Some D&O insurance policy exclusions are written with the broad “based upon, arising out of, in any way relating to” preamble. These exclusions sweep broadly, precluding coverage for a wide range of claims. The ever-present question when insurers seek to rely on these exclusions’ sweeping reach is: how broad of a reach it too broad? What is the outer limit of these exclusions’ preclusive effect?
In a decision that is worth reading closely, the Delaware Supreme Court recently concluded that, despite its broad preamble, a management liability insurance policy’s professional services exclusion did not apply to preclude coverage for the underlying claim. The decision not only explores important questions about the reach of exclusions with the broad preamble, but it also underscores the deeper question about the use of the broad preamble for these types of exclusions in the first place. The Delaware Supreme Court’s September 14, 2023, opinion in the case can be found here.
Guaranteed Rate, Inc. (GRI) underwrites and issues loans to borrowers. As an approved lender in the federal government’s mortgage insurance program, GRI can endorse mortgage loans for insurance and guarantees by certain federal agencies. Under the government program, approved lenders like GRI must certify that each loan meets the rules of the government program. If a loan is endorsed by an approved lender and the borrower defaults, the lender can submit a claim to the government to cover certain losses.
In 2017, a former GRI employee brought a qui tam action against GRI, alleging that GRI violated the False Claims Act (FCA) by falsely certifying to the government that certain loans were eligible for the government program. The claimant also alleged that GRI falsely claimed that it complied with all lending requirements. On June 22, 2019, the U.S. Department of Justice issues a civil investigative demand to GRI, in which the DOJ notified GRO that it was investigating allegations relating to alleged violations of federally insured mortgage loan program. In February 2020, GRI settled the False Claims Act claims with the government and with the claimant for $15.06 million.
At relevant times, GRI maintained two programs of insurance with the same insurer, a professional liability insurance policy and a management liability insurance policy. GTI sought coverage under both policies for the FCA claim and the settlement under both policies. The insurer took the position that the professional liability insurance policy expressly excluded the False Claims Act allegations. The insurer also took the position that, because the False Claims Act allegations arose from GRI’s professional services, the FCA allegations were also excluded under the management liability insurance policy.
The Coverage Action
GRI filed an action in Delaware Superior Court seeking coverage under the management liability insurance policy for the settlement amount and for defense costs incurred in connection with the government investigation. GRI asserted claims for breach of contract and for bad faith.
The insurer filed a motion to dismiss GRI’s action, arguing among other things that the professional services exclusion precluded coverage for the underlying investigation and claims. The insurer contended that the underlying investigation and settlement were based upon GRI’s underwriting services; GRI argued that the claims were about GRI’s “quality control deficiencies,” as measured by duties owed to the government, not to borrowers.
The Superior Court denied the insurer’s motion to dismiss and subsequent motion for summary judgment, although the Court granted summary judgment to the insurer on the bad faith claims. The parties filed cross-appeals.
The Relevant Policy Language
The professional services exclusion in the management liability insurance policy precludes coverage for Loss from any Claim “alleging, based upon, arising out of, or attributable to any Insured’s rendering or failure to render professional services.” The Policy does not define professional services. GRI’s professional liability policy, issued by the same insurer, defines professional services as “mortgage banking and mortgage underwriting services and loan servicing for others for a fee.”
The September 14, 2023, Opinion
On September 14, 2023, in an opinion written by Chief Justice Collins J. Seitz, Jr. for a unanimous three-judge panel, the Delaware Supreme Court affirmed the Superior Court.
In ruling that the Superior Court correctly concluded that the management liability insurance policy’s professional services exclusion did not preclude coverage for the underlying investigation and claim, the Court first considered a case out of the Eastern District of Louisiana, IberiaBank Corp. v. Illinois Union Insurance Company, in which the same insurer had successfully argued that false loan compliance certifications at issue in a False Claims Act claim did not qualify as professional services and therefore that the claim was excluded from coverage under a professional liability insurance policy.
The district court in the IberiaBank case expressly concluded that the FCA claims were “not predicated on the insured’s professional services” and that the insured in that case did not provide “professional services” to the government when it falsely certified loans to the government. The IberiaBank court, the Delaware Supreme Court said, was on “firm precedential footing” when it concluded that the FCA claims did not involve professional services. These courts’ conclusions, the Delaware Court said, “map closely to the coverage determinations in this case.”
The False Claims Act charges against GRI, the Delaware Court said, “did not relate to the performance of professional services it provided to others.” Instead, the Court said, GRI “settled charges that it defrauded the government under the FCA by falsely certifying that loans met FHA and VA insurance requirements.” Because GRI’s alleged misconduct arose out of the false certifications, not the professional services GRI provided to borrowers, the FCA charges and settlement “did not fall within the professional services exclusion in the Management Liability Policy.”
The insurer sought to evade the force of this precedent by trying to argue that the exclusions in the other cases, including in the IberiaBank case, did not have “arising out of” preamble. The insurer sought to argue that the preclusive effect of its policy’s exclusion, with its broader preamble, was broader than in those other cases, and that it swept broadly enough to reach the underlying claim. The insurer attempted to argue that “but for” the professional services in the form of the lending underwriting for the benefit of borrowers, the alleged FCA violations would not have occurred.
The Court acknowledged that Delaware’s courts have “interpreted liberally the words ‘arising out of’ in insurance policies.” However, the court noted that Delaware’s courts also have said that “exclusions must be interpreted narrowly.” Interpretation of exclusions with the broad preamble requires some “meaningful linkage between the two conditions imposed by the contract.”
The “main problem” for the insurer, the court said, is that the False Claims Act claims against GRI “were not caused by the professional services provided to borrowers.” The Court acknowledged that “in a technical sense,” without GRI’s underwriting conduct, some of the certifications would not have been false. But a “meaningful linkage” is “absent give the difference between the subject of the FCA claims – false certifications – and the underwriting conduct used to demonstrate the falsity of the claims – underwriting loans.” The insurer, the Court said had “failed to persuade us that the policy language in this case is materially different from the policy language in other cases.”
In a part of the opinion that I think is particularly important, the Court said that the insurer’s interpretation of the “arising out of” language “effectively extends coverage of the exclusion to just about everything remotely connected to the professional service.” The Delaware court added that adopting the insurer’s “but for” interpretation “would mean that many acts only incidentally related to professional services, such as record keeping or false certifications, would be excluded under the professional services exclusion if the act would not have arisen but for the rendering of professional services to apply.” In other words, for the exclusion to apply, “a linkage must be meaningful, not tangential.”
Insurer-side D&O insurance professionals reading this opinion may be inclined to think, well, here’s yet another decision in which the Delaware courts sided with the policyholders, just like they always do. However, I believe it would be short-sighted to read the opinion this way. What the Court is saying here – that there has to be a logical stopping point to the reach of an exclusion with the broad preamble language – is important and should not be overlooked or dismissed out of hand.
The Delaware court in effect said that, while our state’s courts recognize that that exclusions with the broad preamble sweep broadly, there still has to be a sufficient connection between the underlying allegations and the conduct precluded by the exclusion in order for the exclusion to apply. As the court put it, the linkage must be “meaningful, not tangential.” This is an important point that, in my mind, in every case ought to be part of the analysis with regard to the application of an exclusion with the broad preamble.
The Delaware Supreme Court put its finger on the problem created when insurers seek to apply exclusions with the broad preamble in a sweeping way — the overly broad interpretation “effectively extends coverage of the exclusion to just about everything remotely connected to the professional service.”
This overly broad reading is a problem for any company, but it is particularly a problem of companies in the professional services industries, as everything the companies do, as a matter of course, arises out of or relates to the delivery of professional services.
This overbroad interpretation of the professional services exclusion is such a prevalent problem that I have in fact described this recurring coverage interpretation as one of the things that D&O insurers regularly get wrong.
In my view, in order to think about these issues correctly, it is important to start with the basic reason why a professional services exclusion is in the D&O insurance policy in the first place. The professional services exclusion is one of several standard exclusions in private company D&O insurance policies that are designed to keep claims in their proper lanes.
For example, the D&O policy should not be used to provide insurance for claims properly covered by the policyholder’s GL policy, so the D&O policy has a bodily injury/property damage exclusion. These kinds of exclusions avoid overlapping coverages between the policyholder’s various policies.
The professional services exclusion is there so that the D&O policy is not used to provide coverage for claims properly covered by the policyholder’s professional liability insurance policy.
Because the purpose of the professional services exclusion is to prevent overlap between the D&O insurance policy’s coverage and the coverage under the professional liability insurance policy, the appropriate wording to be used in the exclusion, in my view, should the narrower “for” wording rather than the broader “based upon, arising out of” wording.
I have always felt that the use of the broad “based upon, arising out of” preamble sweeps far too broadly for the exclusion’s purpose and threatens to extend the exclusion’s preclusive effect beyond the exclusion’s purpose of keeping the various liability claims in the appropriate insurance lane. The use of the broad wording unfortunately lends itself to coverage interpretations which, if correct, would entirely swallow up coverage under the policy – or, in the words of the Delaware Supreme Court, interpretations of the policy that extend the exclusion “to just about everything remotely connected to the professional service.”
Setting aside the question of how these exclusions properly ought to be worded and turning to the way that the Delaware Court interpreted the actual language in GRI’s policy, the Court’s interpretation “upholds the well-established insurance policy interpretation rule that exclusions must be construed narrowly and in favor of coverage,” according to an October 20, 2023, Law360 article (here) attorneys for the Cohen Ziffer law firm. (In an earlier version of this article, I incorrectly stated that the Cohen Ziffer law firm represented the policyholder in this coverage litigation; in fact the policyholder was represented by Lilit Asadourian and Alice Kyureghian of the Barnes & Thornburg law firm. I apologize for the error.)
The memo’s authors add that the ruling clarifies that “although the words ‘arising out of’ are generally read broadly in the context of provisions granting insurance coverage, when exclusionary language is at issue, those words require a meaningful linkage between the two conditions imposed by the insurance policy,” and not a mere “tangential” link.
Finally, the authors note that the Delaware Supreme Court’s ruling in the case “has wide-ranging application in coverage disputes involving any exclusions that employ ‘arising out of’ or similar prefatory language.”
One final note. It surely didn’t help the insurer in this case that in the prior case the insurer had taken the exact opposite position on the question of whether or not an authorized lender’s certifications under the federal mortgage lending program represented the delivery of professional services. The contrast between the insurer’s arguments in the prior case and the arguments on which it sought to rely here surely helped the policyholder (fairly or unfairly) to try to paint the picture that insurer was taking its positions based not on principle but rather on its desire to avoid coverage – a very unsympathetic position for any insurer in an insurance coverage dispute. To be sure, the insurer would point to the difference in policy wording to explain the different positions in the two cases, but for me that simply underscores the problem with the broad preamble wording.
Special thanks to a loyal reader for providing me with a copy of the Delaware Supreme Court’s opinion.