In the following guest post, Alison Finn, Claims Counsel, DWF Claims; Elan Kandel, Member, Bailey Cavalieri; and James Talbert, Associate, Bailey Cavalieri, take a look at the most important management and professional liability coverage decisions for 2019, involving the perennial coverage issues for insurers and policyholders. I would like to thank Alison, Elan, and James for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.
As we begin 2020, we take a moment to look back at the key insurance coverage decisions from 2019 involving perennial coverage issues for management and professional liability insurers and policyholders.
Management and professional liability policies, which generally cover “loss” or “damages,” often define those terms to exclude restitution or disgorgement of ill-gotten gains. In order to assess the extent to which a claim seeks such relief, insurers and policyholders should carefully consider all potential remedies available in connection with the allegations against the insured, including the potential for joint and several liability. This was demonstrated in Marcus v. Allied World Ins. Co., 384 F. Supp. 3d 115 (D. Me. 2019). There, the U.S. Securities and Exchange Commission sued the insured, a law firm holding a lawyers professional liability policy, seeking disgorgement of ill-gotten gains (legal fees obtained by fraudulent misrepresentations regarding a securities offering), as well as pre-judgment interest. The policy at issue there covered “Damages,” which was defined to exclude “the return or restitution of legal fees, costs and expenses.”
The court acknowledged that disgorgement of legal fees would be excluded from coverage under the foregoing definition of “damages.” It recognized, however, a possibility that the insured could be held jointly and severally liable for amounts that other defendants may have fraudulently gained, above and beyond the legal fees collected by the insured legal fees (a form of relief that the court termed “excess disgorgement”). Nevertheless, such “excess disgorgement” was also found to be excluded from the definition of “damages,” because, according to the court, it operated as a “punitive deterrent,” and punitive damages were also specifically excluded from the subject policy’s definition of “damages.”
Management and professional liability policies generally only cover insureds for acts or omissions committed in their insured capacity. Coverage issues arise when an individual insured under is sued in an insured and uninsured capacity. For example, in Gleason v. Markel Am. Ins. Co., 2018 U.S. Dist. LEXIS 11608 (E.D. Tex. Jan. 24, 2018), the insureds, owners and officers of Oregon Ice Cream, LLC, sold their equity in that company to a third party, who subsequently sued them for making misrepresentations regarding the company’s financial condition. The insurer denied coverage for the lawsuit on grounds that the alleged wrongdoing was committed by the insureds in their capacity as “sellers of their equity interests,” rather than as officers or directors of the company. The district court rejected this coverage position, finding that the underlying complaint referenced the insureds “both in their capacity as sellers and as officers and directors,” and noting the policy did not explicitly limit coverage to wrongful acts taken by the insureds solely in their capacity as officers and directors. The Fifth Circuit Court of Appeals affirmed the district court’s holding, rejecting the insurer’s argument that the insureds were not acting within an insured capacity as D&Os and thus no wrongful act was alleged. 2019 U.S. App. LEXIS 22546 (5th Cir. July 30, 2019).
A similar issue arose in a Delaware case styled, IDT Corp. v. U.S. Specialty Ins. Co., 2019 Del. Super. LEXIS 55 (Del. Super. Ct. Jan 31, 2019), where an individual (Davidi Jonas) served as Chairman of the insured company while simultaneously holding a controlling equity interest in Straight Path Communications, Inc., a former subsidiary of IDT, which had recently been spun-off. After learning that members of Straight Path’s management were considering pursuing an indemnification claim against IDT, Mr. Jonas intervened to block that plan by leveraging his power as controlling shareholder of Straight Path. Shortly thereafter, a lawsuit was filed, alleging that Mr. Jonas breached his fiduciary duties to Straight Path by putting his own personal interests above those of Straight Path and its stockholders. IDT’s insurer denied coverage for the shareholder lawsuit on grounds that it arose out of acts or omissions by Mr. Jonas in an uninsured capacity—namely, his capacity as a shareholder of Straight Path. The court rejected the insurer’s argument that the policy afforded coverage only where an insured was alleged to have acted solely in an insured capacity, finding: “The fact that Jonas may at the same time also be a controlling stockholder of Straight Path and breaching his concomitant fiduciary duties there does not mean that his actions weren’t taken in his capacity as an IDT officer.”
Professional liability insurance policies generally afford coverage for claims arising out of an insured’s services. Coverage under a professional liability policy may not be available, however, if the services that gave rise to the claim deviated from the insured’s description of its services in its application for coverage. These were the circumstances at issue in Chapman v. Ace Am. Ins. Co., 2019 U.S. App. LEXIS 15013 (11th Cir. May 21, 2019). The insured in that case, an individual who operated a rehabilitation and counseling business, had been offering mental health counseling services to a minor who suffered severe mental health problems and who ultimately committed suicide during the period in which he was being treated by the insured. The professional liability insurer denied coverage for the ensuing wrongful death lawsuit because coverage under the policy was only available in connection with the insured’s professional occupation, which he listed in his insurance application as “drug & alcohol abuse counselor.” Because the underlying complaint contained no allegations that the decedent struggled with substance abuse, or that the insured had provided substance abuse counseling to the decedent, the court upheld the insurer’s coverage denial, relying on the fact that substance abuse counseling and mental health counseling are treated as distinct professions under Florida law, and are governed by separate statutory and licensing requirements.
In Governo v. Allied World Ins. Co., 2019 U.S. Dist. LEXIS 146137 (D. Mass. Aug. 27, 2019), the court addressed the scope of coverage afforded by a professional liability policy (this time a lawyers liability policy). There, several attorneys left the insured law firm to start their own practice. Shortly thereafter, they sued their old firm for: (1) ERISA violations arising from the insured’s failure to provide certain benefits to the defecting attorneys; and (2) impeding clients’ ability to transfer files from the old firm. The insurer denied coverage, finding that the lawsuit amounted to a business dispute, which did not allege a “Legal Services Wrongful Act.” With respect to the ERISA claim, the court agreed with the insurer’s position, finding that “a benefits determination is not a service that a lawyer performs in the ordinary course of professional practice.” However, the court determined that the second cause of action—for interference with the orderly transfer of clients to the new firm set up by the defecting attorneys—did allege a Legal Services Wrongful Act, because “[i]n the real-world practice of law, it is not uncommon for lawyers to switch practices or clients to switch firms or find new lawyers” (regardless of how mercenary the insureds’ subjective motives were).
In Scottsdale Ins. Co. v. Byrne, 913 F.3d 221, 225 (1st Cir. 2019), the court also addressed coverage for claims arising out of professional services, but did so in the context of a professional services exclusion found in a management liability policy. There, the management liability policy barred coverage for claims arising out of or in any way involving “Professional Services,” which was defined to include services as a real estate broker, agent, inspector, or developer, property manager, and construction manager. The insured, a real estate investment vehicle, was sued for squandering invested funds and mismanaging its real estate assets, and its insurer denied coverage under the professional services exclusion. In the ensuing coverage litigation, the First Circuit Court of Appeals recognized that, notwithstanding the professional services exclusion’s use of broad prefatory language, “arising out of” and “in any way involving,” it did not encompass all of the allegations set forth in the underlying complaint, which included generic allegations that the insured lost certain properties to foreclosure and engaged in self-dealing.
What Constitutes a Claim?
Because management and professional liability policies are typically written on a “claims-made” basis, establishing the date on which a claim was first made is an essential element of any coverage analysis. Frequently, this inquiry hinges on a policy’s definition of “Claim,” and the proper interpretation thereof. This issue was raised in BioChemics, Inc. v. AXIS Reinsurance Co. 924 F.3d 633 (1st Cir. 2019). There, the court found that an order of investigation, which was issued to the insured in 2011, constituted a “claim alleging a wrongful act.” First, the court noted the policy defined “claim” to specifically include investigative orders. Second, the court rejected the insured’s argument that the SEC’s May 2011 investigation order failed to “allege a ‘Wrongful Act,’” finding the term “allege” broad enough to encompass the order’s references to securities violations. The court also rejected the insured’s contention that several subpoenas for documents that it received in 2012 were claims in their own right, finding that the subpoenas were merely requests for information, and did not seek “non-monetary relief.” The court also rejected the insured’s argument that that, because the policy’s “interrelated claims” provision was located in the “limits of liability” section, this implied that that provision solely addressed the amount of coverage available, and not the availability of coverage. Lastly, the court rejected the insured’s argument that the SEC’s May 2011 investigation order failed to “allege a ‘Wrongful Act,’” finding the term “allege” broad enough to encompass the 2011 order’s references to securities violations.
In Conduent State Healthcare, LLC v. AIG Specialty Ins. Co., 2019 Del. Super. LEXIS 298 (Del. Super. Ct. June 24, 2019), the court addressed a similar issue. There, the insured received a civil investigative demand (“CID”), which stated that the Texas Attorney General was “investigating the possibility of Medicaid fraud.” The insurer argued that the CID did not rise to the level of a “claim” for a “wrongful act.” Rather, the insurer contended that it commenced an investigation that merely had the potential to culminate in a claim for a wrongful act. The court rejected this argument, noting that the term “claim” was defined to include a “demand for non-monetary relief,” which the court found “broad enough to include a demand for something due.” Further, the court rejected the argument that there is any distinction between “investigating an alleged unlawful act by the insured” and “actually alleging an unlawful act,” labeling this a “distinction without a difference.” As such, the court found that the CID constituted a “claim” for a “wrongful act,” which implicated coverage under the subject policy.
Breach of Contract Exclusion
Breach of contract exclusions manifest the understanding that professional liability policies are not intended to protect insureds from the consequences of their own failure to satisfy their contractual duties. In Crum & Forster Specialty Ins. Co. v. DVO, Inc., 939 F.3d 852 (7th Cir. 2019), the court addressed the interplay between a very broad breach-of-contract exclusion and the illusory coverage doctrine. There, the insured was sued for failing to fulfill its contractual obligations, and its E&O insurer denied coverage for the lawsuit pursuant to the policy’s breach of contract exclusion.
The insured argued that the policy’s breach-of-contract exclusion was so broad as to render coverage under the policy illusory. The court agreed. It noted that the breach of contract exclusion’s prefatory language, “arising out of,” is interpreted very broadly under Wisconsin law, and concluded that the exclusion would eliminate all coverage under the Policy’s E&O coverage part, because professional malpractice necessarily involves a contract, and any injury that implicates coverage under that coverage part would necessarily “arise out of” the underlying contract.
What Constitutes a Securities Claim?
With respect to public company management liability policies, coverage under Part C (insured entity) is only available for “securities claims.” Accordingly, whether a lawsuit or administrative action constitutes a “securities claim” can have profound coverage implications in the context of a management liability policy issued to a public company. This was demonstrated by the case captioned, In re Verizon Ins. Coverage Appeals, 2019 Del. LEXIS 488 (Del. Oct. 31, 2019). There, the insurer denied coverage for a lawsuit alleging violations of certain fraudulent transfer statutes, violations of Delaware General Corporation Law, and common-law counts for breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, etc. The insurer denied coverage on the basis that the lawsuit did not constitute a “securities claim,” which was defined as “a ‘Claim’ against an ‘Insured Person’ ‘[a]lleging a violation of any federal, state, local or foreign regulation, rule or statute regulating securities (including, but not limited to, the purchase or sale or offer or solicitation of an offer to purchase or sell securities).’” The insured argued that the policy’s use of the term “any . . . regulation, rule or statute regulating securities” meant that “the parties did not intend to exclude common law ‘rules’ that do not ‘specifically’ or ‘principally’ regulate securities.” The court disagreed, finding that the term “rules and regulations” appears frequently in the securities statutes and administrative rules, and is consistently used to refer to rules and regulations that are specifically directed toward securities—not common law or statutory laws outside of the securities area.
Coverage for Appraisal Actions
Appraisal actions are a means for dissenting shareholders to establish the fair value of their shares. They are often employed in the context of a merger or other corporate transaction which calls for a divestiture of those shares in exchange for a pre-determined payout. Courts have wrestled with whether these proceedings constitute “securities claims,” for purposes of a management liability policy. For example, in Solera Holdings, Inc. v. XL Specialty Ins. Co., 213 A.3d 1249, 1252 (Del. Super 2019), the court addressed whether an appraisal action constituted a “securities claim,” which was defined in the policy to include any claim “for actual or alleged violation of any federal, state or local statute, regulation, or rule or common law regulating securities, including but not limited to the purchase or sale of, or offer to purchase or sell, securities.” The insurer argued that the appraisal action “was not a claim for ‘violation’ of any federal, state, or local statute, regulation, rule, or common law regulating securities because a ‘violation’ of law must involve wrongdoing, and allegations of wrongdoing are not required in an appraisal action.” The court disagreed, finding that the underlying appraisal action did allege a violation of Delaware’s securities laws, because it alleged that the insured failed to meet its statutory obligation to secure fair value for their shares. The court recognized that “[n]othing in the Policy’s use of the word ‘violation’ purports to limit coverage only to claims containing allegations of wrongdoing because the common meaning of the word ‘violation’ in this context is not limited to wrongdoing. ‘Violation’ simply means, among other things, a breach of the law and the contravention of a right or duty.
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If the past is prologue, we would expect to see courts address these perennial coverage issues again in 2020. The case law that made this year memorable will certainly influence coverage decisions in 2020.