Directors’ & Officers’, Employment Practices and Fiduciary Liability policies are written on a “claims made” basis. This means that a claim is only covered if it is made and reported during the policy period. Generally, a prior acts exclusion is placed on a go forward policy after an acquisition. The exclusion will carve out any claims that occurred prior to the transaction date. However, the Private Equity firm should address this potential gap in coverage by either confirming a run off policy has been purchased for the old company or the go forward policy does not include a prior acts exclusion.

The most common option for the go forward company to provide coverage for past acts is to require the old company to purchase a run off policy for the current in force Executive Liability program in place (if one exists). A run off (tail) policy allows the previous owners to report claims that occurred prior to the transaction but are made and reported post acquisition. Usually a carrier will offer 1 year, 3 year and 6 year tail options. We recommend a six year tail to ensure that the majority of unknown claims will have surpassed the statute of limitations when the run off policy expires. Although the tail policy is often negotiated and purchased by the seller, it is important that the buyer have knowledge of the policy forms. This enables the buyer to work with the seller to report claims that may have occurred before the transaction.

The seller of a company may elect not to purchase a run off policy for various reasons. They may not have purchased executive liability coverage in the past or they feel that the cost of the tail policy is too high. The new owner may feel that this seller decision not to buy run off only leaves a gap in the previous owner’s coverage. However, there are unforeseen past circumstances that could have implications for the future company. For example, a wrongful act that first occurred prior to the transaction date may continue post acquisition. If the claim is made and reported on the go forward policy, naming individuals of the past and present company, it may be denied by the carrier. The insurer will imply, since the claim first occurred before the prior acts exclusion on the policy, that there is no coverage.

Moreover, in many Private Equity transactions, the management team of the old company remains in tact. If this is the case, how does the new company address a claim brought against the old entity and management team, if a run off policy or prior acts coverage is not in place? Who pays for the litigation? Will the new company deny the old management team indemnification? Do you want key personnel tied up in litigation as opposed to focusing on the core business?

Furthermore, the new company may be susceptible to “successor liability”. Even in an asset purchase, the successor may be found liable for a seller’s past liabilities. If the operations of the go forward company closely resemble the operations of the selling company, the successor may be found liable for past acts even though they did not assume any of the past liabilities. A well written purchase agreement may provide the buyer some “indemnification” by the seller for certain past acts but cannot address every situation.

The cost of purchasing a run-off policy or prior acts coverage on the go forward policy is minimal compared to the legal cost to determine who is liable. Equity Risk Partners recommends considering the following steps when purchasing a go forward Executive Liability program to ensure that potential coverage gaps are being addressed:

1. Confirm that the seller currently purchases an Executive Liability program. Have your broker review the policy to ensure that the appropriate coverage and limits are in place.
   
   
2. Ensure that the seller will purchase a six year run off policy and also allow you to keep a copy. It would be ideal if the seller would name the buyer on the tail policy as an insured in regards to “wrongful acts that the buyer may agree to indemnify the seller.” When possible, it makes sense to have the carrier that is on the run off policy be the same insurer that writes the go forward coverage. If the tail and go forward policies have identical carriers then it becomes an internal insurance company decision to what policy will pick up a “grey area” claim
   
   
3. If the seller is not going to purchase a run off policy or they never purchased Executive Liability coverage then we recommend the following options:
   
   A. Purchase a go forward policy with “full prior acts” coverage.
   
   B. Have your broker obtain quotes for a run off policy.