Limiting the Professional Services Exclusion: Lessons for Policyholders from Practice Fusion vs. Freedom Specialty Insurance Company | Pillsbury – Policyholder Pulse Blog

A recent decision by a California appeals court in Practice Fusion, Inc. v. Freedom Specialty Insurance CompanyThe fact that the policyholder was denied over $118 million in directors' and officers' liability insurance because of a broad professional services exclusion is a sobering reminder that this tricky exclusion – when applied too broadly, as in this case – can render your D&O protection worthless. The mere fact that Practice Fusion's insurers have invoked this exclusion in this claim should remind brokers and risk managers of the importance of eliminating, or at least limiting, professional services exclusions when there is a potential argument that the insured is engaged in the performance of some form of “professional services.” While it is of course appropriate to fill any gaps created by the exclusion with appropriate errors and omissions coverage, E&O policies do not provide the same level of coverage or even the same limits as D&O policies.

Practice Fusion Insurance Claim
Practice Fusion developed and licensed free software that enabled healthcare providers to manage electronic health records, appointments, treatment plans, and medications. The software also offered “clinical decision support” (CDS) alerts – prompts that showed providers possible treatments based on a patient's medical data. The company made money by selling advertising in the software, licensing and analyzing data for pharmaceutical companies, and allowing pharmaceutical companies to sponsor the CDS alerts.

The sponsored CDS alert contracts became the focus of a U.S. Department of Justice investigation, which accused Practice Fusion of violating anti-kickback laws. According to the Department of Justice, in order to boost sales, drug manufacturers paid Practice Fusion to develop CDS alerts that recommended the drug companies' products, even when that treatment did not meet accepted medical standards. In January 2020, Practice Fusion paid more than $118,642,000 to settle the CDS kickback allegations as part of a civil settlement with the United States.

After insurers denied Practice Fusion's claim for loss settlement coverage under its D&O liability insurance, 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 exclusion of professional services precluded loss settlement coverage under the CDS claims. Practice Fusion appealed.

Interpretation of the exclusion for professional services
The professional services exclusion in the policy excludes coverage for:

Loss in connection with a claim against an insured … which arise from, are based on or are attributable to the performance of an insured’s obligations or non-fulfillment professional services for others or actionsErrors or omissions in this regard[.]

Practice Fusion argued that the exclusion did not apply for two reasons. First, the CDS alerts it provided to physicians did not constitute the provision of professional services for consideration, as the software and other services it licensed were free, and the sponsorship of the CDS alerts it offered to pharmaceutical companies simply involved the sale of a product: advertising space on its platform. Second, although the coding of the CDS alerts constituted a professional service provided by its employees, any coding for Practice Fusion himself as part of the development of its software and not for the pharmaceutical companies that paid for the CDS alerts.

The Appellate Panel did not further reject these arguments, ruling that Practice Fusion performed non-covered professional services by designing and coding the CDS alerts for the pharmaceutical companies, for which it received a fee. Even if the coding was done primarily for Practice Fusion's own benefit as part of the software design and was at most incidentally related to the sale of advertising space, the broad exclusion is triggered by acts that have only an “incidental relationship” to professional services.

The Panel has broadened the application of the exclusion, finding that under California law, the introductory term “arising out of” requires “only a minimal causal connection or incidental relationship” between the performance of professional services and the event giving rise to liability. In addition, the exclusion extends even further to exclude coverage for claims that merely “allege … based upon or attributable to” “any acts related to” the provision of those services.

The appeal decision runs counter to common sense and – if you will – to the principles of insurance policy interpretation, according to which exclusions must be interpreted narrowly and to the detriment of the insurer. An exclusion of professional services is intended to exclude claims from customers alleged damage caused by the negligent provision of specialised services for this customer. The California court's decision equates liability for executive decisions to enter into (alleged) kickback arrangements with breach of the duty of professional skill and care. In doing so, it conflates two different concepts of liability and insurance coverage, effectively categorizing Practice Fusion's entire business – selling software to medical providers – as the performance of professional services, or at least as ancillary to such services. Indeed, it is difficult to imagine what business conduct would not be excluded if an insurer were required to establish only a “minimal,” “incidental” relationship between the decisions of directors and officers and a company's day-to-day performance of a professional service. This overly broad interpretation of the exclusion renders D&O protection illusory. And the relevant case law makes clear that California courts should not construe an exclusion in a way that makes protection illusory. It is hoped that the decision will be appealed, that certification will be granted, and that common sense will prevail in the California Supreme Court.

In this respect, the case contradicts a number of recent decisions in which other courts have refused to adopt political interpretations that would lead to a similarly absurd result. For example, in Gallup, Inc. v. Greenwich Insurance Co.the Delaware Supreme Court rejected a professional services exclusion that “declared virtually every aspect of the plaintiff's business … to be 'related' to the performance of 'professional services,' which would potentially exclude coverage for all claims under the policy.” In Rob Levine & Assocs. Ltd. v. Travelers Casualty & Surety Co. of Americathe U.S. District Court for the District of Rhode Island rejected a broad interpretation of a professional services exclusion that would render the insurance policy “meaningless and without coverage,” emphasizing that the court “would not construe the contract to produce such an absurd result.” In Great Am. Insurance Co. v. Geostar Corp.the US 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 the possibility of an overly broad exclusion destroying the entire coverage system.” And in Food Pro International, Inc. v. Farmers Insurance Exchangethe California Court of Appeals rejected the insurers' interpretation of a professional services exclusion that “the CGL policy would not apply to any incidents occurring while Food Pro was acting as a technical consultant on a project site.” The court emphasized that ” [a]s Food Pro is an engineering firm, its general liability insurance … would be essentially useless.” See also D&O Diary for recent comments on Practice merger.

Recommendations for policyholders
The good news for policyholders (other than Practice Fusion) is that this situation is avoidable. Some insurers are now willing to eliminate the professional services exclusion entirely. And there are numerous, increasingly standardized versions of the exclusion that limit its scope to the coverage available under the policyholder's E&O policy.

A policyholder who provides “professional services” – or anything that could be described as such – should never have a blanket exclusion for professional services in its D&O policy, especially one with the broad phrase “arising out of” as a predicate. Many insurers have adopted narrower versions of the exclusion to eliminate the “arising out of” predicate and replace that phrase with an exclusion that applies only to liability “for“the professional services rendered (e.g., for damages caused by the negligent performance of services). Standard versions of the exclusion limit it to corporate coverage (Side C claims) or restrict defense coverage or securities claims. Another common modification is a carve-out for liability arising from management liability, which courts have recognized as effective. These insurers recognize that it goes too far to exclude the types of claims related to professional services that are not covered by E&O insurance, such as securities violation claims arising from disclosure obligations resulting from an alleged failure to provide professional services.

Aside from hoping for a reversal of the ruling by the California Supreme Court, a proactive approach to policy renewal can protect your business from catastrophic consequences like those in Practice fusion. We strongly advise you to review your D&O insurance policy to ensure that (1) all professional services exclusions are eliminated or at least appropriately limited to your business risk profile and (2) the term “professional services” is narrowly defined in the policy and covers only those conducts included in the policyholder’s E&O policy.

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