On Monday, a Nevada federal court held that U.S. Fire Insurance Co. (“U.S. Fire”) need not cover its insured, CP Food and Beverage, Inc. (“CP”), a strip club, under its commercial crime policy for a scheme perpetrated by its own employees that resulted in the theft of money from CP customers. A copy of the decision can be found here.

CP operated a Las Vegas Strip club known as Paradise, where customers could buy “funny money” to tip waitresses and dancers. The employees would then turn in the funny money to their employer in exchange for cash.  Between November 2013 and May 2014, employees of CP overcharged customer credit cards by charging customers multiple times for the same bill, as well as charging for bottles of alcohol and funny money that were never purchased.  The unpurchased funny money was then exchanged for cash.  The scheme was discovered following multiple complaints and credit card disputes.  In response to contractual requirements with credit card companies and in agreement with law enforcement, CP paid chargebacks to the customers’ credit cards in an amount totaling $768,617.91, in addition to hundreds of thousands of dollars expended in investigative fees.

CP sued U.S. Fire after it denied CP’s claim to recover the credit card chargebacks and professional fees. U.S. Fire argued in a motion for summary judgment that its policy did not cover the fraud because the employees stole money from CP’s customers as opposed to CP.  Additionally, because CP returned the stolen money as a form of restitution, CP’s loss was not “directly caused” by the theft.  CP argued that the employees did in fact steal from CP when the employees exchanged the funny money for cash.  Further, CP reasoned that because CP had to reimburse for credit card charges, the employees stole from CP.

The court agreed with U.S. Fire. In its analysis, the Court applied the “direct means direct” rule when determining whether or not CP’s loss resulted directly from the employees’ scheme.  Under the rule, the scheme would only be covered if CP suffered a loss of its own funds or other property for which it is responsible through direct means, and absent any intervening steps.

In deciding that the loss was not “direct,” the court reasoned that the loss was contingent on the occurrence of a series of events that were not inevitable, and further stated that “if the customers never discovered the fraudulent charges or chose not to dispute them, CP would not have suffered the loss it now claims.” Moreover, Judge Gordon determined that the policy was not designed to cover CP for liability to third parties for its vicarious liability caused by its employees’ theft of its customers’ property as opposed to its own.  The court found this analysis to be consistent with CP’s reasonable expectations of coverage.  The Court similarly determined that CP’s investigative costs did not directly result from the employees’ theft but instead were a product of CP’s attempt to investigate the claims and support its insurance claim.

The decision highlights the importance of ensuring that policies clearly define appropriate scopes of coverage that are logically tailored to the insured business and the risks at hand. The decision also underscores the importance of eliminating unnecessarily restrictive or limiting policy provisions, which could be applied to negate expected coverage.  Finally, the decision is a reminder to ensure that multiple lines of coverage complement one another so that gaps in coverage are minimized or eliminated.