District Court Lets Insurer off the Hook from Defending FCA Suit

By on December 8, 2016
Posted In Uncategorized

On November 15, the US District Court for the Northern District of California granted Scottsdale Insurance Company’s motion for judgment on the pleadings in Hotchalk, Inc. v. Scottsdale Insurance Co. (Case No. 4:16-CV-03883), ruling that Scottsdale is not required to defend or indemnify Hotchalk from a 2014 False Claims Act (FCA) suit (and subsequent settlement). Hotchalk, an education technology company, was a Scottsdale policyholder and sought coverage related to a qui tam suit that alleged improper employee incentives for student recruitment. The court ultimately found that the underlying allegations related directly to the company’s professional services, and thus were barred from coverage based on a professional services exclusion in Hotchalk’s policy.

Hotchalk provides promotional and administrative services, including recruitment, for universities’ online degree programs. In April 2014, former Hotchalk employees brought a FCA suit against the company and several of its university clients, alleging that Hotchalk falsely certified compliance with Title IV of the Higher Education Act of 1965. The Higher Education Act prohibits certain universities and downstream entities (including Hotchalk) from paying employees commissions, bonuses, or other incentive compensation based directly or indirectly on student recruitment. The United States did not formally intervene in the case, but reached a settlement with Hotchalk on behalf of itself and the relators.

Hotchalk requested a defense from Scottsdale under its directors and officers (D&O) policy, but the insurer denied coverage. Scottsdale took the position that the underlying FCA suit “arose out of” Hotchalk’s professional services and thus was properly excluded from coverage under the D&O policy’s professional services exclusion. Scottsdale continued to maintain this position in the action at hand, further arguing that the exclusion was consistent with the industry standard for D&O insurance and that coverage for risks related to professional services typically would be provided under a separate “professional errors and omissions” policy. Conversely, Hotchalk argued that the underlying FCA suit related strictly to its employee compensation system, an internal business mechanism that was wholly unrelated to its professional services.

While Hotchalk’s D&O policy does not define “professional services,” the court found Hotchalk’s characterization “unavailing,” and agreed with Scottsdale that the exclusion precluded the coverage sought by Hotchalk. The court reasoned that “Hotchalk’s allegedly incentive-based compensation scheme could only have been improper because of the professional services that Hotchalk provided,” as the incentive compensation ban in the Higher Education Act was only applicable to Hotchalk as a result of its professional activities for universities. The court went on to examine a similar 2015 case in which a California district court interpreted the same exclusion provision in a Scottsdale business and management indemnity insurance policy under state law, reasoning that the “causal link between the excluded activity and the actions underlying the lawsuit is even tighter” in Hotchalk’s case based on the professional services Hotchalk provided, the basis of the underlying FCA case, and the named plaintiffs in the underlying case.

Insurance coverage for FCA defendants is an evolving area of law, and is subject to differing interpretations by the courts. As this case demonstrates, any company that faces a realistic possibility of becoming a subject of an FCA investigation or lawsuit should evaluate whether its existing insurance policies provide any coverage, and if so, to what extent.

Chelsea M. Rutherford
Chelsea M. Rutherford focuses her practice on corporate, transactional and regulatory matters affecting a wide range of clients in the health care and life sciences industries. Read Chelsea M. Rutherford's full bio.