The A-B-Cs of E&O insurance.

In addition to discussing some basic features of professional liability policies generally, this article will focus on professional liability policies tailored to club management companies.

What is E&O Insurance?

Professional liability insurance, also called errors and omissions ("E&O") insurance, is a type of coverage essential to every professional and professional services company. Professional liability insurance covers wrongful acts in rendering or failing to render professional services. Such coverage is of vital importance in today's litigious business climate since defending and resolving a lawsuit is a costly and typically unbudgeted expense for many businesses. It is also worth noting that a company doesn't have to do anything wrong to be sued. In fact, a large proportion of lawsuits are meritless. Nonetheless, lawsuits must be defended, and that can be costly.

There are no standard E&O policy wordings since professional liability policies are specifically tailored for different professionals. An E&O policy issued to a law firm may differ significantly from an E&O policy issued to an accounting firm. There is no "one size fits all" E&O policy. The following is only a general guide to professional liability insurance. When a club management company obtains its E&O policy, it should carefully review the terms and conditions specific to the particular policy.

Who is an "Insured" Under E&O Policies?

The "insured" under a professional liability policy typically includes a professional business entity such as a law firm, an architectural firm, or a medical practice group, as well as the individuals who provide professional services on behalf of that entity. The "Named Insured" usually refers to the entity itself, i.e., a club management company. Professional liability policies often provide coverage for subsidiaries of the Named Insured as well, either by definition within the policy or by endorsement. A "Subsidiary" is commonly defined as an entity in which the Named Insured owns more than a 50 percent interest at the time of the alleged wrongful act, error, or omission.

The entity's principals, partners, officers, directors, and employees are also considered insureds under the policy, but only while acting in their capacities as such. The term "employees" may or may not include temporary or seasonal employees and independent contractors, depending on the bargained for terms of the specific policy.

Types of E&O Policies

The most common type of professional liability insurance is the claims-made policy. This type of policy affords coverage for claims that are first made against the insured during the policy period, regardless of when the malpractice occurred. A "claim" is commonly defined as a written demand for damages or the filing of a complaint against the insured. Depending upon the terms of the policy, a claim is considered first made at either the date the claim was issued or filed, e.g., the filing of a lawsuit with the court, or the date the insured first receives notice of the claim, e.g., the date the insured was served with the summons and complaint. Thus, if an architect maintained a claims-made policy from 1995 to 2005, and a malpractice claim was filed against him in 2006 for professional services rendered in 2003, no coverage would be triggered because the claim was not first made during the policy period.

When a business entity completes an application for E&O insurance, disclosure must be made to the insurer of any and all claims or potential claims that have been made prior to the new policy's inception. The insured must also disclose facts or circumstances that might reasonably give rise to a future claim. Such facts and circumstances, as well as prior claims, will likely be excluded from coverage under the new policy. These disclosures may also affect the amount of premiums that may be charged.

Duty to Defend

Most professional liability policies contain a duty to defend clause, which provides that if any covered claim is made against the insured, the insurer has the right and duty to defend the claim. Upon proper and timely notice of a claim, the insurer will retain a lawyer to defend the insured's interests in the litigation or proceeding. Some E&O policies provide that an insured may select its own counsel but most policies do not include a choice-of-counsel provision and the insurer will simply appoint one for the insured. Thus, under a duty to defend policy the insurer effectively funds and controls the defense.

The duty to defend is broader than the duty to indemnify. Depending upon the policy terms, the insurer may have a duty to defend the entire claim, even if it includes non-covered allegations against the insured. For example, if a complaint asserted against the insured includes counts for negligence and fraud, and the subject policy has a fraud exclusion, the insurer may have a duty to defend the entire claim. The insurer is not obligated to indemnify the insured for a settlement, verdict, or judgment based upon any such non-covered allegations, only to provide a defense for such claims.

Common Insuring Agreements and Examples of Covered Claims

Under the more common claims-made policy, a typical insuring agreement in a professional liability insurance policy provides:

"We will pay on behalf of the insured all sums which the insured becomes legally obligated to pay as damages as a result of a Claim first made against an insured and reported during the Policy Period for any act, error, or omission in professional services rendered or that should have been rendered by the insured."

Different policies will define the term "professional services" differently, depending upon the type of business involved, the professional services provided by the insured, and the insurer's drafting preferences. An E&O policy issued to a club management company might define professional services to include those services performed for others for a fee, or pursuant to a management contract. Services provided under a club management contract can include a myriad of tasks such as financial management and accounting services, human resources management services, food and beverage management services, marketing services, operations management services, communications and information technology management services, real property management services, and construction/capital improvement management services.

The type of claim that management companies often face is a dispute over the quality of performance under the management contract. This type of claim can arise when there is a dispute over the right to terminate a contract, the amount of compensation owed under a contract, or general allegations of failure to perform and breach of duty to the management company client. The typical claimant against a management company is the property owner, and a claim may take the form of a letter demanding monetary relief, institution of an arbitration proceeding, or commencement of a formal litigation against the management company and/or individuals acting on its behalf.

Examples of claims that would likely be covered under an E&O policy issued to a club management company include the following:

(1) a claim brought by a club owner against a club management company for failure to effectively market the club, maintain the club property, or account for club earnings and tax liabilities (generally, disputes among owners and management companies can deteriorate into protracted litigation or arbitration);

(2) a claim brought by a club owner seeking the right to terminate the management contract including payment of damages due to mismanagement (in the Massachusetts case of Bernard v. Hemisphere Hotel Management the owner was awarded $500,000 in damages for mismanagement by an arbitration panel);

(3) a claim seeking to enforce a deviation in the written club management agreement that has been observed in practice between the owner and the club management company, such as payment of commissions, payment of earnings percentages, and the like;

(4) a claim arising out of the sale of the property and renewal of the club management agreement with a new owner; disputes can arise between the owners that embroil the management company;

(5) a claim regarding mishandling of confidential computerized information.

In short, the E&O policy is designed to protect the club management company from its clients, namely the club owners, for failure to properly and effectively manage the club business and property. Enhancements may be obtained from particular insurers to include coverage for claims brought by third parties for those acts taken in performance of the management contract that may allegedly harm third parties, such as claims for unfair business practices or unfair marketing claims. Such coverage for claims by third parties is generally excluded from a traditional club management E&O policy, but could be explored with insurers depending on the type of activity engaged in by the insured.

Common Exclusions and Examples of Non-Covered Claims

As with all insurance policies, certain acts may be specifically precluded from coverage by the policy's exclusions. The most common exclusions found in E&O policies apply to bar coverage for:

* Claims based upon criminal, dishonest, or fraudulent acts;

* Claims based upon bodily injury or other personal injury;

* Claims for destruction of property;

* Employment practices claims such as claims for wrongful discharge, sexual harassment, or discrimination brought by employees;

* Third party discrimination claims brought by non-employees;

* Claims involving violation of ERISA laws;

* Claims involving violation of securities laws;

* Claims based upon the discharge, release, test for, or clean up of pollutants;

* Claims based exclusively on indemnification contracts entered into by an Insured;

* Claims brought by an insured, i.e., a general partner.

Examples of claims that would likely be excluded under an E&O policy issued to a club management company include the following:

(1) a claim brought by a club member or an applicant for club membership alleging that he or she was treated differently or denied membership by the insured on account of his or her race, gender, or national origin (exclusion for third party discrimination claims);

(2) a claim brought by a club member for bodily injury stemming from his or her use of the club's facilities or equipment (exclusion for bodily injury);

(3) a claim brought by an employee of the club alleging sexual harassment by her supervisor and wrongful discharge in retaliation for making complaints of harassment to club management (exclusion for employment practices);

(4) a claim brought by a club member or employee for the club's alleged failure to adequately test for or treat the growth of mold spores in club's facilities (pollution exclusion).

Damages Excluded From Coverage

Various damage awards or judgments may be explicitly or implicitly excluded from coverage under the policy. For example, an insurer is only obligated to indemnify the insured up to the per claim and aggregate limits of liability contained in the policy. Settlements, verdicts, or judgments that exceed the limits are not covered.

Typically, professional liability policies exclude coverage for penalties imposed upon the insured for intentional misconduct, such as punitive damages. In fact, most states preclude by statute insurance coverage for punitive damages, thereby making such damages uninsurable. Since the imposition of punitive damages is intended to punish the wrongdoer and deter others from committing similar acts, and insuring against such damages would defeat these purposes, most states proscribe insurance coverage for directly-assessed punitive damage awards. State regulations aside, some professional liability policies exclude coverage for punitive damages, fines, and statutory penalties.

Conclusion

Professional liability insurance is essentially business risk insurance for those entities and individuals performing professional services. E&O coverage is triggered by mistakes, actual or alleged, the insured makes in the course of conducting its business. Some risks, such as claims for bodily injury, property damage, or employment-related claims, are covered by other types of liability insurance, but errors and omissions in the performance of professional services are typically excluded by those other types of policies.

Editor's Note: As this issue was going to press, CMAA announced that it is now offering Directors' & Officers' (D&O) Liability Insurance in partnership with Hays Companies of D.C. Though D&O coverage is often described in relation to Errors & Omissions (E&O) insurance, the two are not entirely synonomous and each deserves its own separate discussion. As such, this article deals exclusively with the subject of E&O insurance.

C. Richard Clark is managing director for real estate & hospitality risk management services of Arthur J. Gallagher & Company. He can be reached at 713-358-5930 or Rich_Clark@ajg. com. Gina Hogue is an associate attorney at Kaufman Borgeest & Ryan LLP. She may be reached at 212-980-9600, ext. 360 or [e-mail]. This information provided is general and educational and not legal advice. For additional information go to http://www. HospitalityLawyer.com.