Prior Acts Exclusion Bars Coverage for Shareholder Suits Based on Failure to Disclose Related-Party Transactions to SEC

The United States Court of Appeals for the Eighth Circuit, applying Minnesota law, affirmed a trial court’s decision that the prior acts exclusion in a directors and officers liability policy barred coverage for shareholder suits arising out of on an insured’s failure to disclose related-party transactions to the SEC before going public. Tile Shop Holdings, Inc. v. Allied World Nat’l Assurance Co., 2020 WL 7133358 (8th Cir. Dec. 7, 2020). The court concluded that the shareholder suits alleged Wrongful Acts that took place prior to the retroactive date or alleged acts that were the same or related to Wrongful Acts that occurred before that date.

Tile Shop operates a chain of retail tile stores. It went public in 2012. As part of that process, it filed a series of documents with the SEC, including key filings between June and early August 2012. In those filings, Tile Shop did not report that it had obtained millions of dollars in supplies from a Chinese company owned by its founder’s brother-in-law, which was considered a related-party transaction under the SEC’s regulations. After Tile Shop went public, an investment research firm discovered the related-party transactions and published a highly critical report urging investors to sell immediately. As a result, Tile Shop faced shareholder class actions, as well as shareholder derivative suits against the company’s directors and officers.

Tile Shop settled the shareholder lawsuits and sought coverage under its directors and officers insurance program. The company’s losses exceeded the limit of liability under its primary policy. Its excess insurer denied coverage on the ground that the shareholder lawsuits were all based on the same or related Wrongful Acts—the failure to disclose the related-party transactions to the SEC prior to going public—which took place before the policy’s retroactive date of August 20, 2012.  Coverage litigation followed, and the United States District Court for the District of Minnesota granted summary judgment for the insurer. The Eighth Circuit affirmed.

While the excess policy followed form to the primary policy, it also contained its own prior acts exclusion. The primary policy’s exclusion included a relation-back clause on which the excess insurer relied in denying coverage. The relation-back clause provided that “Loss arising out of the same or related Wrongful Acts shall be deemed to arise from first such same or related Wrongful Act.” The excess policy’s prior acts exclusion did not include a relation-back clause. The court rejected Tile Shop’s argument that the excess policy’s exclusion replaced the exclusion in the primary policy and therefore the excess insurer could not rely on the relation-back clause. The court noted that the excess policy followed form to the primary policy “except as therein stated” and nothing in the excess policy stated as much.

Applying the primary policy’s prior acts exclusion, which included the relation-back clause, the appellate court concluded that the shareholder suits all alleged Wrongful Acts by the company that were the “same” or “related to” its failure to disclose the related-party transactions to the SEC. Because the relevant SEC filings were made prior to the retroactive date, the exclusion barred coverage.

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