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JOHN B. WHITE, INC. v. PROVIDENCE WASHINGTON INS.

July 13, 1971

JOHN B. WHITE, INC.
v.
PROVIDENCE WASHINGTON INSURANCE CO., Defendant and Third-Party Plaintiff, v. Jules BOYMEL, Third-Party Defendant


Edward R. Becker, District Judge.


The opinion of the court was delivered by: BECKER

This is a civil action to collect the proceeds of a commercial crime coverage insurance policy covering employee embezzlement, issued to plaintiff John B. White, Inc. ("White") by defendant Providence Washington Insurance Co. ("Prov-Wash") on October 1, 1966. *fn1" Prov-Wash has denied liability under the policy and has joined White's auditor and treasurer, Jules Boymel, as a third-party defendant on the allegation that, if it is liable under the policy, it is subrogated to White's rights and is entitled to indemnity from Boymel as a result of Boymel's negligence. This opinion shall constitute our findings of fact and conclusions of law under Fed. R. Civ. P. 52(a).

 White is a corporation engaged in the sale of new and used automobiles. Prior to October 1, 1966, White was insured under a crime coverage insurance policy issued by Royal Globe Insurance Company. On September 30, 1966, White's policy with Royal Globe terminated, and the Prov-Wash policy, with a $15,000 face amount, went into effect. On January 21, 1967, while Prov-Wash's policy was in effect, White discovered that substantial sums had been embezzled over a period of time by White's finance manager, Gerald Belz, through a series of transactions known as accounts receivable "lapping". "Lapping" is a term used in the accounting profession to denote a scheme whereby someone diverts cash received from customers' accounts receivable to his own use and thereafter, by successive book entries, credits the customers' accounts receivable as having been paid by using funds received subsequently from other customers in payment of their accounts receivable. Belz, as finance manager, received cash and check payments from customers, prepared the deposit slips and prepared the book entries crediting customers' accounts. Thus, Belz was in a position where he could receive cash from one customer and credit it as payment to a previous customer's account from which he had actually taken the money.

 In order to establish the Prov-Wash loss, Duke's first step was to make a retroactive audit as of September 30, 1966, the day on which Royal Globe's policy terminated and Prov-Wash's insurance policy went into effect. By listing all accounts receivable on the books as of September 30, 1966, Duke ascertained that the total accounts receivable was $68,311.37; but direct confirmation with the customers showed that only $30,530.09 was owed at that time. He thus found that as of September 30, 1966, there were missing funds of $37,781.28. Since as of January 21, 1967 the funds missing amounted to $52,366.30, by the process of subtraction (i.e., $37,781.28 from $52,366.30), Duke estabished that during the relevant period of the Prov-Wash policy, the loss increased by $14,585.02, which constitutes the amount of White's claim.

 The record contains a stipulation that Belz embezzled substantial funds, far in excess of $14,585.02, and that his embezzlement was ongoing during the period of the Prov-Wash policy.

 White submitted a claim to Prov-Wash for $14,585.02. The proof-of-loss was submitted on Prov-Wash's form and was accompanied by work sheets prepared by Duke showing his audits of the accounts receivable as of September 30, 1966 and January 21 1967. At no time thereafter did Prov-Wash ask for additional information to determine the loss; nor did it send in its own auditors to verify Duke's figures, although the record shows that they were available to it.

 Prov-Wash produced as an expert witness at trial one David W. Brenner, a certified public accountant. Brenner testified that a better procedure for determining the loss would have been for White to have: (1) traced the funds listed as diverted as of September 30, 1966 and January 21, 1967 back to the original customer accounts where the money was actually diverted; (2) determined the sales of automobiles from October 1, 1966 through January 21, 1967 and verified the sales records by checking title to the auto and by direct communication with the customers as to when and how much was paid on these accounts; and (3) traced these customers' payments to the company to see when the defalcation existed and whether or not their funds had been used to cover funds taken previously from other customers' accounts.

 Brenner conceded, however, on cross-examination, that the method used by Duke was not an improper one and could indeed show the amount of the loss. He also agreed that: (1) while the tracing method he suggested would indicate the date on which the funds were originally taken, it might not locate the actual account from which the money was taken; and (2) the accounting fee cost of tracing by his suggested method might exceed the amount of the loss.

 We reject as meritless Prov-Wash's argument that White sustained no loss during the policy period because the funds remitted by the individuals contained on the work sheets covering the period of the Prov-Wash policy were received by White and deposited in its bank account. This overlooks the admitted fact that these funds were used to cover previous shortages in other customer accounts as well as the fact that the embezzlement was continuing, and, as the calculations show, waxing during the period of the Prov-Wash policy. Cf. Edmunds-Bouvier Savings & Loan Ass'n v. New Amsterdam Casualty Co., 8 Pa. D. & C. 2d 229 (Phila. C.P. 1956), aff'd per curiam, 389 Pa. 79, 132 A. 2d 181 (1957).

 The remaining issue is that of Prov-Wash's subrogation claim against Boymel. We will resolve it on the merits, notwithstanding the fact that payment has not yet been made by Prov-Wash to White. *fn3" Contending, in essence, that Boymel was in a position to discover Belz' embezzlement of corporate funds, it alleges that his failure to do so constitutes a breach of some duty which he owed to Prov-Wash by virtue of his corporate capacities.

 Prior to 1965, Boymel, a certified public accountant, was White's outside accountant. In that capacity, he made periodic unaudited statements for White until 1965. At that time, he was retained as White's treasurer and internal auditor for the purpose of watching over the interests of the controlling shareholder, who had left the active management of the company. Boymel's testimony was uncontradicted that his status as treasurer was purely perfunctory, and that as internal auditor, his responsibility was solely to see that the books were prepared and that statements and tax returns were prepared. As an officer of the corporation, he was not permitted, under the rules of the American Institute of Certified Public Accountants, to conduct an audit of the company and prepare certified returns.

 Two further facts bear mention. First, when Boymel "came aboard" with White, he was informed that prior shortages had occurred, but was told that these shortages were small and that his job was not to track them down. Second, in early 1966, White had been audited by a team of outside auditors of Ford Company in connection with a proposed sale of White's business. The auditors were all certified public accountants and conducted a two-week audit of the books and records of the company. During that audit, nothing was discovered out of order. For ...


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