Embezzling Payroll Service Providers Were “Employees” of Insured, Triggering Crime Coverage

A federal district court in North Carolina has granted an insured’s motion for summary judgment, holding that it was entitled to coverage under its crime policy for embezzlement by its payroll service provider because the payroll service provider constituted an “employee” under the terms of the policy.  Colony Tire Corp. v. Federal Ins. Co., 2016 WL 6683590 (E.D.N.C. Nov. 14, 2016).

The insured, an automotive parts and service retailer, retained a service provider to handle its payroll and taxes beginning in 2002.  In 2014, the insured discovered that the service provider’s two founders, sole owners, and managers had embezzled from clients, including the insured.  The insured sought coverage under a commercial crime coverage part for nearly $500,000 in loss due to the embezzlement.  The insurer denied coverage, and the insured sought a declaratory judgment that its loss was covered by the policy.

The court held that the service providers’ founders were “employees” under the policy, triggering coverage under the employee theft insuring clause, because “employee” was defined to include “any contractual independent contractor.”  The policy specified that a “contractual independent contractor” must be (1) a natural person; (2) while in the regular service of an organization in the ordinary course of such organization’s business; (3) pursuant to a written contract for services between such organization and either the natural person or any other entity acting on behalf of the natural person.

The insurer argued that the individuals who had embezzled the funds from the insured were not “contractual independent contractors” because, in forming its contract with the insured, the service provider entity was not “acting on behalf of” the individuals.  The insurer contended that under North Carolina law, a corporation could only act through its agents, and not on behalf of them.  The court held that, while it is true that a corporation may only act through its agents, it does not follow that a corporation cannot also act on their behalf, noting that the policy language defining contractual independent contractors clearly contemplates that an entity may act on behalf of an individual.  The court concluded that, because the individuals who had embezzled were “contractual independent contractors” and therefore “employees” under the policy, the policy applied to the embezzlement claim.