Directors and officers (“D&O”) liability insurance policies typically contain exclusions for claims arising out of the rendering of, or failure to render, professional services for customers or others. These exclusions are intended to limit D&O coverage to management liability, and not professional liability exposures covered under separate professional indemnity policies.
When applied pursuant to their plain meaning, professional services exclusions effectively limit the scope of D&O policies to the bargained for coverage. As other policy terms such as the definition of “Insureds” have broadened in the soft market, coverage disputes regarding the applicability of professional services exclusions are on the rise.
A number of recent decisions by U.S. courts provide guidance regarding the applicability of professional services exclusions in different factual scenarios. These decisions generally examined whether the relevant conduct constituted excluded “professional services,” or rather covered management or business activities. The courts distinguished between professional services performed for a customer or client, and commercial or business activities arising from the insured’s operation of its business.
Many U.S. courts have applied professional services exclusions as written and rejected insureds’ arguments that these provisions eviscerate D&O policies and create illusory coverage.
Most recently, in Beazley Insurance Company, Inc., v. ACE American Insurance Company, et al. 2016 WL 3842315 (S.D.N.Y. July 12, 2016), the Southern District of New York applied a professional services exclusion in a D&O policy to a series of lawsuits against NASDAQ in connection with its alleged mishandling of the Facebook IPO. The court had little difficulty finding that NASDAQ’s alleged failure to properly design, test and implement its systems constituted professional services, and that the plaintiff retail investors were customers and clients. Next, the court considered whether the claim “arose out of” the excluded conduct, noting that under applicable New York law, the phrase “arising out of” turns on whether the claim could succeed “but for” the professional services. As the underlying claims would have failed but for NASDAQ’s failure to properly render professional services in the IPO, the exclusion applied. The court rejected arguments by NASDAQ’s E&O insurer that applying the “but for” test would eviscerate the coverage afforded by D&O policies, and that the exclusion was ambiguous because “professional services” was not defined in the policy.
Another New York federal court in Lerner Assoc., Inc. v. Philadelphia Ind. Ins. Co., 934 F. Supp.2d 533 (E.D.N.Y. 2013), applied a professional services exclusion in a D&O policy to lawsuits alleging that the insured financial adviser made misrepresentations and failed to conduct due diligence as an underwriter of real estate investment trusts. As the policy did not define “professional services”, the common meaning of the term applied. Under New York law, whether an insured is engaged in a professional service depends on whether they “acted with the special acumen and training of professionals when they engaged in the acts.” Also, professional services exclusions are not limited to situations involving “traditional professionals”, such as lawyers, doctors, architects, and engineers.
The court rejected the insured’s arguments that the underlying conduct was merely “ministerial” or “rote” activity, and financial advisers are not classified as professionals under malpractice law. As the performance of due diligence and marketing financial products required specialised knowledge and training, the lawsuits fell within the professional services exclusion.
In Goldberg v. National Union Fire Insurance Co. of Pittsburgh, 143 F. Supp.3d 1283 (S.D. Fla. May 18, 2015), a Florida federal court applied a professional services exclusion in a D&O policy to claims against the insured bank for allegedly providing banking services that aided and abetted the Rothstein Ponzi scheme. As in Beazley, the court found that the professional services exclusion was not ambiguous even though “professional services” was not defined, and application of the exclusion did not render the coverage illusory as the policy covered many types of claims not encompassed by the exclusion. In determining whether the conduct constituted professional services, the court considered whether it involved specialised skill or training and was regulated or required a degree or accreditation, and not “purely internal management and regulatory functions.”
In Hartford Casualty Insurance v. DP Engineering, 2016 WL 3552312 (5th Cir. June 29, 2016), the Fifth Circuit Court of Appeals applied a professional services exclusion in an umbrella policy to a lawsuit arising from an accident at a nuclear plant where the insured provided engineering services. Unlike most D&O policies, the umbrella policy defined “professional service” to include, among other things, “[s]upervisory, inspection, architectural or engineering activities.” Texas law interprets “professional services” to “require specialised knowledge or training and involve the exercise of judgement”, as opposed to administrative services that “occur in the ‘execution’ of a decision that was based on professional judgement.” As the factual allegations in the underlying complaints alleged injuries that arose out of the insured’s allegedly negligent engineering services, the insurers had no duty to defend.1
In other cases, however, courts have found that professional services exclusions in D&O policies did not apply to activities for the insured’s operation of its business. Also, some courts have been sympathetic to insureds’ arguments that applying professional services exclusions as written would “eviscerate” the D&O policy and result in illusory coverage, particularly where the insured was a service provider.
For example, in Education Affiliates Inc., et. al. v. Federal Insurance Company, et al., 2016 WL 4059159 (D. Md. Jul 28, 2016), a Maryland federal court declined to apply a professional services exclusion in a D&O policy to claims against an insured owner of for-profit career colleges for unfair and deceptive marketing practices. Applying Maryland law, the court distinguished the marketing of professional services from the rendering of professional services, finding that marketing does not require specialised knowledge separate and apart from that required in any business. Further, marketing does not involve the delivery of services “for others”, but rather is a service in which the insured engaged for its own benefit. The court noted that if it interpreted the exclusion as broadly as the insurer, coverage under the policy would be “eviscerated.”
Similarly, in Levine & Assoc. Ltd. v. Travelers Cas. and Sur. Co., 994 F. Supp.2d 228 (D. RI 2014), a Rhode Island federal court found that the underlying claim was for the insured’s alleged deceptive advertising to the general public to market its legal services, rather than the actual provision of services to a client, and the exclusion therefore did not apply.
The court reasoned that adopting an expansive reading of the professional services exclusion would render the D&O policy meaningless and provide no coverage as the insured law firm’s business was “related to the rendering of… professional services.”
Other U.S. courts have found professional liability exclusions to be ambiguous where the policy did not define the term “professional services.” In Philadelphia Indemnity Insurance Company v. First Multiple Listing Services, 2016 WL 1109171 (N.D. Ga. Mar 22, 2016), a Georgia federal court found that a professional services exclusion in a D&O policy did not apply to a class action against the insured real estate listing company for an alleged kickback scheme. Under Georgia law, the court held that the professional services exclusion did not preclude coverage for the underlying lawsuit involving the insured’s provision of an electronic real estate listing database, which did not require specialised knowledge or training. Further, the court found that the undefined term “professional services” was ambiguous and therefore would be construed against the insurer as a matter of law.
Professional services exclusions in D&O policies serve a valuable purpose in limiting coverage to its intended scope and avoiding overlap with coverage provided under separate professional indemnity policies.
When determining the potential applicability of professional services exclusions to claims under D&O policies, insurers should closely review the nature of the conduct alleged in the underlying claim and consider how such exclusions are applied under relevant law.