Indirect or Consequential Loss Exclusion: Coming Of Age.

Writing in the December issue of the newsletter of the Fidelity and Surety Committee, Charles H. Witherwax of D'Amato & Lynch, New York City, discusses a recent surety victory in the Kidder Peabody-Boesky affair:

Aetna Casualty & Surety Co. v. Kidder Peabody Co., 676 N.Y.S.2d 559 (App. Div. 1st Dep't 1998), known as Kidder Peabody, has generated much interest in that it held that there was no manifest intent on the part of a Kidder Peabody employee involved in insider trading in the infamous Boesky matter to cause Kidder Peabody a loss, even though it incurred substantial liability as a result of third-party claims against it.

An important aspect

Although this case is best known for the New York Appellate Division's ruling on manifest intent, there is another, and perhaps more important, aspect. In addition to holding that the employee had no manifest intent to cause Kidder Peabody a loss, the court concluded that the loss was not covered because it did not result "directly from" any alleged dishonest activity of the employee.

The court in so ruling stated:

Nor is coverage triggered by the nature of the loss, under the clear exclusions of the bonds. The bonds specifically exclude "damages of any type for which the insured is legally liable, except direct compensatory damages arising from a loss covered under this bond" (emphasis added). Under New York law, compensatory damages are "either general (direct) damages ... or special (consequential) damages" such as a third party's lost profits (Vitol Trading v. S.A. v. SGS Control Services, 874 F.2d 76, 79 (2d Cir. 1989). A direct loss for insurance purposes has been analogized with proximate cause (Sorrentino v. Allcity Insurance Co., 229 A.D.2d 481, 645 N.Y.S.2d 515; E.A. Granchelli v. Travelers Insurance Co., 167 A.D.2d 839, 561 N.Y.S.2d 944). The distinction in the nature of the losses is critical for our purposes. Those terms of the fidelity bonds do not describe indirect and consequential injuries to the employer resulting from legal settlements with third parties who were the actual targets of the employee's acts. In this sense, the insureds' replacement of funds embezzled by the employee from a customer's separate personal bank account maintained by another institution was not a direct loss to the insureds/employer (Lynch Properties v. Potomac Insurance Co., 962 F.Supp. 956 (N.D. Tex. 1996), aff'd, 140 F.3d 622. Finally, in this regard, the putative loss to Kidder arises in part from a...