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AXO Staff Leasing, LLC v. Zurich American Insurance Co.

United States District Court, W.D. Texas, Austin Division

September 16, 2019

AXO STAFF LEASING, LLC, Plaintiff
v.
ZURICH AMERICAN INSURANCE COMPANY, MCCREADIE & MCCREADIE, INC., LASSITER WARE INSURANCE, Defendants

          ORDER

          SUSAN HIGHTOWER UNITED STATES MAGISTRATE JUDGE.

         Before the Court are Defendant Zurich American Insurance Company's Opposed Motion to Compel Examination under Oath and to Abate Lawsuit, filed on April 15, 2019 (Dkt. No. 13); Plaintiff AXO Staff Leasing, LLC's Response, filed on April 22, 2019 (Dkt. No. 14); and Defendant Zurich's Reply, filed on April 26, 2019 (Dkt. No. 18). On August 30, 2019, the District Court referred the above motion and related filings to the undersigned Magistrate Judge for resolution pursuant to 28 U.S.C. § 636(b)(1)(B), Federal Rule of Civil Procedure 72, and Rule 1(d) of Appendix C of the Local Rules of the United States District Court for the Western District of Texas (“Local Rules”).

         I. General Background

         This lawsuit is an insurance coverage dispute between insurer Zurich American Insurance Company (“Zurich”) and named insured AXO Staff Leasing, LLC (“AXO”). AXO is a Texas limited liability company that was in the business of providing “temporary and permanent staffing for companies, processing payroll, withholding income taxes, and managing other similar human resources functions as requested” from 2010 through 2017. Dkt. No. 1-2 at ¶ 8. In October 2012, AXO purchased a commercial insurance policy from Zurich that included a Staffing Industry Crime Coverage Policy providing coverage for “Your Employee's Dishonest Acts.” See Exh. A to Dkt. No. 13 (hereinafter “the Policy”) at § A.1(a). The Policy defined “Dishonest Act” to include “embezzlement” by an “employee.” Id. at ¶ G.10. The Policy had a $5 million limit and was effective from October 26, 2012 through October 26, 2017. Dkt. No. 1-2 at ¶ 10.

         On January 13, 2017, Mathew Marchant, the President of AXO, was notified by the Internal Revenue Service Criminal Investigation Division that AXO's Chief Financial Officer, John Herzer, was under criminal investigation. See Exh. B to Dkt. No. 1-2. The IRS notified Marchant that AXO had failed to file quarterly tax returns and pay payroll taxes from 2010 to 2017. See Dkt. No. 1-2 at ¶ 14. AXO alleges that after Marchant confronted Herzer regarding the IRS criminal investigation, Herzer confessed that “instead of paying over the taxes owed by AXO, he had embezzled the money for personal use.” Id. at ¶ 15. AXO promptly terminated Herzer. Several months later, AXO went out of business. Id. at ¶ 19.[1]

         AXO notified Zurich of the embezzlement on January 25, 2017.On May 12, 2017, AXO filed a Proof of Loss with Zurich, alleging that AXO “was the victim of its Chief Financial Officer's ‘dishonest acts,' which resulted in at least $3.6 million in losses through embezzlement, and has become liable for at least $4.9 million in penalties and interest for the CFO's willful non-payment of payroll taxes (and the underlying tax, at least $9.7 million, remains unpaid).” See Exh. E to Dkt. No.1-2 at p. 1. AXO also notified Zurich that “[i]t may also be necessary for AXO Group LLC to supplement this claim for loss because of the still-developing nature of the IRS investigation and assessment of penalties and interest.” Id.

         On August 23, 2017, through its attorney, Zurich sent AXO a Reservation of Rights letter summarizing the terms of the Policy and raising questions as to whether Herzer was an “Employee” as defined in the Policy. See Exh. F to Dkt. No. 1-2 at p. 6. Zurich noted that the Policy “expressly provides that ‘Employee' does not include:

(i) any broker, factor, commission merchant, consignee, contractor or other agent or representative of the same general character, or
(ii) any natural person who is authorized by you to sign your checks or make withdrawals from your bank accounts without the countersignature of another natural person similarly authorized by you. This does not apply to any natural person described under paragraph 11.c. above.”

Id. (quoting the Policy at § 11). Zurich asked AXO to clarify whether Herzer “was in fact authorized to sign AXO's checks or make withdrawals from its bank accounts without the countersignature of another natural person similarly authorized by AXO.” Id. at p. 7. In addition, Zurich formally requested the following:

         V. REQUEST FOR EXAMINATION UNDER OATH:

Under the circumstances, Zurich requests an examination under oath of AXO, by and through Mr. Marchant, as provided for in the Policy. Please let us know a date, time and location for the examination that is convenient for you and Mr. Marchant. In that regard, Zurich would appreciate it if in advance of the examination you would provide me with documents relating to the issue of whether Mr. Herzer was authorized to sign AXO's checks or make withdrawals from its bank accounts without the countersignature of another natural person similarly authorized by AXO. This would include the account agreements with AXO's banks and related signature cards. Also, please send me the application(s) that AXO submitted to obtain the Policy. In addition, if AXO intends to supplement its Proof of Loss, Zurich asks that AXO do so prior to the examination under oath.

Id. at p. 9.

         On February 15, 2018, AXO responded to the Reservation of Rights Letter disputing the coverage issues and contending that Herzer met the definition of employee under section 11.c of the Policy, which defines an employee as:

Any natural person who is your director, officer, manager or trustee while such person is engaged in handling “funds” or “other property” of any “employee benefits plan” owned, controlled or operated by you, or any natural person who is a director, officer, manager, employee or trustee of an “employee benefits plan”, provided the “employee benefits plan” is listed as a Named Insured under this Coverage Form.

         The Policy at 11.c. AXO also informed Zurich that its forensic accountants were still working to reconstruct AXO's bookkeeping records into a reconciled accurate form. Dkt. No. 1-2 at ¶ 24.

         On May 14, 2018, AXO informed Zurich in a letter that it had completed its forensic accounting and delivered its report to Zurich contending that Herzer embezzled $4, 730, 702 from AXO. Id. at ¶ 25. AXO further suggested that “it would be an appropriate time to begin discussing the sworn examination of Matthew Marchant.” Exh. G to Dkt. No. 1-2.

         On July 2, 2018, Zurich's attorney responded to AXO's letter stating that “Zurich would like to proceed with the examination under oath, but only after ...


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