professional service exclusion

Originally published in The D&O Diary by Kevin M. LaCroix.

In a recent post (here), I discussed a recent federal district court ruling in which the court broadly interpreted the professional services exclusion in a bank’s D&O insurance policy in order to preclude coverage under the policy for a claim that had been made against the bank and certain of its directors and officers in a case arising out of the long-running Rothstein Ponzi scheme scandal. Southern District of Florida Kathleen M. Williams’s May 2015 opinion in the case, which I discussed in that earlier post, can be found here. As I noted in my earlier post, the case presents an example of the problems that can arise when a professional services firm’s D&O insurance policy contains a professional services exclusion with the broad “arising out of, based upon, or attributable to” preamble language.

As discussed below, a recent law firm memo analyzing the court’s ruling called Judge Williams’s expansive reading of the language “troubling” and expressed the concern that the breadth of the court’s reading of the exclusion’s preclusive effect could render the D&O insurance policy’s coverage “largely illusory.”

Background

As I noted in my prior post, the Rothstein law firm bankruptcy trustee along with a lead feeder fund’s bankruptcy trustees had filed claims against Gibraltar Private Bank & Trust and certain of its directors and officers alleging that the defendants aided and abetted Rothstein in the perpetration of the Ponzi scheme fraud. The bank submitted the claims to its D&O insurers, which denied coverage for the claims in reliance on the professional services exclusion in the policies.

The D&O insurers denied coverage for the claim in reliance on the primary D&O insurance policy’s professional services exclusion, which provided that “the insurer shall not be liable to make any payment for Loss in connection with any Claim made against any Insured alleging, arising out of, based upon, or attributable to the Organization’s or any Insured’s performance of or any failure to perform professional services for others, or any act(s), error(s) or omission(s) relating thereto.”

The company’s assignee filed an action seeking a judicial declaration that the D&O insurance policy provided coverage for the claim. The insurers filed motions to dismiss. In a May 18, 2015, opinion, Judge Williams, applying Florida law, granted the defendants’ motions to dismiss with prejudice, holding that the D&O insurance policies’ professional services exclusion precluded coverage for the underlying claims.

Among other things, Judge Williams rejected the plaintiffs’ arguments that the allegations against the bank and the individual directors and officers arose out of purely internal management and regulatory functions, not services to others. Judge Williams concluded that the allegations in the underlying complaint “arise out of, or are attributable to, the Insureds’ performance or failure to perform professional services for others” – specifically banking services for the benefit of Rothstein and the Rothstein law firm accounts.

Judge Williams rejected the argument that applying the exclusion this broadly, basically to encompass anything that happens in connection with bank’s operation as a bank, rendered the policy’s exclusion illusory. She said that the policy would still provide coverage for many claims that do not involve the delivery of services, such as wrongful termination claims or securities claims.

The Law Firm Memo

In a June 30, 2015, post on the Orrick law firm’s Policyholder Insider blog entitled “Blurred Lines: The Professional Services Exclusion in D&O Policies for Services Companies” (here), Darren S. Teshima and Bryan Coffey provide their analysis of Judge Williams’s decision, noting that if interpreted and applied as it was in this case, the “professional services exclusion found in most D&O policies may erase most of the coverage such companies believe they’re purchasing.”

After reviewing the details of the ruling, the authors noted that “the district court’s affirmance of the insurer’s expansive reading of the professional services exclusion is troubling.” The noted that the ruling suggests that “anything a bank or other services company does ‘arises out of’ or is ‘attributable to” the provision of professional services,” which, if so, would render the D&O insurance coverage these firms purchase to be “largely illusory.”

At the memo’s authors point out, most professional services firms buy both D&O insurance and E&O insurance. The purpose of the professional services exclusion in the D&O policy is to “avoid overlapping coverages” for claims that may be covered under a D&O policy, by drawing a line between the coverages. The problem is that for many professional services firms, “this line becomes blurred.” The problem is that applying the exclusion broadly, as Judge Williams did here, “threatens to eviscerate the companies’ D&O coverage.”

Even though, as Judge Williams pointed out, there might still be coverage under the policy for employment practices claims or securities claims, companies buy D&O insurance for a lot more than EPL or securities claims; her reading of the policy, the authors say, “falls far short of the coverage expectations insureds have when they purchase D&O coverage, and renders much of the coverage illusory.” Her reading also “conflicts with the widely-accepted principle that grants of coverage should be interpreted broadly to afford the greatest protection to the insured, and that exclusions are to be read narrowly.”

The authors suggest that professional services firms whose D&O insurance policy include a professional services exclusion with the broad preamble are “putting at risk coverage for some of the most likely and anticipated claims.” These companies, the authors suggest should “remove such ‘arises out of’ language from the professional services exclusion.”

Discussion

I have long thought that because the purpose of the professional services exclusion is just to keep the claims in their proper lanes — with E&O claims under the E&O policy and D&O claims under the D&O policy – the proper and appropriate wording to be used with the exclusion is the narrower “for” wording, rather than the broader “based upon, arising out of, or in any way relating to” language. But whatever the argument in general might be for using the broader language, the broad preamble clearly sweeps too broadly in the context of companies in the services sector. The problem is that for a services business all likely claims will arise out of, or relate in any way to the company’s delivery of services.

For that reason, I have long thought that the only appropriate preamble for a professional services exclusion in a service company’s D&O insurance policy is the narrower “for” wording rather than the broader “based upon or arising our of” language.

Moreover, the examples of the kinds of claims for which Judge Williams tried to argue coverage was preserved notwithstanding the exclusion’s reach are entirely inapposite; the employment practices claims she references are covered under an employment practices insurance policy, not a D&O insurance policy, and the securities law claims while arguably relevant to a public company are somewhat less relevant for a privately held company.

Even if it is true that coverage for these types of claims is preserved notwithstanding the broad sweep of the professional services exclusion, that still leaves the entire remaining universe of possible D&O claims – that is, all of the various types of liability exposures for which a private company might buy D&O insurance – within the reach of the exclusion’s broad preclusive sweep.

Although I think the narrow “for” wording is the only appropriate wording for the professional services exclusion, it may not always be available even in a competitive marketplace. Given the purposes for which the exclusion is in the policy, it is the wording that carriers should be using. The broader wording threatens to sweep to broadly, particularly for services companies, and, as the law firm’s authors note, eviscerate the very coverage for which the insurance was purchased.