In Keybank National Association v. National Union Fire Ins. Company of Pittsburgh, PA, an interesting decision was issued by the New York Appellate Division, First Department recently in which the court considered whether the lower court erred in denying summary judgment to a fidelity bond insurer on a coverage claim. The decision involved questions of what constitutes “manifest intent”, within the meaning of the fidelity bond, to cause the insured to sustain a loss, or create a benefit for oneself so as to trigger coverage as applied to a claim in which the insured bank’s employee diverted $5 million directly to a condominium developer/borrower. The money was supposed to go towards paying down the $20 million the bank had loaned.
In explaining the concept of “manifest intent”, the court described a continuum of conduct. On one end of the spectrum, with embezzlement, which would be entitled to fidelity coverage, the employee “necessarily intends to cause the employer the loss.” On the other end of the spectrum, which would not trigger fidelity coverage, the employee’s dishonesty is an attempt to benefit the employer. The court explained that “manifest intent” exists as a matter of law if it can be established that the employee acted with “substantial certainty” that his dishonesty and misconduct will cause his employer to incur a loss.
Here, the insurer argued that there was no “manifest intent” within the meaning of the bond because the evidence showed the employee, who created the loss by allowing the developer/borrower to receive payments on condo units without using the proceeds to pay down the loan, intended to allow the borrower to obtain the funding necessary to complete the project, which would have actually prevented the bank from sustaining a loss. Further, there was no evidence that the employee personally benefited from the diversion of funds.
The Appellate Division ultimately upheld the lower court’s decision denying summary judgment because there was an issue of fact as to whether the employee’s diversion of checks to the developer without using proceeds to pay down the loan demonstrated his “manifest intent” to harm Keybank. However, in reaching this decision, the court also noted that coverage would be triggered under the fidelity bond if it could be shown that the diversion of checks “manifested an intention to obtain a financial benefit for another person or entity.” In this regard, there was conflicting testimony regarding the cash flow from the lien releases and there was a lack of other evidence establishing whether anyone had obtained a financial benefit from the employee’s actions. By the same token, the Court found an issue of fact as to whether this scheme directly caused the bank to suffer a loss.
This decision is interesting because the court showed a willingness to examine the transaction as a whole in deciding whether the employee demonstrated the “manifest intent” required by the policy. In other words, the employee’s obvious intention to divert money from the bank to the developer did not in and of itself reflect his intent to cause the bank to sustain a loss. The court considered that in executing the diversion, the employee might have actually intended the bank to avoid a loss it would have incurred had the project lost its funding. Thus, when examining “manifest intent”, it is not enough, alone, to look at the conduct of the employee. One must also consider whether there is evidence that the employee engaged in such conduct for the purpose of causing a loss or to obtain a financial gain. Absent a clear showing of this purpose, such as in an embezzlement scheme, insureds will face an uphill battle in obtaining summary judgment in declaratory judgment actions.