Wisconsin Supreme Court Provides Sobering Lesson on the Limits of Standard Commercial Crime Policies
Say you’re a business owner who makes the troubling discovery that you have been victimized in an elaborate fraud scheme. One of your vendors has been submitting invoices accompanied by falsified “delivery tickets,” which included forged signatures of your employees, stating that non-existent supplies were delivered. It turns out that this scheme has spanned some period of time and cost you hundreds of thousands of dollars before discovery. Fortunately, you think to yourself, you have a standard Commercial Crime policy that contains a “forgery or alteration” provision which must surely encompass losses arising from a forged signature on a delivery ticket backing up fraudulent invoices you have been paying. As it happens, your assumption about coverage would be wrong at least according to a very recent decision by the Wisconsin Supreme Court. This update will explain why, and what you should consider doing about it.
Facts and Holding of the Case
In Leicht Transfer and Storage Co. v. Pallet Central Enterprises, Inc., 2019 WI 61, the Wisconsin Supreme Court considered the scenario sketched out above. Leicht Transfer and Storage Co. (“Leicht Transfer”) purchased pallets on an ongoing basis from a company called Pallet Central Enterprises Inc. (“Pallet Central”). In the course of this relationship, it came to light that Pallet Central had, in fact, frequently invoiced Leicht Transfer for pallets that had neither been ordered nor delivered. To perpetuate this fraud, Pallet Central created fake delivery tickets, which were a standard part of the invoicing procedure, and forged the signatures of Leicht Transfer’s employees attesting that pallets had been delivered. The delivery tickets with the forged signatures were presented, along with the invoices, to Leicht Transfer for payment. With this seemingly solid back up in place Leicht Transfer paid the invoices.
The insurance policy in the case was a commonly used standard commercial crime policy that included a provision providing coverage for “forgery or alteration.” It said:
We will pay for loss resulting directly from Forgery or alteration of checks, drafts, promissory notes, convenience checks, HELOC checks, or similar written promises, orders or directions to pay a sum certain in Money that are:
(i) Made or drawn by or drawn upon You; or
(ii) Made or drawn by one acting as Your agent; or that are purported to have been so made or drawn.
Leicht Transfer argued that the falsified delivery tickets containing the forged signatures of Leicht Transfer employees constituted a “direction to pay a sum certain” per the policy language when accompanied by an invoice and, therefore, triggered coverage under the crime policy. A majority of the Supreme Court ruled that this, in fact, did not rise to the level of a “direction to pay,” as there was no direction at all on the forged delivery ticket, and that even when bundled with an invoice there was a mere “request to pay.” With the “direction to pay” element missing, the Court had no need to delve further into the coverage analysis.
Justice Ann Walsh Bradley filed a lone dissent, noting that the delivery ticket was “functionally” the same as a direction to pay. Invoking the oft-employed “If It Walks like a Duck” rationale to point out that to a reasonable insured, the policy would provide coverage for what was treated by the parties as a “direction to pay.”
Justice Bradley’s dissent was accurate that “functional equivalents” can, and have in prior cases, sufficed to meet an element necessary to show that a loss was covered under the policy. Indeed, to a reasonable insured the distinction between a “request to pay” and a “direction to pay” seems quite thin. However, there are other problems with coverage in this case that makes the result understandable. For starters, there is a difference between a delivery ticket where the actual forgery occurred and the invoice where it did not—and the invoice is the only document that could actually be characterized as a “direction to pay.” Moreover, other elements in the coverage grant would also seem to negate any intent that it was designed to cover a forgery in something other than a negotiable instrument. The title of the coverage part was “Checks,” suggesting that it was a forged check or similar type of negotiable instrument that would be the subject of coverage. In addition, the actual language of the coverage grant required, in addition to there being a “direction to pay a sum certain,” that the instrument be “made or drawn by or drawn upon” the insured or its agent, and it is hard to see how a delivery ticket could be so characterized. “Made or drawn by or drawn upon” is the language of negotiable instruments and it is not unreasonable to suggest that a business person would view such language as pertaining to a negotiable instrument rather than just any type of document that was in some form part of an attempt to obtain payment.
So the result here is not surprising. But this case still bears mention because it underscores the very limited nature of coverage under a standard crime policy. We have seen a number of instances in our practice where clients have faced various types of fraudulent schemes that they believe to be insured, only to learn upon review of the policy that they are not. This is largely due to the very narrow language of a standard crime policy, which is quite specific in what the policy covers and does not often allow much room to maneuver in interpretation. These policies invariably contain a series of different types of coverage parts, including coverage for Computer Fraud, Funds Transfer Fraud, Employee Theft, Credit Card Fraud, Premises Theft, Forgery, etc., and each coverage part has very specific and limiting elements that must be met before coverage will exist.
Leicht Transfer illustrates these limits and highlights a real gap in coverage, particularly when vendors or contractors, as opposed to employees, perpetrate a fraud on a business. With outsourcing of critical tasks becoming commonplace in modern business, vendors or contractors may have access to a company’s financial records and accounts and are well-positioned to perpetrate fraud. Yet, the standard crime policy provides no direct coverage for vendor or contractor fraud.
Certain potential workarounds exist to protect your business from vendor-perpetrated fraud. First, when placing this coverage, consider asking for so-called “agency coverage” or an “agents coverage endorsement,” which essentially expands the definition of employees to include vendors and employees to bring them within coverage under the employee theft coverage part of the commercial crime policy.
Alternatively, insist that a vendor or contractor purchase a fidelity bond which contains “theft of client property” coverage endorsement covering your company’s assets and listing your business as a loss payee. The vendor’s fidelity bond should also expand the definition of employees to include contract employees or independent contractors to the extent the vendor uses either in your business.
These measures could provide certain protections that are currently lacking in the standard crime policy for vendor fraud. From a risk management standpoint it is important that insureds understand this type of policy and make sure that the risks that it covers are risks that they actually face in connection with their business. It is also important for insureds to realize that insurance is never a substitute for sound accounting and internal controls. In fact, having adequate controls in place may be a prerequisite to obtaining expanded coverage, such as agency coverage, in a commercial crime policy.
For more information on standard commercial crime insurance policies, please contact your Quarles & Brady attorney or a member of our Insurance Recovery Team: