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.

Topics:  Class Action, D&O Insurance, Due Diligence, FINRA, Insurers, Professional Service Exclusion, REIT

Published In: Business Organization Updates, Business Torts Updates, Civil Procedure Updates, Insurance Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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