Ongoing litigation between Heartland Bank (previously Marac) and Vero Liability should be of interest to both insurers and financial institutions. It provides the first significant in-depth judicial consideration in New Zealand of fidelity cover and the issues it throws up in proving dishonesty and related matters: Vero Liability Insurance Ltd v Heartland Bank Ltd [2015] NZCA 288.
Fidelity cover is a form of insurance which covers businesses against the financial fraud of their own employees. In the marketplace this kind of product is sometimes known as a fidelity bond or a bankers blanket bond (although it is not a bond, but a simple contract of insurance).
Over the relevant period one of Marac's senior managers, an employee, knowingly continued to commit the company to lending to a customer well in excess of the employee's authority, causing loss to the company. The evidence was that the employee had taken steps to disguise what he was doing, including omitting relevant information about the lending from reports submitted to the company's credit committee, instructing more junior staff to alter internal records of arrears, and failing to mention it to a close colleague in whom he usually confided about his work issues. When the situation was queried in the course of an internal audit, after making one final attempt to cover it up the situation was uncovered and the employee did not return to work.
Marac made a claim under its "Crime Insurance" policy with Vero Liability. The policy covered direct financial loss consequent on dishonest acts of employees committed with the clear intent of causing loss to the company.
One remarkable feature of this case was that there was no suggestion, or evidence presented, that the employee ever made, or intended to make, any kind of real financial gain for himself from the transactions in question. Instead, the evidence was that he continued with the unauthorised lending transactions to disguise what he was doing to avoid or at least postpone being found out and inevitably losing his job. A further remarkable feature was that the employee, who Vero Liability called to give evidence at trial ten years after the events in question, could not explain why he started the unauthorised loans in the first place. For whatever reason, he could remember very little.
Both the High Court and Court of Appeal found that the employee's conduct in continuing to make the unauthorised lending available was dishonest. The more challenging issue was whether Marac had established that the employee had acted with "clear intent" to cause loss to Marac. This was a difficult question because, as outlined, the employee's motivation did not appear to be cause any harm to the company, or obtain anything for himself. This may have been an easier question to address if the genesis of the scheme had been shown to have some malign motivation, but as already noted, this was not the evidence. Rather this aspect remained something of a historical mystery, potentially more linked to the employee lacking operational expertise and competence in managing work of the relevant kind. So, what might have begun as an incompetent mistake or error of judgment ended up turning into a dishonest scheme the employee felt he could never reveal.
The High Court held that intent to cause loss was a question of fact to be inferred from the available evidence. Knowledge that an act would result in loss was strong evidence pointing towards the required intent existing. The Court held that intent could be distinguished from desire, and the fact that an employee did not desire loss to the employer, while relevant, did not prevent a determination that intent existed for the purposes of the relevant provision of the insurance policy. In a later judgment the High Court went on to assess the quantification of the loss the insured could claim as a result.
The Court of Appeal made a different assessment of the evidence and as a result of that different assessment, it reached a different view on the intent issue. The Court noted that from a particular date onwards, the evidence was that the amounts received from the customer exceeded the sums advanced during the same period, as shown in documentary records for that period. The Court of Appeal considered that these records, and the efforts made to obtain repayments from the customer, demonstrated a concern inconsistent with a clear intent on the part of the employee to cause loss to Marac.
The Court of Appeal also considered it was relevant to the intent issue that there was no evidence of dishonesty in relation to the commencement of the lending programme and that the employee did not receive any financial advantage from the transactions, other than remaining employed (in the sense that when he was uncovered, he would inevitably be fired).
The Court of Appeal concluded that Marac had not established on the balance of probabilities that the employee had a clear intend to cause Marac loss. It therefore allowed an appeal on this issue.
The Court of Appeal's reasoning will satisfy insurers because it aligns more closely with the historical purpose and function of fidelity cover type policies. They are geared towards embezzlement by employees where the financial gain by the employee usually equates to the loss claimed by the company under the policy. Insurers would say that the wider scope suggested by the High Court judgment would need to be priced differently.
The Supreme Court website shows that Marac has applied for leave to appeal to the Supreme Court. This does not reveal the existence of any cross-appeal in relation to the Court of Appeal's confirmation of the High Court finding that the employee was dishonest for the purposes of the policy. There seems to be a reasonable case for arguing that the "clear intent" issue is of sufficient significance to be considered by the Supreme Court, because the lower Court's decision is the only New Zealand decision on point. Presumably Marac has sought to argue that it would be unsatisfactory for an incorrect decision (in its view) to regulate the way all like New Zealand fidelity policies are treated for future claims. From the point of view of legal principle and argument, this will be an attractive case for the Supreme Court to grapple with. I doubt whether any cross-appeal for leave to appeal in relation to the dishonesty issue will succeed. There was ample scope for both the trial Court and the Court of Appeal to conclude that there was dishonesty. These findings were very much of a factual nature and the Supreme Court would not be inclined to permit Vero Liability to relitigate this point. The existence of the required "clear intent" is a different matter.
The Court of Appeal also disagreed with the High Court's assessment of the quantification of the loss. That is also the subject of Marac's leave application to the Supreme Court.
Court of Appeal judgmentHigh Court judgment (liability)High Court judgment (quantum)
Steve KeallBarrister13 September 2015
Amended on 15 September 2015 to reflect that Vero Liability and not Marac called the employee as a witness at trial.