                 IN THE COURT OF APPEALS OF TENNESSEE
                       WESTERN SECTION AT JACKSON
              _______________________________________________
                                                                      FILED
STRINGS & THINGS IN MEMPHIS,
INC.,                                                                 November 8, 1995

      Plaintiff-Appellant,                                           Cecil Crowson, Jr.
                                                                      Appellate C ourt Clerk

                                                Shelby Equity No. 101098-1
Vs.                                             C.A. No. 02A01-9408-CH-00195

STATE AUTO INSURANCE COMPANIES,

      Defendant-Appellee.
_________________________________________________________________________

               FROM THE CHANCERY COURT OF SHELBY COUNTY

                  THE HONORABLE NEAL SMALL, CHANCELLOR




                             Robert A. Wampler of Memphis
                                     For Appellant

              Kenneth R. Shuttleworth and Archie Sanders, III of Memphis
                                    For Appellee




                      VACATED, RENDERED AND REMANDED

                                    Opinion filed:




                                                       W. FRANK CRAWFORD,
                                                       PRESIDING JUDGE, W.S.

CONCUR:

DAVID R. FARMER, JUDGE

BROOKS MCLEMORE, SPECIAL JUDGE
        This appeal involves a suit to recover on a policy of insurance covering employee

dishonesty. Plaintiff, Strings & Things in Memphis, Inc., appeals from the judgment of the

chancery court in a nonjury trial that dismissed its suit against defendant, State Auto Insurance

Companies. The only issue on appeal is whether the evidence preponderates against the findings

of the chancellor.

        Plaintiff's complaint alleges that plaintiff maintained a policy of insurance with defendant

for the period of April 1, 1990, to April 1, 1991. Under the "crime" coverage of the policy,

defendant insured plaintiff against property loss caused by employee dishonesty, theft,

disappearance, destruction, or robbery. The complaint avers that on or about July 1, 1990, one

of plaintiff's employees discovered that insured property was missing from a secured warehouse

area. Plaintiff alleges that the merchandise was stolen by an employee and that the total value of

the merchandise exceeded $31,000.00. The complaint further avers that plaintiff fully complied

with all provisions of the insurance policy, and therefore, plaintiff is entitled to a recovery under

the policy.

        Defendant's answer admits that the policy of insurance was valid and in effect at the time

of the loss. However, defendant contends that the loss is excluded from coverage under Section

2(b) of the policy, because "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, as the case may be, the
                proof of which, either as to its factual existence or as to its
                amount, is dependent upon an inventory computation or a profit
                and loss computation.

        Plaintiff's proof consisted of various exhibits as well as the testimony 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 Avenue in Memphis,

Tennessee, is a retail seller of musical instruments and related equipment.           The policy of

insurance issued by defendant was obtained from defendant's agent, Jim Barkley, and provided

coverage for employee dishonesty. Plaintiff utilized floor plan financing for a large part of its

                                                 2
inventory, and in April, 1990, it came to the attention of Lovell that some of the floor plan

merchandise was missing and that there was no record of the sale of the merchandise. All of

the missing items were identifiable by serial number, and a sale of any of the items would have

been evidenced by a sales receipt. The items involved were kept in secured areas, accessible

only by the owners of the business and two other employees.1 There was no indication that there

was any forcible entry to any of these locations. Plaintiff concluded that the two employees who

had access to the secured areas were responsible for the theft, and plaintiff reassigned the

employees to sales positions in which they would no longer have access to the vaulted areas.

       On April 30, 1990, Lovell notified defendant's agent Barkley that there appeared to be

an employee theft loss. Barkley advised Lovell to investigate the theft and to keep him updated

as to the progress of the investigation. Lovell contacted Barkley numerous times regarding the

theft, and in November, 1990, plaintiff's counsel forwarded Barkley written notice of the claim

and an itemized list of the missing property. Plaintiff was furnished a proof of loss form which

was completed and returned to defendant's agent. In January, 1991, defendant sent an

investigator to take a statement from Lovell, and at that time the investigator also requested

various documents from plaintiff. All of the items requested were furnished to defendant, even

though defendant denied plaintiff's claim prior to receiving the requested material.

       At trial, plaintiff introduced invoices, packing lists, sales receipts, and other documents

into evidence to show that plaintiff had purchased and financed the missing items, and that the

items had not been sold in the ordinary course of business. A trial, the only witness that testified

on behalf of defendant was Lee Boyer Herrington, an employee of Equifax Services. Equifax

was retained by the finance company to perform audits of plaintiff's floor plan merchandise. Ms.

Herrington testified that her company had been performing audits at Strings & Things for a

number of years prior to 1990, and that audits of Strings & Things were especially difficult due

to the company's disorganized merchandise and "sloppy" record keeping. She stated that


       1
       Some of the more expensive items were kept in an additional secured
area, referred to as the "vault," which was located inside of another locked
area.

                                                 3
plaintiff's employees had difficulty locating merchandise and were "lax" in recording serial

numbers of inventory. She further stated that the first year in which Equifax audited Strings &

Things, the vault was not kept locked, but thereafter plaintiff began locking it.      On July 30,

1990, an audit of Strings & Things revealed that there were fifteen less items of inventory on the

floor than in the previous month. The plaintiff paid the inventory financer for eleven of the items

and refused to pay for the remaining four claiming that they were stolen. Plaintiff's claim was

denied by defendant in its letter of May 20, 1991, which states:

               Dear Mr. Lovell:

               We have conducted an investigation into the claim presented by
               your company, Strings & Things in Memphis. We have found the
               proof of the claim, both in terms of its factual existence and its
               amount, is based solely on the discrepancy between the sales
               records and the physical inventory taken by the floor plan
               company.

               Please refer to the MP 04 05 endorsement attached to your policy.
               On page 3 of 5, under EXCLUSIONS, section 2., paragraph (b),
               the following language is found:

                       This endorsement does not apply: (b) under
                       Insuring Agreement 1A or 1B, to loss, or to that
                       part of any loss, as the case may be, the proof of
                       which, either as to its factual existence or to its
                       amount, is dependent upon an inventory
                       computation or a profit and loss computation;

               Therefore, we must respectfully deny your claim, as presented,
               and decline payment. If facts are developed which support the
               existence and the amount of the claim, separate form [sic]
               inventories, we will reconsider our position.

        Subsequently, on October 23, 1991, Lovell wrote a letter to defendant's investigator once

again explaining his claim. The letter states:

               Dear Mr. Adams:

               This letter is a supplement to the employee theft claim which was
               made by Strings & Things in Memphis, Inc. on November 12,
               1990.

               The claim was made for employee theft which occurred on or
               immediately prior to July 1, 1990.

               The initial discovery of the theft was made by the undersigned.
               The discovery was made when the top half of a Roland KR 500

                                                 4
keyboard was discovered missing from the secured warehouse
area. The bottom half of that keyboard was in its proper place.
The keyboard is sold with both bottom and top half and is never
separated for sale.

My investigation revealed that the particular missing item was on
inventory as having been received from the distributor, but there
was no sales ticket indicating a sale of that particular unit.

Later on the same day of that discovery, I checked both of the
secure warehouse areas where these products are stored and it was
discovered that other Roland products that had been received into
inventory were also missing with no evidence of a sale.

It has been this company's custom to stock large quantities of
Roland products due to that manufacturer's concession on
floorplan interest. The corporation owns the building at 1492
Union Avenue and leases the ground floor of 1500 Union
Avenue, the adjoining building. These buildings are separated by
a small alley. There is a secured warehouse area in both buildings
for the storage of inventory. Only one employee has access to
these areas. That person is the Warehouse Manager.

Within 48 hours after the initial theft discovery, floorplan auditors
from Textron came to do their monthly floorplan audit. This
audit verified the Roland product that had been received but
without evidence of sale [sic].

After the audit, I again began an in-depth investigation into this
apparent employee theft. I obtained copies of all Roland packing
slips and compared all of the Roland product received to our
inventory and the Textron floorplan audit.

I then, again, reviewed all sales tickets, loaner lists, and any other
document that would indicate the whereabouts of the missing
Roland inventory.

Also at this time, I attempted to make a determination as to the
employee or employees who were responsible for this theft loss.
All of the missing Roland products were removed from the
secured warehouse areas and not from display inventory.

During the time of this theft discovery, Craig Walker was the
warehouse manager, who was the person entrusted with the key
to the warehouse area.

Mr. Walker was hired on May 21, 1990 and was terminated on
November 16, 1990.

After the employee learned of the investigation being undertaken
to determine the person or persons responsible for the theft loss,
Mr. Walker requested a transfer from his position as warehouse
manager to the sales staff.


                                  5
               The reason for his continued employment was that I hoped he
               would disclose to some of the other employees his actual
               involvement in the theft.

               Immediately before his termination, a background check of Mr.
               Walker revealed that he had been arrested on two separate
               occasions which involved theft.

               The employee theft loss amount of $31,812.30 is not dependent
               upon an inventory shortage computation or a profit and loss
               computation, but is verified by actual documents of receipt and
               the lack of documents evidencing sales.

               Mr. Walker was also a keyboard player and prior to his
               employment had been a customer seeking to purchase a Roland
               KR keyboard.

               Mr. Walker was transferred to the sales staff on or about August
               15, 1990, and all of the missing merchandise was noted missing
               between his date of employment and his date of transfer.

               Quite frankly, I do not understand the company's denial of this
               claim as per your letter of May 20, 1991. I would like to reiterate
               that this claim is supported by actual product identification of the
               particular item missing and not by a general inventory shortage
               calculation.

               I have previously furnished to you all documents supporting this
               claim.

               After you have reviewed the enclosure, please contact my
               attorney.

       At the conclusion of trial, the chancellor found that plaintiff had not carried its burden

of proving that the loss of the inventory was due to employee theft. The chancellor believed that

plaintiff did not take appropriate action after suspecting that a loss had occurred, because the

plaintiff failed to 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 was disorganized, and that plaintiff had difficulty locating merchandise. The chancellor

also gave weight to Ms. Herrington's testimony that plaintiff's vault was not kept locked all of

the time.

       While we agree with the chancellor that plaintiff did not confront the suspected

employees, that plaintiff did not inform the police of the loss, and that plaintiff did not operate

an organized business, we have not been directed to any provision in the policy that would

                                                6
prevent recovery because of plaintiff's failure to do these things. We must respectfully disagree

with the chancellor's finding that Ms. Herrington testified that the vault was not kept locked all

the time. Our reading of the record reveals that she testified that the vault was not locked during

the first year that her company performed audits for plaintiff, but thereafter plaintiff kept 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

locked area accessible by two employees, that there is no record that these items were ever sold

in the ordinary course of business, and that these items were not found in the locked area where

they should have been.

       Defendant asserts that plaintiff's claim is excluded by the policy provisions set out above,

because the factual existence of the loss and the amount of the loss are "dependent upon an

inventory computation." The parties have cited no Tennessee authority dealing with this precise

policy provision, nor has our research revealed any such authority. However, this provision has

been dealt with by courts in other jurisdictions. In Ace Wire & Cable 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 that the phrase "inventory computation" is to be
               construed to proscribe proof of the fact or amount of loss through
               a generalized estimate, calculated, for example, from sales
               records and average markup, of what the dollar value of inventory
               on hand should be. It does not, however, preclude proof of the
               fact or amount of loss through inventory records (whether
               perpetual or periodically made) detailing the actual physical count
               of individually identifiable units such as are described in the
               Deutsch affidavits. That conclusion finds support in Popeo v.
               Liberty Mut. Ins. Co., 369 Mass. 781, 785, 343 N.E.2d 417
               ["Where the missing items are identified from such records (unit-
               type or perpetual inventory records), it has been held that there is
               no 'inventory computation' within the meaning of the inventory
               exclusion clause"]; Paramount Paper Prods. Co. v. Aetna Cas.
               & Sur. Co., 182 Neb. 828, 839, 157 N.W.2d 763 ["the
               exclusionary clause does not bar an inventory made upon a unit
               basis, but does bar inventories which require computation to
               reduce them to some other basis, or, where when one inventory is
               compared with a later one, 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 an inventory

                                                7
                 computation . . . but on the contrary consisted of an enumeration
                 of each missing item, suit by suit, based upon a check of the stock
                 record, the swatch book, against the stock actually on hand"]
                 (citations omitted).

Ace Wire & Cable Co., 457 N.E.2d at 764-65.

          The language in the policy in this case refers to an "inventory computation," which

denotes some type of mathematical calculation. Considering the language used, we feel that the

holding of the court in Ace Wire correctly construes the policy exclusion as not applying to a

physical count of individually identifiable units of inventory. When dealing with individual

identifiable units, there is no computation involved; the unit is simply present and accounted for,

or it is missing. We think it is significant that the policy language excludes a loss based on an

inventory computation rather than on an enumeration of missing items. In the case at bar, the

evidence showing the purchase of the individual items and the absence of these items from

inventory without evidence of a sale is not an inventory computation as contemplated by the

policy.

          The policy that the defendant 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 applicable

because the proof of the loss is not dependent upon an inventory computation.

          The policy also provides as follows:

                  LOSS CAUSED BY UNIDENTIFIABLE EMPLOYEE

                  Section 4. If a loss is alleged to have been caused by the fraud or
                  dishonesty of any one or more of the Employees covered under
                  Insurance Agreement 1A or 1B, as the case may be, and the
                  Insured shall be unable to designate the specific Employee 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 endorsement provided that the
                  evidence submitted reasonably proves that the loss was in
                  fact due to the fraud or dishonesty of one or more of the said
                  Employees, and provided, further, that the aggregate liability of
                  the Company for any such loss shall not exceed the Limit of
                  Liability applicable to such Insuring Agreement. (emphasis
                  added).

                                                   8
       In the instant case, plaintiff proved that the items in question were received by plaintiff

and were not 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 owners of the business. Although

there is proof that plaintiff's business was somewhat unorganized, the fact remains that the items

were purchased by plaintiff, were not sold by plaintiff, were kept under lock and key, were not

found in inventory, and were accessible by only two employees, Under Section 4 of the policy,

plaintiff is required to reasonably prove that the loss was due to the dishonesty of its employee

or employees. We think plaintiff has reasonably proven that the loss was due to the dishonesty

of one or both of the employees who had control of the keys where the insured property was

located.

       Plaintiff, in addition to seeking the value of the missing items, seeks to recover the

interest paid on the floor plan financing of the items. We find nothing in the policy that provides

coverage for such a loss. Plaintiff's proof shows an aggregate loss of merchandise in excess of

the $25,000.00 contractual limit.

       The judgment of the trial court is vacated. Judgment is entered for plaintiff against

defendant in the amount of $25,000.00. The case is remanded to the trial court for such further

proceedings as may be necessary, and costs of the appeal are assessed against the appellee.

                                               ____________________________________
                                               W. FRANK CRAWFORD,
                                               PRESIDING JUDGE, W.S.

CONCUR:


________________________________
DAVID R. FARMER, JUDGE


________________________________
BROOKS MCLEMORE,
SPECIAL JUDGE




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