Fidelity claims and inventory records: lessons from American courts
With retail crime costing Australian businesses approximately $2.3 billion per year many are seeking to recoup these losses through a variety of first party insurance policies, including fidelity insurance. [1]
Fidelity insurance indemnifies the insured against employee dishonesty and misappropriation of money or property, which accounts for 24 per cent of retail crime loss per year. [2] However, to prevent insureds from seeking coverage for losses arising from other circumstances that may result in loss (which are not contemplated by the fidelity coverage) – such as negligence, bookkeeping errors, waste, inexactness or pilferage by nonemployees – underwriters will often include an inventory computation exclusion .
In their standard form, inventory computation exclusions deny coverage where the insured relies upon inventory computation or enumeration as proof of the factual existence of, or the amount of the loss. Inventory computation or enumeration is nothing more than a comparison of inventory computation records with profit and loss computation records.
This exclusion is becoming increasingly more contentious as insurers and insureds disagree as to the extent to which inventory computations may be relied upon to establish or prove loss.
How these exclusions are to be interpreted has not yet been examined by Australian courts. Rather, much of the jurisprudence has come out of American courts which may provide guidance on how such exclusions may be interpreted domestically. They also assist in the approach to be taken when a fidelity claim is made and there is an inventory computation exclusion.
Interpretation Issues
In interpreting inventory exclusions, American courts have followed two distinct approaches, referred to as the ‘Majority’ and ‘Minority’ rules.
Majority Rule
The ‘Majority Rule’ interprets inventory shortage exclusions as unambiguous and as a condition precedent to any claim for coverage, requiring the proof of fact and amount of loss to be substantiated wholly independently of any inventory record.
Critics of the ‘Majority Rule’ highlight that a literal reading of the clause would limit the coverage to extra-ordinary circumstances that are contradictory to the reasonable expectations of coverage of the purchaser of the insurance. For this reason, the ‘Majority Rule’ is not likely to be adopted in Australia, given it is widely accepted that an exclusion may not be construed in such a way that would excessively circumscribe the insuring promise and therefore the commercial object of the policy. [3]
Whilst the ‘Majority Rule’ is a particularly advantageous approach for insurers it has been seldom applied since the 1970s.
Minority Rule
The ‘Minority Rule’ proffers an approach far more advantageous to the insured and one that is likely to be more palatable to Australian courts.
In adopting a narrow construction of the exclusion, the ‘Minority Rule’ permits reliance on inventory calculations where the insured can produce some independent affirmative evidence to substantiate their claim.
Examples of independent affirmative evidence which was accepted in these decisions include insured customer records which independently prove the loss claimed, an enumeration of each item of stock against stock on hand, and a comparison of daily sales tickets against inventory.
This interpretation recognises the incongruity of the exclusion, when strictly construed, with the overall insuring promise.
The likely way forward
In fidelity claims there is often a tension between ensuring the insured is indemnified for the risk contemplated by the policy and proof that employee dishonesty led to the claimed loss. As with most policies, the cause of the loss is key.
In practical terms, relying solely on computation of loss to establish the fact of the loss would unlikely be sufficient for the insuring clause to be triggered as it is not proof of any employee dishonesty. It is proof only of a potential loss.
In an Australian context, the exclusion puts the insured to proof as to the quantification of that loss. The Minority Rule strikes more of a balance in terms of the purpose of the insurance and establishing the sum of the loss.
[1] NSW Bureau of Crime Statistics and Research, The rising cost of retail theft? Trends in steal from retail to June 2023 (Catalogue Number 168, September 2023); Micheal Townsley and Benjamin Hutchins, 2022 Australia & New Zealand Retail Crime Study (Research Paper, Institute of Criminology, Griffith University, 2022).
[2] Ibid.
[3] See e.g, Weir Services Australia Pty Ltd v AXA Corporate Solutions Assurance [2018] NSWCA 100, [125] cited in Sunwater Ltd v Liberty Mutual Insurance Company [2022] NSWCA 273, [56].
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