Insurance Coverage During Mergers & Acquisitions

Insurance Coverage During Mergers & Acquisitions

By David A. Gauntlett*

When considering mergers and acquisitions (“M&A’s”), a company must assess the potential liability it could be taking on. Whether such liability transfers as part of the process is an entire topic of its own, but let’s skip past that and assume that potential liability has developed into a lawsuit. Who’s going to pay for it? Luckily, the answer doesn’t have to be “you.” With the right insurance policy, M&A liability can be an insurer’s problem instead.

Primary M&A Coverage Option – Representations and Warranties Policies

            The ordinary source of M&A coverage is a Representations and Warranties policy purchased by the buyer of the transaction.[1] They protect against losses arising due to the seller’s breach of certain representations in the acquisition agreement. As with any policy, these come with a set of standard exclusions. They preclude coverage for the following:

·         any (i) Breach of which any of the Deal Team Members had actual knowledge prior to Inception or (ii) material inaccuracy in the No Claims Declaration or the Application;

·         any (i) purchase price, net worth or similar adjustment provisions of the Acquisition Agreement or (ii) indemnification provisions set forth in . . . the Acquisition Agreement;

·         any consequential, special, indirect, multiplied . . . , punitive or exemplary damages or criminal or civil fines or penalties . . . ;

·         any injunctive, equitable or other non-monetary relief; [or]

·         any covenant (or breach thereof), estimate, projection or forward looking statement.[2]

An Alternative Coverage Source – D&O Policies

Alternatively, some liability might be covered by a Directors & Officers (“D&O”) policy. Coverage can often be found here because suits seeking restitution commonly arise in connection with litigation that is a consequence of M&A transactions. Such claims are traditionally not covered under Commercial General Liability (“CGL”) policies, but they may fall within the scope of covered “Wrongful Acts” that are a form of restitutionary relief within the scope of coverage provided by a D&O policy.[3]

Relying on pre-existing D&O policies, however, can be problematic if not handled appropriately.  The average D&O policy is a “claims made” policy, meaning the insurance does not cover the company succeeding the policy’s expiration. Any claim filed against the seller following the D&O policy expiration date will result in liability for which the seller is without coverage.

Depending on specific contract details, that liability could transfer to the buyer corporation, which would then be stuck footing the bill for wrongful acts it did not even commit. These policies often contain a “change in control” provision[4] that limits the available coverage for these “Wrongful Acts” if there is a change in company ownership.

While the exact coverage changes vary from one policy to the next, a typical policy will not insure “Wrongful Acts” that occur after the triggering event and will only cover acts and omissions which occurred in the regular course of business (i.e., prior to the change in control). Subsequent claims after a change in control will be uncovered. Notably, the change in control provisions of some D&O policies are even stricter and eliminate all coverage, even for acts and omissions that predate the change in control. 

For that reason, buyers must consider adding the seller’s directors and officers to their own D&O policy. New coverage is required for any future actions of the board of directors following the merger or acquisition completion. 

Does an M&A Deal Create a Gap in D&O Coverage?

D&O insurance policies, working on the aforementioned “claims made” basis, generally only cover claims made while the policy is in effect. As addressed above, if a merger or acquisition triggers a policy’s change in control provision, then any claims based on conduct after the transaction date may not be covered and any claims presented for pre-transaction conduct will only be covered through the end of the policy period (likely a matter of months after the transaction). This creates a potential gap in coverage because the acquiring company’s policy will not respond on behalf the selling company’s directors and officers for pre-transaction conduct. 

How, then, do you cover claims for pre-transaction conduct that are made after the policy expires? The answer is “tail” or “runoff” coverage. This coverage extends the D&O insurance policy for a certain period of time beyond the standard policy period. Essentially, the D&O insurance policy is held open for a certain number of years to address claims that may arise after the deal is closed. Typically, the tail or runoff period is six years.[5]

Accounting for tail or runoff coverage is critical because it safeguards the directors and officers of the selling company in the event the acquiring company refuses to protect them or, in the case of bankruptcy, is not there to protect them. Accordingly, the purchase of a tail or runoff policy should be a critical deal point for the selling company in any negotiation.

Be Wary of a Policy’s “Bump-Up” Clause

After an M&A deal, shareholders of the sold entity frequently file suit alleging they are owed greater compensation for the shares that were purchased. In fact, 82% of M&A deals result in litigation from shareholders just from the transaction itself (with an average of more than 3 lawsuits per deal).[6]  These lawsuits will seek recovery of the difference between the amount received and the purported actual value of the shares.

Such a claim may be barred from coverage by a policy’s “bump-up” clause, which is typically included in the definition of “Loss.”[7] These provisions can vary substantially, but they usually preclude coverage for judgments and settlements stemming from these shareholder-initiated lawsuits. Choosing the right policy, however, can at least secure coverage for the defense costs associated with the lawsuit. Others will even limit the exclusion to claims under specific insuring clauses[8] or claims that would be paid by the insured corporation rather than a director or officer.[9]

Conclusion

The M&A process can be a quagmire of potential liability, and the best possible protection is a dedicated Representations and Warranties policy. Failing that, coverage can still be found for many claims in a D&O policy. If relying on the latter, be sure to closely examine the details related to M&A transactions as they can vary significantly from one policy to the next. Specialized insurance coverage attorneys can help evaluate the level of coverage your policy provides and assist in analyzing whether a Representations and Warranties policy is worth the additional cost.

*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] For a full discussion of Representations and Warranties coverage, see David A. Gauntlett, Expanding Opportunities for Coverage of M&A Transactions in Representation and Warranty Insurance, https://www.gauntlettlaw.com/news/expanding-opportunities-for-coverage-of-mampa-transactions-in-representation-and-warranty-insurance (July 29, 2021).

[2] AIG Mergers & Acquisitions Insurance Group Buyer-Side R&W Template, available at http://www.hedgefundinsurance.com/Publications/AIG%20Reps%20and%20Warranties_Buy%20Side%20policy%20form.pdf.

[3] David A. Gauntlett, Coverage for Restitutionary Relief Based on Disgorgement, https://www.gauntlettlaw.com/news/coverage-for-restitutionary-relief-based-on-disgorgement (Feb. 24, 2022).

[4] “If, during the Policy Period: 1. the Named Insured merges into, or consolidates with, another entity such that the Named Insured is not the surviving entity; or 2. another entity, person, or affiliated group of entities or persons acting in concert, acquires more than 50% of the outstanding securities or voting rights . . . , then coverage under this Policy will continue until termination of this Policy, but only with respect to Claims for Wrongful Acts . . . occurring before such event.” Travelers Directors, Officers, and Organization Liability Coverage, available at https://www.travelers.com/iw-documents/apps-forms/directors-officers/pcdo-16001.pdf.

[5] See, e.g., Travelers Directors, Officers, and Organization Liability Coverage, available at https://www.travelers.com/iw-documents/apps-forms/directors-officers/pcdo-16001.pdf.

[6] Cornerstone Research, Shareholder Litigation Involving Acquisitions of Public Companies, https://www.cornerstone.com/wp-content/uploads/2021/12/Shareholder-Litigation-Involving-Acquisitions-of-Public-Companies-2018.pdf.

[7] See, e.g., Travelers Directors, Officers, and Organization Liability Coverage, available at https://www.travelers.com/iw-documents/apps-forms/directors-officers/pcdo-16001.pdf (denying coverage for “any amount of damages, judgments, or settlements that represents, or is substantially equivalent to, an increase in the price or consideration paid, or proposed to be paid, for: (i) an actual or attempted acquisition of all, or substantially all, of the ownership interest in, or assets of, an entity; or (ii) merger with any entity”).

[8] See, e.g., Genzyme Corp. v. Federal Ins. Co., 622 F.3d 62, 72 (1st Cir. (Mass.) 2010) (“bump-up” provision applied only to Insurance Clause 3).

[9] See, e.g., Arch Ins. Co. v. Murdock, No. N16C-01-104 EMD CCLD, 2019 Del. Super. LEXIS 227, *5–6 (Super. Ct. May 7, 2019) (definition of Loss did not include “any amount representing the increase in the consideration paid (or proposed to be paid) by the Policyholder in connection with its purchase of any securities or assets”).