What Happens to a D&O Policy in a Merger or Acquisition?

Mergers & Acquisitions

There is certainly a lot of M&A activity happening in all types of industries and professions these days.  For some firms, merging or being acquired, or being the acquirer is a growth strategy – to get to the next level, for some it’s a survival strategy – with margins squeezed, consolidation helps preserve a livelihood.   One issue that needs to be addressed during M&A activity is your D&O policy.  Yes, most of your other insurance policies need to be addressed as well, but the focus here will be on D&O and Management Liability in general.

Most all management liability policies have a provision that addresses a merger, acquisition or sale of a business.   The transaction clause in the policy effectively terminates coverage as of the transaction date, and the policy is “put into run-off”.  This is critically important to understand.

When the transaction is signed, the selling party or the party (ies) willing to be merged into an existing or new entity, will have their D&O policy terminated.  The premium for the policy in most cases is considered to be fully earned (meaning there is no refund for the “unused” portion of the policy).  Most importantly and the focus of this article is that the insured needs to make an election as to what to do with extending the policy’s reporting period.

As a claims-made policy, there is a thorny issue to deal with at termination and that is what to do with the potential for claims which may be presented to the insured after the policy terminates?  If the insured does not elect to purchase an extended reporting period (commonly called a “tail”) than any future claims presented to the insured or their successor company for acts that occurred prior to the termination date will not be covered.

As a footnote, in some policies and amended by some states, there are short automatic extensions already built into the policy for 30, 60, or 90 days, which are very insufficient to protect the insured from long tailed claim reportings.

As mentioned, this is a potential liability for the seller and for the buyer, so the purchase and sale agreement need to address this issue and coverage extended appropriately.  The common approach is to agree that the seller will purchase at the transaction an extended reporting period of at least three years (some deals push that out to 6 years).  The cost of that extension can be 150% to 300% of the terminated policy’s annual premium, depending on the duration of the tail and the insurer.  Many D&O policies will contain what the charges are for the extended reporting period, but if you’re unsure it is best to contact your broker.  Who bears the cost of that extension?  Often that will be wrapped into the deal terms with the buyer assuming the cost as part of the transaction.

While we’ve talked about D&O, this same conversation applies to most all management and professional policies – Employment Practice Liability, Fiduciary Liability, Errors & Omissions, Cyber, etc. are all forms written on claims made and should be addressed for run-off coverage.

For firms actively involved in buying and selling companies such as private equity, venture capital or investment banking the transaction clause or change in control provisions are well known, planned and thought out prior to a deal happening.  Where we see this as problematic is when a privately held firm does one or two transactions during their lifecycle and the advisors to the transaction are not well informed to these particulars.  That’s why getting your insurance broker involved in discussions early on in negotiations can be important.  If necessary, have non-disclosure agreements at the ready to protect the confidentiality of your deal terms, but getting professional guidance is critical to make sure you’re not left with uninsured exposures following the close of your transaction.

For more information on D&O, or insurance transactions through the merger and acquisition process, please contact me for a conversation!

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