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Note: From 2003, Tesoro Refining and Marketing Company, L.L.C. (Seller) sold fuel on credit to Enmex Corporation (Third Party Purchaser). In 2005, Seller’s employee, Calvin Leavell (Employee) supervised Third Party Purchaser's unsecured account which at that time had a credit limit of USD 25,000,000. When auditors and consultants questioned the growing balance of the account, Employee represented that the account was secured by a USD 12,000,000 standby letter of credit although it was not. Shortly afterwards, Employee created and saved a false standby on the Tesoro server. In January 2008, Employee modified the standby to reflect an increase to USD 24,000,000. By March 2008, Third Party Purchaser's balance had grown to USD 59,000,000 in credit. In May 2008, Employee created and saved a security agreement that falsely appeared to have been executed by Third Party Purchaser in January 2008. The credit balance continued to grow, and when the previous false letters of credit expired in September 2008, Employee forged a new USD 24,000,000 false letter of credit, and a PDF version was submitted with a Bank of America (Bank) logo and a bank representative's signature forged. By December 2008, Third Party Purchaser's balance was USD 90,000,000. Seller then presented the false letter of credit to the Bank, demanding payment. Bank responded that the standby was not valid. Seller ceased sales to and sued Third Party Purchaser for breach of contract and fraud. The parties settled the lawsuit.

Seller then claimed “Employee Theft” loss under its USD 15,000,000 commercial crime policy issued by National Union Fire Insurance Company of Pittsburgh, Pennsylvania (Insurer). When Insurer denied coverage, Seller sued Insurer for breach of contract and bad faith. The lawsuit was transferred from the United States District Court for the Central District of California to the U.S. District Court for the Western District of Texas. The Texas Court granted Insurer's motion for summary judgment and denied Seller's motion for partial summary judgment on the coverage issue. Seller then appealed. On appeal, the U.S. Court of Appeals for the Fifth Circuit, in an opinion by Southwick, J., affirmed summary judgment for Insurer, ruling that the commercial crime policy did not cover Seller's losses from alleged acts of forgery by its Employee.

The appellate court first addressed the proper interpretation of the “Employee Theft” provision in the commercial crime policy. The specific insuring agreement of Insurer’s policy states:

“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. For the purposes of this insuring agreement, “theft” shall also include forgery.”

“Theft” was defined by the policy as “the unlawful taking of property to the deprivation of the Seller.” Seller claimed the sentence addressing forgery covered losses from any employee forgery, independent of any “unlawful taking,” and that the language “shall also include” expands the definition of “theft” to include “something new and different,” namely forgery. Insurer argued the “Employee Theft” agreement always requires that a theft, an “unlawful taking” has occurred. The court concluded the word “include” simply means a forgery within the category of “theft” is also covered, but does not cover a forgery completely distinct from “theft.” The appellate court viewed the disputed sentence – “‘theft’ shall also include forgery” – as beginning with a defined term, followed by an undefined term and held that the fact “theft” was already defined prevented the expansion of the definition to include forgery. The court reasoned from the sentence that a forgery that leads to “theft” is covered, but not simply any employee forgery, as Seller had claimed. The court agreed with Insurer’s interpretation that employee theft effectuated by forgery is covered under the policy. It also found that to exclude all employee forgery involving commercial paper from the “Forgery or Alteration” insuring agreement, only then to include all kinds of employee forgery under “Employee Theft” as Seller contended would be unreasonable.

The appellate court concluded that Seller was only eligible for coverage under the policy if it could show that an “unlawful taking” occurred. The trial court had granted summary judgment for Insurer because Seller failed to create a genuine dispute of material fact as to whether Employee committed an “unlawful taking,” which the trial court defined as “the act of seizing or otherwise exercising control over an article such that possession or control of the article is transferred without the owner’s authorization or consent.” The trial court determined Seller’s loss of property was the credit extended to Third Party Purchaser.

The appellate court, for the purpose of analysis, simply referred to Seller’s sale of the fuel as the loss. Seller argued that any act qualifying as theft under Texas criminal law is “unlawful taking” and that Employee committed theft by deception. Insurer accepted the district court’s definition of “unlawful taking,” noting that Texas Penal Code defines theft by deception as having occurred when one “unlawfully appropriates property with intent to deprive the owner of property,” and that property is unlawfully appropriated when “it is without the owner’s effective consent.” The appellate court reviewed Texas criminal case law to determine what constitutes theft by deception. Under Texas case law, it noted that theft by deception requires “that the owner of the misappropriated property was induced to consent to its transfer because of [the] deceptive act of the” wrongdoer. The appellate court concluded that those who consent to the transfer must be aware of the deceptive representation in order to be induced by it. Inducement also requires that the decision-makers would have acted differently if they knew the truth. The deception needs to be at least a “substantial or material factor in the decision-making process.”

The appellate court stated that for the deception to have induced its consent, Seller needed to show that the forged documents were a “substantial or material factor” in its decision to continue selling fuel to Third Party Purchaser. In its opinion, Seller failed to explain how the forged letters of credit and security agreement induced Seller to continue such sales; Seller’s evidence showed at best that Employee mentioned the forged security documents to outside auditors, a Seller consultant, a CFO, and the Treasurer, but failed to prove how these communications affected the decision to continue selling fuel to Third Party Purchaser. In addition to Seller’s lack of evidence to support its case, the fact that sales to Third Party Purchaser continued for the month between the expiration of the first forged letters of credit and the Employee’s creation of a new one led the appellate court to reason that Seller would not have acted differently even if it had known the letters of credit were forged and valueless. The appellate court ruled that Seller cannot survive summary judgment because Seller cannot prove a theft by deception had occurred.

[AWL]

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