Court Holds Prior Acts Exclusion Bars Coverage for Securities Lawsuit

In a win for Wiley Rein’s client, the United States District Court for the Central District of California has held that a prior acts exclusion in a management liability policy bars coverage for a securities lawsuit brought by shareholders alleging misrepresentations before the prior acts date and continuing after the prior acts date.  Jayhawk Private Equity Fund II LP v. Liberty Ins. Underwriters, Inc., No. 17-cv-5523 (C.D. Cal. June 7, 2018).

The insured, a post-secondary education and e-services learning provider in China, was sued by shareholders alleging that it issued false statements and assurances to investors regarding its financial health and internal controls from February 14, 2011 to April 2, 2012.  In reality, the insured’s CEO and other officers were embezzling millions of dollars and transferring the insured’s assets to themselves and their affiliates.

The insured tendered the lawsuit for coverage under two successive management liability policies.  The first policy contained a “run-off” endorsement that extended the policy period but precluded coverage for any claim “based upon, arising from or in any way related to any Wrongful Act committed or allegedly committed on or after December 1, 2011.”  The second policy contained a prior acts exclusion, barring coverage for claims “based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any act, error, [or] omission . . . committed or allegedly committed prior to December 1, 2011 [the inception date of the policy].”  Both insurers denied coverage for the securities lawsuit, and a default judgment was entered against the insured for $65.8 million.  The securities class sued the insurers seeking coverage for the default judgment.

The court held that the run-off endorsement—barring coverage for wrongful acts after December 1, 2011—and the prior acts exclusion—barring coverage for wrongful acts before December 1, 2011—applied to the securities action because it alleged misrepresentations both before and after December 1, 2011.  The court held that the exclusion in the run-off endorsement of the first policy applied because the securities action alleged misrepresentations after December 1, 2011.  It held that the prior acts exclusion barred coverage for the securities action because the post-December 1, 2011 misrepresentations arose out of misconduct and misrepresentations made before December 1, 2011.

The securities class argued that the policies were negotiated by the insured’s brokers to facilitate the insured’s transfer of risk, and the policies were required to be “jointly construed” to cover the securities action.  The court rejected the argument that the two policies should be interpreted together to effectuate the insured’s “reasonable expectation,” finding at a minimum that no facts in the complaint alleged “any sort of coordinated negotiation” of the two policies.  In addition, the plaintiffs offered no support for the legal proposition that two separate policies from different insurers should be construed jointly.  Finally, the court noted that reliance on the terms of one policy to interpret a separate policy would be extrinsic evidence that cannot be used when policy language is unambiguous.  And, it reasoned that the class failed to identify any ambiguity in the policies’ language or provide any other reasonable construction of the plain language.  Rather, the plaintiffs “merely insist[ed] that [the policies] cannot possibly mean what [they] plainly say[] because it would mean no coverage” for the securities action.

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