Category Archives: Manifest Intent

Hantz Financial Services: U.S. District Court applies “Direct Means Direct” Approach in Finding No Coverage for Third-Party Losses under Financial Institution Bond

By David S. Wilson and Chris McKibbin

In Hantz Financial Services, Inc. v. National Union Fire Insurance Company of Pittsburgh, PA., the U.S. District Court for the Eastern District of Michigan held that a Financial Institution Bond did not provide coverage to a financial services firm in respect of frauds perpetrated by an employee upon the firm’s clients. The decision is notable in that the Court applied the “direct means direct” approach to loss causation under the Bond. The Court also made some interesting comments with respect to the manifest intent requirement for coverage, and whether a defaulter can manifestly intend a loss to the insured in a third-party loss scenario.

The Facts

Hantz Financial Services, Inc. (“Hantz”) employee Michael Laursen stole more than $2.6 million which Hantz’s clients had provided to him to invest and/or to purchase insurance on their behalves. Initially, Laursen deposited cheques written by clients directly into his personal bank account. Some cheques were written to Laursen directly, while others were made payable to “Hantz Financial Services”, “HFS”, “Hantz” or “Hantz Consulting”. At one point during the course of the fraud, Laursen opened a bank account in the name of “Henary Firearms Service” and directed his clients to write cheques payable to “HFS”, which he then deposited into that account. The fraud came to light in March 2008. In all, 23 clients were affected by Laursen’s fraud.

The Employee Dishonesty Coverage

Hantz submitted a claim to National Union under its Financial Institution Bond. The Bond covered Hantz for:

Loss resulting directly from dishonest or fraudulent acts committed by an Employee with the manifest intent: (a) to cause the insured to sustain such loss. …

The Bond also excluded “Indirect or consequential loss of any nature.”

National Union determined that there was no coverage under the Bond because Laursen stole money from Hantz’s clients, not from Hantz directly. Accordingly, Hantz’s liability was indirect, arising only by virtue of clients’ subsequent claims against it.

Direct Loss Requirement

Hantz commenced an action on the Bond, and also sought coverage from its E&O insurer in the same litigation. The Bond claim proceeded to cross-motions for summary judgment on the issue of whether there had been a direct loss to Hantz.

In seeking a determination of no coverage under the Bond, National Union relied on the Sixth Circuit’s 2012 decision in Tooling, Manufacturing & Technologies Association, in which the Court 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. The Court agreed with National Union, holding that:

This Court is bound by the holding in Tooling. Thus, if Hantz’s losses followed “immediate[ly]” from Laursen’s conduct, there would be coverage under the Bond. Hantz’s characterization of its losses requires the opposite conclusion. As will be discussed further below, Hantz, in seeking coverage under the E & O Policy, argues that its losses derive from third-party claims for negligent supervision. So Hantz acknowledges that the money belonged to its clients, and Hantz’s own losses resulted from having to reimburse those clients for Laursen’s misappropriation, not from Laursen taking Hantz’s money. Thus, if the Court were to find that Hantz’s losses were covered by the Bond, it would be finding that an employee fidelity bond covers third-party losses. But Tooling’s “direct is direct” approach precludes such a finding.

Hantz contended that Tooling was distinguishable because it involved loss sustained by a subsidiary, whereas Laursen had stolen cheques directed to HFS itself. The Court rejected this contention, holding that:

Even if, absent Laursen’s theft, the money would have passed through Hantz’s hands, there is no question that the money belonged to Hantz’s clients. This is demonstrated by Hantz’s decision “to offer each claimant a dollar-for-dollar return of their principal investment stolen by Mr. Laursen.” … And this conclusion is bolstered by the Bond’s requirement that the employee have “the manifest intent: (a) to cause the insured to sustain such loss.” … Laursen surely intended to cause his clients to lose the money he stole, but no reasonable jury could find that he manifestly intended that Hantz reimburse the clients and thereby sustain a loss. The Court agrees with National Union that the money Hantz paid its clients to reimburse them for Laursen’s theft is not a covered loss under the Bond. [emphasis added]

The Court concluded that, as a matter of law, Hantz’s losses were indirect and therefore not covered by the Bond.

Conclusion

Hantz is significant for two reasons. First, it is a further example of recent fidelity decisions in which U.S. courts have affirmed that the “direct means direct” approach is the proper approach to causation under fidelity bonds carrying a direct loss requirement, as opposed to the proximate cause approach adopted in a minority of jurisdictions. The recent Taylor & Lieberman decision (which we discussed in our July 14 post) is to similar effect.

Second, the Court made a rather striking statement in observing that, in the circumstances alleged by Hantz, no reasonable jury could find that Laursen manifestly intended that Hantz reimburse the clients and thereby sustain a loss. This is significant, insofar as it is sometimes argued that such intent might be inferred where a defaulter has stolen money from his clients in circumstances in which it was likely that his employer would eventually be found vicariously liable to those clients. While the Court’s observations with respect to manifest intent might be characterized as obiter dicta, the Court’s statement may nonetheless be helpful to fidelity insurers in rebutting manifest intent arguments advanced in support of establishing coverage for third-party losses.

Hantz Financial Services, Inc. v. National Union Fire Insurance Company of Pittsburgh, PA., 2015 WL 5460632 (E.D. Mich.)

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KeyBank: New York Appellate Division denies Summary Judgment in Mortgage Lien Release case due to Material Issues of Fact as to Bank Employee’s Intent

By Chris McKibbin

On January 22, 2015, the New York Supreme Court, Appellate Division, released its decision in KeyBank National Association v. National Union Fire Insurance Company of Pittsburgh, Pa. The decision highlights the difficulties which sometimes arise in assessing manifest intent in financial institution losses.

The Facts

The insured, KeyBank, loaned a developer some $20 million for a condominium project. The loan was secured by, inter alia, mortgage liens on the condominium units. As individual condo units were sold, a percentage of the proceeds was to be used to pay down the loan, and to release the liens on those individual units.

The developer ran into financial difficulties.  KeyBank’s employee, Martin, permitted the liens on 20 units to be released without the paydown amounts, which had the effect of causing the developer to retain some $5 million that should have been paid to KeyBank. Martin concealed the shortfall by falsely representing to KeyBank that the units had not closed. KeyBank’s “Suspicious Activity Report” concluded that Martin had contravened KeyBank’s procedures and the loan contracts, but turned up no evidence of financial gain by Martin resulting from his actions.

Manifest Intent Requirement

The relevant provision in National Union’s fidelity bond indemnified KeyBank for:

Loss resulting directly from dishonest or fraudulent acts committed by an Employee acting alone or in collusion with others. Such dishonest or fraudulent acts must be committed by the Employee with the manifest intent:

 

(a)        to cause the Insured to sustain such loss; or

 

(b)        to obtain financial benefit for the Employee or another person or entity.

KeyBank moved unsuccessfully for summary judgment in 2013. The Appellate Division affirmed the motions court’s ruling, holding that there were material issues of fact as to whether Martin had the manifest intent to cause KeyBank to sustain a loss, and as to whether Martin intended to obtain a financial benefit for the developer.  At first blush, that conclusion may not make a lot of sense. However, a closer analysis demonstrates the logic of the Court’s ruling.

With respect to subparagraph (a) of the manifest intent requirement, the Court adopted the “substantial certainty” threshold, holding that “[m]anifest intent to injure an employer exists as a matter of law where an employee acts with substantial certainty that his employer will ultimately bear the loss occasioned by his dishonesty and misconduct.” Here, the available evidence indicated that Martin was concerned about the condominium project failing, and that his intent was to allow the developer to retain funds needed to complete the project, in order to prevent KeyBank from sustaining an even greater loss.

With respect to subparagraph (b) of the manifest intent requirement, the Court held that there were material issues of fact (including conflicting expert evidence) as to whether the cash flow from the lien releases had, in fact, been used to pay construction costs, rather than simply being pocketed by the developer.

Direct Loss Requirement

The Court also held that summary judgment had been properly denied on the issue of whether KeyBank had suffered a direct loss. Given the factual issues surrounding whether the diverted funds had been applied to construction costs, rather than simply being stolen by the developer, the Court held that KeyBank had failed to demonstrate that there was no material issue of fact as to whether it had sustained a direct loss.

Conclusion

KeyBank demonstrates the difficulties which can arise in assessing manifest intent in the financial institution context. A bank employee involved in extending credit, or similar activities, may have any number of motivations for engaging in conduct which ultimately results in a loss. A careful consideration of the direct evidence of the employee’s intent (if any), together with the surrounding circumstantial evidence, is essential to a proper manifest intent analysis.

KeyBank National Association v. National Union Fire Insurance Company of Pittsburgh, Pa., 2015 WL 263930 (N.Y.A.D. 1 Dept.)

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