E&O Coverage for Embezzlement Precluded by Commingling Exclusion

The United States District Court for the District of North Dakota, applying North Dakota law, has held that a commingling exclusion precluded coverage for an insured’s controller’s theft of funds under the property management company’s errors and omissions policy.  Campbell Prop. Mgmt., LLC v. Lloyd’s Syndicate 3624, 2020 WL 1846985 (D.N.D. Apr. 10, 2020).

After discovering its controller embezzled over $1 million from client accounts over a four-year period, the insured recovered a portion of the stolen money under its commercial lines insurance policy coverage for employee theft.  The insured tendered a claim for the remaining amount under its errors and omissions policy.  The insurer denied coverage, and the insured brought a breach of contract suit.  The court granted the insurer’s motion to dismiss, determining that the controller’s theft fell squarely within the commingling exclusion.

The policy’s commingling exclusion consisted of two prongs:  The first precludes coverage for claims “based upon or arising out of any actual or alleged commingling of . . . funds,” and the second precludes coverage for claims “based upon or arising out of any actual or alleged . . . inability or failure to safeguard funds.”  The insurer argued that both prongs applied because the insured’s controller commingled funds with her personal account, and the insured failed to safeguard the client accounts from the controller’s theft.  The court agreed, holding that each prong of the commingling exclusion independently and unambiguously barred coverage.

The court rejected the argument that the exclusionary language applied only to the commingling of client funds with the company’s own funds.  Under North Dakota law, when used in an exclusion  “arising out of” is interpreted broadly to mean “causally connected with,” and therefore the identity of the actor that commingled the funds was irrelevant.  Further, the court noted that the deliberate acts exclusion contained an innocent insured exception, but no such qualifier was placed upon the commingling exclusion.  Reading the policy as a whole, the court concluded based on its plain language that the commingling exclusion turned on the nature of the conduct triggering the claim, not who caused the loss, and precluded coverage for any claims tied to commingling activities carried out by anyone.


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