Rainforest reported the loss to its insurer, Sentinel Insurance Company, Ltd., from which it had acquired a business owner policy.

In a series of letters, Rainforest claimed the loss was covered under provisions of the insurance policy covering losses due to forgery, for forged or altered instruments, and for losses resulting from computer fraud.

Sentinel denied coverage.

In a continuing attempt to obtain coverage for the loss, Rainforest also claimed coverage under a provision of the policy for the loss of money or securities by theft. Sentinel again denied coverage, primarily relying on an exclusion for physical loss or physical damage caused by or resulting from false pretense.

Litigation ensued and the parties moved for summary judgment based on a statement of agreed facts.

The trial court held that Sentinel was correct in denying coverage under the false pretense exclusion. It conceded that other courts had decided that transfers of funds were not “physical” within the meaning of the exclusion because they were the losses of funds on deposit in a bank, rather than losses of cash, such as paper money or coins. The trial court, however, explained that it was not persuaded by those decisions because funds held by a bank fell within the Sentinel policy's definition of “money,” defined as “[c]urrency, coins and bank notes whether or not in current use.”

Accordingly, the trial court denied Rainforest's motion, granted Sentinel's motion, and entered judgment in favor of Sentinel.

The case reached the Vermont Supreme Court, where Rainforest argued that the false pretense exclusion did not apply because it only excluded “physical loss or physical damage” and its loss was not a physical loss.

The Sentinel Policy

The Sentinel insurance policy provided:

We will not pay for physical loss or physical damage caused by or resulting from: . . . .

False Pretense: Voluntarily parting with any property by you or anyone else to whom you have entrusted the property if induced to do so by any fraudulent scheme, trick, device or false pretense. 

The court reversed.

In its decision, the court compared the forgery, money and securities, and computer fraud provisions of the Sentinel policy. The court observed that the forgery provision stated that Sentinel would “pay for loss resulting directly from forgery . . . in 'money'” and that the money and securities provision stated that Sentinel would “pay for loss of 'money,'” while the computer fraud provision stated that Sentinel would pay “for physical loss or physical damage to 'money.'”

In the court's opinion, this differing use of “physical loss” and “loss” meant that it could not be said that all “money” was subject solely to physical loss simply because funds, whether or not in current use, qualified as “money” under the policy.

The court added that if Rainforest or another insured business sought to clarify the extent of its coverage, it likely would have turned toward the policy language itself and perhaps existing case law interpreting similar policies. However, the court found, this search “would not have produced a clear, unambiguous answer for a reasonably prudent person.”

The court pointed out that the policy used the two distinct phrases – “physical loss or physical damage” and “loss and damage” – in different sections throughout the policy, sometimes switching between the two sentence to sentence, which would lead the average reader to assume there was some difference between them. According to the court, the policy itself did not define or explain the difference between the two phrases. It noted that the trial court dismissed this as “sloppy drafting” but the court said that “sloppiness should not excuse an insurer from covering losses that a reasonable insured party would expect to be covered, based on a reasonable reading and interpretation of the policy language.”

Moreover, the court said, if Rainforest or another insured business looked to case law, “they would have been met with a similarly opaque answer” because there was case law that supported both Sentinel's and Rainforest's interpretations.

The court then held that the false pretense exclusion was subject to at least two reasonable interpretations and, therefore, was ambiguous. The court interpreted the exclusion in Rainforest's favor, and concluded that the loss suffered was not physical and, therefore, coverage was not barred by the false pretense exclusion.

The case is Rainforest Chocolate, LLC v. Sentinel Ins. Co., Ltd., No. 2018-095 (Vt. Dec. 28, 2018). Attorneys involved include: James W. Runcie of Ouimette & Runcie, Vergennes, for Plaintiff-Appellant. Richard Windish of Hayes, Windish & Badgewick, Woodstock, for Defendant-Appellee.

FC&S Legal Comment

Recently, the U.S. District Court for the District of Montana interpreted this exact insurance policy provision in the context of a procedural history, fact pattern, and insurance policy that was virtually the same as the Rainforest case. See, Ad Advert. Design, Inc. v. Sentinel Ins., No. CV 17-140-BLG-TJC (D. Mont. Sept. 26, 2018).

In the Montana case, an employee received several emails from a supervisor's email account requesting that specific sums be transferred to an outside bank account. Believing the emails were legitimate, the employee wired money from the business's (Ad Design's) account into the specified accounts only to find out, after the transfers were complete, that the emails were fraudulent. Ad Design filed a claim with its insurer, Sentinel, seeking coverage for the loss, but Sentinel denied the claim, explaining that the policy excluded coverage under the false pretense exclusion. The only apparent differences between the Ad Design facts and the facts in Rainforest were: (1) Ad Design made four distinct transfers for a total of $115,595, where Rainforest only made one transfer of $19,875; and (2) Ad Design was not able to limit its loss by freezing its account and thus lost the entirety of the transferred amount, where Rainforest's bank was able to successfully freeze the transfer and limit its loss to $10,261.

The relevant provisions of the insurance policies in Ad Design and Rainforest were identical.

The Montana district court found that there were two reasonable interpretations of the policy and that the false pretense exclusion was ambiguous. Accordingly, the district court construed the policy to mean Ad Design did not suffer a physical loss, and therefore, the false pretense exclusion did not bar coverage.