A recent decision by a California appellate court in Practice Fusion, Inc. v. Freedom Specialty Insurance Company, denying the policyholder more than $118 million in Directors & Officers liability coverage based on an expansive professional services exclusion, is a sobering reminder that this nettlesome exclusion—when over-broadly applied, as was the case here—may render your D&O coverage worthless. The mere fact that Practice Fusion’s insurers asserted this exclusion in the circumstances of this claim should remind brokers and risk managers of the importance of eliminating, or at least narrowing, professional services exclusions where there is any potential argument that the insured is engaged in providing any form of “professional services.” Although it is of course appropriate to fill any gaps created by the exclusion with commensurate Errors & Omissions coverage, E&O policies do not provide the same scope of coverage, or even limits, that are available under D&O policies.
Practice Fusion’s Claim for Coverage
Practice Fusion developed and licensed free software that enabled health care providers to manage electronic health records, appointments, treatment plans and medication. In addition, the software provided “clinical decision support” (CDS) alerts—prompts that display potential treatments to providers based on a patient’s medical data. The company made its money by selling advertisements in the software, licensing and analyzing data for pharmaceutical companies, and allowing pharmaceutical companies to sponsor the CDS alerts.
The contracts for sponsored CDS alerts became the focus of a DOJ investigation alleging that Practice Fusion had violated anti-kickback laws. According to the DOJ, to boost sales, drug manufacturers paid Practice Fusion to design CDS alerts that recommended the pharmaceutical companies’ products, even when that treatment did not reflect accepted medical standards. In January 2020, Practice Fusion paid more than $118,642,000 in a civil settlement with the United States to resolve the CDS kickback allegations.
After insurers denied Practice Fusion’s claim for coverage for the settlement under its D&O liability policy, the company sued its D&O insurers for breach of contract. The trial court granted summary judgment in favor of the insurers, holding that the policy’s broad professional services exclusion applied to bar coverage for settlement of the CDS claims. Practice Fusion appealed.
Interpretation of the Professional Services Exclusion
The policy’s professional services exclusion barred coverage for:
Loss in connection with any Claim made against any Insured … alleging, arising out of, based upon or attributable to an Insured’s performance of or failure to perform professional services for others, or any act(s), error(s) or omission(s) relating thereto[.]
Practice Fusion argued the exclusion did not apply for two reasons. First, the CDS alerts it provided to doctors did not involve the provision of professional services for a fee because the software it licensed and other services were free and the sponsorship of CDS alerts it offered to pharmaceutical companies merely involved the sale of a product: advertising space on its platform. Second, even though the coding of CDS alerts constitutes a professional service performed by its employees, any coding was done for Practice Fusion itself as part of the development of its software and not for the pharmaceutical companies that paid for the CDS alerts.
The appellate panel gave short shrift to these arguments, holding that Practice Fusion provided non-covered professional services by designing and coding the CDS alerts for the pharmaceutical companies for which it was paid a fee. Moreover, even if any coding was primarily done for Practice Fusion’s own benefit as part of its software design and was at most incidental to the sale of advertisement space, the broad exclusion is triggered by acts with only an “incidental relationship” to professional services.
Stretching to apply the exclusion, the panel found that under California law the prefatory term “arising out of” requires “only a minimal causal connection or incidental relationship” between the provision of professional services and the event creating liability. What’s more, the exclusion extends even further to bar coverage for claims merely “alleging … based upon, or attributable to” “any act(s) relating” to the performance of those services.
The appellate decision defies common sense, and—respectfully—the canons of insurance policy interpretation, under which exclusions must be construed narrowly and against the insurer. A professional services exclusion is intended to exclude claims by customers alleging harm from the negligent provision of specialized services for that customer. The California court’s decision equates liability for C-suite decisions to enter into (alleged) kickback agreements with the breach of a duty of professional expertise and care. In so doing, it conflates two distinct concepts of liability and insurance coverage, and effectively categorizes Practice Fusion’s entire business—selling software to medical providers—as the provision of professional services or at least incidental to such services. Indeed, it is difficult to imagine what business conduct would not be excluded where an insurer need only frame a “minimal,” “incidental” relationship between the decisions of directors and officers and a company’s day-to-day provision of a professional service. This overly broad interpretation of the exclusion renders the D&O coverage illusory. And controlling case law makes clear that California courts should not construe an exclusion in a way that renders the coverage illusory. It is hoped the decision will be appealed and cert. accepted, and that common sense will prevail in the California Supreme Court.
In this regard, the case contravenes a number of recent decisions in which other courts have refused to adopt policy interpretations that would lead to a similarly absurd result. For example, in Gallup, Inc. v. Greenwich Insurance Co., the Delaware Superior Court disapproved a professional services exclusion that rendered “virtually any aspect of Plaintiff’s business … ‘related’ to rendering ‘professional services’ which conceivably would preclude coverage for all claims made under the Policy.” In Rob Levine & Assocs. Ltd. v. Travelers Casualty & Surety Co. of America, the U.S. District Court for the District of Rhode Island disapproved a broad interpretation of a professional services exclusion that would render the insurance policy “meaningless and provide no coverage,” emphasizing that the court would “not construe the contract to create such an absurd result.” In Great Am. Insurance Co. v. Geostar Corp., the U.S. District Court for the Eastern District of Michigan stressed that “professional E&O exclusions in D&O policies must be interpreted more narrowly to avoid negating the entire coverage scheme through the operation of an overly broad exclusion.” And, in Food Pro International, Inc. v. Farmers Insurance Exchange, the California Court of Appeal rejected the insurers’ interpretation of a professional services exclusion that “would render the CGL policy inapplicable to any incident that occurs while Food Pro is on a project site as an engineering consultant.” The court emphasized that, “ [a]s Food Pro is an engineering firm, its general liability policy … would be essentially useless.” See also D&O Diary for recent comments on Practice Fusion.
Policyholder Recommendations
The good news for policyholders (other than Practice Fusion) is that this situation is avoidable. Some carriers are now willing to delete the professional services exclusion altogether. And there are numerous, increasingly standard, versions of the exclusion that limit its scope to match the coverage available under the policyholder’s E&O policy.
A policyholder in the business of providing “professional services”—or anything that could conceivably be described as such—should never have a blanket professional services exclusion in its D&O policy, especially one with the broad phrase “arising out of” as a predicate. Many carriers have adopted narrower versions of the exclusion to eliminate the “arising out of” predicate and replace that wording with an exclusion that applies only to liability “for” the professional services performed (e.g., for damages caused by the negligent performance of services). Standard versions of the exclusion limit it to entity coverage (Side C claims), or carve back defense coverage or securities claims. Another common revision is a carve-back for liability based upon management liability, which courts have recognized as effective. These insurers recognize that it is overreaching to exclude the kinds of professional services-related claims that are not covered by E&O insurance, such as claims for securities violations that result from disclosure obligations arising from an alleged failure to perform professional services.
Beyond hoping for a reversal in the California Supreme Court, a proactive approach during policy renewal may protect your company from catastrophic results like those in Practice Fusion. We strongly advise reviewing your D&O insurance policy to ensure that (1) any professional services exclusion is deleted or at least appropriately limited to your business risks profile, and (2) that the policy narrowly defines “professional services” to cover only that conduct encompassed in the policyholder’s E&O policy.