Recent Cases Addressing Professional Services Coverage & Exclusions Under General Liability, Directors & Officers And Professional Liability Policies

Transcription

1 ABA Litigation Section, Insurance Coverage Litigation Committee Mad Skillz: Professional Services Coverage & Exclusions In The High-Tech Era Tucson, Arizona March 1, 2018 Recent Cases Addressing Professional Services Coverage & Exclusions Under General Liability, Directors & Officers And Professional Liability Policies Jeff Kiburtz and Rani Gupta 1 The concept of professional services is an often overlooked but important concept under multiple lines of commercial insurance. Routinely excluded from commercial general liability (CGL) and directors and officers (D&O) policies, and covered under professional liability or errors and omissions (PL) policies, 2 whether a particular claim involves professional services can be a central issue in coverage claims involving activities that are arguably professional in nature. It is an issue that can, depending on the circumstances, lead to a policyholder obtaining coverage under more than one line of coverage. See, e.g., Utica Nat l Ins. Co. of Tex. v. Am. Indem. Co., 141 S.W.3d 198 (Tex. 2004) (possible coverage under CGL policy despite payment by PL insurer). Or, conversely, a finding that a claim fits squarely within a gap between, for example, the company s D&O and PL policies. See, e.g., Tagged, Inc. v. Scottsdale Ins. Co., No. JFM , 2011 WL (S.D.N.Y. May 27, 2011) (claim did not involve advertising services for others, for a fee, as required for coverage under PL policy, but did involve the rendering or failing to render professional services for purposes of exclusion under D&O policy). Seeking to avoid the latter result, companies and their brokers review their policies in an effort to eliminate gaps between the various policies. This is typically accomplished, at least in the first instance, by comparing the breadth of the insuring agreement in the PL policy relative to the exclusions in the CGL and D&O policies, making sure that the exclusions are no broader than the coverage grant. 1 Jeff Kiburtz is Special Counsel in the Los Angeles, CA office of Covington & Burling LLP. Rani Gupta is an Associate in the Silicon Valley, CA office of Covington & Burling LLP. They exclusively represent policyholders in insurance coverage matters. The opinions stated in this paper are their own and should not be attributed to co-panelists, the law firm or to its clients. 2 PL coverage includes industry-specific coverages such as tech E&O (which is distinct from, but sometimes packaged with, cyber coverage), contractor professional liability and banker s professional liability policies. There also are, further, the more traditional types of PL coverage such as that professional such as architects, engineers, doctors, and lawyers have been buying for decades.

2 But what about a company that does not perceive itself as performing professional services and therefore does not purchase PL coverage? It probably will not give much thought to the professional services exclusions in its CGL and D&O policies, particularly given that professional services are often associated with doctors, lawyers and other traditional professionals and exclusions are generally undefined. Companies that do not consider these issues may be surprised when their insurer denies coverage under a professional services exclusion for claims involving what the company might think is its normal, non-professional business operations. For instance, in Atain Specialty Insurance Co. v. Szetela, the insured obtained CGL coverage for its small business, which was the use of regular passenger vehicles on public highways to accompany trucks carrying oversized loads. No. 2:14- cv-02991, 2016 WL (E.D. Cal. Mar. 23, 2016). The court, however, found that licensing and other requirements applicable to pilot car services made the activity sufficiently professional to come within the scope of the professional services exclusion. Id. at *4, 6 7 (citing Hollingsworth v. Commercial Union Ins. Co., 208 Cal. App. 3d 800, 810 (1989) (earpiercing is a professional service for purposes of exclusion under CGL policy)). For their part, insurers that advance expansive interpretations of professional services exclusions in CGL and D&O policies may be acting against their collective interests with regard to PL coverage. For instance, if driving a passenger car and ear-piercing are considered professional services for purposes of a professional services exclusion, can an insurer reasonably take the position that almost anything a modern, sophisticated company is not a professional service for purposes of an insuring agreement? By a similar token, adopting unduly constrained interpretations of the coverage grant in PL policies may also limit as a practical matter insurers ability to take expansive positions on the exclusions. Setting aside what may be in the long-term interests of the insurance industry, the cases discussed in this article reflect significant disagreements between policyholders and insurers, particularly as to the scope of exclusions. Although these cases do not arise from high-tech circumstances, it is not hard to imagine how at least some of these cases could provide arguments against coverage when a claim involves the work of highly skilled employees or a sophisticated product that requires specialized training to operate. Companies therefore may be well-advised to consider these issues before a claim arises, and delineate where possible the contours of both coverage grants and exclusions for professional services. I. Background Three Key Concepts There are three primary concepts related to professional services provisions, as follows: A. The Meaning of Professional Some policies answer this question through the use of detailed definitions, but many do not. For those that leave the concept undefined, or only minimally defined, courts often give the term a broad meaning focused on the nature of the service provided: Something more than an act flowing from mere employment or vocation is essential.... A professional act or service is one arising out of a vocation, 2

3 calling, occupation, or employment involving specialized knowledge, labor, or skill, and the labor or skill involved is predominantly mental or intellectual, rather than physical or manual.... In determining whether a particular act is of a professional nature or a professional service we must look not to the title or character of the party performing the act, but to the act itself. Bank of Cal., N.A. v. Opie, 663 F.2d 977, 981 (9th Cir. 1981) (quoting Marx v. Hartford Accident & Indem. Co., 157 N.W.2d 870, (Neb. 1968)). At least some courts have, however, adopted an even broader understanding of professional, holding that the term generally signifies an activity done for remuneration as distinguished from a mere pastime, Hollingsworth, 208 Cal. App. 3d at 807, and is generally understood as the antonym of amateur, Atain, 2016 WL , at *4. Taken to the extreme, and in the context of an exclusion, the approach reflected in Hollingsworth would render illusory the coverage provided by any business insurance policy, as it arguably would mean that the professional services exclusion applies to almost any purposeful activity done in furtherance of the insured s business[,] as State Farm unsuccessfully advocated in North Counties Engineering, Inc. v. State Farm General Insurance Co., 224 Cal. App. 4th 902, 929 (2014). See also Liberty Life Ins. Co. v. Travelers Indem. Co. of Ill., 181 F.3d 88, at *3 (4th Cir. 1999) (rejecting insurer s argument where everything [insured] does, whether part of its core [business] function or not, would fall under the exclusions. ) The rationale of Hollingsworth may, however, carry greater weight in the context of an insuring agreement, as contract interpretation rules in most states require that coverage grants be construed broadly in favor of coverage, and that terms that are reasonably susceptible of more than one meaning be construed in favor of the insured. See, e.g., MacKinnon v. Truck Ins. Exch., 31 Cal. 4th 635, 655 (2003) (court must find coverage so long as there is any... reasonable interpretation under which recovery would be permitted ); Butterfield v. Giuntoli, 670 A.2d 646, 652 (Pa. Super. Ct. 1995) (when a term is reasonably susceptible of more than one meaning, the term must be construed in the light most favorable to the insured ). B. The Meaning of Services Whether found in a coverage grant or exclusion, policies often incorporate an express requirement that the professional services be performed for a third-party, such as a client or a customer. See, e.g., PMI Mortg. Ins. Co. v. Am. Int l Specialty Lines Ins. Co., 394 F.3d 761, 764, 768 (9th Cir. 2005) (professional services defined to include those performed pursuant to an agreement with the customer or client ). Such policies frequently provide, further, that the services provided to others be rendered for a fee or other compensation. See, e.g., Apartment Inv. & Mgmt. Co. (AIMCO) v. Nutmeg Ins. Co., 593 F.3d 1188, 1196 (10th Cir. 2010). But even where coverage under a policy requires that services be rendered to others for compensation, coverage remains available even when the underlying suit is brought by someone other than the recipient. See, e.g., PMI Mortg., 394 F.3d 761 (services rendered to lender clients; underlying 3

4 suit brought by borrowers); see also Phila. Indem. Ins. Co. v. Allied Mortg. & Fin. Corp., No , 2011 WL , at *3 (S.D. Fla. Oct. 3, 2011) (coverage not restricted only to claims brought by those persons or entities who pay a fee to [the insured] for [professional] services ). Where a policy does not specify that the activities in question be performed for compensation and for a party other than the insured, the outcome is less clear whether professional services can include activities undertaken without a profit motive or for the insured s own benefit. Consistent with the understanding of services as [l]abor performed in the interest or under the direction of others; specif., the performance of some useful act or series of acts for the benefit of another, usu. for a fee[,] Service, BLACK S LAW DICTIONARY (10th ed. 2014), courts have recognized that a principal s own work does not qualify as professional services even if performed in conjunction with a party providing professional services to the principal. See, e.g., U.S. Fid. & Guar. Co. v. Shorenstein Realty Servs., L.P., 700 F. Supp. 2d 1003, 1007 (N.D. Ill. 2010) (property owner s own work not professional services for purposes of CGL exclusion); Patrick Eng g, Inc. v. Old Republic Gen. Ins. Co., 973 N.E.2d 1036, (Ill. App. Ct. 2012) (utility s own work not professional services for purposes of CGL exclusion); cf Educ. Affiliates Inc. v. Fed. Ins. Co., No. JFM , 2016 WL , at *2 (D. Md. Jul. 28, 2016) ( marketing of professional services [for own benefit] is not the rendering of professional services to others for purposes of exclusion). Decisions from other courts could, however, suggest that it is the nature of the work that is determinative, not whether it was performed by the insured for its own benefit, see Energy Ins. Mutual Ltd. v. Ace Am. Ins. Co., 14 Cal. App. 5th 281, 305 (2017) (property owner s failure to mark its own pipelines excluded professional services), or for others without compensation, see Amex Assurance Co. v. Allstate Ins. Co., 112 Cal. App. 4th 1246, 1252 (2003) ( it is the type of activity, rather than actual compensation, that controls ). C. The Nexus Between Professional Services And Insured s Liability A third concept is the nexus required between the professional services and the liability. In the absence of language requiring a different approach, many courts have held that a claim for professional services is one that arise[s] out of the special risks inherent in the practice of the profession. Opie, 663 F.2d at 981. Under this approach, a D&O or CGL insurer cannot deny coverage under a professional services exclusion when the insured s liability is based on non-professional activities, even when performed in the course of rendering professional services. See, e.g., Food Pro Int l, Inc. v. Farmers Ins. Exch., 169 Cal. App. 4th 976, 991 (2008) (insurer must show that the injury... arose from the performance of a professional service, not merely at the same time the insured was otherwise providing professional services to a third party ); see also N. Counties, 224 Cal. App. 4th at (professional services exclusion does not apply when liability arose from 4

5 engineer s performance of non-technical construction work); Liberty Life Ins. Co., supra, 181 F.3d 88; Educ. Affiliates, supra, 2016 WL Conversely, a PL insurer need not cover liability that arises in the course of rendering professional services when the specific risk involved is not unique to that particular profession. See, e.g., Med. Records Assocs., Inc. v. Am. Empire Surplus Lines Ins. Co., 142 F.3d 512, 515 (1st Cir. 1998) (overcharging for copies and including improper charges on bills is not a professional service); Inglewood Radiology Med. Grp., Inc. v. Hosp. Shared Servs., Inc., 217 Cal. App. 3d 1366, 1370 (1989) (alleged wrongful termination of physician did not involve professional services even though evaluation of employee s performance required professional skills). These general concepts are, however, subject to change depending on the particular policy language at issue as construed under the applicable rules of contract interpretation. See, e.g., Bayley Constr. v. Great Am. E & S Ins. Co., 980 F. Supp. 2d 1281, (W.D. Wash. 2013) (underlying suit for failure to pay prevailing minimum wage on construction project covered by professional liability policy that included construction management in definition of professional services ). II. Recent CGL Cases In Energy Insurance Mutual Ltd. v. Ace American Insurance Co., a California court of appeal considered the scope of a CGL policy s professional services exclusion in the context of a massive explosion caused by construction activities that ruptured a high-pressure petroleum pipeline. 14 Cal. App. 5th 281 (2017). Energy-industry mutual insurer EIM provided coverage to the pipeline owner, Kinder Morgan. Kinder Morgan claimed rights as an additional insured under a policy issued by Ace to Comforce, a staffing company. After settling the claims against its insured, EIM pursued subrogation and other claims against Ace. As relevant here, Ace denied coverage on grounds of the professional services exclusion, which applied to any liability arising out of the providing or failing to provide any services of a professional nature. The policy does not further define professional liability or services of a professional nature. As relevant to the case, the underlying liability was premised on Kinder Morgan s failure to correctly identify the location of the line. Three individuals were implicated; one was a Kinder Morgan employee working as a line rider, and the other two were construction inspectors contracted through Comforce. Despite being nominally employed by Comforce, Kinder Morgan selected, trained and supervised the two Comforce employees. Both line riders and inspectors were expected to have specialized knowledge or training in pipeline construction or location. Focusing first on whether the activities were professional in nature the court observed that the activities involved in owning and operating a pipeline, including mapping and marking underground installations are clearly analogous to other skilled services that have been held to be professional services. Id. at 293. The court then turned to the nexus issue, holding that the liability arose directly from the failure to properly locate the pipeline, which the court held was within the scope of what it considered to be the professional responsibilities of the employees. 5

6 The court also addressed EIM s argument that the separation of insureds provision required a separate finding as to whether the activities of Kinder Morgan, itself, qualified as professional in nature. See Shorenstein Realty, 700 F. Supp. 2d at 1007; Patrick Eng g, 973 N.E.2d at The court agreed that the relevant inquiry is whether the additional insured engaged in professional services, but proceeded to conclude that Kinder Morgan was, in effect, rendering services to itself. There is no discussion of whether Kinder Morgan could be considered as providing or failing to provide any services to itself under the applicable rules of interpretation. Lastly, the court addressed EIM s argument that a finding of no coverage would render the policy illusory. It held that since the policy did not provide coverage for professional liability risks, an exclusion for professional liability did not withdraw virtually all of the coverage promised by the coverage grant. Energy Ins., 14 Cal. App. 5th at 306. Although the court cites to Safeco Insurance Co. of America v. Robert S., 26 Cal. 4th 758 (2001), as controlling California authority on the illusory doctrine, the Supreme Court did not rule in Safeco that virtually all coverage must be withdrawn before an interpretation makes the coverage illusory. Id. at 764 (a policy is illusory where interpretation renders the promised coverage practically meaningless ). Nor does Safeco mandate that the analysis be performed by reference to the insuring agreement alone. Id. at 766 (the proper inquiry is whether an insured would reasonably expect coverage under the circumstances). In Orchard, Hiltz & McCliment, Inc. v. Phoenix Insurance Co., the Sixth Circuit addressed professional services exclusions found in two contractors CGL policies under which an engineering firm sought coverage as an additional insured. 676 F. App x 515 (6th Cir. 2017). The engineering firm was retained by a municipality to provide design and construction administration services under two separate contracts. During the construction phase of the project, the engineering firm s services were expanded to include monitoring and documenting the general contractor s activities at the construction site. As an employee of the engineering firm was performing the expanded scope of duties, i.e., taking photographs of a digester lid being performed, an explosion killed one worker and injured another. In the suit that followed, the underlying plaintiffs alleged that the engineering firm was liable for breaching its alleged obligations to supervise all operations and to include in the plans, specifications and drawings, methods for safe removal of the digester lids and act as a reasonably prudent professional engineer, professional architect, and inspector. Both CGL insurers denied coverage outright based on professional service exclusions that barred coverage for injury caused by a... engineer with respect to liability arising out of the preparation or approval or the failure in preparation or approval of [plans, change orders, etc.] or the performance of any other professional services by such person or organization. The court held that much of the work, e.g., design, implementation, acting as an on-site consultant, and supervision, was predominantly intellectual in nature and therefore within the 6

7 scope of the professional services exclusion. Id. at 522. The court went on to hold that even if there were allegations related to activities that could be described as non-professional, such activities were performed as part of the broader suite of professional services provided by the engineering firm. Id. at 523. In Western National Mutual Insurance Co. v. TSP, Inc., the South Dakota Supreme Court held that the professional services exclusion in a general contractor s CGL contract barred coverage for a claim stemming from a subcontractor s land-surveying error. 904 N.W.2d 52 (S.D. 2017). The architect for a condominium project sued the general contractor for funds used to purchase a strip of land necessitated by a surveying error of a subcontractor. The court agreed with the insurer that land surveying was due to the rendering of or failure to render any professional service. Id. at 57, 13. Though the exclusion did not define professional service, the court looked to other South Dakota statues that described land surveying consistently with a professional service. Id. at 57 58, 14. The court distinguished land surveying, which requires intellectual assessments and the use of professional judgment, from a general construction task like putting up a wall, which involves manually implementing an existing plan. Id. at 58, 15. Finally, the court rejected the insured s argument that the exclusion did not apply to subcontractors, holding that the exclusion was not ambiguous and broadly written. Id. at 58, 16. III. Recent D&O Cases Another example is HotChalk, Inc. v. Scottsdale Insurance Co., which is currently on appeal to the Ninth Circuit. There, the insured provided promotional, recruitment and administrative services for universities online programs. HotChalk was sued under the False Claims Act for providing incentive-based compensation to its employees in violation of federal regulations. The insured had conceded that its provision of technology and support services to universities looking to create or expand online education programs were professional services within the meaning of the exclusion. 217 F. Supp. 3d 1058, 1064 (N.D. Cal. 2016). The court held that there was no meaningful distinction between those services and the insured s alleged practice of compensating employees based on their success in securing enrollments, which was the basis of the False Claims Act lawsuit. Id. The district court reasoned that the allegedly incentive-based compensation scheme could only have been improper because of the professional services that HotChalk provided. Id. In reaching this conclusion, the district court analyzed the legislative history of the incentive compensation ban that was enacted as part of federal education law and concluded that this ban only applied to HotChalk s compensation of its employees because it provided those professional services of providing technology and support services to universities. Id. at Thus, the court held that the claims were barred by the broad language of the exclusion, which applied to claims based upon, arising out of, attributable to, directly or indirectly arising from, in consequence of, or in any way involving the rendering or failing to render professional services. Id. at The court did not address whether its interpretation of the professional services exclusion rendered the coverage illusory. 7

8 But in Education Affiliates Inc. v. Federal Insurance Co., a federal district court in Maryland held that a professional services exclusion did not bar coverage for claims that the defendants engaged in deceptive marketing of career colleges WL The court agreed with the insureds that the marketing of professional services is not the rendering of professional services, much less professional services for others as is required to trigger the exclusion. Id. at *2. The court rejected the insurer s argument that coverage was precluded because the marketing relates to the professional services to be rendered to others. Id. The insured s core business, the court reasoned, was the rendering of educative services to others. Id. Conflating the rendering of these services with the marketing of them would provide an evisceration of coverage. Id. The court refused to adopt such a reading, noting that Maryland law prevents reading an exclusion to eviscerate the coverage that the policy affords. Id. (citing Liberty Life Ins. Co. v. Travelers Indem. Co. of Ill., No , 1999 WL , at *2 (4th Cir. May 5, 1999)). Similarly, in Philadelphia Indemnity Insurance Co. v. First Multiple Listing Services, Inc., the court held that the relevant lawsuit involved business aspects of the insured s real estate listing company, not its professional services. 173 F. Supp. 3d 1314, 1319 (N.D. Ga. 2016). The court held that the insured s professional services involve the maintenance of an electronic database on which its members, licensed real estate brokers, list and find properties. Id. at The lawsuit, however, challenged the fees the insured charged to its members as well as payment of a portion of those fees to its members (which were alleged to be an unlawful kickback). Id. The court found that the fee structure and remittance were nothing more than an ordinary task associated with the business aspects of the insured and had nothing to do with [the insured s] professional services. Id. (citing Auto-Owners Ins. Co. v. State Farm Fire & Cas. Co., 678 S.E.2d 196, 201 (2009) ( a professional must perform more than an ordinary task to furnish a professional service; the task must arise out of the acts specific to the individual s specialized knowledge or training )). Though the court reached its conclusion based on the plain language of the policy, the court held in the alternative that the undefined term professional services was, at best for the insurer, ambiguous and must be construed in favor of coverage. Id. In The Point/Arc of Northern Kentucky, Inc. v. Philadelphia Indemnity Insurance Co., the court found coverage based on a negligent supervision carve-out in a D&O policy s professional services exclusion. 154 F. Supp. 3d 503, 512 (E.D. Ky. 2015). The underlying lawsuit alleged that the insured s failure to engage in adequate record-keeping and oversight led to the embezzlement of the underlying plaintiff s personal funds by an employee of the insured. Id. The court in Lifespan Corp. v. National Union Fire Insurance Co. of Pittsburgh, Pa. emphasized the importance of reading the professional services exclusion in light of the policy as a whole and the endorsement in which the exclusion appeared. 59 F. Supp. 3d 427, (D.R.I. 2014). That endorsement was specific to nonprofit health care organizations like the insured. Id. at 457. Therefore, the court held that professional services exclusion excludes 8

9 from coverage only professional services involved in the actual provision of healthcare to others, rejecting the insurers broader reading that the exclusion extended to claims arising out of the insured health system s corporate management services to an affiliated hospital. Id. The court reasoned that the insurers reading would eviscerate coverage provided by the D&O policy, and that any ambiguity must be construed against the insurer. Id. at The Tenth Circuit s decision in Western Heritage Bank v. Federal Insurance Co. focused on two carve-outs in a professional services exclusion in a D&O policy issued to a bank. 557 F. App x 807 (10th Cir. 2014). The court held that the exclusion did not bar coverage for legal services or post-control actions, rejecting the insurer s argument that these services were excluded Lending Services. Id. at 813. The court noted the insurer s argument that an exclusion cannot create coverage, but held that this principle did not apply to a carve-out contained in an exclusion. Id. at 814. However, the court held that the insured made no argument on appeal as to how the relevant lawsuit arose from either covered legal services or post-control actions and therefore waived any argument that the lawsuit fell within the scope of coverage. Id. at 816. Finally, in Rob Levine & Associates Ltd. v. Travelers Casualty & Surety Co. of America, the court held that misrepresentation claims against a law firm were not professional services excluded pursuant to a D&O policy s Legal Services Exclusion. 994 F. Supp. 2d 228, 233 (D.R.I. 2014). The exclusion barred coverage for claims arising out of any Wrongful Act related to the rendering of, or failure to render, professional services. Id. The court held that under the plain meaning of render, the exclusion only applied to the insured providing legal services. Id. The court rejected the insurer s broader reading of the exclusion based on the use of the term related to, reasoning that any conduct by [the insured] would be excluded under the insurer s expansive view. Id. 9