# FILED

Novemb er 8, 1995 Cecil Crowson, Jr . App ellate C ou rt Clerk IN THE COURT OF AP PEALS OF

TENNESSEE WESTERN SECTI ON AT JACK SON

_______________________________________________ STRINGS & THINGS IN M EMPHIS, INC., Plaintiff

-Appella nt, Shelby Equity No. 101098-1 Vs. C.A. No. 02A01-9408-CH-00195 STATE AUTO IN SURANCE C OMPANIES, Defendant-Appellee.

_________________________________________________________________________

FROM THE CHANCERY COURT OF SHELB Y COUNTY THE HONORABLE N

EAL SMAL

L, CHANCEL

LOR

Robert A. Wampler of

Memphis For Appellant Kenneth R. Shuttlew orth and A

rchie Sa nders, I II of Memphi s For Appellee

VACATED

, RENDERED AN

D REMANDED Opinion filed:

W. FRANK CRAWF ORD,

PRESIDIN G JUDG

E, W.S. CONCUR: DAVID R. FARMER, JUDGE BROOKS MCL EMORE, SPE CIAL JUDGE2 This appeal involves a suit to recover on a policy of insurance coveri ng em pl oye e di sh on es ty. Plaintiff, Strings & Things in Memphis, Inc., a ppea ls from t

he judgment of the chancery court in a nonjury trial that dismissed its suit against defendant, State Auto Insuranc e Companies

. The only issue on appeal is whether the evidence preponde rates agains t the findi ngs of the chancellor. Plai ntiff 's co mp la in t a ll eg es th at pl ai nt if f m ai nt ai ne d a po li cy of insurance with def endant for the period of April 1, 1990, to April 1, 1991. Under the "crime" coverage o f t he po li cy, defendant insured plaintiff agains t proper

ty lo ss cause d by

employ ee dishonesty , theft, disappearance, destruc tion, or r obbery . The com

plaint av ers that on or abou t July 1, 1990, one of plaintiff's employees discovered that insured property

was missing from a secured w arehous e

area. Plaintiff alleges that themerchandise was stolen by an employ

ee and that the total value of the merchandise exceeded $31,000.00. The complaint further avers that plaintiff fully complied withall provisions of the insurance policy , and therefore, plaintiff is entitled to a recover y under the policy. Defend ant's answer admits that the policy of insuranc e was va

lid and in e

ffect a t the time of the loss. However, defendant contends that the loss is excluded from coverage under Section 2(b) of the policy, beca

use "computation of the loss was a result of inventory computation and/or profit and loss computation." Section 2( b) of the policy provides : This endorsement

does not apply: . . . Under insuring agreement 1A or 1B to loss, or that part of any loss, asthe case may be, the pro of of which, either as to its factual existence or a s to it s amount, isdepende

nt upon an

inventor y c omputation

or a prof it and loss computation. Plai ntiff 's proof co nsisted of various e xhibits as we

ll as the te sti mony of Christopher John Lovell, a principal and manager of the plaintiff. We will briefly summarize this proof: Plaintiff, Strings & Things in Memphis, Inc ., located on Union Avenuein Memphis, Tennessee, is a retail seller of musical instruments and related equipment. The policy of insurance issued by defenda nt was obtained from defendant's ag ent, Jim Barkley, and provided

co ve ra ge fo r e mp lo yee di sh on es ty. Plaintiff utilized floor plan fina ncing f or a lar ge par t of its1 Some of the more expensive it ems were kept in an addit ional secured area, referred to as t he "vault," which was located inside o f anot her locked area. 3 in ve nt or y, and in Apr

il, 1990, it came to the attention of Lovell that some of the floor plan mercha ndise was missing and that there was no record of the sale of the merchandise. Al l of the missing items were identifiable by seria l number, and a sale of any of the items would have been evidenc ed by

a sales r eceipt. The itemsinvolved w ere kept in secur ed area s, acce ssib l e only by t he owner s of the bu siness and two othe r employ ees. 1 There was no indication that there

was any forcible entry to any

of these locations. Plaintiff concluded that thetwo employees who had acces s to the secured areas were r esponsible for the theft, and plaintiff reassigned t h e employees to sales positions in which they would no longer have access to the vaulted a reas. On April 30, 1990, Lovell notified defendant' s agent Barkley that there appeared to b e

an employee thef

tloss. Barkley

advised Lovell to investigate the thef t and to keep him updated

as to the progress of the investigation. L ovell contacted Barkley

numerous times regarding the theft, and in Novem ber, 1 990, p laint iff's counsel f orward ed Bar kley written n otice of

the claim andan itemize d list

of the missing property . Plaintiff was furnished a proof of loss form which

was completed and returned to de fendant's ag ent. In January , 1991, defendant sent an investigator

to take a state me nt from Lovell, and at that time the investigator a lso requested various documents from

plaintiff. All of the items requested were furnished to defe ndant, even though d efenda nt denied plaintiff 's claim prior to r

eceiving the requested material

. At trial, pla intiff intr oduced in voices, p acking

lists, sale s recei

pts, and other

document s into evidence to show that plaintiff had purchased and financed the missing items, and that the items had not been sold in the ordinary c ourse of business. A trial, the only witness that testified

on behalf of defendant was Lee Boy er Herrington, an employ

ee of Equifax Services. Equifax

was retai ned by the finan ce comp any to perf orm au dits of pla inti ff's floor plan merchandise. Ms. Herrington

testifie d that her

company had bee n perfor ming aud its at Strings & Things for a number of years pr ior to 1990, and th at aud its o f Stri ngs & Thin gs were especially difficult due to the company' s disorganized merchandise and "sloppy " record keeping. She stated tha t4

plain tiff's employees had dif ficulty locating

merchand ise and we re "lax" in recording seria l numbers of

in ve nt or y. She furth

er state d that the

first y ear in wh ich Equif ax audited

Strings & Things, the vault

was not kept locked, but thereafter plaintiff beg an locking it. On July 30, 1990, an audit of St rings & Things revealed that there were fifteen less items of inventory on the floor than in the previous month. The plaintiff paid the inventory finance r for ele ven of the items and refused to pay

for the remaining four claiming that they were stolen. Plaintiff's claim was denied by defenda nt in its lett

er of Ma y 20 , 1991, wh

ich state s: Dear Mr . Love

ll: We have conducted

an investigation into the claim presented by your co mp an y, Strings &

Things in Memphis. We have found the proof o f the claim, both in terms of its factual existence and i t s amount, is based solely on the discre pancy be tween the s a les records and the physical inventor y taken bythe floor plan company. Please refer to the MP 04 05 endorsement attached to your po li cy. On page 3 of 5, under EXCL USIONS, section 2., parag raph (b), the following language is found: This e ndor sement does not apply: (b) unde r In s uring Agreement 1A or 1B, to loss, or to that part of any loss , as the case may

be, the proof of which, eit

he r as to its f

actual e xistence o

r to its amount, is dependent upon an i nven tory computation or a profit and loss computation; Therefore, we mu st res pectfully deny your claim, as pre sented, anddecline pay

ment. If facts are

developed which s upp ort the existence and th e amount of the claim, separate form [sic] inventories, we will reconsider our position. Su bs eq ue nt ly, on October 23, 1991, Lovell wrote a letter to def endant's investigator

once again e xplaining his claim. The lette

r states: Dear Mr . Adams: This letter isa supplement to the employee theft claim whichwas ma de by Strings &

Things in Memphis, Inc. on November 12 , 1990. The claim was made f

or employee thef

t which occurred on or immediately prior to July 1, 1990. The initial discovery of the theft was made by the undersigned. The discovery wa s made when the top half of a Roland KR 5005 keyboard was disco vered mi ssing fr om the sec

ured wa rehouse area. The bottom

half of th at key

board wa s in its p roper place. The keyboa

rd is sold with both bottom and top half and is never separated for sale. My investigation revealed that the particular missing item wa s on inventory as having been received f rom the distributor, butthere was no sa les ticke t indicating a sa

le of tha t particular unit. Later on the same day of

that discovery, I

checke d both of the secure warehouse are as wher e these products are stored and it was discovered

that other Rolandproductsthat had b een rec eived int o inventory wer

e also missing with no evidence of a sale. It has been this com pany' s custom to stock large quantities of Roland products due to that manufacturer's conc ession on floorplan interest . The cor poration owns the bu ilding at 1492 Union Avenue and leases the ground floor of 1500 Union Avenue, the adjoining building. These buildings are separ ated by a small alley. There

is a secured

warehouse area

in bo th bu ildi ngs for the storage of

inve ntory . Only

one employe e has ac cess to these areas. That person is the Warehouse Mana ger. Within48 hours a

fter the initial the ft discov ery , flo orpla

n auditors from Textron ca

me to do the

ir monthly

floorpla n audit. This audit verified the Roland product that had b een rece ived but without ev iden ce of

sale [sic]. After the audit , I a

gain be gan an

in-depth investi gation into this apparent employee thef

t. I obtained copies of all Roland packing slips and compa

red all o f the Rola

nd product received to our inventor y a nd the Textron floor

plan audi t. I then, again, reviewed all sales tickets, loaner lists, and any other document that wo ul d indicate the whereabouts of the missing Ro la nd in ve nt or y. Also at this time , I a

ttempted t

o make a d

etermina ti on a s to the employee or employees w

ho were responsible for

this theft loss. All of the missing Roland products were r emoved from the se cu re d w ar eh ou se ar ea s a nd no t f ro m d is pl ay i nv en to ry. During the time of

this theft discovery, Cra ig Walker was the warehous e manager, who was the person e ntrusted with the key to the warehouse area. Mr. Walker was hired on May 21, 1990 and wa s terminated on November 16, 1990. After the employee lea

rned of the investigation being undertaken to determine the per son or persons resp onsible f or the the ft loss, Mr. Walker re

quested a transf

er from h is position a s warehouse manager to the sales staff.6 The re ason fo r his continued employment was that I hoped he would disclose to some of the other emplo yees his actual involveme

nt in the the

ft. Imme diately

before his termination, a background check of Mr. Walker r eveale d that he h ad been arrested on two se

parate occasio ns which in

volved the

ft. The employee thef

tloss amount of $31,812.30 is not dependent upon an inventory s hortag e computa tion or a p

rofit and loss computation, but is ve rified by actual documents of receipt and the lack of docume

nts evide ncing sa les. Mr. Wa lk er wa s a ls o a ke yb oa rd play er and pr

ior to his employment

had b een a cu stomer seeking to purchase a Roland KR keyboard. Mr. Walker was transferred to the sales staff on or about A

ugust 15, 1990, and all of the missing merchandise was noted missing between his date of employ ment and his date of transfer. Quite frankly , I do

not u nderstan d the comp any 's denia l of this claim as per your

letter of May 20, 1991. I would like to r eiterat e that this claim is supported by actual product identification of the particular item missing and not by

a ge neral i nvent ory short age calculation. I have pre viously furnished to you

all document s supporting this claim. Af t er you have re viewed th

e enclos ure, ple ase cont act my at to rn ey. At the conclusion of trial, the chancellor found that plaintiff had not car ried its burden of proving that the loss of the inventory was due to employee theft. The chancellor believed that plaintiff did not ta

ke approp riate action after suspecting that a loss had oc curred, because the plaintiff failedto confront the employees suspected of the theft, and failed to inform the police that the items were stolen. The chancellor also noted that Ms. Herrington had testified that the business w as disorg anized, and that plaintiff had difficulty locating merchandise. The chanc ellor also ga ve weig ht to Ms. Herrington's testimony that plaintiff's vault was not kept locked all of the time. While we agree with the chanc ellor that plaintiff did not confront the suspe cte d employ ees, that plain

tiff did not inform the police of the los s, and tha

t plaintif f did not op erate

an organized business, we have not been directed to any provision

in the policy th at would7

prevent recove ry because of pla inti ff's failure to do these

things. We

must respe

ctfully disagree withthe chancellor's finding that Ms. Her rington testified that the vault wasnot kept lo cked all the time. Our reading of

the rec ord reve als that she testified that the vault was not locked during the first year

that her company

performed audits for plaintiff, but thereafter p laintiff ke pt the vault locked. As we read the record, the uncontroverted proof in the case is that plaintiff received various items of merchandise for the purpose of resale, that these items were kept in a lockedarea accessible by

two employees, that ther

e is no record that these items were ever sol d in the ordin ary

course of business, and that these items were not found in the locked area where they should have bee

n. Defendant

assertsthat p laint iff's claim is excluded by the policy provisions set out above, because the fac tual existe

nce of th e loss and

the amoun

t of the los s are "dependent upon an inventory computation." The parties have cited no Tennesseeauthority dealing with this pr

ecise policy provision, nor has our research revea led any such a

uthority. However , this provision has been dealt with by courts in other jurisdictions. I n Ace Wire & Ca ble Co., Inc. v. Aetna Casualty & Surety Co. , 457 N.E.2d 761 (1983), the New York Court of Appeals considered a virtually identical policy

provision. The Court stated: We hold tha

t the phra se "inve

ntory computa tion" i s to be construedto proscribe proof of the fact or amount

of los s thro ugh a generalized estimate, calculated, for example, from sales records and average markup, of what the dollar value of inventory o n hand should be. It does not, however, preclude proof of the fact or amount

of lo ss through inventory records (whether perpetual or period ically made) de tailing the actual phy sical count of individually identifiable units such as are described in the Deutsch affidavits. T hat co nclusion finds support in Popeo v. Liberty Mut. Ins. Co. , 369 Mass. 781 , 7 85, 343 N.E.2d 417 ["Where the missing items are identified from such record s (unittype or perpe tual inve ntory record s), it has b een held that ther e is no 'i nventory

computat

ion' with in the mea

ning of t he invent o r y exclusion c lause" ]; Paramount Pape r Prods. Co. v. Aetna Cas . & Sur. Co. , 182 N eb. 8 28, 839, 157 N.W.2d 763 ["the exclusionary

clause does not bar an invent or y m ade upon a unit ba sis, but does bar inventories which require computation t o reducethem to some other basis, or, wher

e when one invento

ry is compared with alater o ne, it is necessary to compute and allow for sales and purchases made in the interim"]; and Sun Ins. Co. v. Cullum's Men Shop , 331 F.2d 988, 991 (5th Cir. 1964) ["proof of the amount of the loss did not depend upon aninv entory8 computation

. . . but on the contrary consisted of an enumeration of each mis sing ite

m, suit by suit, based upon a check of the stock record, the swatch bo ok, against t he stock actu ally on hand"] (citations omitted). Ace Wire & Cable Co. , 457 N.E.2d at 764-65. The la ng ua ge in th e p ol ic y in th is ca se re fe rs to an "i nv en to ry c omputation," which denotes some type

of mathematical calculation. Considering the lang uage used, we feel that the holding of the court in Ace Wire correc tly const rues t he pol icy excl usio n as no t appl ying to a physical count of individually identifiable units of inventory . When dealing wi th indiv idual identifia ble units, the

re is no c omputation

involved; the unit is simply present and accounted for, or it i s miss ing. We think it is significant that the policy lang

uage excludes a loss based on an i nventory computation rather than on an enumeration of missing items. I n the case at bar, the evidence sh owing the pu rchase of the individual items and the absence of these items fr om inventory wi th ou t e vi de nc e o f a sa le is no t a n i nv en to ry c omputation as contemplated by the policy. The policy that the defe ndant issued to plaintiff provides that defendant will pay plaintiff for "loss of money , securities and other property which the insured shall sustain,

. . . resulting directly from one or more fraudulent or dishonest acts committed by an employee , acting alone

or in collusion with others." As stated above, the exclusion in Section 2(b) is not app licabl e because the proof of the loss is not dependent upon an inventory computation. The polic y a

lso provid

es as follows: LOSS CAUSED BY UNI DENTIFI ABLE EMPL

OYEE Section 4. If a loss is alleged to have been caused by

the fraud or dishonest y of any one or

more of the Employee s covered under Insurance Agree ment 1A or

1B, as th

e case ma y be, a

nd the Insured shall be unable to designate the specific Employ ee or Employees causing such loss, the Insured shall nevertheless have the benefit of

such applicable Insuring

Agreement subject

to the provisions of Section 2 (b) of this endor sement provided t hat the evidence submitted reasonably proves that th e loss was in factdue to the

fraud or dishones ty of one or more o f the said Employees , andprovided , furthe r, that the aggr egate liability of the Co mp an y fo r a ny such los s shall not exceed the Limit of Liab ility applica ble to such I

nsuring Agree ment. (e mphasis added).9 In the instant case, plaintiff proved that the items in question were received by plaintiff andwere no t sold in

the usual course of business. Plaintiff also proved that the items were kept in a locked area accessible by two employees other

than the owne

rs of the business. Alth ough there is proof that

plaintiff's business was somewhat unorganized, the fa ct remains that

the items

were purchas ed by

plaintiff , were n ot sold

by plaintiff, were kept under lock and key , were not found in in ve nt or y, and were accessible by only twoem pl oye es , U nd er Se ct io n 4 of th e p ol ic y, plaintiff is requiredto reasonably pr ove that the loss was due to the dishonesty of its employee

or employees. We think plaintiff has reasonably pr oven that the loss was due to the di shonesty of one orboth of the employees w ho had control of the key s where the insured property was located. Plaintiff, in addition to seeking the va lue of th e missing items, seeks to recover the interest paid on the floor planfinancing of the items. We find nothing in the policy that provides

covera ge for su ch a lo ss. P laint iff's proof sho ws an ag greg ate loss o f merch andise in excess of the $25,0 00.00 con

tractua l limit. The judgment of the trial court is vac ated. Judgment i s entere d for pla intiff ag ainst defendant in the amount of $25, 000.00. Th e case is remand

ed to the trial court for such further proceedings as may

be necessary , and costs of the appeal are assessed a gainst the appellee.

____________________________________ W. FRANK CRAWF ORD, PRESIDIN G JUDG

E, W.S. CONCUR:

________________________________ DAVID R. FARMER, JUDGE

________________________________ BROOKS MCLEMORE, SPECIAL JUD GE