Fidelity Bond’s Termination Clause Triggered by Dishonest Acts
This article originally appeared in Goldberg Segalla’s Professional Liability Matters. Read the issue here.
The New York Supreme Court recently held that a termination clause in a fidelity bond was triggered by an insured’s knowledge of dishonest acts prior to the inception of the bond. The court acknowledged that a fidelity bond insures losses caused directly from dishonest or fraudulent acts by an employee. However, fidelity bonds do not cover losses from breaches of
contract and fiduciary duties arising from fraudulent acts of which an insured is aware prior to the purchase of the bond.
In Starr Insurance Holdings, Inc. v. United States Specialty Insurance Company, an insurance company insured warranty contracts purchased by consumers of electronic products. The insurance company contracted with Global Warranty Group LLC (GWG), a managing general agent/ broker, who both sold these service contracts
and loss/theft insurance through its network of dealers, and also administered all claims arising from those contracts. The insurance company required GWG to set up a separate trust account to be used solely for claim funds furnished by the insurance company to GWG as it administered claims. The insurance company also required GWG to remit premiums collected on the warranty contracts within 60 days of the sale of the contract.
The insurance company discovered that GWG was having cash flow problems. As a result, GWG started commingling funds from its general operating account with the funds forwarded by the insurance company to pay warranty claims as well as the funds collected in premium. Indeed, the insurance company determined that over $747,000 was missing from the trust account that was supposed to be used solely for warranty claims insured by the insurance company. The insurance company learned that GWG was raiding the purported claims account by diverting funds from that account to its general operating account to assist with its cash flow problems and recycle claim funds from the insurance company to pay premiums.
After the insurance company discovered these dishonest acts by GWG, it purchased a fidelity bond. Thereafter, GWG collapsed and was unable to forward any additional premium payments to the insurance company. After GWG’s collapse, the insurance company made a claim under its fidelity bond, seeking indemnity for loss resulting directly from dishonest or fraudulent acts committed by its “employee,” GWG. While the court questioned whether GWG was an employee under the fidelity bond, its attention was drawn to the termination provision in the bond. It was because the insured insurance company knew of the dishonest acts which gave rise to its claim under the fidelity bond before the bond period, which resulted in the bond being terminated upon inception.
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