Professional Services and ERISA Exclusions Do Not Bar Coverage for Mismanagement Lawsuit Brought by Pension Fund Against Real Estate Advisory Fund

The United States Court of Appeals for the First Circuit, applying Massachusetts law, has affirmed the district court’s holding that a professional services exclusion in a real estate advisory fund’s D&O policy did not excuse the duty to defend a lawsuit brought by an investor in the fund because the allegations at issue were ambiguous as to the insured’s alleged misconduct aside from investing in the properties at issue.  Scottsdale Ins. Co. v. Byrne, No. 18-1526, 2019 WL 211420 (1st Cir. Jan. 16, 2019).  The court likewise concluded that an ERISA exclusion did not apply because the complaint contained a count for negligence that did not reference ERISA-like fiduciary duties.  Finally, the court concluded that a conduct exclusion did not limit the insurer’s indemnity obligations because the default judgment against the insured encompassed both improper gains and losses resulting from negligence.

The insured, a real estate advisory fund, was sued by a union pension fund alleging that the insured had mismanaged the pension fund’s investment through the insured’s investment in certain real estate properties.  The pension fund brought two counts for negligence and violations of ERISA, respectively.  The first count alleged that the insured was negligent in overleveraging the properties, failing to pay property taxes, and retaining income from the investment properties for its own use.  The second count alleged that through the insured’s retention of revenues from one of the properties, the insured took on fiduciary duties to the pension fund, which it subsequently violated.  A default judgment was entered against the insured, and the insured assigned its rights under its insurance policy to the pension fund.  The insurer declined coverage for the lawsuit based on the policy’s professional services and ERISA exclusions.

The policy’s professional services exclusion precluded coverage for Loss “based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving the rendering or failure to render Professional Services,” wherein “Professional Services” means “services as a real estate broker or agent, multiple listing agent, real estate appraiser, title agent, title abstractor or searcher, escrow agent, real estate developer, real estate consultant, property manager, real estate inspector, or construction manager” and “services” include “the purchase, sale, rental, leasing or valuation of real property; the arrangement of financing on real property; or any advice proffered by an Insured in connection with any of the foregoing.”  The ERISA exclusion applied to Loss “for any actual or alleged violation of the responsibilities, obligations or duties imposed by [ERISA] . . . or similar provisions of any federal, state or local statutory or common law[.]”

After the district court ruled in favor of the pension fund, on appeal, the First Circuit affirmed the entry of summary judgement for the pension fund that the exclusions did not apply, and further concluded that the insurer was not entitled to limit its indemnity obligation based on the policy’s conduct exclusion.

First, the court concluded that the professional services exclusion did not apply because,  for at least two properties at issue, the complaint alleged only that the insured had invested in the properties and the properties were “lost to foreclosure or written down to a zero value because of tax or mortgages owed” and that the insured “engaged in self-dealing by retaining investment income from the properties for its own use.”  Therefore, the “limited allegations preclude any meaningful evaluation of whether the loss of the [properties] was attributable to [the insured’s] actions as a property manager, developer, investor, or otherwise.”  Therefore, because the allegations were not “clearly within the Professional Services Exclusion,” the exclusion did not excuse the duty to defend.

Second, the court rejected the insurer’s argument that the ERISA exclusion barred coverage because the negligence count was preempted by ERISA.  The court concluded that the exclusion was ambiguous as to whether it extended to a common law action for negligence that did not specifically allege ERISA-like fiduciary duties.

Finally, the court rejected the insurer’s argument that the conduct exclusion, barring coverage where a final judgment concludes that an insured gained any profit, remuneration or financial advantage to which it was not legally entitled, limited the insurer’s indemnity obligation.  The court reasoned that “much of the complaint is concerned not with [the insured’s] improper gain or pecuniary advantage, but rather the squandering of [the pension fund’s investment] through, among other things, negligently overleveraging and failing to pay taxes and service mortgages on the properties.”  The court concluded, therefore, that the insurer did not provide a basis which the court “could conclude that the Conduct Exclusion covers all of the material allegations established in the Underlying Action,” and did not “demonstrate any grounds for allocating the judgment award between portions attributable to [the insurer’s] improper gains and negligent losses.”

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