Category Archives: Ownership

Cooper Industries: Fifth Circuit applies Crime Policy’s Ownership Condition in finding No Coverage for Loss of Funds in Ponzi Scheme

By David S. Wilson and Chris McKibbin

On November 20, 2017, the Fifth Circuit Court of Appeals released its decision in Cooper Industries, Limited v. National Union Fire Insurance Company of Pittsburgh, PA.  The Court applied a crime policy’s ownership condition in ruling that the insured did not have coverage for the loss of funds incurred when an investment entity to which it had provided funds in exchange for promissory notes collapsed due to the entity’s principals’ Ponzi scheme.

The dispute arose out of the same Ponzi scheme that gave rise to the decision of the Eighth Circuit in 3M Company v. National Union Fire Insurance Company of Pittsburgh, PA (see our June 13, 2017 post).  Although there are important factual distinctions between the two losses, the Fifth Circuit reached the same conclusion as the Eighth Circuit in finding that the insured had not demonstrated that it owned the property in issue.

The Facts

Cooper Industries, Ltd. (“Cooper”) was a publicly-traded electrical equipment supplier.  Cooper provided its employees with a pension plan, which was managed by Cooper’s Pension Investment Committee (the “Committee”).  The Committee divided the plan assets into two funds: a bond fund and an equity fund.

In 2004, Cooper began dealing with the principals of WG Trading Company LP (“WGTC”) in respect of investing the benefit plan assets.  The principals of WGTC had another entity, WG Trading Investors, LP (“WGTI”), which was a limited partner in WGTC.  WGTC was a regulated and audited entity, whereas WGTI was not.  The Committee invested approximately $175 million from both its equity and bond funds with the WG entities.  Some of the funds were provided to WGTI in exchange for promissory notes.

Unbeknownst to Cooper, the principals of WGTC and WGTI were running a Ponzi scheme and, over the course of several years, diverted over $130 million from WGTI for their personal use.  The Court noted that, during the course of the fraud, one of the principals spent over $3 million to amass a collection of 1,348 teddy bears, and another $32 million on a hunter pony farm.

In February 2009, the SEC and the CFTC initiated an enforcement action against the WG entities and the principals, and obtained receivership orders.  The receiver had considerable success in recovering assets (including liquidating the teddy bears).  As of the time of the Court’s decision, Cooper had recovered all of its equity fund principal, and all but $1.1 million of its bond fund principal from WGTI.

The Ownership Condition

Cooper claimed under its crime coverage with National Union in respect of the loss.  The policy’s ownership condition provided that:

The property covered under this policy is limited to property:

 (1) That you own or lease; or

 (2) That you hold for others whether or not you are legally liable for the loss of such property.

Before both the District Court and the Fifth Circuit, Cooper maintained that it “owned” the funds in issue, on the basis that it had a beneficial interest in the funds and that the term “own” should encompass both legal and equitable ownership.

Like the District Court before it, the Fifth Circuit rejected Cooper’s contention:

The Policy clearly does not use “own” in such a broad sense.  …  Cooper did not “own” the principal and earnings in the way most people would use that word. It loaned money to WGTI in exchange for promissory notes.  When it made that loan, it gave up possession and control of the funds.  Rather, it “owned” the notes, and the [WG] Entities “owned” the funds.  …  Cooper has cited no case where a Texas court has held that a party continues to “own” funds it was fraudulently induced to loan to someone else.  [emphasis added]

The Fifth Circuit also rejected Cooper’s attempts to rely on case law from other areas to expand the meaning of the term “own” in the policy:

Courts have recognized that “own” can vary with the context.  However, in insurance disputes, courts have generally used the common, everyday definition of the word “own.”  …  Cooper also touts the cases it has identified in a number of other legal contexts — criminal, tax, trust, forfeiture, and takings laws — that recognize that the common meaning of “own” includes equitable ownership.  That entirely misses the point.  Just because courts have interpreted “own” in certain legal contexts to include equitable ownership does not mean that equitable ownership has been imported into the common definition of “own” as a result.  [emphasis added; citations omitted]

The Court also rejected Cooper’s efforts to distinguish the 3M decision:

The Eighth Circuit has likewise held that another victim of Greenwood and Walsh’s fraud did not “own” funds invested through WGTC.  …  Cooper attempts to distinguish 3M because the insured did not argue that “own” included equitable ownership.  We have already rejected that argument and, in doing so, interpret Cooper’s policy not to cover property no longer in the insured’s possession but given over to the [WG] Entities, much as the Eighth Circuit interpreted 3M’s policy.  Adopting Cooper’s position would result in inconsistent interpretations of similar policy provisions — a result we strive to avoid.

As a consequence, Cooper could not establish that it “owned” the funds in issue.

Conclusion

Like 3M and the recent decision of the U.S. District Court for the District of New Jersey in Posco Daewoo (see our November 6, 2017 post), Cooper Industries provides another example of a court applying the ownership condition using the accepted meaning of legal ownership, and rejecting an attempt to unduly broaden the scope of the condition.  While the structure of Cooper’s investments in the WG entities was significantly different from the structure of the investment in issue in 3M, the courts reached the same result.  In each case, the court applied the ownership condition by reference to the concept of legal ownership only, to conclude that neither arrangement satisfied the ownership condition.

Cooper Industries, Limited v. National Union Fire Insurance Company of Pittsburgh, PA, 2017 WL 5562300 (5th Cir.)

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Posco Daewoo: U.S. District Court rejects Creditor’s “Reverse” Social Engineering Fraud Claim under its own Crime Policy

By David S. Wilson and Chris McKibbin

On October 31, 2017, the U.S. District Court for the District of New Jersey released its decision in Posco Daewoo America Corp. v. Allnex USA, Inc. and Travelers Casualty and Surety Company of America. This case features an interesting twist on the usual social engineering fraud claim scenario, in that it was the intended payee of the funds, not the payor, which asserted a claim under its own crime policy for recovery of funds which the payor had been duped into paying to an impostor. This type of claim has been referred to as a “reverse” social engineering fraud claim. Numerous such claims have been advanced by intended payees recently, typically when it comes to light that the payor did not maintain its own social engineering fraud coverage.

The Court applied traditional concepts of ownership in finding that the intended payee did not “own” the funds at any time, and thus could not establish that its claim met the ownership condition in its policy.

The Facts

Posco Daewoo America (“Daewoo”) is an importer and exporter of chemicals. Allnex USA (“Allnex”) is a vendor of specialty chemicals, and was a customer of Daewoo. Daewoo supplied Allnex with product for which Allnex owed payment. In early 2016, an impostor posing as an employee of Daewoo’s accounts receivable department sent emails to an employee of Allnex, requesting that payments to Daewoo on certain outstanding receivables be remitted to “new” Wells Fargo accounts.

Allnex paid $630,058 into the Wells Fargo accounts. By the time that the fraud was discovered, $367,613 had been transferred from the Wells Fargo accounts to accounts overseas. Daewoo never had possession of any of the funds owed to it by Allnex at any time.

The Travelers Coverage

Daewoo maintained a Wrap+ policy with Travelers. Daewoo submitted a claim to Travelers under its Computer Fraud coverage, asserting that the impostor’s emails to Allnex, coupled with Allnex’s transfers to the Wells Fargo accounts, constituted a Computer Fraud loss to Daewoo.

Travelers moved to dismiss the action pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief could be granted. While Travelers took the position that the substantive elements of the Computer Fraud coverage had not been established, Travelers also pointed out a more fundamental concern with the claim – Daewoo had not satisfied the ownership condition in the policy. This condition provided as follows:

Ownership of Property; Interests Covered

 The property covered under this Crime Policy … is limited to property:

 i. that the Insured owns or leases;

ii.  that the Insured holds for others:

     (a) on the Insured’s Premises or the Insured’s Financial Institution Premises; or

     (b) while in transit and in the care and custody of a Messenger; or

 iii. for which the Insured is legally liable, except for property located inside the Insured’s Client’s Premises or the Insured’s Client’s Financial Institution Premises.

Travelers took the view that, while Daewoo was undoubtedly owed money by Allnex, Daewoo never actually held the funds, nor had Daewoo been legally liable for them, nor had Daewoo owned the funds.

The Court agreed. In the Court’s view, Daewoo’s failure to meet the ownership condition was dispositive. Until such time as funds were actually transferred to Daewoo, Daewoo had, at most, a receivable and a chose in action (i.e., a right to sue) in the event that it was not paid. This was insufficient for the purposes of the ownership condition:

[Daewoo] has not plausibly pled sufficient facts for the Court to find that it rightfully … possessed or had legal title to the money Allnex transferred into the Wells Fargo accounts. [Daewoo]’s strongest claim to owning that money stems from Allnex’s intention. The parties do not dispute that Allnex intended [Daewoo] to receive the wired money as payment for a debt.   However, a party’s intention of transferring legal title does not equate to an actual transfer of legal title without more. …

 The Court agrees with Travelers that before Daewoo actually received the monies due, Daewoo owned a receivable, or a right to payment, as well as a potential cause of action for payment if it was not made. … In other words, Daewoo did “own” something of value, but it was not the cash in the Wells Fargo accounts. It owned a receivable and a potential cause of action if Allnex did not pay. [emphasis added]

As a result, the Court granted the motion.

Conclusion

Posco Daewoo represents a straightforward application of the ownership condition to a claim that was anything but straightforward. The Court’s analysis reaffirms the fundamental coverage requirement that an insured must own, hold or have antecedent legal liability for the property which forms the subject of a claim.

The Court’s decision provides helpful guidance to fidelity claims professionals in clarifying the distinction between funds which meet the ownership condition, and funds in respect of which the insured has only a right as creditor. The Court effectively rejected the notion that Daewoo’s status as creditor made it a “constructive” owner of the funds in Allnex’s possession. Fidelity insurers occasionally face creative arguments concerning “constructive” ownership, and Posco Daewoo is an example of a court rejecting such arguments.

The decision also reinforces the importance of social engineering fraud coverage – in this case, for companies in the position of Allnex. Although it is not clear from the Court’s reasons, one surmises that Allnex did not maintain social engineering fraud coverage, which might have responded to the loss in issue here. Given the increasing frequency of vendor impersonation and other social engineering fraud losses, insureds would be well-advised to consult with their brokers about the risks that social engineering fraud poses to their business, and the availability of social engineering fraud coverage.

Posco Daewoo America Corp. v. Allnex USA, Inc. and Travelers Casualty and Surety Company of America, 2017 WL 4922014 (D.N.J.)

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3M: Eighth Circuit applies Crime Policy’s Ownership Condition in finding No Coverage for Loss of Undistributed Limited Partnership Earnings in Investment Fraud

By David S. Wilson, John Tomaine and Chris McKibbin

On May 31, 2017, the Eighth Circuit Court of Appeals released its decision in 3M Company v. National Union Fire Insurance Company of Pittsburgh, PA. The Court affirmed the decision of the U.S. District Court for the District of Minnesota (see our October 13, 2015 post), which had applied a crime policy’s ownership condition in ruling that the insured did not have coverage for the loss of investment earnings incurred when an investment entity in which it had a limited partnership interest collapsed due to the entity’s principals’ Ponzi scheme. The Eighth Circuit’s decision provides a good illustration of the interaction between the ownership condition and statutory and common law concepts of “ownership” as they relate to partnerships.

The Facts

In 1999, 3M began investing its employee benefit plan assets in WG Trading Company LP (“WG Trading”). 3M’s investment was structured as a limited partnership in WG Trading. The principals of WG Trading also maintained another entity, WG Trading Investors, LP (“WG Investors”), which was a limited partner in WG Trading. WG Trading was a regulated and audited entity, whereas WG Investors was not.

Unbeknownst to 3M, the principals of WG Trading and WG Investors were running a Ponzi scheme and, over the course of several years, diverted hundreds of millions of dollars from the two entities for their personal use. The SEC and the CFTC initiated civil lawsuits against the WG entities and the principals, and obtained receivership orders. The receiver had considerable success in recovering assets. 3M was able to recover all of the net capital contributions that it had invested in WG Trading.

Nevertheless, 3M took the view that it had still suffered a loss, since at least some of its capital had been invested by WG Trading in legitimate vehicles and had produced legitimate earnings, but 3M was never paid those legitimate earnings. 3M submitted a claim to National Union under its Blanket Crime Policy, and to its excess crime insurers under their follow-form excess policies.

The Ownership Condition

National Union determined that there was no coverage under the policy because, even if the invested funds generated legitimate earnings, the earnings did not fall within the requirements of the ownership condition set out in Endorsement 8 to the policy, which provided, in relevant part, that:

The insured property may be owned by the Insured, or held by the Insured in any capacity whether or not the Insured is legally liable, or may be property as respects which the Insured is legally liable.

National Union took the view that, even if 3M’s investment with WG Trading generated legitimate earnings that could be quantified and attributed to 3M, those earnings were not (i) owned by 3M; (ii) held by 3M in any capacity; nor (iii) property for which 3M was legally liable. 3M argued that the ownership condition did not apply or, in the alternative, that it could be applied in a manner that would bring the claim within coverage.

Before the Eighth Circuit, 3M’s first argument was that the ownership condition did not even apply, as the relevant insuring agreement encompassed “Money, Securities or other property”. 3M asserted that the ownership condition did not apply to coverage for theft of “other” property, because the ownership condition only applied to “insured” property, and the insuring agreement did not specify whose “other” property was covered.

The Eighth Circuit, like the District Court before it, made short work of this argument:

Although the Employee Dishonesty provision does not expressly state whose other property is covered, it is entirely unreasonable to interpret the provision as extending coverage under the Policy to other property that is not insured property. Interpreting the Employee Dishonesty provision as extending to coverage to other property that is not insured property runs afoul of Endorsement 8, which details the property and interests that are covered under the Policy. Thus, when viewed within its context and with common sense, the only reasonable construction of the Employee Dishonesty provision limits coverage under the provision to insured property. Thus, we determine that the ownership requirement of Endorsement 8, which defines insured property, applies to the Employee Dishonesty provision.

3M’s second argument was that, if the ownership condition applied, 3M “owned” the lost earnings because it had a right to possess the earnings and the Court should interpret the condition broadly. The Eighth Circuit rejected this contention as well, essentially adopting the reasoning of the District Court:

However, up until the point at which the earnings were distributed to the partners, the stolen earnings were property of WG Trading — not property of 3M. It is fundamental that property acquired with partnership funds is partnership property, and individual partners do not own partnership assets until the winding up of the partnership.

3M’s final argument was that it met the ownership condition because it had ERISA fiduciary duties relating to the earnings, which rendered 3M “legally liable” for the earnings within the meaning of Endorsement 8. While the District Court did not address the substance of this argument at first instance, the Eighth Circuit considered the argument on the merits and rejected it, holding that:

the ERISA regulation does not alter general commercial property rights, but merely defines the nature and scope of the fiduciary duties owed to plan participants. Thus, this does not affect the ownership nature of WG Trading’s partnership assets. [emphasis added; citations omitted]

As a result, 3M could not bring the lost earnings within the ambit of the ownership condition, and no coverage was available.

Conclusion

The Eighth Circuit’s decision in 3M provides two key findings of assistance to fidelity insurers. First, it rejects the contention that the ownership condition acts as anything other than a pre-condition for recovery under a fidelity policy. Insureds (or their counsel) occasionally contend that there is a dichotomy between an insuring agreement and the ownership condition. The ownership condition, like other conditions in a crime policy, is intended to clarify the coverage provided under insuring agreements. Here, the Court recognized that the ownership condition was to be construed in harmony with, and supportive of, the relevant insuring agreement, and explained why the insured’s attempt to distinguish between “other property” and “insured property” was without merit. A loss must fall within an insuring agreement, and must also meet the ownership condition, in order to trigger coverage.

Second, the Eighth Circuit affirmed the District Court’s analysis of the limited partnership agreements in issue (and its application of state law) in concluding that what 3M actually “owned” was not any of WG Trading’s assets, but rather a limited partnership interest in WG Trading itself, with only the possibility of future receipt of earnings upon distribution.

The same general principles of partnership law apply in Canadian common law jurisdictions such as Ontario. For example, subsection 21(1) of the Ontario Partnerships Act makes it clear that partnership property is legally distinct from property owned by the partners themselves. Thus, it is arguable that a similar result should follow, were such a claim to be litigated north of the border.

[Editors’ Note: Our guest co-author, John Tomaine, is the owner of John J. Tomaine LLC, a fidelity insurance and civil mediation consultancy in New Jersey.  After over thirty-one years with the Chubb Group of Insurance Companies, he retired as a Vice President in 2009.  He is an attorney admitted in Connecticut and New Jersey, and holds a Master’s Degree in Diplomacy and International Relations.  He is available to serve as an expert witness in fidelity claim litigation and to consult on fidelity claim and underwriting matters.]

3M Company v. National Union Fire Insurance Company of Pittsburgh, PA., 2017 WL 2347105 (8th Cir.)

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3M: U.S. District Court applies Ownership Provision in finding No Coverage for Loss of Undistributed Limited Partnership Earnings in Investment Fraud

By David S. Wilson, John Tomaine and Chris McKibbin

[Editors’ note: Our guest co-author John Tomaine is the owner of John J. Tomaine LLC, a fidelity insurance and civil mediation consultancy in New Jersey. After over thirty-one years with the Chubb Group of Insurance Companies, he retired as a Vice President in 2009. He is an attorney admitted in Connecticut and New Jersey, and holds a Master’s Degree in Diplomacy and International Relations. He is available to serve as an expert witness in fidelity claim litigation and to consult on fidelity claim and underwriting matters. He will be a speaker at the FSLC’s Fall 2015 meeting in Washington D.C.]

In 3M Company v. National Union Fire Insurance Company of Pittsburgh, PA, the U.S. District Court for the District of Minnesota considered and applied a crime policy’s Ownership Provision in concluding that the insured did not have coverage for the loss of investment earnings suffered when an investment entity in which it had a limited partnership interest collapsed due to its principals’ Ponzi scheme. The decision provides an example of the interaction between the Ownership Provision and statutory and common law concepts of “ownership” as they relate to partnerships.

The Facts

In 1999, 3M began investing its employee benefit plan assets in WG Trading Company LP (“WG Trading”). 3M’s investment was structured as a limited partnership in WG Trading. The principals of WG Trading also maintained another entity, WG Trading Investors, LP (“WG Investors”), which was a limited partner in WG Trading. WG Trading was a regulated and audited entity, whereas WG Investors was not.

The principals of WG Trading and WG Investors were running a Ponzi scheme and, over the course of several years, diverted hundreds of millions of dollars from the two entities for their personal use. In 2009, the SEC and the CFTC initiated civil lawsuits against the WG entities and the principals, and obtained receivership orders. The receiver had considerable success in recovering assets; in fact, 3M was able to recover 100 per cent of its net capital contributions to WG Trading.

Nevertheless, 3M took the view that it had still suffered a loss, because at least some of its capital had been invested by WG Trading in legitimate vehicles and had produced legitimate earnings, but 3M was never paid those legitimate earnings.

The Ownership Provision

3M submitted a claim to National Union under its Blanket Crime Policy, and to its excess crime insurers under their follow-form excess policies. National Union determined that there was no coverage under the Crime Policy because, even if the invested funds generated legitimate earnings, the earnings did not fall within the condition of the Ownership Provision set out in Endorsement 8 to the policy, which provided that:

The insured property may be owned by the Insured, or held by the Insured in any capacity whether or not the Insured is legally liable, or may be property as respects which the Insured is legally liable.

National Union took the view that, even if 3M’s investment with WG Trading generated legitimate earnings that could be quantified and attributed to 3M, those earnings were neither owned by 3M nor held by 3M in any capacity, nor were they property for which 3M was legally liable. 3M argued that the Ownership Provision did not apply or, in the alternative, that it could be applied in a manner that would bring the claim within coverage.

3M initially contended that the Ownership Provision did not even apply to the claim, because it applied only to “insured property”, whereas the Employee Dishonesty insuring agreement encompassed “direct losses of Money, Securities or other property caused by Theft or forgery”. Similarly, Theft was defined as “the unlawful taking of Money, Securities or other property”. 3M contended that, because the Employee Dishonesty insuring agreement and the definition of Theft used the term “other property” rather than “insured property”, the Ownership Provision had no application in the circumstances.

The Court quickly dismissed this argument, holding that:

Clearly, then, Endorsement 8 is not intended to define “insured property,” as 3M’s argument implies. Instead, Endorsement 8 simply uses the term “insured property” to limit the coverage afforded under the “Employee Dishonesty” insuring agreement. And giving that phrase its plain and ordinary meaning, … the phrase “insured property” can only be understood as a shorthand way of saying “property whose loss is insured under this Policy”—that is, property that is insured under at least one of the insuring agreements in the Policy, such as the “Employee Dishonesty” insuring agreement.

Indeed, because “insured property” is not a defined term, the Court is at a loss to know what else it could mean. If it does not refer to property whose loss is insured under one or more of the various insuring agreements, then the Policy itself becomes nonsensical.

Did 3M “Own” the Earnings?

The more conceptually interesting ruling in the Court’s decision concerned whether 3M’s earnings came within the Ownership Provision. National Union contended that they did not, as 3M only owned a limited-partnership interest in WG Trading itself, rather than any of WG Trading’s assets. The Court accepted National Union’s position, holding that:

… what 3M owned was a limited-partnership interest in WG Trading. Up until the point at which earnings were distributed to the partners, the earnings of WG Trading were owned by WG Trading, and not by 3M or any of the other limited partners.

As noted, 3M’s investment was structured as a limited-partnership interest in WG Trading. WG Trading’s partnership agreements are governed by Delaware law [which] is crystal clear that a limited partner such as 3M has “no interest in specific limited partnership property.” The partner’s right to receive distributions of the partnership’s assets does not change this fact.

Consequently, the lost earnings were not “owned” by 3M within the meaning of the crime policy, and the insurers had no obligation to indemnify 3M.

“Legally Liable”

In a footnote, the Court noted that 3M had argued for the first time in its reply brief that it had fiduciary duties in respect of the lost earnings and, therefore, the earnings fell within the “property as respects which the Insured is legally liable” part of the Ownership Provision. The Court, relying on established authority, stated that it would not consider this argument, as it had been raised for the first time in 3M’s reply brief.

Conclusion

3M provides two key findings of assistance to fidelity insurers. First, it rejects the contention that the Ownership Provision acts as anything other than a pre-condition for recovery under the policy. In our view, 3M’s argument on this point was without merit, insofar as it attempted to draw an artificial distinction between the term “insured property” as used in the Provision, and the term “other property” as used in the relevant insuring agreement and the definition of Theft. A loss must fall within an insuring agreement and must also meet the Ownership Provision.

Second, and more importantly, the Court carefully analyzed the limited partnership agreements, and applied state law, in concluding that what 3M actually “owned” was not any of WG Trading’s assets, but rather a limited partnership interest in WG Trading itself, with only the possibility of future receipt of earnings upon distribution.

The same general principles of partnership law apply in Canadian common law jurisdictions such as Ontario. Subsection 7(2) of the Ontario Limited Partnerships Act states that a limited partner’s interest in the limited partnership is distinct personal property, while subsection 21(1) of the Ontario Partnerships Act makes it clear that partnership property is legally distinct from property owned by the partners themselves. Thus, it is arguable that the same result should follow, were such a claim to be litigated north of the border.

3M Company v. National Union Fire Insurance Company of Pittsburgh, PA., 2015 WL 5687879 (D. Minn.)

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