediary prior to reaching his pocket did not change the fundamental nature of the employee’s actions being an “unlawful taking” nor its affect, the “deprivation of the insured” and was a “loss” under the crime policy. The insurer’s arguments that the loss was only theoretical or indirect in nature did not find favour with the court.

On similar wording and facts, a similar result would follow in South Africa.