Regular readers know that one of my hobby-horse issues is what I perceive as insurers’ overbroad application of the professional services exclusion typically found in private company D&O insurance policies, particularly with respect to policyholders in services businesses. Because of this long-standing concern, I was interested to see that a policyholders’ rights group has filed an amicus brief in the Ninth Circuit in support of a policyholder’s appeal of a district court ruling that coverage under a D&O insurance policy for the underlying claim was precluded by the professional services exclusion. While the amicus brief may help focus the appellate court on the problems involved in what is a recurring situation, the larger point may be that as an industry we need to address a problem that affects all industry participants.
The insurance coverage dispute involved in the appeal arises out of a False Claims Act lawsuit that was filed in April 2014 against HotChalk Inc. by certain of its former employees. HotChalk is in the business of helping universities create or expand their online degree programs. Their services include promoting and administering those programs, including recruiting students. The plaintiffs in the False Claims Act suit alleged that the HotChalk provided forms of incentive payments to its employees responsible for recruiting student, in violation of Department of Education regulations prohibiting companies involved in federal student grant and loan programs from paying commissions or incentive compensation. HotChalk ultimately settled the underlying lawsuit.
HotChalk submitted the False Claims Act lawsuit to its D&O insurer, which denied coverage for the lawsuit on the grounds that the lawsuit arose out of the company’s professional services rendered to its customer universitites and were therefore excluded from coverage under the policy’s professional services exclusion. HotChalk filed a coverage lawsuit against the insurer. The insurer filed a motion for judgment on the pleadings.
In a November 15, 2016 order (here), Northern District of California Judge Claudia Wilken entered an order granting the D&O insurer’s motion. In granting the motion, Judge Wilken rejected HotChalk’s argument that the underlying lawsuit arose out of its alleged employee compensation practices, which, the company argued, strictly involved an internal aspect of the way it ran its business and therefore was unrelated to its delivery of professional services.
Judge Wilken concluded that HotChalk’s incentive compensation scheme “could only have been improper because of the professional services that HotChalk provided.” The statutory scheme that prohibited the incentive compensations was intended to “protect the government’s own financial interests and its interest in protecting student borrowers.” Absent HotChalk’s provision of professional services, Judge Wilken said, the company would not have been subject to the law that it was alleged to have violated in the underlying lawsuit. Therefore, she concluded, the False Claim Act lawsuit arose out of HotChalk’s professional services and could not potentially fall outside the professional services exclusion.
HotChalk filed a notice of appeal to the Ninth Circuit.
The professional services exclusion in HotChalk’s D&O insurance policy provides that the
Insurer shall not be liable for Loss under this Coverage Section on account of any Claim alleging, 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, provided, however, this exclusion shall not apply to any Claim(s) brought by any securities holder of the Company in their capacity as such.
The Amicus Brief
On March 30, 2017, United Policyholders (UP) filed an amicus brief in support of HotChalk’s appeal. The amicus brief can be found here. According to its website, UP is a not-for-profit organization whose mission is to “be a trustworthy and useful information resource and a respected voice for consumers of all types of insurance in all 50 states.” According to its amicus brief, the organization has filed over 400 friend of the court briefs in state and federal court cases and in the U.S. Supreme Court.
In stating its interest in filing the amicus brief in support of HotChalk’s appeal, UP stated that in its view the D&O insurer’s “interpretation of the subject exclusion renders paid-for coverage illusory.” UP elaborated that the interpretation of the exclusion “is so broad as to effectively eliminate D&O coverage for allegedly wrongful management decisions made by entities in the business of providing services, and is inconsistent with California law.”
The purpose of the professional services exclusion, the UP asserts, is to preclude coverage for claims more appropriately address under a company’s E&O exclusion. UP said that the district court decision in this case is one of “a string of court decisions” in which D&O insurers have stretched the professional services exclusion far beyond this intended scope, rather than limiting to its preclusive effect to claims involving an error or omission in the rendering of services to a customer.
The end result of this overbroad interpretation is that the exclusion is applied preclude coverage for claims relating to the ordinary internal business activities of the insured company. Because any and all actions of a services business relate in some way to the services the insured company provides, the exclusion swallows up the policy coverage, rendered the possibility of coverage under the policy illusory.
I want to emphasize that I am expressing here no views of the merits of HotChalk’s appeal. I have not read the parties’ briefs and I have not independently researched California law regarding the relevant issues. The outcome of the appeal will depend on this legal considerations as well as the specific wordings of the D&O insurance policy at issue. My interest here has to do more with the larger issues, beyond this specific dispute.
On that score, I think it is a good thing that UP has intervened, in order to emphasize the importance of the issues involved in this case. The UP’s brief emphasizes that these issues are important to all private company D&O insurance policyholders. I would add that this is an important issue not just for policyholders but for all participants in the D&O insurance process. Insurers in particular have a stake in the issues involved in this case. If the professional services exclusion has the preclusive effect that the insurer urged here, there not only would be no coverage left under the policy for any claim against a professional services company, there would be little reason for anyone to buy the insurance.
As the UP argued in its amicus brief, the professional services exclusion is one of several exclusions in a private company D&O insurance policy to make sure that claims stay in their proper lanes. The bodily injury/property damage exclusion is there to make sure that BI/PD claims go under the GL policy. The ERISA exclusion is there to make sure that those kinds of claims go under the fiduciary liability policy. And the professional services exclusion is there to make sure that claims arising out of the rendering of professional services go under the E&O policy.
The focus of a professional services exclusion ought to be on whether or not the claim at issue arises out of allegations of errors or omissions in connection with the delivery of professional services. That means that if the claim arises out of ordinary business activities of the type in which any business is involved, such as, for example, compensating employees, the exclusion should be irrelevant. The logic the court used here to bootstrap HotChalk’s participation in federal grant and loan programs to extend the exclusion to claims arising from the company’s employee compensation initiatives means that there is no aspect of its business activities to which the exclusion does not apply — everything the company does is related in some way to its participation in government grant and loan programs. If everything is related, then everything is excluded, and coverage under the policy is illusory.
There are features of the exclusion at issue that are worth considering. For starters, neither the exclusion nor the policy defined professional services. Also, the exclusion at uses the broad “based upon, arising out of” preamble; given the intended purpose of the professional services exclusion, the narrower “for” preamble would be more appropriate, particularly for policyholders in the professional services business. Another feature that might provide added clarity would be if the exclusion were to specify that its preclusive effect only applied to claims arising out of the rendering or failure to render the delivery of professional services “to others” – although, given the district court’s bootstrap logic here, that type of wording might not have made a difference here.
These are a number of ways the dangerous potential of the professional services exclusion might be modified. The more important consideration is that the D&O insurers themselves need to take hard look at the way they are interpreting and applying this exclusion. The reason I keep banging on and on about this topic is that, as I have commented before, I think the insurance industry regularly gets it wrong when it comes to the professional services exclusion. It is past time for senior managers at the insurance companies to take control of this issue in order to ensure that they are not undercutting the reason for which people buy this insurance in the first place. This issue is a problem for everybody, and it is as big of a problem for the insurers as it is for everybody else.