There are a multitude of issues and terms to address when companies merge or when one company acquires another. One aspect of the deal that is often overlooked is insurance. Specifically, directors and officers liability insurance, also known as D&O insurance, is an essential part of any merger or acquisition and must be carefully considered in order to avoid significant liability down the road. Companies should not overlook the option of representations and warranties coverage when planning a merger or sale.
This is especially true in the current climate. Merger and acquisition activity since the latter half of 2020 has seen unprecedented growth. Some bankers have said that the M&A market has gone into “overdrive” and the number of mergers and acquisitions is “far beyond the historical norm.” With this increased M&A activity, litigation resulting from the transaction – including shareholder lawsuits – is inevitable. According to Cornerstone Research, 82% of the significant deals announced in 2017 and 2018 were challenged by shareholders, resulting in roughly three lawsuits filed per challenged deal.
Suffice it to say, the risk and exposure in a merger or acquisition is high, for the companies involved but also individual executives. This article addresses some of the key insurance issues that decision makers should keep in mind to mitigate that risk and maximize coverage.
D&O liability insurance is meant to protect directors and officers if they are named as individual defendants in lawsuits for acts taken in their roles as such. D&O insurance protects the insureds in the event of suits by plaintiffs such as employees, shareholders, competitors, investors, and customers. Some D&O policies also provide coverage for the company.
D&O policies usually provide coverage for legal fees incurred as well as amounts paid by the insureds in judgments or settlement disbursements. If the directors and officers are entitled to indemnification from the company by way of company bylaws or their employment contracts, that indemnity obligation is typically backed financially by a D&O policy.
Change in Control Provisions
D&O insurance policies typically insure against certain “Wrongful Acts” as defined by the policy that the company or other insureds allegedly commit. These policies often contain a “change in control” provision that limits the available coverage for these “Wrongful Acts” if there is a change in company ownership. Before any merger or acquisition, it is crucial to review and understand any change in control provisions and corresponding notice requirements to keep the intended insurance in place, uninterrupted, or secure new coverage.
Change in control provisions are generally triggered upon the happening of a named event (i.e., mergers, acquisitions, or change in voting control). When that triggering event occurs, coverage under the policy changes. While the change in coverage will depend on the specific policy language, the provisions typically provide that the policy will not insure “Wrongful Acts” that occur after the triggering event and will only cover acts that occurred prior to the change in control. That is, the policy will cover acts and omissions which occurred in the regular course of business, but not those after a change in control when circumstances (e.g. management, business goals, or other essential characteristics of the insured) have been altered. When the triggering event occurs and the coverage terminates, the policy is placed into run-off (discussed below). Note that the change in control provisions in some D&O policies are even stricter and eliminate all coverage, even for acts and omissions that predate the change in control.
Questions of change in control are highly fact-specific and are determined by the policy language, deal specifics, and the governing law. Therefore, it is important to understand these nuances before any deal, especially because once the provision is triggered, it can create unintended gaps or even eliminate all D&O coverage.
A change in control provision can also include notice conditions that require the insured to provide notice to the insurer within a specific time frame (either in advance of a deal or after its completion) to preserve coverage for the new entity. Like all notice requirements in an insurance policy, it is imperative that an insured not overlook these notice requirements, or the company risks losing coverage.