OUSTING AMBIGUITIES

Rough Notes, May 2008 by Malecki, Donald S

This case involved an auto dealership and its sales arrangement with two financial institutions. Customers seeking financing for auto purchases submitted credit applications to the dealership, which were then forwarded to one of the two lending institutions. For each approved application, the dealer would enter into an installment sale contract with the purchaser, taking a cash deposit after accepting the customer's note. The lending institution would then take an assignment of the dealer's rights under the customer's installment contract, including the security interest.

In 1998, one of the lending institutions investigated numerous credit applications that it had accepted through this arrangement. It discovered that an employee of the dealership had engaged in a number of credit application frauds to secure loans for customers who were not otherwise creditworthy. For example, some of the customers were without driver's licenses, or had fictitious licenses. Others had falsified pay stubs-which were actually the defrauding employee's own pay stubs.

Following several defaults, the lending institution filed suit against the dealership seeking to have the dealership repurchase all outstanding installment contracts that had not been paid in full. Its demand, in terms of damages, was nearly $832,000. The dealer agreed to pay the lending institution $215,000 in full settlement of the claims.

The auto dealership then sought coverage under a so-called "master pak" endorsement attached to its package policy. This endorsement provided employee dishonesty coverage for no more than $5,000 in any one occurrence. After litigation pursued, the court found that the employee defrauded the lending institution on 27 different occasions. Accordingly, the insurer owed the dealership $135,000.

Focusing on the definition of "occurrence," the insurer countered with two arguments. First, the plain language ofthat definition "limits occurrences to one per employee/ wrongdoer," thereby making the maximum payable $5,000. It contended, secondly, that an "occurrence" was not limited to a single event but, instead, to all loss arising from a "series of related acts."

The court disagreed holding, in part, that the sales did not involve "a single act or a series of related acts," but were distinct sales to separate purchasers for separate autos. Even though the defrauding employee employed similar techniques for each fraud-induced sale, the court explained, the fact remained that by virtue of the employee's conduct, the dealership was required to relinquish possession of 27 autos on 27 separate occasions to 27 distinct customers.

The court also stated that the definition of "occurrence" was not clear whether a series of acts could also include acts occurring prior to the inception of the current policy. As a result, the court held that the acts of the defrauding employee at different times were separate occurrences.

Coverage changes

It is not certain whether other insurers will follow suit, but ISO decided in 2006 that the time was ripe to amend its crime forms to eliminate the kind of adverse decisions as in the Auto Lenders Acceptance Corporation and the Sherman & Hemstreet, Inc., cases among many others.