Drawing a Line in the Sand: The Second Circuit Tries to Define Where D&O Coverage Ends and E&O Coverage Begins

Policyholders often obtain both errors and omissions (E&O) and directors and officers (D&O) liability insurance policies because they provide complementary coverage. E&O policies provide coverage for claims for wrongful acts arising from the provision of “professional services,” and while D&O policies also provide coverage for claims for wrongful acts, they often exclude coverage for such claims arising from the provision of professional services. Despite this distinction, determining the scope of a “professional services” exclusion in a D&O Policy is not always an easy task. The Second Circuit’s recent decision in Beazley Ins. Co., Inc. v. ACE Am. Ins. Co., No. 16-2812-cv (2d Cir. Jan. 22, 2018) illustrates the difficulties inherent in interpreting these types of provisions.

In Beazley, the court addressed an inter-carrier coverage dispute arising from a class action filed by retail investors against NASDAQ (the insured) for NASDAQ’s failures in executing Facebook’s initial public offering. Prior to the filing of the class action, NASDAQ had purchased an E&O tower from three insurers, one of which was Beazley, and a D&O tower from two insurers, ACE and Illinois National Insurance Company. ACE and Illinois National disclaimed coverage for the class action, relying on the “professional services” exclusion in the ACE policy.

Thereafter, the E&O tower paid the settlement for the class action as well as defense costs, and Beazley filed suit against ACE and Illinois National arguing that the “professional services” exclusion did not apply. The exclusion at issue provided that ACE “shall not be liable for Loss on account of any Claim … by or on behalf of a customer or client of the Company, alleging, based upon, arising out of, or attributable to the rendering or failure to render professional services.” Id. at 67.

Beazley’s principle argument was that the exclusion did not apply because retail investors are not “customer[s] or client[s]” of NASDAQ. The Second Circuit disagreed. Although insurance is a matter of state law, the Second Circuit looked to federal securities law to determine whether the terms “customer” or “client” have clear meanings in the insured’s industry. To justify its resort to federal law, the court stated “[w]ho counts as a customer of a particular insured within the meaning of the generic exclusion will often depend on the nature of the industry in which the insured does business.” Id. at 70. In this particular context, the court held that there was “little distinction between looking to ‘industry usage’ and federal case law to define a term.” Id. Having recognized federal law as a source to aid in the interpretation of undefined terms in the ACE policy, the court held that federal case law routinely recognized retail investors as customers or clients of NASDAQ.

The court also held that the underlying claims clearly arose out of the rendering of “professional services” within the meaning of the exclusion because they were based on NASDAQ’s alleged failure to properly execute purchase and sale orders and deliver timely confirmations.

The Second Circuit’s opinion shows that a court may look at different sources to determine the meaning of undefined terms in a policy, and may go so far as to look at federal law for an issue which is generally a matter of state law.