Koger Management Group, Inc. v. Continental Casualty Company et al

Filing 67

MEMORANDUM OPINION re: the Court's findings of fact and conclusions of law pursuant to Fed. R. Civ. P. 52(a). Signed by District Judge Leonie M. Brinkema on 3/3/09. (tfitz, )

IN THE UNITED

STATES

DISTRICT

COURT

FOR THE

EASTERN DISTRICT OF VIRGINIA

.

Alexandria Division

L1

KOGER MANAGEMENT GROUP,

INC.,

)

in »-3
CLL '· A; l>.

Plaintiff,

)

V.
CONTINENTAL CASUALTY CO. ,
Defendants.

)
et aL, )
)

1:O8CV3O1

(LMB/JFA)

MEMORANDUM

OPINION

This Memorandum Opinion constitutes
fact and conclusions of

the Court's
R. Civ.

findings of
P. 52(a) in

law pursuant to Fed.

this dispute between an insured and its insurance companies. specific dispute centers on whether the defendant insurance

The

companies may rescind the crime insurance policies issued to

plaintiff because of an allegedly false statement made in the
original insurance application. The defendants have stipulated

that if they are not entitled to rescind the policies, pay plaintiff the $1,000,000 policy limit.
I. Procedural Background

they will

Plaintiff,

Roger Management Group,

Inc.

("RMG"),

filed a

complaint against defendants,
Continental Insurance Company

Continental Casualty Company and
{together "CNA"),1 seeking a

covering 2003-2004 and also issued the renewed policy covering
2004-2007. Continental Casualty Company issued the renewal of

1 Continental Insurance Company issued the first policy

the policy for 2007-2008.

Continental Insurance Company is a

wholly owned subsidiary of Continental Casualty Company.

declaration that CNA was not entitled to rescind the crime insurance policies issued to KMG and that to the CNA was liable for the

$1,000,000 policy limit pursuant policy.2 CNA filed a one-count it was

2004-2007

insurance

counterclaim,

seeking a insurance

declaration that

entitled to rescind the

policies because they were information in the original
II. Discussion
A.

issued in reliance on materially false application.

Factual Background

Robert Roger founded KMG and,

along with his wife,

has

owned

it

for 33

years.

During this
KMG,

time,

Robert Koger has

continuously

served as

President of

which is a homeowners'

association

management company operating in Virginia,
Virginia, and the District of Columbia.

Maryland,
As part of

West
its

management activities,
activities on behalf of transactions,

KMG engaged in numerous
its clients.

financial
these

To facilitate

KMG opened a unique bank account

for each

homeowners'

association.

KMG referred to these accounts as

"Clients'

Accounts."

The operation of a client account was
KMG opened the bank account,
from the homeowner members of the

relatively straightforward:
collected and deposited dues

association into the account,

and withdrew money from the account

2 KMG also sought attorneys'
the Virginia Code, claiming that

fees under Section 38.2-209 of
CNA acted in bad faith in

deciding to rescind the policies.

On August

19,

2008,

this

Court

granted defendants' Motion for Partial plaintiff's claim for attorneys' fees.

Summary Judgment on the

to pay the

association's

vendors

or

to make

investments

for

the

benefit of

the association.

KMG's

accounting department

accepted

the member dues and printed deposit slips
associations. the Clients' A separate KMG employee, Accounts. In addition,

or checks

for the
reconciled association

Doug Stewart,

each homeowners' its

generally hired its
account.

own accountant

to audit

individual

In approximately 2001,
KMG if

one of the association clients asked
could pay their association fees

their homeowner members

with credit cards

or

through automatic withdrawals

from their

checking accounts.
payment arrangement,
"Transfer Account." holding account

To accommodate

this

increasingly popular
account called the
a

KMG set up a special
This

account primarily functioned as

for credit card and automatic withdrawal payments

until KMG transferred the payments into the specific client
account for which the payment was intended. When a homeowner

paid an association fee by credit KMG first recorded the payment by

card or automatic withdrawal, the homeowner and deposited the

credit

card or automatic withdrawal payment
The funds would

directly into
of

the

Transfer Account.

then be moved out

the

Transfer Account and deposited into

the corresponding homeowners'

association client account on a monthly basis.
transfers, KMG employees manually entered each

To make

these

homeowners'

association account number and the amount
into a spreadsheet. Then, Jeffrey Koger,

due

to

that account
son and

Robert Roger's

the Chief Financial Officer of KMG,
software that directed an electronic

uploaded that data into
transfer from the Transfer

Account into the association account.
transfers were made
Koger was

During the entire time
Jeffrey

in and out of the Transfer Account,
able to make

the only KMG employee who was

those

electronic transfers.3 and did,

In addition,

Jeffrey Koger was able to, Account into the

transfer funds out of

the Clients'

Transfer Account to facilitate purchases
B.

for the association.

The Insurance Policy Application the company expanded and hired more theft, KMG began

As KMG's business grew, employees.

To protect against employee

purchasing crime insurance

sometime in the mid-1990s.

In 2001,

KMG's insurance agent,
crime

Tom Welch,
to

suggested that KMG increase its
Robert Koger

insurance policy limit

$1,000,000.

followed this advice and completed a new application for crime
insurance with the Chubb Group. Welch testified at trial that he

thought,

but did not specifically remember,

that he reviewed the

2001 crime Koger.

insurance application and its questions with Robert the Chubb Group stopped renewing its Working through broker Ian H. crime

In 2003,

insurance policies. Insurance,
CNA.

Graham

Welch recommended that KMG purchase a policy issued by
and a CNA application was sent to KMG.

Robert Koger agreed,

3 Disbursements
by checks.

from the Transfer Account could also be made
only Jeffrey Koger had the authority to

Although Robert Koger had the authority to draw
withdrawals.

checks

on the account,

make electronic

The

application at

issue

in this

litigation was and Commercial

titled Crime

"Property Managers Errors

& Omissions

Application"

and served as an application for both crime Central to this

insurance and errors and omissions coverage.4

litigation is Robert Koger' s answer5 to Question 5 on page 4 of
the application, which asked:

Are bank accounts reconciled by someone not

authorized to deposit or withdraw therefrom? The application was marked "Yes" in response to this question.
CNA's Underwriting

After receiving the application,

Department approved the

issuance of a policy, insurance 2003

and Continental 267876704) 2004. The

Insurance Company issued crime

(Policy No.

to KMG for the period from May 1, policy had a $1,000,000

through May 1,

limit per occurrence and was

subject to a

$10,000 deductible.

It covered thefts of money,
that resulted

securities,

and

property by KMG employees

in KMG sustaining a loss.

In 2004,
May 1,

the policy was
to May 1,

renewed on the same

terms

for the period

2004

2007.

No new application

for commercial

crime

insurance was required from KMG before

the 2004

renewal

because the policy met the renewal: 1)

following criteria for automatic

policy liability limit of no more than $1,000,000,

4 Crime insurance covers thefts of company property by
employees, and errors and omissions insurance covers thefts of

clients'

property by employees.

5 Testimony at trial revealed that Jeffrey Koger actually
completed the majority of the 2003 application,
April 16, 2003.

but the parties

agree that Robert Koger reviewed the application and signed it on

2)

total premium of

no more

than $15,000,

and 3)

no claims initiated, the

submitted. policy was

After the

rescission investigation was on different

renewed for 2007-2008

terms.

In 2006,

KMG discovered that Jeffrey Koger had embezzled
from the
from

over $2,000,000
transferring

Transfer Account

by electronically
into bank accounts

funds

the Transfer Account

that he

and his

wife managed.

These

thefts went undetected

for

so long primarily because Jeffrey Koger was solely responsible
for managing the Transfer Account. On April 16, 2007, Robert
KMG's

Koger submitted a claim

for approximately

$1,000,000

under

2004-2007

crime

insurance policy with CNA.

Upon

learning more

about

the

loss and the

length of

time over which it occurred, CNA decided

CNA

began considering the possibility of rescission.
that it was entitled to rescind the crime

policies after it authority to reconcile

learned that at

least one person had dual

and to deposit
Clients'
the

into or withdraw from the Transfer Account and the
CNA asserted that
false and

Accounts.

this

dual authority made

answer

to Question 5

that

the misrepresentation was

material brought
C.

to the

initial decision to issue to enforce the policy.

the policy.

KMG

this suit

The Key Factual

Issue

Defendants argue that
with regards to the

the answer to Question 5 was
Robert

false

Transfer Account because

Koger

reconciled that

account and had authority to deposit and withdraw

from it.

Plaintiff does not dispute that Robert Koger had such

dual authority.

Plaintiff,

however,

maintains

that when Robert
to which

Koger answered Question 5 he believed the bank accounts

it referred were the Clients'
true. Defendants respond that

Accounts,

for which the answer was

the Question included the Transfer

Account,

but even if

it did not,

the answer was also

false as

to

the Clients'
Clients'

Accounts because:

1)

Jeffrey Koger reconciled three

Accounts

from which he had the authority to make

withdrawals;

2)

Jeffrey Koger played a supervisory role over
Accounts from which he also had the

reconciliations of Clients'

authority to make withdrawals;
deposit into Clients' Accounts,

and 3)

all employees at KMG could

so any employee who reconciled

Clients'
accounts.

Accounts also had the authority to deposit into the

III.

Applicable Legal

Standard

In Virginia,

an insurance company seeking rescission must 1) material

clearly prove that a statement in the application was

to the risk assumed and 2)
However, when, as here,

untrue.

Va.

Code Ann.

§

38.2-309.
language

the application also

includes

requiring that the applicant attest to the truth of the
statements to the best of his knowledge,6 the insurance company

must also clearly prove

that the answer was

"knowingly false."

6 Page 5 of the April 2003 application stated, "[t]he undersigned declares that to the best of his/her knowledge the
statements set forth herein are true and correct and that

reasonable efforts have been made

to obtain sufficient

information from all of the insured Persons to facilitate the
proper and accurate completion of this application for the
proposed policy."

Old Republic Life Ins. 1973); Parkerson v.

Co.

v.

Bales.

195

S.E.2d Co.. 797

854, F.

856 Supp.

(Va. 1308,

Fed.

Home Life

Ins.

1315

(E.D.

Va.

1992) .7

This

is a subjective

standard,

but

the

applicant's of

"subjective facts."
law, to

state of mind must be reasonable in light Parkerson. 797 F. Supp. at 1317.
the

the objective

Under

this established

succeed on a rescission claim, that the statement at

defendants must clearly prove

issue was

material,

that

is was
false.

false,

and that

the

insured knew the

statement was

A.

Materiality
trial that the answer to Question 5 was not there

KMG argued at material to the

issuance of

the original policy because

were discrepancies between CNA's underwriting guidelines and the application for crime insurance.
to Question 5 was not material to

KMG also argued that
the issuance of the

the answer
2004-2007

renewal policy because

CNA automatically renewed the policy

without requiring additional
arguments have no merit.

information from KMG.

These

Under Virginia law,
insurance is material to

a statement
the

in an application for
if it reasonably

risk assumed

influenced the insurance company's decision to issue the policy. See Times Ins. Co. v. Bishop. 425 S.E.2d 489, 492 (Va. 1993). At

7 At trial,

KMG argued that the terms of the policy required

CNA to show that Robert Koger intended to defraud the company before it was entitled to rescission. This contention is unsupported by the terms of the policy and relevant caselaw.

trial,
Weston,

CNA's Assistant Vice-President for Underwriting,

Kay

and the underwriter for KMG' s crime policies both

testified that CNA would not have issued a crime policy to KMG in
2003 if Question 5 had been answered in the negative. They

explained that segregation of duties, inquired, employees.

about which Question 5

protects against embezzlement and false deposits by Specifically, Weston testified that segregation of
issued. The

duties had to be in place before a crime policy was

testimony of the CNA witnesses clearly demonstrated that the

answer to Question 5 reasonably influenced their decision to
issue KMG's first crime policy in 2003.

The answer to Question 5 also reasonably influenced CNA's

decision to issue a renewal of that policy to KMG in 2004.
Weston testified that CNA relied on the information in the
original application in deciding whether to renew a policy. She

stated that neither an original policy nor a renewal would have been issued if Roger answered "No" to Question 5.

Accordingly,

CNA clearly proved that

the answer to Question

5 was material to its decision to issue the crime policies.8
B. Falsity

Next,

an insurance company seeking rescission must clearly

prove that the insured answered a question on the application

8 At

trial,

defendants

repeatedly referenced Jeffrey Roger's

"verification" in August 2003. This so-called "verification" is irrelevant to the instant civil action because the verification

was part of an application for Errors & Omission insurance,
is not at issue here.

which

falsely.

See Times

Ins.

Co..

425

S.E.2d at

491-92.

Question 5

asked whether

"bank accounts"

were reconciled by someone who was The

not authorized to deposit or withdraw from the accounts.
Court finds that the answer "Yes" was false
the

as

to

the Transfer
and

Account

because Robert

Koger reconciled

Transfer Account

was authorized to withdraw from it in 2003.9
false as Stewart to the Clients' Accounts because Jeffrey Koger was

The answer was also

the testimony of Doug solely responsible for

established that

reconciling three of time period he was accounts
burden of
false.

the Clients'

Accounts and that

in the 2003

also authorized to withdraw from these transfers.
the

through electronic
clearly proving

Therefore,

CNA met
was

its

that

answer

to Question 5

C.

Knowingly False this finding, the Court must determine whether
answer to Question 5 as he

In light of

Robert Koger knowingly gave a false

understood it.

As CNA correctly argues,

Robert Roger's

subjective understanding of the question does not determine its
meaning. His subjective understanding does, however, affect Cf.
the cases

the

inquiry into whether he knowingly gave a false answer.
Parkerson, 797 F. Supp. at 1317-18. In the majority of

addressing the
the terms of

"knowingly false"
but

standard,

the insured understood
a false answer based

the question,

arguably gave

9 Robert Koger also testified at trial that if
accounts"
correct answer would have been no.
10

"bank
the

in Question 5 did refer to the Transfer Account,

on the

applicant's knowledge

of

the

facts when he answered the

question. S.E.2d 169,
however,

See, 172

e.g.. (Va.

Mutual of Omaha Ins. 1967). The

Co.

v.

Echols.

154

"knowingly false"

standard,

also applies

to cases

in which the applicant

misunderstands

the question,

but answers

truthfully based on his

understanding of the facts. (discussing, but rejecting,

Cf.

Parkerson.

797

F.

Supp.

at 1318

the possibility that
If the

the applicant

misunderstood the question at issue). misinterprets a question, but answers

insured

it truthfully based on his

understanding of
answer. Cf.

the question,
Co.

he has not knowingly given a false
v. Dansey, 81 S.E.2d 446, 451 (Va.

Sterling Ins.

1954)
its

("[A]n incorrect statement innocently made in the belief in
. . . .") (internal

truth will not avoid the policy
and citations 1. Robert omitted).

quotations

Robert Roger's Koger testified

Interpretation of Question 5 he misunderstood Question 5 on

that

the crime policy application,

believing that

the phrase

"bank

accounts"

in the question referred to the Clients'

Accounts,

not
He

to KMG's own accounts,

which included the Transfer Account.

explained that he came

to this conclusion because

the questions

immediately preceding Question 5

in the application all referred

to client-related matters.
the collection process
checks for

Specifically,

Question 3

asked about

for the Clients'
the Clients'

Accounts,

and Question 4

asked about

Accounts.

Robert Koger was

a credible witness.

His

testimony

11

explaining why he believed Question 5

referred to Clients'

Accounts was plausible and consistent with other evidence
record. Of particular significance is Robert Roger's

in the

answer to

Question 4
issuance.
all

on the same page as Question 5,
Question 4-b asked,
In response,

regarding check
required on
a

"Is

a countersignature
Koger answered that

checks?"

Robert

countersignature was In fact,

required on all checks

in excess of

$1000.

the evidence established that a countersignature was Accounts, but

required for checks over $1000 drawn from Clients'
was not required for checks of that

amount drawn from KMG

accounts.

Robert Roger's answer to Question 4-b supports his
addressed the Clients'

assertion that he believed Question 5
Accounts.

Additionally, was

Robert Roger's misinterpretation of Question 5 Evidence at trial demonstrated that other
same mistake
F. Supp. at

not unreasonable.

similarly situated applicants had made
answering Question 5. See Parkerson.

the
797

in

1318

(considering it relevant whether an average person might

misunderstand the question).

RMG's

insurance agent,

Welch,
company

testified that two of his other association management
clients had also misunderstood Question 5 believing on CNA's

application,

it asked about how they handled the homeowners'
accounts, Roger was not how they handled not their own accounts. who misunderstood

associations Thus, Robert

the only applicant

the

scope

of

Question

5.

12

Moreover, imprecise.

the wording of Question 5

is

confusing and limit itself to

The language of Question 5 for example,

does not

specific accounts, accounts,"
"all" or

by asking about

"the insured's

and neither are

"bank accounts"
that

modified by the words
the nature of the

"every."

Although CNA argued

crime

insurance

for which Roger was

applying,

that

is

coverage

for KMG's own accounts,

should have alerted Robert

Koger

that

the

question was asking about KMG accounts,
Transfer Account, both crime

which

included the
an application for own accounts)

the application doubles as (which insures the

insurance

company's

and errors accounts),
Question 5

& omissions and it
is

insurance

(which insures

the clients' "accounts"

is not entirely clear to which

referencing.

Furthermore, reasonable
to the

from the structure of

the application, that Question 5
Section IV of

it was referred

for Robert Koger to conclude
Accounts.
questions

Clients'

For example,
about

the

application asks applicant

the properties

managed by the in managing

and activities

the applicant

undertakes

those properties.
about

Questions

in the next
the

section,

V,

also ask
the
and

client-related activities:
the

coverage

requested,
for rents,

location of properties,

collection process

check issuance.
of this evidence,

Question 5
the Court

appears

in Section V.
that Robert

On the basis
Koger intended

concludes

his answer to Question 5
the Transfer Account.

to relate

to the Clients'

Accounts,

not

13

2.
At trial,

Jeffrey Koger Reconciled the
OTA argued that even

Clients'

Accounts

if Robert

Koger believed

Question 5

referred to

the

Clients'

Accounts,

the answer was

knowingly false because he knew that Jeffrey Koger reconciled three of the Clients' Accounts from which Jeffrey Koger was also The evidence at
to reconcile

authorized to make withdrawals.

trial
the

showed
Clients'

that Robert Koger hired Doug Stewart Accounts. Although Stewart

testified that

Jeffrey Koger

reconciled the Sequoia,
accounts on his own,

Ashburn Farm,

and Preswick association
he did not recall

he also

testified that

telling Robert Koger that Jeffrey Koger was

reconciling any of

the Clients'

Accounts on his own.

He also stated that Robert

Koger never indicated to him that he knew Jeffrey Koger was
reconciling these accounts. not know Jeffrey Koger was Robert Koger testified that he did

reconciling any of

the Clients'

Accounts on his own.

However,
April of 2003

the

evidence at trial also established that
sometimes assisted with

in

Jeffrey Koger

reconciliations of

the other Clients'

Accounts.

Stewart

testified that when he had a problem with a reconciliation, would take it
not resolve

he

to his

supervisor and that

if his

supervisor could
the
Meg

the issues,

Jeffrey Koger would reconcile
in KMG's accounting

account.

Two

other employees

department,

Gray and Paulette Heiderman Wilson,

also

testified that,

in 2003,

problems with reconciliations would ultimately go to Jeffrey

14

Koger if Stewart or his Finally,

supervisor could not

resolve them.

Robert Koger acknowledged he knew that Jeffrey Koger

acted as a
Thus,

"back up"

if there were problems with reconciliations.
Koger was aware that Jeffrey

CNA demonstrated that Robert

Koger reconciled the Clients'
subordinates could not solve.

Accounts if there were problems his

CNA also established that Jeffrey Koger was authorized to
withdraw from the
testified at trial

Clients'

Accounts

in 2003.

Robert Koger

that Jeffrey Koger was

the only KMG employee

who knew the electronic

code for the Transfer Account,

and was,

therefore,
transfers

the only employee who could actually make electronic
in and out of the Transfer Account. He also stated the

that Jeffrey Koger could and did transfer money out of

Clients'
Thus,

Accounts and into the Transfer Account on occasion.
authorized to

Robert Koger knew that Jeffrey Koger was Clients' Accounts in 2003.

withdraw from the
On this

record,

the defendants have was knowingly false.

clearly proven that When he answered

the

answer to Question 5 Question 5, Robert

Koger knew that Jeffrey Koger sometimes

reconciled Clients'
was unable was to

Accounts when Doug Stewart or his supervisor
them. He also knew that Jeffrey Koger Accounts.
the

reconcile

authorized to withdraw from the Clients'
believed he was answering

Even

though he may have

question

truthfully,

his awareness

of these

two facts made his answer to

15

Question 5
Echols. IV. 154

knowingly
S.E.2d at

false.
171-72.

See

Parkerson.

797

F.

Supp.

at

1319;

Conclusion

For

the

forgoing reasons,

the

Court

finds

that

CNA clearly

proved that

the answer to Question 5

was material,
the Court

false,

and

knowingly false when made. defendants' favor.

Therefore,

finds

in the

An appropriate Order will

issue.

Entered this 3

day of March,

2009.

Alexandria,

Virginia

Leonie M. Brinkema United States District Judge

/s/

16