Material Misrepresentations in Application Preclude Coverage for More Than $2 Million Embezzlement

The United States Court of Appeals for the Eleventh Circuit, applying Alabama law, has held that a policy providing crime coverage does not afford coverage to an insured for its employee’s embezzlement of more than $2 million because of material misrepresentations in the policy’s application. Scottsdale Indem. Co. v. Martinez, Inc., 2015 WL 38223728 (11th Cir. June 22, 2015).

The insured is a building-maintenance company. In 2004, the insured hired an individual, who later became the insured’s CFO and CEO, to handle the company’s financial accounting, including overseeing the insured’s bank accounts. The individual was fired in 2011 after the owner of the insured company discovered that the CFO/CEO had embezzled more than $2 million from the company’s bank accounts for personal use by writing checks to herself and using the company’s petty cash for personal purchases.

The insured company sought coverage for the more than $2 million that was embezzled under a business and management indemnity policy that provided, among other things, crime coverage. The policy provided that “[i]n the event the Application . . . contains any misrepresentation or omission made with the intent to deceive, or contains any misrepresentation or omission which materially affects either the acceptance of the risk or the hazard assumed by Insurer under this Policy, this Policy, including each and all Coverage Sections, shall not afford coverage . . . for any Claim alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving, any untruthful or inaccurate statements, representations or information.” The policy further provided that this provision applies if “any past or present chief executive officer, [or] chief financial officer . . . of the [insured company] knew the facts misrepresented or the omissions, whether or not such individual knew of the Application, such materials, or this Policy.”

In applying for renewal of the policy, the insured submitted an application stating that: (i) there was an annual audit or review by a CPA of the insured’s books and accounts, including a complete verification of all securities and bank accounts; and (ii) the bank accounts were reconciled by someone not authorized to deposit or withdraw from the accounts. Because the individual who embezzled the money was the former CFO and CEO of the insured and filled out the renewal application, the insurer denied coverage for the claim based on alleged material misrepresentations in the renewal application relating to the insured’s financial accounting practices. The trial court granted summary judgment to the insurer, and an appeal followed.

On appeal, the Eleventh Circuit ruled that, while a CPA may have cursorily reviewed the insured’s books each year, as asserted by the insured, “no reasonable jury could conclude that an ‘annual audit or review performance by an independent CPA on the books and accounts, including a complete verification of all securities and bank balances’ occurred. Consequently, . . . [the CFO/CEO’s] response to [this question] was a misrepresentation.” Likewise, the court held that there was a misrepresentation with respect to the reconciling of accounts given that the embezzling CFO/CEO performed reconciliation functions and also had access to the insured’s bank accounts.

The court next held that the misrepresentations “were material to the issuance of the policy.” In this regard, the court noted that, based on the testimony of the underwriter of the policy, the insurer’s “underwriting policies assigned a higher rating factor and higher total premium where an insured answers ‘no’” to the questions at issue and that the insurer “would normally have charged an increased premium for the policy in question had [the CFO/CEO] provided correct answers about [the insured’s] accounting practices.”

Because the misrepresentations were material, the misrepresentations undisputedly were related to the claimed loss at issue, and the CFO/CEO irrefutably knew of the facts misrepresented, the court held that the policy did not afford coverage for the embezzled funds.


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