In its recent decision in National Reimbursement Group Inc. v. Gemini Ins. Co., 2013 U.S. Dist. LEXIS 118435 (M.D. Ga. Aug. 21, 2013), the United States District Court for the Middle District of Georgia had occasion to consider whether a company insured under a professional liability policy was entitled to coverage for a claim arising out of embezzlement of client funds committed by one of its employees.
Gemini Insurance Company insured National Reimbursement Group (“NRG”) – a medical billing and collection service company – under a professional liability policy. Sometime during the policy period, NRG received notice from the U.S. Department of Health and Human Services that it was undertaking an investigation into whether a former NRG employee diverted medical insurance checks intended for a client of NRG’s into her own personal bank account. NRG sought coverage for the investigation, but Gemini disclaimed coverage. NRG’s client subsequently filed suit, seeking repayment of the diverted funds. Gemini did not provide coverage for this suit either. NRG ultimately settled with the client for approximately $134,000 and then filed a declaratory judgment action against Gemini. Gemini moved to dismiss NRG’s complaint, arguing that the conduct alleged did not qualify as a wrongful act (defined by the Gemini policy as “any negligent or unintentional breach of duty imposed by law, or Personal Injury, committed solely in the rendering of Professional Services by an Insured”) or that coverage was precluded based on various exclusions.
The parties disputed what conducted should be considered the “wrongful act” for the purpose of analyzing coverage. NRG contended that the wrongful act was its own negligent supervision of its dishonest employee while Gemini contended that the wrongful act was the employee’s intentional diversion of client funds, which by its very nature could not be considered a negligent or unintentional breach of a duty. Gemini further argued that negligent supervision of an employee did not fall within the policy definition of wrongful act because NRG’s obligations to its client with respect to the stolen funds arose out of a contract, and its breach of the contractual relationship could not be considered a “breach of a duty imposed by law.” The court rejected Gemini’s arguments, observing that (a) failure to supervise could be considered the wrongful act since employers have a reasonable duty of care in supervising their employees, and (b) the existence of a contract between NRG and its client did not preclude NRG from breaching a duty imposed by law. With respect to the latter point, the court reasoned that Gemini’s interpretation would essentially be render coverage under the policy illusory since NRG, presumably, had a contract with each of its clients.
While the court held that the underlying conduct qualified as a wrongful act in the first instance, it agreed with Gemini that coverage was barred based on an exclusion applicable to claims arising out of any actual or alleged criminal, fraudulent, dishonest, or knowingly wrongful act or omission committed by or with the knowledge of any insured. The policy specifically defined the phrase “arising out of” to mean “connected to, incidental to, originating from or growing out of, directly or indirectly resulting from.” Looking to Georgia case law construing this phrase in the context of similar exclusions, the court concluded that the test for whether a claim “arises out of” the prohibited conduct is a “but for” test, that requires the court to look to whether the claim would exist in the absence of the prohibit conduct. In applying this analysis, the court agreed that the underlying negligent supervision claim was barred from coverage since the claim “would not exist but for, and therefore arises out of, [the employee’s] embezzlement.”
In reaching its conclusion, the court considered NRG’s argument that the exclusion did not apply since the individual employee did not qualify as an insured when diverting client funds for her own use, since in doing so, she was operating outside the scope of her employment. The court rejected this argument, noting that while creative, it was clear that the employee was engaged in billing practices and thus was an insured. The fact that she embezzled funds while engaged in those billing practices did not have the effect of changing her insured status.