In August 2018, a US federal court ruled that an insurer did not have to cover a strip club for third party reimbursement costs arising from credit card fraud on its customers by the club’s employees because no direct loss was suffered by the club itself.
The insured, a club owner, was the holder of a commercial crime policy which covered ‘loss of or damage to money, securities and other property resulting directly from theft by an employee’. 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 the insured owned or leased or held for others whether or not the insured was legally liable for the loss of such property.
The policy contained an exclusion that it did not cover 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’.
Several employees of the insured ran a theft scheme where patrons of the club would buy ‘funny money’ to tip waitresses and topless dancers. The waitresses and dancers would then turn the funny money back into cash from the insured but in doing so, would overcharge customers’ credit cards, by either charging a credit card multiple times for the same bill or charging for funny money that the customer never purchased and then cashing in the funny money with the insured. The scheme was uncovered after a number of customers complained to the police and disputed the charges with their credit card companies.
On discovering the fraud, the insured paid chargebacks to the credit card companies and also as part of an agreement with law enforcement. The insured also incurred significant expenses in professional fees to investigate and resolve the fraud by its employees. However, if a customer did not dispute a charge or if the customer’s dispute was not sustained, the insured did not pay a chargeback.
The insured then submitted an insurance claim to recover the credit card chargebacks and professional fees, arguing that because the employees exchanged the funny money for cash from the insured and because the insured had to reimburse the customers for credit card charges, the employees stole from the insured and the loss was covered under the policy.
The court held that the policy covered loss resulting ‘directly’ from an employee’s theft, and the employees did not directly steal the insured’s own money. The employees stole customers’ money through unauthorised charges to the customers’ credit cards. They then used that stolen money to purchase funny money from the insured. But the theft was from the customers’ (or perhaps the credit card companies) funds, not the insured’s. If the customers never discovered the fraudulent charges or chose not to dispute them, the insured would not have suffered the loss it now claims.
The insured was not a direct victim of the theft but was seeking to recover for its liability to the customers which was not a covered loss.
Furthermore, the court said the investigation costs did not result from the employee’s theft but from the insured attempting to investigate the theft which was an excluded risk under the policy.
The case is CP Food & Beverages v US Fire Insurance Co.