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The Salary Exclusion: A Fidelity Coverage Limitation Earns its Place

Because salary, commissions, bonuses and other such benefits are routinely paid to employees, such money channels provide attractive targets for dishonest employees looking to steal from their employers. Consequently, fidelity bond and crime policy claims asserting loss due to employee dishonesty frequently involve a dishonest employee’s successful attempts to fraudulently obtain or inflate salary, commissions, bonuses or other benefits of employment.

Most standard fidelity bonds and commercial crime policies contain language limiting coverage for such claims by what has come to be referred to as the “salary exclusion”, and the substantial majority of courts have applied that limiting language to preclude coverage involving dishonest acts to fraudulently obtain employee benefits. However, a few courts have failed to properly apply and enforce this important coverage limitation, and claimants still often seek coverage where none exists. Additionally, the manner in which application of the salary exclusion has been described in some opinions from both the majority and the small minority jurisdictions, could lead to possible errors in its application in varying claim scenarios.

The salary exclusion is not a true “exclusion”, but a limitation set forth in the fidelity insuring agreement of most fidelity bonds and commercial crime policies. Standard language contained in Financial Institution Bonds and Commercial Crime Policies typically limit coverage for loss resulting from dishonest acts undertaken with the intent to obtain a financial benefit earned in the normal course of employment, including: salaries, commissions, fees, bonuses, promotions awards, profit sharing or pensions) . . . .

The majority of federal and state court jurisdictions have construed the salary exclusion to exclude fraudulently obtained or inflated benefits of employment such as salary, commissions and similar payments. The rationale behind these and other cases enforcing the salary exclusion recognizes that the language limiting coverage unambiguously excludes schemes intended to fraudulently inflate or obtain salary, commissions, bonus or other such payments.

One argument that has consistently been made, and continues to be raised, in efforts to avoid application of the salary exclusion is that the inflated salary, fraudulent commissions or other dishonestly obtained benefits were not “earned.” Thus, the argument goes, the phrase “employee benefits earned in the normal course of employment” does not apply, and the unearned benefits constitute a covered loss. This argument has been almost uniformly rejected by the courts.

Notwithstanding the large majority of jurisdictions enforcing the salary exclusion in instances of fraudulently obtained employee benefits, a few jurisdictions have held in recent years that the exclusion does not apply in similar scenarios. These cases represent a clear minority view, and appear to rely on rationales not properly based on the pertinent salary exclusion language. Other recent cases have rejected or simply declined to follow the approach cited in those cases.

The salary exclusion was introduced in fidelity bonds to limit coverage for a certain type of dishonesty characterized by the intent to obtain the type of financial benefit that is paid by employers as a normal employee benefit, such as salaries, commissions, bonuses and the like. The majority of courts across the country have applied this limiting language to preclude coverage for loss resulting from schemes in which employees sought to fraudulently inflate or obtain such payments.

Most efforts to misconstrue the limiting language of the salary exclusion, such as the “unearned benefit” argument, have been uniformly rejected. However, a few courts have either misconstrued or misapplied the case law developing out of the salary exclusion clause to limit its application improperly. By revisiting the actual language of the limiting clause, and by analyzing cases in which that language has been precisely considered and properly applied, defense counsel can better determine if the salary exclusion applies to a particular set of facts and effectively counter arguments that the salary exclusion does not apply in cases in which it should.

This is a summary of a more detailed article that appeared in the Defense Research Institute’s (“DRI”) magazine For the Defense. The article was published as part of a series of articles prepared by the DRI Fidelity and Surety Committee.

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