No coverage under crime and fidelity coverage part of commercial lines policy for employee thefts occurring within policy period but discovered after policy cancellation, where insured had replacement coverage

by Christopher J. Graham and Joseph P. Kelly

Midway Truck Parts, Inc. v. Federated Insurance Co., Case No. 11 CV 9060 (N.D. Ill. Feb. 4, 2013):

Insurer issued Insured a commercial lines insurance policy effective from October 6, 2008 to October 6, 2009. The policy’s Crime and Fidelity Coverage Part, subject to its terms, covered employee thefts discovered after policy cancellation, but only if the discovery was:

No later than 1 year from the date of that cancellation. However, this extended period to “discover” loss terminates immediately upon the effective date of any other insurance obtained by you, whether from us or another insurer, replacing in whole or in part the coverage afforded under this insurance, whether or not such other insurance provides coverage for loss sustained prior to its effective date.

Insured’s policy ended on October 6, 2009, so Insured purchased a policy from another insurer with employee theft coverage valid October 6, 2009 to October 6, 2010. Insured discovered on September 30, 2010 that a former employee had stolen around $1 million from Insured, so Insured notified both Insurer and the issuer of its subsequent policy. Court granted Insurer’s summary judgment motion, resolving the issues as follows:

Issue #1: Is “replacing” in discovery clause unambiguous? Yes

Insurer argued that “replacing” as used in the discovery clause was unambiguous: Insured bought a substitute policy, therefore Insurer’s obligation ended. Insured argued that “replacing” was ambiguous and could be interpreted as only occurring if Insured terminated the policy prior to the scheduled expiration date and purchased substitute coverage covering the same time period the first policy covered.

Applying Illinois law, the Court held that “replacing” was not ambiguous. While “replacing” was not defined in the contract, the plain meaning (according to Webster’s) is “to take the place of: serve as a substitute for or successor of: succeed, supplant.”

Issue #2: Should “replacing” be considered ambiguous because of Insured’s “reasonable expectations”? No.

“Illinois law … disfavors the reasonable expectations doctrine. Smagala v. Owen, 717 N.E.2d 491, 496 (Ill. App. Ct. 1999) (“The reasonable expectations test has been rejected by the courts of this state.”). At best, the reasonable expectations doctrine is used as a tool of construction in assessing the intent of the parties when a contract is ambiguous, which is not the case here. Id. at 497.”

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