New York Court Holds Professional Services Exclusion Applicable

In its recent decision in David Lerner Assocs. v. Philadelphia Indem. Ins. Co., 2013 U.S. Dist. LEXIS 46333 (E.D.N.Y. Mar. 29, 2013), the United States District Court for the Eastern District of New York had occasion to consider the application of a professional services exclusion in a directors and officers policy.

Philadelphia Indemnity Insurance Company insured David Lerner Associates, Inc. (“DLA”) under a Private Company Protection Plus Insurance Policy.  During the policy period, DLA was named as a defendant by FINRA in a disciplinary proceeding that alleged DLA had sold shares in a REIT without performing adequate due diligence and that DLA also misrepresented the value of the shares.  The complaint also alleged that DLA targeted its sales to senior citizens and/or unsophisticated investors.  DLA was later named as a defendant in three class actions relating to the same facts as alleged in the FINRA proceeding.

Philadelphia’s policy insured DLA against D&O Wrongful Acts, defined as:

1.   act, error, omission, misstatement, misleading statement, neglect, or breach of duty committed or attempted by an Individual Insured in his/her capacity as an Individual Insured; or

2.   act, error, omission, misstatement, misleading statement, neglect, or breach of duty committed or attempted by the Private Company; or

3.   act, error, omission, misstatement, misleading statement, neglect, or breach of duty committed or attempted by an Individual Insured arising out of serving in his/her capacity as director,  officer, governor or trustee of an Outside Entity if such service is at the written request or direction of the Private Company.

The policy, however, contained a professional services exclusion stating:

… the Underwriter shall not be liable to make any payment for Loss in connection with any Claim made against the Insured based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving the Insured's performance of or failure to perform professional services for others.

It is provided, however, that the foregoing shall not be applicable to any derivative action or shareholder class action Claim alleging failure to supervise those who performed or failed to perform such professional services.

The term “professional services” was not defined in the policy.

DLA denied coverage to DLA on the basis of this exclusion, prompting DLA to bring a declaratory judgment action.  Philadelphia moved to dismiss the complaint on the basis of the professional services exclusion, arguing that the allegations in the underlying complaints pertained to DLA’s failure to identify “red flags” regarding the REIT and that it failed to exercise due care and skill in providing information to its investors.  These allegations, argued Philadelphia, necessarily pertained to the provision, or lack thereof, of professional services under New York law.  DLA, on the other hand, argued that because the term “professional services” was not defined in the policy, it was an ambiguous term that, at the very least, precluded dismissal under Fed.R.Civ.P. 12(b)(6).

In considering these arguments, the court looked to the long line of New York decisions setting forth the standard that whether one is engaged in a professional service depends on whether that individual acted with a special degree of acumen and training.  The court further observed that under New York law, the term “professional services” is not limited to “traditional” professions such as lawyers, doctors, architects and engineers.  Against the backdrop of these cases, the court concluded that underlying claims pertained to DLA’s professional services:

… it is clear that the only reasonable interpretation of "professional services" is that individuals engaged in the due diligence and sale of financial products are engaged in professional services. According to the underlying complaints, DLA was an underwriter for Apple REITs.  It was required to conduct due diligence for these products, including performing financial analysis and meeting with Apple REIT management. DLA then recommended and sold over $442 million of this security. These actions, allegedly taken by DLA and individuals within the company, fall squarely within a common-sense understanding of “professional services.”

The court further noted that case law from other jurisdictions, such as Minnesota and Arizona, would require a similar determination. 

In reaching its conclusion, the court considered and rejected DLA’s argument that it was merely performing ministerial tasks that did not rise to the level of professional services, explaining that “performing a due diligence analysis and marketing financial products requires specialized knowledge and training, and is not a rote activity performed by a professional.”  The court further rejected DLA’s assertion that discovery should be allowed to proceed on the issue of whether it was performing professional services, noting that the allegations in the underlying claims contained sufficiently clear allegations from which to conclude the issue.

Oregon Court Holds General Contractor Not Performing Professional Services

In its recent decision in State Farm and Casualty Co. v. Lorrick Pacific, LLC, 2012 U.S. Dist. LEXIS 57922 (D. Ore. Apr. 24, 2012), the United States District Court for the District of Oregon had occasion to consider whether a general contractor’s coordination and management of subcontractors constituted “professional services” for the purpose of an exclusion in a general liability policy.

The insured, Lorrick, was named as a defendant in a construction defect lawsuit involving an apartment complex for which it had been the general contractor.  The complaint alleged, among other things, that Lorrick failed to properly supervise and coordinate the construction of the various subcontractors.  Lorrick’s insurer, State Farm, sought a judicial declartion that it had no duty to indemnify Lorrick in connection with the underlying suit on the basis of a policy exclusion applicable to:

… bodily injury, property damage or personal injury due to rendering or failure to render any professional services or treatments.  This includes but is not limited to:

a.     legal, accounting or advertising services;

b.     engineering, drafting, surveying or architectural services, including preparing, approving, or failing to prepare or approve maps, drawings, opinions, reports, surveys, change orders, designs or specifications;

c.     supervisory or inspection services;

d.     medical, dental, x-ray, anesthetical or nurisng services or treatments, but this exclusion only applies to an insured who is engaged in the business or occupation of providing any of these services or treatments;

                                          *          *          *

While the exclusion did not specify management, oversight or coordination of subcontractors, State Farm argued that based on the Oregon Supreme Court’s decision in Multnomah County v. Oregon Automobile Ins. Co., 256 Or. 24 (Ore. 1970), the term “professional services” must be interpreted to include such activities.  In Multnomah, the Oregon Supreme Court considered whether a medical technician’s administration of insulin shots constituted a professional service.   The court interpreted the phrase to mean service “arising out of a vocation, 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.”  The court also observed that it is the insured’s act that must be considered rather than the insured’s title at the time of performing the act.

Relying on the Multnomah court’s reasoning, the Lorrick court rejected State Farm’s argument that coordination of contractors constitutes a “professional service,” explaining:

I do not read the Oregon Supreme Court's decision in Multnomah County as holding that under the facts here, the term "professional services" in the Policy excludes from coverage managing, coordinating, and overseeing the work of subcontractors. Nothing in Multnomah County demonstrates that managing, coordinating, and overseeing the work of subcontractors involves "specialized knowledge" or labor that is "predominantly mental or intellectual" akin to a medical technician's ability to determine whether a patient's condition requires the injection of a medical drug.

Ultimately, the court held that there was a question of fact as to whether Lorrick’s coordination and management of subcontractors requires a “specialized knowledge.”  This question of fact precluded a finding of summary judgment in State Farm’s favor.

State Farm also argued that the exclusion applied based on subparagraph c. of the exclusion, which included “supervisory” services as an example of professional services.   State Farm contended that the plain meaning of “supervisory” necessarily includes work such as coordination and oversight of subcontractors.  The court rejected this argument as well, explaining that in the context of a professional services exclusion, the term “supervisory” has a more specific meaning than commonly ascribed it in a standard dictionary.  As such, and given the holding in Multnomah, the court concluded that supervisory services must mean something beyond merely overseeing the work of subcontractors, explaining:

Here, the Professional Services Exclusion provides explicit examples of the types of services qualifying as "professional services." Such examples include legal, accounting, engineering, architectural, "supervisory or inspection," medical, and veterinary services. It is noteworthy that although the Policy states that "supervisory" services fall under the term "professional services," it makes no mention of coordinating services, including coordinating the work of subcontractors.

The court found this lack of a specific reference to work performed by general contractors to be fatal to State Farm’s argument. 

California Court Holds Professional Services Exclusion Ambiguous

In its recent decision in Corky McMillin Construction Services, Inc. v. U.S. Specialty Ins. Co., 2012 U.S. Dist. LEXIS 3438 (S.D. Cal. Jan. 11, 2012), the United States District Court for the Southern District of California considered the application of an errors and omissions exclusion contained in a directors and officers insurance policy.

At issue in Corky McMillin was the insured’s right to coverage for an underlying class action.  Plaintiffs in the suit alleged that the insured, Corky McMillin, made various misrepresentations and omissions regarding the nature, value and desirability of certain residential neighborhoods. The policy provided coverage for “Insured Organization Loss arising from Claims first made against [the insured] during the Policy Period or Discovery Period (if applicable) for Wrongful Acts.” By endorsement, however, the policy contained an errors and omissions exclusion, stating in relevant part that:

… the Insurer will not be liable to make any payment of Loss in connection with any Claim against the Insured Organization arising out of, based upon or attributable to the rendering or failure to render services for others, including without limitation services performed for or on behalf of customers or clients of the Insured Organization … .

U.S. Specialty denied coverage on the basis of this E&O exclusion. Corky McMillin argued that the exclusion was ambiguous since the term “services” was not defined in the policy. U.S. Specialty countered, and the court agreed, that the term “services” should be interpreted based on its common dictionary definition, meaning “the work performed by one that serves.” The court further agreed with U.S. Specialty that while this definition of “services” was broad, the mere breadth of the term did not otherwise render it ambiguous.

The court nevertheless found the exclusion as a whole to be ambiguous when considered in the context of the policy’s insuring agreement, which provided coverage for “wrongful acts,” defined in pertinent part as “any other actual or alleged act, error, misstatement, misleading statement, omission or breach of duty (a) by the Insured Organization … .” The court noted that while the intent of the E&O exclusion was to bar coverage for liability arising out of the insured’s services, it was not clear whether “services,” with its broad meaning, encompassed, and therefore excluded, the same “wrongful acts” covered under the policy’s insuring agreement.  For instance, explained the court, while the definition of “wrongful act” included misstatements, misleading statements and omissions, the exclusion, on its face, would operate to bar coverage for misstatements, misleading statements and omissions contained in the insured’s marketing materials – the very basis on which the insured was sued in the underlying suit. Given the “canons of construction” that insuring agreements are to be interpreted broadly in favor of the insured and that exclusions are to be interpreted narrowly against the insurer, the court concluded that “there is, at a minimum, ambiguity about the meaning of the term ‘services’ as used in the E&O Endorsement.”