Recent D&O survey results continue to confirm that D&O claims susceptibility and frequency materially increase if a company is involved in an M&A transaction. Although directors and, to a lesser extent, officers of the target company are the most likely defendants in such litigation, the D&Os of the acquiring company may also be sued under certain circumstances. The following summarizes issues to consider in the capacity of the acquiring or target company.
The principle D&O insurance issue for acquiring companies is the extent to which the insurer is entitled to receive notice and to underwrite the acquisition mid-term. Preferably, the D&O policy should provide for automatic coverage to newly acquired subsidiaries unless the acquired subsidiary exceeds a large reporting threshold (e.g. 25% of the parent company's assets). If the reporting threshold is exceeded, policies vary as to whether the insurer is entitled to charge an additional premium only or to also impose additional terms and conditions to the policy mid-term. In any event, coverage for the newly acquired subsidiary typically applies only with respect to wrongful acts taking place after the date of acquisition.
Because the D&Os of the target company may be replaced or removed following the acquisition, they should purchase prior to the acquisition a pre-paid, non-cancelable extended run-off insurance policy which cannot be amended or affected in any way by the acquiring company or subsequent management. In light of applicable statute of limitations in various jurisdictions, the term for this run-off policy often is six years. To assure the availability of this coverage, some D&O policies provide that in the event the parent company is acquired, the insurer is obligated to afford at least three years of run-off coverage or at least issue a quotation for an extended run-off policy. Another option is to waive the "change in control" provision contained in almost all D&O contracts so that the policy will continue in force post transaction with full prior acts coverage. This option is sometimes difficult to accomplish with insurers and is less desirable in most circumstances due to the sharing of limits for "oldco" and "newco" and the potential dilution of limits associated with a pre-close act reported post-close.
When structuring a run-off policy, the following issues should be considered:
- Is corporate reimbursement coverage desired? If so, who is the insured organization? For example, if the target company is merged into the acquiring company, does the acquiring company become the new insured organization under the run-off policy?
- If the acquiring company or the surviving company sues the prior D&Os for mismanagement, will the insured v. insured exclusion in the run-off policy eliminate coverage? Should claims by the acquiring company and/or the surviving company be excepted from this exclusion?
- Should a presumptive indemnification provision exist in the run-off policy? If the surviving company is permitted but refuses to indemnify the insured D&Os, will the D&Os be required to personally fund the large corporate reimbursement deductible pursuant to the presumptive indemnification clause?
- How does the run-off policy respond to a claim for a continuous wrongful act which commences prior to the acquisition and continues after the acquisition? Although the run-off policy generally does not cover claims for wrongful acts after the acquisition, should coverage exist for inter-related wrongful acts which begin before and end after the date of acquisition? How does the surviving company's ongoing policy respond to such interrelated wrongful acts? If the run-off policy and the continuing policy for the surviving company are issued by different insurers, will the two insurers each try to deny coverage? If the policies are issued by the same insurer, does that insurer have concerns about stacking of both policies' limits of liability?
- Should any securities or employment practices entity coverage which may exist in the target company's D&O policy be deleted from the run-off policy in order to avoid unnecessary dilution of the run-off limit of liability?
- Will the run-off policy have a new limit of liability or an extension of the existing limit under the target company's policy?
If the target company is a subsidiary being divested by the parent company, additional complications arise since the run-off coverage should be independent from and unaffected by acts of both the selling parent company and the acquiring company. A claim for pre-acquisition wrongdoing may implicate both the run-off policy and the policy issued to the selling parent company. If the same insurer issued both policies, stacking of limits issues will exist; if different insurers issued the policies, fighting between the insurers regarding their respective obligations should be expected. At a minimum, difficult allocation issues between the respective policies are likely. Companies are encouraged to analyze and negotiate with their D&O insurer at least some of these issues before the M&A transaction arises. Because a crisis management atmosphere may develop once an acquisition is announced, waiting until that time before any of these issues are considered further increases that crisis atmosphere and potentially jeopardizes the quality and availability of an appropriate risk management response to the transaction.
