Post-Assignment: What Happens to D&O Coverage When Your Company Undergoes an ABC?

The ABC Environment and Heightened D&O Risk

An assignment for the benefit of creditors, or an ABC, is the process by which a public or private company that can no longer operate and fulfill its financial obligations hires a third-party firm to manage and liquidate its assets and distribute them to the appropriate creditors.

This state-law, non-judicial alternative is often preferred over a Chapter 7 bankruptcy for publicly listed companies or private ones, as the latter can have costlier legal fees, lengthier processing times, and sometimes garner more attention from the public. Here’s who’s who in the ABC scenario:

• Assignor: The insolvent company seeking to liquidate its assets in the most efficient way.
• Assignee: The fiduciary entity responsible for liquidation, whether by selling, auctioning, or otherwise liquidating the assignor’s assets and distributing them to creditors.
• Creditor: The entities that are owed loans, goods, or services by the assignor.

The Inherent Risks of Fiduciary Duty Shifts and Legal Claims

As it goes, an ABC’s crucial point is in shifting duties from shareholders and board members (equity) to the creditors as the company enters the “zone of insolvency.” This is the point where directors are instantly exposed to claims of mismanagement, improper asset sales, or preferential transfers that benefit one creditor over another, making risk management crucial.

With such claims, this is where things get tricky for broader coverage, making D&O ABC coverage more crucial than ever.

Often, legal action and claims arise from the assignee on behalf of the creditors, disgruntled unsecured creditors, and even the purchaser of assets, in the case of getting caught in the web of misrepresentations. It’s at this stage that insurance coverage must jump to protect and cover the legal fees and defense costs of the insured directors and officers, and their personal assets.

Securing the Mandatory Defense: D&O Tail Coverage

Insurance policies might be the last thing on your mind during an ABC, and insurers understand this more than anyone. This is why, as a precautionary measure, there’s nothing like Tail coverage as part of your insurance program to keep claims, legal costs, and other issues in check, even past the deadline.

The Lifeline for Past Acts

A D&O Tail insurance policy provides coverage for wrongful acts that occurred before the ABC closing date, but were not filed until years later. A six-year Tail is typically the standard due to statutes of limitations, giving you ample time to review the ABC process and the opportunity to make a D&O claim if needed.

However, some considerations are key to avoiding challenges of policy non-renewal and cancellation. For instance, if the policy is not renewed or the Tail that was purchased before the current policy is canceled or lapses, the right to purchase a Tail for liability coverage may be lost.

Critical Tail Policy Features to Negotiate

In preparation for an ABC, it’s also indispensable to know that the assignee must be contractually required and funded to purchase the Tail for the benefit of the former directors, ensuring adequate coverage.

This is where another kind of negotiation takes place to secure the proper insurance policy for your ABC process. These are the three elements to look out for when you sit down with your chosen assignee:

• Dedicated limit: Agree to a dedicated and sufficient Tail limit for the directors of the former entity, without being eroded by the purchasers’ or assignee’s claims against your company, whether sold or merged.
• Retention/Deductible: Ensure the retention is paid by the Assignee or the acquiring entity, not the individual former directors.
• Entity coverage: Does your D&O include Side B or Side C coverage for entities? Often, the directors are concerned with Side A (personal liability coverage), but the assignee may need Entity Coverage for corporate defense costs, so consider this extra shield when negotiating your Tail.

The M&A Theme: Asset Sales and Successor Liability

An ABC might also create risk scenarios similar to those of an M&A. As a company and its officers get acquired or merge with another (or, in the case of an ABC, get liquidated), distressed asset sales take place to square out debt, leaving purchasers with certain liabilities that we must address.

Although these purchases may be advantageous for buyers, they create classic M&A D&O exposures such as successor liability. So, despite there being Tail coverage that protects the seller’s past acts, the acquirer instantly inherits the seller’s risks, which aren’t included in the Tail.

The ABC process is designed to inherently mitigate these associated risks thanks to the due diligence of specialized firms, but sophisticated might still demand assurances, requiring specific D&O representations.

The Go Forward Trap for New Entity Coverage

Here, it’s relevant to stress that a Go Forward Policy, although it might seem like it, wouldn’t do much to benefit the buyer with direct coverage. This policy is generally irrelevant to the assignor’s previous leaders and their directors and officers liability insurance—they typically have an exclusion clause for prior acts—as their governance ends at the assignment date of the ABC. This is why focus must still remain on Tail coverage, rather than other risk-adjacent policies.

A Suitable Liability Coverage Solution

What works for buyers in M&A scenarios is exactly what can be applied to those involved in an ABC. Distressed sales are usually accompanied by Representations and Warranties (R&W) insurance, which gives assignees and assignors a clean liquidation process while protecting purchasers from financial losses with liability coverage.

It’s important to clarify that R&W does not replace D&O in any way. The former insurance covers contractual breaches, such as misstated financials in the deal documents, while the latter covers wrongful acts, such as breach of fiduciary duty. They are complementary, not substitutes.

The Urgency of the Directors and Officers Insurance Exit Strategy

A D&O insurance policy is often the last to be executed in an ABC, and also the most vital for founders, which is why it’s primordial to secure Tail coverage before assets are transferred to the assignee for liquidation.

In planning for an ABC, Tail premiums cannot become an afterthought. Including it in your D&O, especially as a capital-constrained company contemplating an ABC, can profoundly mitigate risks to the personal assets of the directors.

As such, you’re not just protecting yourself and your individual directors, but also vouching for a smoother ABC process, and potentially gaining the trust of purchasers and creditors.

As a founder, we advise you to get your deal team together with an experienced D&O insurance broker who understands officers liability policies, and legal counsel that can help you negotiate and fund the Tail before the assignment closes. As you look for new horizons, do so with peace of mind.

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