Samuel Renko, president of Senframe Hotel Management Company, authorized the purchase of a $2 million fidelity insurance policy, the purpose of which was to protect the company in the event of employee theft or fraud. In discussing the purchase with the insurance agent, Jana Foster, Mr. Renko assured Ms. Foster that all hotel controllers were subject to a thorough background check before they were hired. As a specific condition of the insurance policy, background checks on controller candidates were required prior to employment.

The insurance policy was purchased and went into effect on January 1, 2011. On June 1, 2011, the Senframe Hotel Management Company took over the management and operation of the Roosevelt Hotel, a 300-room property in a resort area. As part of the operating agreement with the Roosevelt Hotel's owners, the hotel's controller and its director of sales were retained by Senframe. On December 20, 2011, Senframe management discovered that the Roosevelt Hotel's controller had been creating and submitting false invoices. The invoice payments were deposited in a bank account he had established for himself five years earlier. Total losses for the five-year period that the falsification occurred were over $500,000.

The controller resigned, but the hotel owners sued Senframe for the portion of misappropriated fund ($70,000) taken during the period the hotel was under Senframe's management. Ms. Foster maintained that her insurance company was not liable to indemnify Senframe, because the controller had not been subjected to a background check as Mr. Renko had promised. Mr. Renko countered that the controller, although not background checked, had no criminal record of any kind, and thus a background check would not have prevented the hotel from hiring the controller.

1. Must Ms. Foster's company defend Senframe in the litigation brought by the hotel's ownership? 2. If you were on a jury, would you hold Senframe responsible for the employee theft? 3.Regardless of the outcome of this situation, what changes in operational procedure should be implemented by Mr. Renko and the Senframe Hotel Management Company?