Pacific Enterprises v. Federal Insurance

Ninth Circuit

Pacific Enterprises v. Federal Insurance

18 F. App'x 626

Court of Appeals for the Ninth Circuit·Decided September 7, 2001·No. No. 99-56309; D.C. No. CV-94-00838-ABC·Published

Opinions

MEMORANDUM

Footnotes

*

Pacific Enterprises and its subsidiaries were covered under Federal Insurance Company’s crime policy during the relevant period from May 21, 1990 to May 21, 1991. The policy limit was $25 million, with a $500,000 deductible, and it provided fidelity insurance. Fidelity insurance is insurance against loss of money or securities caused by the theft or forgery by identifiable employees of the insured. The employee theft provision in the policy covered “direct losses of Money, Securities and other property caused by Theft or forgery by any identifiable Employee(s) of any Insured.” The depositors forgery coverage provision provided that Federal “shall be liable for direct losses caused by forgery or alteration of, on, or in any check, draft, promissory note, bill of exchange or similar written promise, order or direction to pay a sum certain in money, made or drawn by, or drawn upon the [628] insured.” The depositors forgery coverage excluded forgery committed by an employee, which is defined as a person in regular the service of the insured, or someone in collusion with an employee. The policy also stated that Federal was not liable for a loss sustained by one insured to the advantage of any other insured.

In 1985, Thrifty Corporation, a subsidiary of Pacific, permitted FTM Sports Corporation, a majority-owned subsidiary of Thrifty, to use, first, Thrifty’s letter of credit facility, and then, a facility that Thrifty arranged in FTM’s name at Bank of America. Under these arrangements, FTM would submit letter of credit applications through Thrifty and would have four to six months to cover its obligations. When Thrifty created FTM’s own facility, it also established an FTM “sweep” account at Bank of America to handle a variety of FTM’s financing needs, including advances to pay FTM’s letter of credit obligations to Bank of America. Under this system, at the end of each business day, Thrifty’s “concentration account” automatically deposited funds into FTM’s sweep account to cover drafts or withdrew excess funds deposited in the account.

In April of 1991, Pacific discovered accounting irregularities at FTM. After investigating, it discovered that Robert J. Miller, FTM’s president, engaged in fraud. Specifically, Miller would apply to Bank of America for letters of credit ostensibly for the purchase of inventory from two other corporations to which he had ties, Cactus Golf and Sports Marketing, Inc. Miller then prepared false invoices and other documents using the signatures of Cactus’s and Sports Marketing’s principals so that it would appear that goods had shipped even though no inventory really changed hands. He then presented the false invoices to Bank of America, who issued a corresponding draft in favor of Cactus or Sports Marketing. The drafts were deposited in Cactus or Sports Marketing’s accounts, to which Miller had access, several months before FTM was obligated to repay Bank of America. The parties dispute the ultimate destination of the funds, but agree that some of the funds were funneled back to the FTM sweep account and then t'o Thrifty.

Miller was convicted in Florida of forging and negotiating bills of lading in interstate commerce, and the district court in the criminal case made a finding that Miller caused a loss to Thrifty of $39 million. FTM and Thrifty also successfully sued Miller civilly for RICO violations, fraud, conspiracy to commit fraud, breach of fiduciary duty, professional negligence, negligent misrepresentation, and violating the criminal practices act. The district court in that case found they had losses of $39 million.

Pacific reported its loss to Federal in April of 1991 and submitted its formal proof of loss in January of 1992. Federal declined coverage for the depositors forgery claim on the ground that altered financial statements are not orders to pay money and that there was no direct loss of money or securities, which are both required by the Federal policy. Federal declined coverage for the employee theft claim on the grounds that there was no theft loss, and since FTM was not an insured and the thief was its employee, there was no theft by an employee of the insured. After the denial of coverage, Pacific sued for breach of contract, for breach of implied covenant of good faith and for declaratory relief.

The district court (1) granted partial summary judgment to Federal on Pacific’s employee theft claim because Pacific failed to meet its burden of establishing specific facts from which a jury could infer their [629] loss was caused by the theft of the letter of credit proceeds; (2) held that there were no issues of material fact as to the bad faith and punitive damages issues; (3) denied Pacific’s motion for partial summary judgment holding that Federal raised a genuine issue of fact as to whether Pacific made reasonable efforts to mitigate its damages; (4) issued an order granting summary judgment as to the depositors forgery coverage in favor of Federal; and (5) held that Pacific failed to raise a genuine issue of material fact as to whether the funds Bank of America advanced in response to the forged letters of credit directly caused the $42.5 million net increase in the FTMTThrifty concentrated account.

A. Pacific’s Loss

We review a grant of summary judgment or partial summary judgment de novo.² Viewing the evidence in the light most favorable to the nonmoving party, we must determine whether there are any genuine issues of material fact and whether the district court correctly applied the relevant substantive law.³ If the nonmoving party has the burden of proof at trial, the moving party may show that no reasonable trier of fact could fail to find for it by demonstrating that there is an absence of evidence to support the nonmoving party’s case.⁴

Pacific argues that there is a genuine issue of material fact as to whether it suffered a loss. The district court held that Pacific had the burden of proving the amount of its loss because that is the law in general liability insurance cases. However, it is often difficult to know the amount of an employee’s misappropriations, and as California has noted, “[t]he fact alone that it is difficult, and perhaps impossible, to reach an accurate accounting, should not deprive the insured of all relief.”⁵ That the insured kept faulty books just goes to the weight of the evidence, but does not necessarily prevent it from proving its loss.⁶ Consequently, even though the legitimate sweep/concentration account system Thrifty employed made it impossible to trace the proceeds from the fraudulent letters of credit, this should at most go to the weight of Pacific’s evidence, not function as a bar to its claims.

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MEMORANDUM

Footnotes

*

Pacific Enterprises and its subsidiaries were covered under Federal Insurance Company’s crime policy during the relevant period from May 21, 1990 to May 21, 1991. The policy limit was $25 million, with a $500,000 deductible, and it provided fidelity insurance. Fidelity insurance is insurance against loss of money or securities caused by the theft or forgery by identifiable employees of the insured. The employee theft provision in the policy covered “direct losses of Money, Securities and other property caused by Theft or forgery by any identifiable Employee(s) of any Insured.” The depositors forgery coverage provision provided that Federal “shall be liable for direct losses caused by forgery or alteration of, on, or in any check, draft, promissory note, bill of exchange or similar written promise, order or direction to pay a sum certain in money, made or drawn by, or drawn upon the [628] insured.” The depositors forgery coverage excluded forgery committed by an employee, which is defined as a person in regular the service of the insured, or someone in collusion with an employee. The policy also stated that Federal was not liable for a loss sustained by one insured to the advantage of any other insured.

In 1985, Thrifty Corporation, a subsidiary of Pacific, permitted FTM Sports Corporation, a majority-owned subsidiary of Thrifty, to use, first, Thrifty’s letter of credit facility, and then, a facility that Thrifty arranged in FTM’s name at Bank of America. Under these arrangements, FTM would submit letter of credit applications through Thrifty and would have four to six months to cover its obligations. When Thrifty created FTM’s own facility, it also established an FTM “sweep” account at Bank of America to handle a variety of FTM’s financing needs, including advances to pay FTM’s letter of credit obligations to Bank of America. Under this system, at the end of each business day, Thrifty’s “concentration account” automatically deposited funds into FTM’s sweep account to cover drafts or withdrew excess funds deposited in the account.

In April of 1991, Pacific discovered accounting irregularities at FTM. After investigating, it discovered that Robert J. Miller, FTM’s president, engaged in fraud. Specifically, Miller would apply to Bank of America for letters of credit ostensibly for the purchase of inventory from two other corporations to which he had ties, Cactus Golf and Sports Marketing, Inc. Miller then prepared false invoices and other documents using the signatures of Cactus’s and Sports Marketing’s principals so that it would appear that goods had shipped even though no inventory really changed hands. He then presented the false invoices to Bank of America, who issued a corresponding draft in favor of Cactus or Sports Marketing. The drafts were deposited in Cactus or Sports Marketing’s accounts, to which Miller had access, several months before FTM was obligated to repay Bank of America. The parties dispute the ultimate destination of the funds, but agree that some of the funds were funneled back to the FTM sweep account and then t'o Thrifty.

Miller was convicted in Florida of forging and negotiating bills of lading in interstate commerce, and the district court in the criminal case made a finding that Miller caused a loss to Thrifty of $39 million. FTM and Thrifty also successfully sued Miller civilly for RICO violations, fraud, conspiracy to commit fraud, breach of fiduciary duty, professional negligence, negligent misrepresentation, and violating the criminal practices act. The district court in that case found they had losses of $39 million.

Pacific reported its loss to Federal in April of 1991 and submitted its formal proof of loss in January of 1992. Federal declined coverage for the depositors forgery claim on the ground that altered financial statements are not orders to pay money and that there was no direct loss of money or securities, which are both required by the Federal policy. Federal declined coverage for the employee theft claim on the grounds that there was no theft loss, and since FTM was not an insured and the thief was its employee, there was no theft by an employee of the insured. After the denial of coverage, Pacific sued for breach of contract, for breach of implied covenant of good faith and for declaratory relief.

The district court (1) granted partial summary judgment to Federal on Pacific’s employee theft claim because Pacific failed to meet its burden of establishing specific facts from which a jury could infer their [629] loss was caused by the theft of the letter of credit proceeds; (2) held that there were no issues of material fact as to the bad faith and punitive damages issues; (3) denied Pacific’s motion for partial summary judgment holding that Federal raised a genuine issue of fact as to whether Pacific made reasonable efforts to mitigate its damages; (4) issued an order granting summary judgment as to the depositors forgery coverage in favor of Federal; and (5) held that Pacific failed to raise a genuine issue of material fact as to whether the funds Bank of America advanced in response to the forged letters of credit directly caused the $42.5 million net increase in the FTMTThrifty concentrated account.

A. Pacific’s Loss

We review a grant of summary judgment or partial summary judgment de novo.² Viewing the evidence in the light most favorable to the nonmoving party, we must determine whether there are any genuine issues of material fact and whether the district court correctly applied the relevant substantive law.³ If the nonmoving party has the burden of proof at trial, the moving party may show that no reasonable trier of fact could fail to find for it by demonstrating that there is an absence of evidence to support the nonmoving party’s case.⁴

Pacific argues that there is a genuine issue of material fact as to whether it suffered a loss. The district court held that Pacific had the burden of proving the amount of its loss because that is the law in general liability insurance cases. However, it is often difficult to know the amount of an employee’s misappropriations, and as California has noted, “[t]he fact alone that it is difficult, and perhaps impossible, to reach an accurate accounting, should not deprive the insured of all relief.”⁵ That the insured kept faulty books just goes to the weight of the evidence, but does not necessarily prevent it from proving its loss.⁶ Consequently, even though the legitimate sweep/concentration account system Thrifty employed made it impossible to trace the proceeds from the fraudulent letters of credit, this should at most go to the weight of Pacific’s evidence, not function as a bar to its claims.

Pacific showed that $92 million were funded under the forged letter of credits, that FTM had a $42 million intercompany debt, and that Miller was convicted of fraud totaling $39 million. And it showed that a criminal court finding established that Miller caused a $39 million loss to Thrifty, as did a civil judgment. Though not res judicata, these judgments are evidence of which judicial notice may be taken. Pacific does not have to prove the éxaet amount of its loss to preclude summary judgment. Its evidence established a genuine issue of fact that the fraud caused Pacific an actual loss in excess of its deductible, $500,000.

Pacific met its burden to survive summary judgment by showing that there was a theft in excess of $500,000. Pacific’s actual loss was less than the amount sto[630] len.⁷ We therefore reverse the district court’s grant of summary judgment against Pacific as to its loss.

B. Pacific’s bad faith and punitive damages claims

Pacific also argues that there is a genuine issue of material fact as to whether Federal acted in bad faith and should pay punitive damages. “In order to establish a breach of the implied covenant of good faith and fair dealing under California law, a plaintiff must show: (1) benefits due under the policy were withheld; and (2) the reason for withholding benefits was unreasonable or without proper cause.”⁸ Negligence does not constitute unreasonable behavior, and consequently, does not establish a breach of the implied covenant of good faith and fair dealing.⁹ If the defendant can show that there was a genuine dispute as to coverage, a district court may dismiss a bad faith claim on summary judgment.¹⁰

This case does not involve a factual or legal situation where any insurer acting in good faith would pay the claim. Instead, it presented complicated issues that Federal genuinely disputed after a complete investigation by its adjustor and a team of accountants and lawyers. Pacific’s evidence does not establish a genuine issue of fact as to whether Federal’s denial of the claim was made in good faith.

“To justify an award of punitive damages, the defendant must be guilty of oppression, fraud, or malice. It must act with intent to vex, injure, or annoy, or with a conscious disregard of plaintiffs rights.”¹¹ There is no evidence of such behavior here.

C. Duty to Mitigate

Pacific argues further that the district court erred in finding that there was a genuine issue of material fact as to whether it had to mitigate its losses. In cases involving notice provisions of fidelity insurance policies, California courts have held that the insured only has to give notice if it knows of the loss, not if it did not know but could or should have known.¹² Mere suspicion is not sufficient [631] to qualify as a discovery of dishonest acts.¹³ Similarly, an insured is not required to mitigate its losses before it is aware of them, and a failure to investigate suspicious facts should not raise a duty to mitigate that, if not met, effectively terminates policy coverage. Casualty insurance insures against the insured’s own negligence, and neither the duty to give notice nor the duty to mitigate can turn a coverage case into a negligence case directed at the insured’s conduct before it knew of the theft. We therefore reverse the district court’s denial of Pacific’s summary judgment as to Pacific’s duty to mitigate.

D. Burden of proof for the employee exclusion

The policy’s depositors forgery clause has an exclusion for employees, and Pacific argues that the burden of proof is on Federal to establish the applicability of the exclusion. California law is clear that the insurer bears the burden of bringing itself within any exculpatory clause contained in the policy.¹⁴ Thus, Federal bears the burden to prove a factual basis for the employee exclusion.

AFFIRMED IN PART, REVERSED IN PART.

This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by Ninth Circuit Rule 36-3.