Guest Co-Author: John Tomaine

The recent decision of the U.S. District Court for the District of New Jersey in Frazier Industrial Company v. Navigators Insurance Company provides a useful example of judicial analysis of the Employee Theft coverage in the context of a bid-rigging scheme between an insured’s employee and an outside contractor.  The Court analyzed the plain wording of the Commercial Crime Policy in issue to find that, although kickbacks paid to the employee by the contractor represented a covered Employee Theft loss, the portion of the excess payments retained by the contractor was not covered.

The Facts

Frazier Industrial (“Frazier”) was a manufacturer of structural steel storage systems.  Frazier’s sales to its customers included installation services, which Frazier typically contracted out to independent contractors.  The independent contractor’s price was included in Frazier’s quote to its customer, and the customer paid Frazier for both sales and installation.  CTC was one independent contractor utilized by Frazier.

In March 2011, Frazier learned that its Vice President – Operations, identified as “JMG”, had engaged in a bid-rigging scheme with CTC whereby:

(i)         JMG identified projects with considerable profit margins;

(ii)        if CTC’s bid for the project was substantially below Frazier’s internal budget, JMG would inform CTC that it could increase its bid (and by how much), while still winning the contract; and,

(iii)       JMG approved the inflated bid and CTC would split the padded amount with JMG, after it was paid by Frazier.

Frazier alleged that the padded sums amounted to at least $1,938,000 and that, of this, JMG received over $960,000 from CTC.

The Employee Theft Coverage

Frazier maintained a Commercial Crime Policy with Navigators which contained the following Employee Theft insuring agreement:

We will pay for loss of or damage to “money”, “securities” and “other property” resulting directly from “theft” committed by an “employee”, whether identified or not, acting alone or in collusion with other persons.

“Theft” was in turn defined as “the unlawful taking of property to the deprivation of the Insured.”

Frazier contended that the entire amount of its loss was covered by the Policy, insofar as JMG had colluded with CTC in the bid-rigging scheme and Frazier had incurred a loss as a result.  Navigators’ position was that the portion of the funds retained by CTC did not constitute an unlawful taking by JMG and that, consequently, that portion of the loss did not come within coverage.

The Court held that it was necessary to first assess coverage in respect of the excess amounts paid by Frazier to CTC and then, secondly, the portion paid by CTC to JMG.  With respect to the amount paid by Frazier to CTC, the Court reviewed the case law on payments to third parties induced by dishonest employees (including Tesoro Refining, which we discussed in our April 14 post), and observed that:

Courts have generally found that payments to third-parties do not qualify as a “loss” under commercial crime policies.  This is the case even where the employer’s loss was as a result of the employee colluding with the third party.  In finding so, courts rely on the understanding that such payments are not an “unlawful taking” by the employee and are, therefore, outside the scope of the policies.  In cases where courts have found a loss under the policy, the entire transaction was a fraudulent setup by the employee and the insured never received the good or service from the third-party, thus negating the employer’s authorization.  [citations omitted]

In the Court’s view, the bid-rigging scheme, which involved the provision of actual services albeit at inflated prices, was not a fraudulent setup from the outset, and Frazier had received some benefit.  The fact that JMG exercised control over the bidding process did not change this conclusion.  Thus, the Court concluded that the excess payments to CTC did not constitute an Employee Theft loss:

Frazier bought insurance from Navigators to protect it from employee theft, not against a less favorable deal from a deceitful contractor. … Frazier does not assert that the underlying transaction was fraudulent and that the independent contractor did not perform its work. … In addition, Frazier has not argued nor demonstrated that CTC’s bids were either unreasonably priced or not the lowest for a particular job — the latter likely to be the case otherwise JMG’s choice of CTC would have raised suspicions.  Rather, Frazier set an internal budget and expected that any independent contractor it chose would make a profit on their service. As such, Frazier was not “unknowingly deprived of money.”  Consequently, the “loss” that Frazier claims here is — at its core — an inability to obtain the lowest price, and that is not a basis to raise a claim under the Crime Policy.  [citations omitted]

The Court reached a different conclusion with respect to CTC’s payments to JMG, holding that the payments to JMG were not payments to a third party and that Frazier had not consented to such payments.  The Court concluded that:

In each case, Frazier authorized a payment intended only for CTC, as compensation for the respective installation.  JMG’s scheme resulted in him receiving a portion of these payments, fraudulently profiting from compensation that Frazier did not intend for him.  Thus, the employee’s actions are no different than if he inflated the bids himself and skimmed a portion off-the-top, before forwarding the payments on to the unsuspecting contractor. … Put another way, the payment to CTC was merely a pretext for JMG to receive his share.  Consequently, the fact that JMG had the money pass through an intermediary prior to reaching his pocket does not change the fundamental nature of the employee’s actions — an “unlawful taking” — nor its effect — to the “deprivation of the insured.”  [citations omitted]

The Court briefly considered, and rejected, the application of the indirect loss exclusion to the CTC loss, holding that, on the wording of the exclusion there in issue, there was no “inability to realize income that [Frazier] would have realized had there been no loss of or damage to ‘money.’”  The exclusion might have applied, had Frazier been seeking income it could have realized from the profits taken by the employee (such as interest).  However, no such claim was advanced.


Frazier Industrial provides an example of the distinction that may be drawn between employee benefits and third-party benefits in bid-rigging and similar schemes, and demonstrates the importance of careful factual analysis of the flow of funds in a dishonest scheme involving benefit to both an employee and a third party.  The decision is also instructive in distinguishing between schemes which involve a real transaction through which the insured receives some actual benefit, and schemes which are wholly fraudulent and fictitious from the outset.

[Editors’ Note: Our guest co-author, John Tomaine, is the owner of John J. Tomaine LLC, a fidelity insurance and civil mediation consultancy in New Jersey.  After over thirty-one years with the Chubb Group of Insurance Companies, he retired as a Vice President in 2009.  He is an attorney admitted in Connecticut and New Jersey, and holds a Master’s Degree in Diplomacy and International Relations.  He is available to serve as an expert witness in fidelity claim litigation and to consult on fidelity claim and underwriting matters.]

Frazier Industrial Company v. Navigators Insurance Company, 2015 WL 8134055 (D.N.J.)