Insurance Requirements in Commercial Contracts (Part 4)

Welcome to Part 4 of the Insurance Requirements in Commercial Contracts series.
 
In Part 1, we touched on the importance of insurance provisions in commercial contracts, the use of outdated terms, and additional insured status.  In Part 2, we reviewed the difference between a deductible policy and a self insured retention.  In Part 3, we explained the difference in Loss Payee versus Lender Loss Payee status.  Today's blog post is about theft and commercial crime coverage.

A secured lender may wish to require the borrower to obtain coverage for “theft” of the property (equipment, inventory, etc.) which secures the loan. Otherwise, the personal property could be stolen and the secured lender would be left without any collateral securing the financing.  

Ordinary property coverage will typically cover many types of theft, subject to exclusions and any special terms of the policy. At the same time, the insurer may require the insured (i.e., the borrower) to have certain physical security measures in place before writing the insurance, such as fences, locked gates, security cameras, or a monitored burglar alarm. The underwriter of the insurer will typically, either prior to writing the policy or shortly after inception, verify the existence of these physical security measures. These physical security measures not only assist the insurer in helping to prevent a claim, but ultimately also inure to the benefit of the lender who will be protected when the borrower maintains physical possession and custody of the items securing the loan. However, in many cases these policies will contain an exclusion for employee theft. This is significant because, by some estimates and depending on industry, up to 80% of workplace crime is the sort of insider theft/white-collar fraud conducted by a company’s own employees. 

A commercial crime policy, often described as a fidelity bond or fidelity insurance, is designed to insure against criminal acts of a company’s own employees, as well as certain other criminal acts by non-employees. This policy is directly squarely at the theft of money, marketable securities, embezzlement, certain computer crimes, forgery, and other crimes which businesses are sometimes targets of and victims of. Dedicated crime coverage will also often cover other situations where a business is the victim, such as the receipt of counterfeit money or a financial loss which is the result of a forgery or facsimile signature. 

Like many types of insurance, a crime policy also serves as a type of credit enhancement to a lender. If a borrower already has a crime policy (or is required to obtain one) the borrower will be better able to weather an unpredicted criminal event and thus be better able to have the cash flows to service its debt obligations. 

While a crime policy will cost additional premium, it will provide much broader coverage in the event of criminal acts, particularly by “insiders” of the company such as employees, management, and often officers of the company. When drafting or insisting on contract terms which require the provision of “theft” insurance, the parties need to clarify whether the financing documents only require ordinary property coverage, or also require a commercial crime policy or fidelity bond.

Later this week we will probably post Part 5, the final installment of our series on insurance provisions in commercial contracts.